Earnings Call Transcript - WFG Q1 2024

Operator, Operator

Good morning, ladies and gentlemen. Welcome to West Fraser Q1 2024 Results Conference Call. Please note that all lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. During this conference call, West Fraser's representatives will be making certain statements about West Fraser's future financial and operational performance, business outlook and capital plans. These statements may constitute forward-looking information or forward-looking statements within the meaning of Canadian and United States securities laws. Such statements involve certain risks, uncertainties and assumptions, which may cause West Fraser's actual or future results and performance to be materially different from those expressed or implied in these statements. Additional information about these risk factors and assumptions is included both in the companion webcast presentation and in our 2023 annual MD&A and annual information form, which can be accessed in West Fraser's website or through SEDAR+ for Canadian investors and EDGAR for United States Investors. Please note that today's call is being recorded. I would now like to turn the call over to Mr. Sean McLaren, President and Chief Executive Officer. Please go ahead.

Sean McLaren, President and CEO

Thank you, Lara. Good morning, everyone, and thank you for joining our first quarter 2024 earnings call. I am Sean McLaren, President and CEO of West Fraser. And joining me today in our Quesnel office on the day of our Annual General Meeting are Chris Virostek, our Senior Vice President and Chief Financial Officer; Matt Tobin, our Senior Vice President of Sales and Marketing; and other members of our leadership team. As just mentioned, later today, we will be holding our AGM where, among other things, we plan to discuss our progress with sustainability initiatives, some of the broader challenges that the North American lumber industry continues to face, adding meaningful supply, our recent track record, allocating capital, including capital returns through buybacks and dividends, and the attractive long-term total returns realized by West Fraser stockholders. On the earnings call this morning, I will begin with a brief overview of West Fraser's Q1 2024 financial results and then pass the call to Chris for additional comments before I share some thoughts on our outlook and offer concluding remarks. West Fraser generated $200 million of adjusted EBITDA in the first quarter of 2024, representing a 12% margin. We experienced mixed results across our business again in Q1 with strength in our North American Engineered Wood Products segment, as well as SPF lumber markets, partially offset by continued soft demand for SYP lumber products and in our European business. While new home construction in the U.S. remained resilient through the quarter, supporting demand for OSB and, to a large extent, SPF lumber, continued elevated mortgage rates appear to be constraining existing home sales activity and tempering repair and remodeling spending, which had a greater impact on SYP lumber demand. On a trailing four-quarter basis, adjusted EBITDA was $703 million, up from the $561 million we reported for fiscal 2023. On a pro forma basis, with the inclusion of Norbord, this level of trailing four-quarter adjusted EBITDA is approximately $460 million higher than that of the down cycle in 2019, reflecting synergies from the Norbord transaction, the benefits of our capital investment program, as well as the acquisitions and strategic initiatives we've undertaken in recent years. Finally, our resilient balance sheet and $1.8 billion of total liquidity at quarter-end remained strong, offering financial flexibility to support our capital allocation strategy. With that overview, I'll now turn the call to Chris for additional detail and comments.

Chris Virostek, Senior Vice President and CFO

Thank you, Sean, and good morning, everyone. A reminder that we report in U.S. dollars and all my references are to U.S. dollar amounts unless otherwise indicated. The Lumber segment posted $10 million of adjusted EBITDA in the first quarter, improving from negative $51 million in the fourth quarter. Our North American EWP segment generated $188 million of adjusted EBITDA in the first quarter, up from $143 million in the fourth quarter. The Pulp & Paper segment generated $3 million of adjusted EBITDA in the first quarter, similar to the $2 million reported in the fourth quarter, while in Europe, adjusted EBITDA was a negative $1 million in the first quarter versus $3 million in the fourth quarter. Higher prices were the largest driver for the sequential EBITDA increase across our North American lumber and engineered wood products businesses, while increased shipments of SPF products also contributed meaningfully to the sequential improvement. Further, our lumber business benefited from the actions we took in January to curtail production at two higher-cost mills. In effect, we replaced that volume with production from other lower-cost mills. Cash flow from operations was negative $41 million in the first quarter, with our cash balance net of debt still at a healthy $174 million versus $361 million last quarter. The relative decrease in our cash balance reflects a combination of the typical seasonal build in working capital, $122 million of capital expenditures, plus the approximate $31 million of cash deployed towards share buybacks and dividends. With that brief financial overview, I will pass the call back to Sean.

Sean McLaren, President and CEO

Thank you, Chris. We are proud of the company we have built with the geographic and product diversification that has allowed us to weather what has been a period of challenging markets, particularly in our lumber business. As seen in the right side figure on Slide 6, our North American EWP segment has generated nearly $750 million of adjusted EBITDA over the last four quarters, which has been a period of tougher cyclical conditions for our other segments. It is this diversity in our wood building products offering that has allowed us to generate more than $700 million of adjusted EBITDA on a consolidated basis over the last four quarters, representing a meaningful improvement from the down cycle of 2019. As an update to our ongoing portfolio optimization strategy, we recently completed two important transactions, namely the disposition of our Hinton pulp mill in February and more recently, the disposition of our two BCTMP mills, which we disclosed earlier this week. We also announced in April the dissolution of our 50-50 joint venture at Cariboo Pulp & Paper where we are now the sole owner and operator of the mill, which better positions us to support the mill's needs as well as its talented workforce. On balance, we believe the sale of the three pulp mills, along with many other recent adjustments to high-grade our mill portfolio, will allow us to reduce the variability of our earnings stream while also improving a higher EBITDA floor through the cycle. Shifting to our outlook and concluding remarks, we expect to continue to face a number of market uncertainties over the near term. Having said that, we remain encouraged that inflation expectation and mortgage rates in the U.S. are below the highs of last year. Inflationary cost pressures have largely stabilized across much of our supply chain and we do not expect to see any meaningful upward cost pressures over the near term. Further, constraints to new supply are very real, particularly for the North American lumber industry, where net new supply growth has been essentially nil over the last several years despite a number of strong up cycles. Of modest concern, as we suggested on our Q4 2023 earnings call in February, unusually warm weather in Western Canada hampered our winter logging activities, limiting the accumulation of log inventories at some of our mills, which required us to take downtime at select SPF mills in the first quarter. The impact of weather on our log decks remains a risk factor to our near-term ability to manufacture and ship SPF lumber in Western Canada, and we continue to monitor the situation closely. For our lumber operations in the U.S. South, persistently weak market conditions are a challenge and have increased the downside risk to our near-term production and shipments of SYP in the region. In conclusion, while demand markets remain mixed early in 2024 and there are near-term challenges across our business, we continue to be pleased with how our teams are performing all across West Fraser. We remain confident that we have the right people, processes, and foundation to execute on challenges and opportunities as they unfold. As always, we remain optimistic about the continued growth in future demand for the types of sustainable and renewable wood products that West Fraser manufactures and for which the company is known. With that, we'll turn the call back to the operator for questions.

Operator, Operator

Thank you, sir. Ladies and gentlemen, we will now begin the question-and-answer session. Our first question comes from the line of Ben Isaacson from Scotiabank. Please go ahead.

Apurva Kilambi, Analyst

Good morning. This is Apurva on for Ben. Congrats on the quarter, folks. My first question is whether you can give us a sense of how customer buying patterns have evolved over the quarter. I think last quarter you mentioned that things looked stable. So wondering if there's been any evolution there?

Sean McLaren, President and CEO

Yeah. Good morning, Apurva. Sean here. I'll make a couple of comments then ask Matt Tobin to fill in what I miss. From our perspective, we started the year stable and expected some more activity out of our R&R segment and our treaters, in particular, which really has been slower than I would say we would typically expect for the spring kind of season. As a result, we've seen price pressure, particularly in Southern Yellow Pine. Maybe I'll just stop there and ask Matt to weigh in with anything I missed there.

Matt Tobin, Senior Vice President of Sales and Marketing

Thanks, Sean. I believe that’s accurate. As the remodeling and restoration markets have slowed, we’ve noticed a slight decrease in demand from our customers, especially in Southern Yellow Pine. However, we believe that in the long run, remodeling and restoration will rebound due to the age of the housing stock and improving affordability.

Apurva Kilambi, Analyst

Thank you. I have a quick follow-up. Considering the R&R segment, which you expect to maintain strong demand in the long term, when we notice some weakness in that area, do you see it as demand deferral or demand destruction? Is it just that someone is delaying a remodel by a couple of quarters, or have they completely abandoned the pursuit? What are your thoughts on this?

Chris Virostek, Senior Vice President and CFO

I think we would consider that demand deferral. I think, like I said, with the age of housing stock, we believe that R&R is well positioned for the long term. And right now, it's just around affordability and market dynamics.

Apurva Kilambi, Analyst

Thank you.

Operator, Operator

Our next question comes from the line of Hamir Patel from CIBC Capital Markets. Please go ahead.

Hamir Patel, Analyst

Hi. Good morning. Sean, given how low prices have fallen in the Southeast, are you surprised we haven't seen more curtailments in the region from some of your peers that are perhaps higher cost, and what do you think has been holding producers back from announcing shuts?

Sean McLaren, President and CEO

Yeah. Good morning. Good morning, Hamir. Again, not a lot of visibility to what everybody is doing in the South. I can only speak to what we're doing. Of course, as we announced early in the year, we took pretty strong action with the curtailment of the indefinite curtailment of Huttig and the closure of Maxville, and we continue to run to first our economics, secondly, our customer needs. And when those things line up, we operate, and when they don't fit, we take action. And I think in the South, I can't speak to what others are doing, but you don't really have the ability to build big inventories in the South. So I think probably people would behave like we are, which is reacting to what your inventories are doing and what you can move into the market.

Hamir Patel, Analyst

Fair enough. And so I wanted to ask about on the pulp and paper side. You've taken full ownership now of the Cariboo mill. How big a CapEx investment in coming years would you expect to need to commit there to keep that mill viable over the long term?

Sean McLaren, President and CEO

What I would say, Hamir, is that Cariboo Pulp is in a very different situation compared to what we discussed at Hinton. The asset is about 20 years newer and has been well maintained. While kraft mills do require significant shutdowns every few years, and some level of shutdown annually, we don't anticipate any major capital needs beyond the regular maintenance typically associated with a kraft mill.

Hamir Patel, Analyst

Great. Thanks, Sean. That's all I had on the pulp side. And just a final question for Matt. It looks like your lumber realizations fared quite a bit better than the benchmarks and at least what one of your peers have been pointing to any thoughts on what kind of drove the relative strength?

Matt Tobin, Senior Vice President of Sales and Marketing

I guess I'll probably just maybe get down to mix, or I can't really comment on what our peers are doing, but they might just deal with mix in the quarter that we'll average out over time.

Hamir Patel, Analyst

Okay. Fair enough. Go ahead. I’ll turn it over. Thanks.

Matt Tobin, Senior Vice President of Sales and Marketing

Thank you.

Operator, Operator

Our next question comes from the line of Ketan Mamtora from BMO Capital Markets. Go ahead, please.

Ketan Mamtora, Analyst

Thank you and good morning, everyone. First question, maybe to your earlier comments, Sean, around SPF inventories being below normal levels on the log side, to be clear, is there any way to sort of quantify where your log inventories are versus typical levels for this time of the year? Just sort of rough order of magnitude.

Sean McLaren, President and CEO

Yeah. Good morning, Ketan. I guess the way I would quantify it is we've got a couple of places where we came in below what our targets would have been. And what really that means is we've just flagged it as a risk. It means we need to have a little earlier start to our delivery season. We typically wouldn't be expecting to bring logs in, in Western Canada till the second half of June or late June. We've got a few sites where we're going to need to start hauling wood earlier than that. And I think our team has done an excellent job of staging product roadside and having us in a position to be able to haul that. But we are going to need some support from conditions are very dry, there's fire risk in both provinces. So we're going to need things to kind of align for us to be able to do that. I wouldn't view it though, as we're talking a couple of mills in our portfolio of a dozen mills here.

Ketan Mamtora, Analyst

Understood. No. That's helpful. And just one follow-up on that. Have those production disruptions at those two mills continued into Q2 or into April at this point or you guys have been able to manage it?

Sean McLaren, President and CEO

No. We've been able to manage it. We took some forward action in Q1 to ensure that we had log inventories to at least get us to the early part of June. And we have plans in place whether permitting to be able to operate normally through the period. We flagged it as a risk if weather conditions change or we have disruption in the forest, it's going to impact a couple of our plants.

Ketan Mamtora, Analyst

Got it. No, that's helpful. And then switching to OSB. Can you just update us as to kind of where Allendale is with the ramp-up and where you expect that mill to be by the end of this year in terms of rate of production? I know you flagged kind of a pretty extended ramp-up period in your release. But just curious kind of what you're expecting for '24.

Sean McLaren, President and CEO

Yeah. No, the first thing I would say there, Ketan, is I’m very pleased with the progress that we're making at Allendale and the team we have in place there. That mill started in July of last year and so we're 10 months later. The mill is going to take two to three years to ramp up. And I would say when you look at the capacity of the mill and sort of look out three years from when we started, if you drew a line, a start-up line that would probably – you probably end up pretty close in terms of where we'd expect to be by the end of this year. Saying that, we're happy with the progress. It's going to lower our cost footprint in our OSB business, which is the reason we bought Allendale and we're well on track to deliver that.

Ketan Mamtora, Analyst

Understood. And just one final question from my side before I turn it over to an earlier question around R&R demand. Have you seen outside of seasonality, obviously, as we move through April and May and June activity picks up. But outside of seasonality, have you seen any change in the demand pattern, whether sort of any slowdown or has it kind of largely been stable with this recent uptick in interest rates? Just curious about that.

Matt Tobin, Senior Vice President of Sales and Marketing

I think we've seen a slowdown in R&R demand across our different products. Like I said, I don't think we think it's a long-term issue. We think that we're well positioned for R&R in the long term. But certainly, this quarter, we've seen across our segments just weakened customer demand around R&R.

Ketan Mamtora, Analyst

Okay. That’s helpful. I’ll jump back in the queue. Good luck. Thank you.

Matt Tobin, Senior Vice President of Sales and Marketing

Thank you.

Operator, Operator

Our next question comes from the line of Sean Steuart from TD Cowen. Go ahead, please.

Sean Steuart, Analyst

Thank you. Good morning, everyone. Matt, I just want to follow up on the last point. When you talk about a slowdown in R&R volumes, can we put some percentage numbers around that quarter-over-quarter? Are we talking mid-single digit volume declines? Just trying to get better granularity on what's happening across various demand channels.

Matt Tobin, Senior Vice President of Sales and Marketing

I would say we don't have perfect visibility to the end markets around that, but there are customer segments, anecdotally is what we're reporting, and that's what we're seeing through the typical channels that we see those products move for R&R. So I can't give you an exact percentage because we don't have that visibility, but we certainly feel that slowness through the channels that we typically move our products to support R&R.

Sean Steuart, Analyst

Okay. And on lumber with respect to finished goods inventories through the distribution channel, you guys and comps the last few quarters have pretty routinely positioned it as lean. But I'm hoping you can reconcile that characterization with prices sort of spinning their wheels here, looking for traction. Any updated thoughts on finished product inventories? It feels like it's pretty low at the mill level, but what you guys are seeing through the supply chain and the end markets?

Sean McLaren, President and CEO

Good morning, Sean. I'll comment on that and then ask Matt to add anything I might miss. It's challenging for us to discuss the situation comprehensively. We can only address our inventories and customer purchasing behaviors. Our inventories are stable, and our customers seem to be buying as needed. There doesn't appear to be any significant urgency to purchase, and we're not observing anyone increasing their inventory out of concern for supply. So, that's where we stand, but it's difficult for us to provide a clear picture of the entire system.

Sean Steuart, Analyst

Okay. Thanks for that Sean. Just one last question maybe for Chris. The $11 million quarter-over-quarter decline in operating costs that was referenced in the waterfall slide in the deck, how much of that is tied to the U.S. South optimization initiatives? And can we expect follow-on progress on that front in the coming quarters or is that a step function change and a new level, and you should just expect that same level going forward?

Chris Virostek, Senior Vice President and CFO

We are considering various factors as we approach the upcoming quarters. The decrease in prices has provided some relief in stumpage costs in Canada, which has positively impacted our expenses. The effects of the Fraser Lake mill won't be fully realized until the third or fourth quarter as we continue to manage inventory and operations there. The closure of the two mills in the U.S. South was completed more quickly due to typically leaner inventories in that region, allowing for a rapid winding down of operations. We managed to replace that lost production with output from our newer, more cost-efficient mills, effectively maintaining our shipping pace while benefitting from an overall lower cost structure. We remain dedicated to improving costs across all our operations, having invested significantly in our capital programs over the past few years. This focus on capital investment differentiates us, as we aim to enhance asset quality and operational efficiency even during downturns. We intend to keep optimizing costs in our lumber business and beyond, and we've seen promising results already this quarter, with our teams actively working on this initiative every day.

Sean Steuart, Analyst

Okay. Thanks a lot, Chris. Appreciate it.

Operator, Operator

Thank you. We have our next question coming from Matthew McKellar from RBC Capital Markets. Go ahead, please.

Matthew McKellar, Analyst

Hi. Good morning, and thanks for taking my questions. First, I'd like to ask, I think you talked about having a few more organic projects in the queue for your U.S. lumber platform. Is the softness we're seeing in Southern Yellow Pine today changing your view at all on whether those projects pencil out over the longer term or potentially changing the timing of when you may move forward with some of those new investments in the U.S. South?

Sean McLaren, President and CEO

Good morning, Matthew. This is Sean. When we mention ongoing projects, the most significant is our Henderson project, and we are not slowing down on that. It is progressing on schedule and within budget. We consider it a strategic investment that will be well-positioned regardless of market cycles once we achieve operational efficiency and integrate it into our Texas platform. For upcoming projects, our priority is on enhancing what we already have and ensuring we utilize the capital we've invested and complete the ongoing projects. Although we are planning for future initiatives, we will be selective about when to launch new ones. Our primary focus at West Fraser is to successfully execute the projects already in progress and those that are starting up.

Matthew McKellar, Analyst

Great. Thanks very much for that. The next question, you've been pretty clear on outlining what factors you consider when pursuing M&A. And with that as a background, can you describe what the pipeline of opportunities you see in the market looks like today?

Sean McLaren, President and CEO

Maybe I'll make a comment or two and ask Chris to just weigh in here. But I would say, our view in West Fraser is and has been for an M&A opportunity, it needs to be high quality, immediately make us stronger, support our existing business. It needs to tick all of the boxes like Angelina did, like Allendale did, like Spray Lakes or Cochrane did. I would say those opportunities are pretty few and far between today and people with high-quality assets. The odd one might come to market, but tough to find them. So that would be my perspective, and who knows, but I think we're well positioned to react to anything that we're interested in that comes on the market, but the bar is pretty high in West Fraser.

Matthew McKellar, Analyst

Great. Thanks very much. One last kind of cleanup for me. On Hinton, I know you have a long-term contract to supply residuals into that facility. My question is whether you expect any significant downside of that mill between now and 2027 as they work through their paper machine investments. It would mean you have to find a home for those residuals on an interim basis? And if so, how should we think about the financial significance of that?

Chris Virostek, Senior Vice President and CFO

I think how they plan to execute their capital is really their decision. However, we feel very confident in our ability to sell our residuals in Alberta. It’s a low-cost area for us that we want to ensure operates efficiently. We believe we have taken all the appropriate steps in that transaction to give us the assurance that we can continue doing this for a long time.

Matthew McKellar, Analyst

Great. Thanks a lot for the color. I’ll take a back.

Chris Virostek, Senior Vice President and CFO

Thank you.

Operator, Operator

We have a follow-up question coming from the line of Sean Steuart from TD Cowen. Go ahead, please.

Sean Steuart, Analyst

Thanks. Just one follow-up, guys. OSB in North America, it looks like prices are starting to crack after really surprising run over the last several months. Can I get your perspective on downside risk to that market? How far do you expect prices could fall before downtime kicks in? And I appreciate you're taking a slow and steady approach with Allendale, but broader thoughts on managing supply as prices potentially correct here over the next little bit?

Chris Virostek, Senior Vice President and CFO

I'll make maybe a comment or two here, Sean, and then get Matt to fill in here. I guess from my perspective, our OSB sales team and the entire team has done a very good job. I think we've strengthened relationships with key customers, built programs that are supported by OSB and lumber. And I think that's given us an ability to ramp up Allendale into those programs. In terms of what it's going to happen, really tough for us. We know supply is coming on, saying that, the business has consistently held up better than our expectations, which we've been pleased by, and our team has done an excellent job of strengthening relationships with our key customers for both products. Matt, anything to add?

Matt Tobin, Senior Vice President of Sales and Marketing

No, that's perfect. We're really focused on supporting our key customers to meet their demand and supply them through all markets.

Sean Steuart, Analyst

Okay. That’s it for me. Thanks, guys.

Operator, Operator

We have a follow-up question coming from the line of Ketan Mamtora from BMO Capital Markets. Go ahead, please.

Ketan Mamtora, Analyst

Thanks for taking my follow-up question. Question on what you're seeing in Europe in terms of activity level. Are you still seeing activity under pressure or are you seeing things stabilize?

Sean McLaren, President and CEO

Hi, Ketan. Europe has been slow for several quarters now. As we enter Q2, while prices haven't really improved significantly, we've noticed some increase in volume. Rate inflation appears to be decreasing a bit faster over there. That said, Europe is still quite slow. We have excellent assets and a strong team. We'll see when conditions improve, but we feel positive about our ability to operate effectively in this environment and continue advancing our operational excellence and business goals despite the challenging pricing.

Ketan Mamtora, Analyst

Got it. And then just one related question to that. If Europe remains weak, and it sounds like it is fairly weak, what is the risk that we start to see an uptick again in imports of lumber into the U.S. from Europe? I mean it's been coming down here in the last little bit. But just curious how you see that potentially shaping out as we move through Q2 and into Q3?

Sean McLaren, President and CEO

Again, we don't have lumber assets in Europe. So our visibility is not as good as maybe some others. But I mean, I guess our view is that there's been a lot of investment by European producers opening up those supply chains they're unlikely to let those supply chains close. So we likely will continue to see volume flowing. Saying that, as things improve in other markets that they normally go to, we'll see that volume go to those markets. So we view it could be up and down, but we view it long term likely volumes going to stay in their more traditional markets.

Ketan Mamtora, Analyst

Got it. That’s helpful. Thank you.

Operator, Operator

Thank you. There are no further questions at this time. I'd now like to turn the call back over to Mr. McLaren for final closing comments.

Sean McLaren, President and CEO

Thanks, Lara. As always, Chris and I are available to respond to further questions as is Robert Winslow, our Director of Investor Relations and Corporate Development. Thank you for your participation today. Stay well and we look forward to reporting on our progress next quarter. Thank you.

Operator, Operator

Thank you, sir. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Have a lovely day.