Earnings Call Transcript - WFG Q2 2022

Operator, Operator

Good morning, ladies and gentlemen, and welcome to the West Fraser Q2 2022 Results Conference Call. At this time, all lines are in listen-only mode. Following the presentation, we will conduct 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 contain forward-looking information or forward-looking statements within the meaning of Canadian and United States securities law. 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 risks, factors, and assumptions is included both in the accompanying webcast presentation and in our 2021 annual MD7A and annual information form, which can be accessed on West Fraser's website or through SEDAR for Canadian investors and EDGAR for United States Investors. This call is being recorded on Thursday, July 28, 2022. And I would like to turn the conference over to Mr. Ray Ferris. Please go ahead, sir.

Ray Ferris, President and CEO

Thank you, Sylvie, and well done. So listen, good morning, everyone, and thank you for joining our second quarter 2022 earnings call today. So I'm Ray Ferris, President and CEO of West Fraser, and I'm joined by Chris Virostek, our Chief Financial Officer; and Chris McIver, our Senior VP, Marketing, Corporate Development; and several other members of our executive team. I'll begin with a review of key highlights of West Fraser's second quarter results and then pass the call to Chris for additional comments. In the second quarter, West Fraser achieved strong financial results in the face of ongoing transportation and logistics challenges. As you may recall, in recent quarters, transportation challenges had been particularly acute and of longer duration than we and others had originally expected. However, we did see the start of signs of improvement in the second quarter, and that trend has continued early into the third quarter. Demand for wood-based building products was robust in the second quarter, generating USD 1.12 billion of adjusted EBITDA, representing a margin of 39% of sales. The benefits of our products and geographic diversity continue to be a differentiator for West Fraser. As a result, we saw a more resilient EBITDA for the North American Wood Products segment in the quarter, where our lumber business saw a more significant sequential decline. On capital allocation, it's important to note that in the past 18 months, the company has repurchased approximately 37 million common shares through normal course issuer bids and the completion of two substantial issuer bids. Altogether, this equals 67% of the shares issued in respect to the Norbord acquisition. Through this same period, we've increased our dividend three times to a level of USD 0.30 today. Notwithstanding this return of capital, our balance sheet continues to offer significant financial flexibility, which is a key priority of our capital allocation strategy. With that short overview, I'll now turn the call over to Chris for additional detail and comments.

Chris Virostek, Chief Financial Officer

Thank you, Ray, 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. Our North American EWP segment generated $623 million of adjusted EBITDA, down approximately 15% from the first quarter, while lumber generated $449 million of adjusted EBITDA, down approximately 44% in the prior quarter. And while improved from the prior quarter, the Pulp and Paper segment had a negative $3 million of adjusted EBITDA in the quarter. And while we're not satisfied with the pace of progress we are making in this business, we remain focused on our long-term solutions to improve the Pulp and Paper segment, which includes our UKD strategy. In Europe, adjusted EBITDA was $54 million versus $78 million in the prior quarter. Price was the single largest driver for the sequential EBITDA decline in North America, more than offsetting improvement in shipments from the first quarter. While in Europe, lower second-quarter shipments more than offset better pricing. Cash flow from operations in the second quarter was $1.06 billion, supported in part by a seasonal decrease in working capital, while cash net of debt declined quarter over quarter to $746 million, as we repurchased nearly $1.5 billion of our common shares in the second quarter. Included in these share repurchases was $1.13 billion of shares repurchased upon the successful closing of our second substantial issuer bid in the last 12 months, furthering our track record of returning significant capital to our shareholders. As Ray mentioned, we also raised our quarterly dividend to $0.30 per share to distribute a substantially similar amount of cash through dividends after considering the shares repurchased through the NCIB and the SIB. I'll now shift to our 2022 operational outlook for the balance of the year. In part due to the ongoing transportation challenges in North America and despite the considerable progress we made with our Q2 shipment volumes compared to Q1, we're providing a slightly more cautious annual SPF lumber guidance. We now expect SPF shipments to be closer to the bottom end of the range of $2.8 to $3.40 billion. We are maintaining our guidance for SYP shipments, which we still expect to fall within the range of $3 million to $3.2 billion for this year. For our North American OSB business, given continued constraints to trucking services and signs of slowing demand, we are reducing our annual shipment guidance to a range of $5.9 million to 6.2 million square feet on a 3-inch basis. In Europe, we are seeing early signs of slowing demand, and as such, we are slightly reducing our OSB shipments guidance. We now expect 1 million to 1.2 million square feet on a 38-inch basis this year. Lastly, we are reiterating our guidance range of $500 million to $600 million for planned capital expenditures in 2022. However, given the rate of expenditures in the first half of the year and ongoing supply chain challenges, we expect our capital spend may fall closer to the bottom end of this range. As discussed last quarter, it remains difficult to estimate when full transportation services will be available. In the meantime, we continue to actively seek and utilize alternative transportation routes and methods to the extent they are available to continue servicing our customers. Given this uncertainty, further reductions in operating schedules across our production platform may be required to manage raw material supply, inventory levels, and our integrated fiber supply chain. Consistent with our previous quarters across much of our supply chain, we are experiencing greater than usual inflationary cost pressures and availability constraints for labor, transportation, energy, and raw materials such as resin and chemicals. We expect these cost pressures and availability constraints to be elevated through the remainder of 2022. With that overview, I'll now turn the call back to Ray.

Ray Ferris, President and CEO

Thank you, Chris. Look, as we navigate the operating environment and manage the ongoing challenges, as Chris noted, I remain confident that our product and geographic diversity, our culture of cost control and operational discipline, our strong customer relationships, and our balanced approach to capital allocation will continue to serve us well. Equally as important is the diligence and determination of our people who continue to adjust as needed to meet our operating customer needs. Given the macro environment and market developments in recent months, I'd like to make just a few comments on the environment in which we find ourselves today. We acknowledge that there is a growing uncertainty surrounding rising interest rates, elevated energy prices, and broad inflationary cost pressures which, in many instances, are directly connected to strained supply chains. In particular, there are questions around the potential impact of these and other factors you may have on housing affordability and repair remodeling spending, which may result in short-term fluctuations in demand for our wood building products. It's important to remind everyone that our focus is on the long term, and our self-improvement strategy is to be low cost, have great people and assets, and be supported by a strong balance sheet. We are very fortunate to have a seasoned team with a proven track record of successfully navigating through previous cycles. So in terms of market fundamentals, despite these near-term headwinds, we believe the longer-term supply demand and the growing role of important sustainable forest products in a low-carbon economy remain robust. Ongoing constraints due to limited fiber availability and supply chain issues may continue to make it difficult to quickly adapt to increasing demand. Also, the historically key lumber-producing region of British Columbia continues to see downward pressure on its longer-term ability to contribute to the need for supply, which has recently been exacerbated by increasingly stringent public policies that are driving further reductions to that province's annual outlook. In contrast, despite significant industry investment growth in the U.S. South region, overall North American supply response has not been sufficient to offset reductions in other regions. In terms of demand, an apparent housing shortage in North America appears to be constrained by affordability, limiting consumers' ability to purchase homes. Rising interest rates and wage inflation, although a short-term impact, can play an important role in improving housing affordability in the longer term. I would now like to update you on the progress we’ve made with some of our recent acquisitions, specifically the Allendale OSB mill in the Angelina, South. First, with Allendale, which is our idled OSB mill we acquired late last year, we continue to make progress rebuilding the front end of the mill, which we expect will simplify the process and make the mill easier to operate, thereby improving productivity. I'm also pleased to note that our Allendale team has made good progress with our early staffing needs, giving us confidence that we will be able to attract the necessary talent as we move towards eventual startup. Supply chains and cost inflation have impacted us everywhere, including Allendale, and we now expect our potential restart date will be in the first quarter of 2023. We believe the large-scale Allendale mill, with the help of our skilled OSB team, will be among the lowest-cost mills in our OSB portfolio when it's operating at full production. Secondly, and moving to Angelina, I am pleased to report that this acquisition has gone very well so far, exceeding many of our base assumptions for that sawmill. Operationally, we are seeing better production at lower costs than what we anticipated. The mill's EBITDA since acquisition is approximately three times our original base forecast. Thanks to this strong financial performance and better-than-expected timing of certain tax deductions, we estimate the IRR for this acquisition, while still early, is approaching high teen percentages, well ahead of our original estimate of approximately 13%. With the announcement of our second quarter financial results, I'm also pleased to announce the publication of our 2021 sustainability report. A tremendous amount of work went into this report, and we are proud of our progress to date. I wish to specifically recognize our key sustainability officer, Shenandoah Johns, and our dedicated team for the progress we have made. As we continue to take steps towards becoming a sustainability leader, highlights from the report, which I encourage all to read, include West Fraser becoming the first Canadian wood products company to commit to joining the science-based targets initiative to materially reduce greenhouse gas emissions by 2030, in alignment with the Paris agreement. Additionally, we are improving the overall diversity and inclusion of our workforce, having more than doubled the female representation on our board in 2021. Perhaps, most importantly, while we clearly understand that we have much more work to do to eliminate serious incidents and injuries in the company, we achieved our lowest recordable injury rate in our history. Before turning to the Q&A portion of today's call, I'd like to make a few additional remarks on our capital allocation strategy. Our priorities aim to balance disciplined investments in the business with returning capital to shareholders, all while maintaining our financial flexibility. We continue to believe that a consistent balanced approach is key to long-term value creation. To that end, our top priority for us continues to be reinvesting in our existing businesses. This includes deploying capital towards advanced automation technologies that drive further innovation to enhance our operating platform. We will also continue to prioritize returning excess capital to our shareholders, whether that’s through dividends or share repurchases when we believe our shares are trading at a discount to their intrinsic value. At the same time, with the objective of maintaining financial flexibility through the cycle, we keep sufficient cash to invest in the business and enable opportunistic acquisitions and/or pursue larger-scale strategic growth initiatives when they are available. Given our strong balance sheet, we will continue to look for additional opportunities to effectively deploy our capital as we execute on our strategic objectives. Reflecting on these priorities, since 2016, nearly 35% of our cash generation has gone towards capital expenditures and acquisitions directed to improving and expanding the company. Approximately 15% of our cash flow has been retained or used to pay down debt. Lastly, nearly half of our cash flow generation has been returned to shareholders, including approximately USD 3.7 billion of share repurchases over the last 6-plus years, highlighted by the successful completion of two substantial issuer bids in the last 12 months. In short, and overall, we are pleased with our results this quarter. Our balance sheet is strong. We have the necessary liquidity to allow us to navigate future challenges and opportunities. And just as important, we have the knowledge to continue to move the company forward and to grow and create value, whether organically or through acquisitions when attractive M&A opportunities arise. While recognizing the potential near-term headwinds for our business, we remain optimistic about our people and the company's longer-term prospects, as well as continued growth in the use of sustainable and renewable wood products. We remain diligent and focused on being agile to navigate the after-market challenges and the demands of our customers. Finally, I would be remiss if I didn’t mention that we issued a press release last week in response to recent media speculation. I believe that the release is clear and concise. And so in that spirit, I will not be adding any further comments and will simply refer you to the press release. Thanks. With that, I'll turn the call back to the operator and ask for questions. Thank you.

Operator, Operator

Thank you, sir. Your first question will be from Sean Steuart at TD. Please go ahead.

Sean Steuart, Analyst

Thank you. Good morning, everyone. A few questions for you, Ray. With respect to the lower 2022 volume guidance for a few of the segments, it sounds like it's a combination of ongoing freight availability constraints and demand backing off? And I guess I'd like to focus on the latter a little bit. In North America, can you give us a bit more detail on specific end market weakness? It feels like it's more skewed to new home construction right now than repair and remodeling. But any details that you can give us on what you're seeing in the North American end markets for lumber and panels?

Ray Ferris, President and CEO

Well, good morning, Sean. Look, we're going to tag team on this. So I'm going to - and I'll turn it over to McIver here. But I would say for the second quarter, a lot of our demand is falling off. Interestingly enough, we saw furniture demand in some of our OSP and Industrial Specialty business slow down significantly. I think we've seen more softening in those areas and less in the single-family housing area, but I'll let Chris elaborate on that. Chris?

Chris McIver, Senior VP, Marketing and Corporate Development

Good morning, Sean. Yeah, you know, not all of that. We suspect that we will see a little slowing down in single-family going forward. But so far, we haven't, and repair and remodel has remained robust.

Sean Steuart, Analyst

Okay. Thanks for that detail, Chris. On Allendale, it sounds like you're taking a measured approach to doing the work there ahead of the restart. And you mentioned the Q1 2023 target. I think in some of your other work in the slide deck and investor materials would correspond with us. Where do you think the OSB market right now, the capacity would fit basically USD 1.5 million housing starts? And I guess the question is, if we trend a little bit below that on an annualized basis, is there a potential that the Allendale restart could be pushed out later in 2023 or even 2024, if demand dictates that?

Ray Ferris, President and CEO

Well Sean, look, I mean, we've got a plan. We're executing on that. Our intention is to start that mill up as we've discussed. As you can imagine, starting a mill will take us at least a couple of years to get up to somewhere near rated capacity. So decisions that we make aren't likely to be quarter-to-quarter ones; they will be longer-term ones. This is a longer-term decision. But look, we'll read the tea leaves as we get closer to that final decision. If the market doesn't want any more OSB, we're going to have to take that into context. But again, we'll be looking to the long term in making that decision. Currently, our plans are to continue as we discussed.

Sean Steuart, Analyst

Okay. Thanks very much, Ray. I will get back in the queue.

Ray Ferris, President and CEO

Thanks, Sean.

Operator, Operator

Thank you. Next question will be from Hamir Patel at CIBC. Please go ahead.

Hamir Patel, Analyst

Hi, good morning. I wanted to first ask about the European OSB business. Just wondering if you can give us more sense as to how much demand has moderated there. If there's any notable differences between maybe the new residential and repair and remodel components? And how you see prices evolving for OSB in Europe in the second half?

Ray Ferris, President and CEO

Good morning, Hamir. I think it's a good question. I think the European OSB market is interesting. I think with the onset of the war and the impact on Russia, Ukraine, and Belarus, there has been a focus on how that will shake out. Many of us are still seeing how that sorts out. Demand did soften. It's hard to determine exactly why that is. Part of it, we believe, has to do with the fact that although all these sanctions are coming into effect, you have to remember these impacted shipments out of Russia, Belarus, and other areas didn't take effect until July 10. It will be interesting to see what Q3 and Q4 look like for demand, but I think it's going to take some time to understand the impact of those sanctions and how much demand has softened versus potentially a lot of shipments getting out of Eastern block countries and getting into Europe. I wish I had a better answer for you, but I think we're trying to understand that. It's certainly soft and slow. But I would say, rather than a specific residential or repair and remodel focus, I would say it's probably even across the segment.

Hamir Patel, Analyst

Fair enough. Thanks, Ray. That's helpful. And just coming back to the lumber business. I know BC is only about a quarter of your capacity. But could you just fill us in on how much stumpage in the province at least in your geographies is up in Q3, where you see that going into Q4? And where you'd estimate breakeven is today for the BC industry?

Ray Ferris, President and CEO

I think earlier in Q1, we said we thought it would be around $40 a cubic meter. The final number came out around $35 to $40, depending on the region that you're in. That's a pretty significant jump in cost now. It obviously impacts how much on the available economic fiber you are willing to pursue for new operations. I'm not going to comment on what I think the breakeven prices in British Columbia are. There's lots of information available, and it's directionally accurate depending on what sources you look at, but it's a pretty high number. We don't see softening until really Q4. So, thanks, Hamir.

Hamir Patel, Analyst

Okay. Great. Thanks, Ray. That’s all I had. I’ll get back in the queue.

Operator, Operator

Thank you. Next question will be from Mark Wilde at BMO. Please go ahead.

Mark Wilde, Analyst

Thanks. Good morning, Ray.

Ray Ferris, President and CEO

Morning, Mark.

Mark Wilde, Analyst

Question for Chris McIver. I wonder if you could just talk with us a little bit about what he sees in channel inventories, whether he has seen buyers a little more willing to step in and take on some inventory with lower prices. And then also just help us with your thinking around how much carry-through there is with builders just working through current backlogs right now?

Chris McIver, Senior VP, Marketing and Corporate Development

Good morning, Mark. That's a big question, but yes. Firstly, regarding inventories, the information is anecdotal because there's not really a legitimate measure. But we understand from our customers that generally they're being cautious, inventories are low, and they are purchasing as they need to, which I think is very good for the industry. With regard to prices coming down, we've seen a rebound in the retail sector, which has been very helpful. As for builders, again, we hear what you do. They're finishing what they have and looking to the future. That's more or less what we're seeing.

Mark Wilde, Analyst

Do you have any view, Chris, on how long that sort of working-off-the-backlog process might take? You have a view that it's kind of 6 months? Is it 4 months? Is it 8 months? What would be your best estimate on that?

Chris McIver, Senior VP, Marketing and Corporate Development

Yes, Mark, we really don't have a view. We don't have visibility into that from builder-to-builder, so I really can't say.

Mark Wilde, Analyst

Okay. And then I'm just curious, has there been any impact on your OSB and plywood operations from all the litigation around Brazilian plywood imports?

Chris McIver, Senior VP, Marketing and Corporate Development

No. Nothing that we haven't noticed, anyway.

Mark Wilde, Analyst

Okay. All right. That's it for me. Thank you.

Ray Ferris, President and CEO

Thanks, Mark.

Operator, Operator

And your next question will be from Paul Quinn at RBC. Please go ahead.

Paul Quinn, Analyst

Yeah. Thanks so much. Morning, guys.

Ray Ferris, President and CEO

Good morning, Paul.

Paul Quinn, Analyst

I just want to follow up on this point under the looking board on your slide deck that you continue to ramp up at Inverness Phase 2 and Gank and try to reconcile that with the comments that shipments overall in '22 here will be down. Can you - I need to do this, but can you repeat that question, Paul? Sure. So just on your - I guess this is Slide 8, you've got a point that you continue to ramp up at Dudley, Chambord, and you've also named Inverness Phase 2 and Gank. I know you've got capital projects; that’s a lot of money at both those facilities. Just trying to reconcile that with your reduced guidance on shipments going forward to the balance of '22. Does that mean you're going to increase operating rates but build inventory or how do we reconcile that?

Ray Ferris, President and CEO

You're fortunate to be looking at the webcast now, and I'm trying to unpack the question there, Paul. When it comes to - I'll just go through this and tell you what we're trying to say. So Chambord, we're ahead of our plan, and I'm going to say we're running at about three-quarters of capacity. We're quite pleased with the progress the team has made there. Inverness is essentially there. I think we’ve talked about the slowdown in Europe; we are kind of operating the meat market again. That’s running extremely well. I think we've talked a bit about Angelina. I'm not sure I'm answering your question very clearly, Paul, but maybe I can help clarify something if you have a follow-up question.

Paul Quinn, Analyst

Maybe I should just ask you an easier question. Maybe just looking over the lumber side. Now that North American prices have come down, does that give you an increased opportunity in offshore markets?

Ray Ferris, President and CEO

First of all, Paul, I need easy questions. You know that. So, thanks for that. Any contraction in pricing has been relatively short-lived. I would say there is no real change at this point. I think it would take an extended period of time before we see an opportunity to create further opportunity. I would think Chris mentioned that, although things have softened, people have become more cautious. People still have a pretty robust view around the supply and demand fundamentals of our business and the needs out there. If you look past the next few months or the next couple of quarters, people's expectations are still pretty strong.

Paul Quinn, Analyst

Okay. And then just lastly, not that you need the cash, but just wondering what you're going to take in light of softwood lumber? Is there any movement here at all? And is it something that you guys are pushing for?

Ray Ferris, President and CEO

Certainly, we believe that the continued dispute is with the U.S. We expect to see those duties return and continue to fully support the litigation process that we're involved in, and we'll see an announcement around final termination of the AR3 in the next week or two. We expect that to support our point of view. With respect to the negotiations and resolution, there's really nothing happening. There's a little bit of back-and-forth in the media, but it doesn't appear that anything meaningful is taking place to move that forward.

Paul Quinn, Analyst

Okay. Just as a follow-up, I understand the AR3 is coming out. But where are we at with the WTO and NAFTA processes? And is there any expectation that you're getting some kind of ruling in '22 or '23?

Ray Ferris, President and CEO

I'm not - I really don't have anything to add there, Paul. I can't predict what comes from them, or at what time.

Paul Quinn, Analyst

All right. That’s all I had. Best of luck, guys. Thanks.

Ray Ferris, President and CEO

Thank you, Paul.

Operator, Operator

Thank you. And at this time, Mr. Ferris, we have no further questions. Please proceed.

Ray Ferris, President and CEO

Listen, thank you so much for everyone joining the call, and we look forward to talking to you on our Q3 results. Thank you.

Operator, Operator

Thank you, sir. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. And at this time, we do ask that you please disconnect your lines.