Earnings Call Transcript - WFG Q4 2021

Operator, Operator

Good morning, ladies and gentlemen. And welcome to West Fraser Q4, 2021 Results Conference Call. Please note that all lines have been placed on mute to prevent any background noise. 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 company webcast presentation and in our 2021 annual MD&A and Annual Information Form, which can be accessed on West Fraser's website. After the speakers’ remarks, there will be a question-and-answer session. Thank you. Mr. Virostek, you may now begin the conference.

Chris Virostek, CFO

Thank you. And good morning, everyone, and thank you for joining our Q4 2021 earnings call today. I'm Chris Virostek, CFO and I'm joined by Ray Ferris, our President and CEO, and Chris McIver, our Senior Vice President, Marketing and Corporate Development. This morning, I'll start with a brief recap of West Fraser's Q4 and 2021 financial results. I'll then pass the call to Ray who will provide an update on the business, including a discussion about some of West Fraser's recent initiatives, the opportunities we see ahead for the company, followed by a few concluding remarks before we transition to Q&A. In the fourth quarter, West Fraser achieved strong financial results, capping off a record year, despite unprecedented weather-related challenges in Western Canada at the end of 2021. We managed to navigate significant transportation and mill disruptions during a fourth quarter that experienced some of the worst flooding seen in modern times in the BC interior and lower mainland of Vancouver, which severely disrupted our ability to transport finished goods from Western Canada to market. As announced in an operational update news release last November, we navigated these challenges by reducing operating schedules at multiple Western Canadian locations to manage our inventory levels, raw material supplies, and our integrated fiber supply chain. In the face of these supply constraints, demand for our wood-based building products remained robust in the fourth quarter, and as such, we generated $615 million of adjusted EBITDA, representing a margin of 30% of sales, taking full-year adjusted EBITDA to a record $4.57 billion, or 43% of sales. As in the third quarter, the benefits of our product and geographic diversity of production were a significant advantage. We had a strong sequential improvement in our Lumber business, which saw adjusted EBITDA nearly triple to $240 million from the third quarter, helping to offset the sequential decline in our North American EWP business that generated $343 million of adjusted EBITDA in the fourth quarter. In Europe, adjusted EBITDA was $61 million, the second best result ever for that business. Price, seasonal volume trends, and downtime per capita project all played a role in the European results. Cash flow from operations in the fourth quarter was $290 million in cash net of debt declined quarter-over-quarter to approximately $1 billion after completing two acquisitions in the quarter for combined consideration of approximately $580 million. In the fourth quarter, we repurchased another $100 million worth of West Fraser shares, taking our full-year share repurchases to $1.3 billion. With our Q4 earnings release, we also declared a $0.25 per share dividend up from the previous level of $0.20 per share. We continue to deploy capital not only to shareholder returns but also to growth opportunities as evidenced by the recent closings of the two acquisition transactions in the fourth quarter, namely our turnkey Angelina sawmill in Lufkin, Texas, and the idled OSB mill near Allendale, South Carolina. We're now in our third month since closing the acquisition of Angelina Forest Products. Our integration is proceeding well, and results have exceeded the expectations we had at the time of acquisition. And on Allendale, we have commenced work on the mill to prepare for an eventual restart and are pleased with the progress to date. In November, the administrative review to rate was finalized and set the new cash deposit rates for countervailing and anti-dumping duties for the Canadian softwood lumber industry. Our rate for cash deposits changed from 8.97% to 11.14% for lumber shipments from Canada to the U.S. on or after January 10th of 2022. Whereas the rate for all other non-mandatory respondents in Canada is 17.91%. These rates will be in place until at least June 2022. In terms of outlook, we're providing operational guidance for 2022, which you can see on slide four, where we have provided ranges for key product shipments and our planned capital expenditures. We have also identified in our earnings release some of the key challenges currently facing our overall operations early in the year. Namely, that we continue to see logistics and transportation constraints affecting our business early this year. While infrastructure repairs to rail and truck routes resulting from the severe BC weather and flooding in late 2021 are progressing, rail service availability, operator shortages, and the backlog from disruptions in the fourth quarter are all still negatively impacting our ability to ship products. With January 2022, Western Canadian lumber and plywood shipments down approximately 20% compared to the prior year. Even our Western Canadian OSB operations have been forced to take unscheduled downtime as a result of these transportation constraints. Given these developments, further reductions of operating schedules across our production platform, in order to manage inventory levels, raw material supplies, and our integrated fiber supply chain may be required. Currently, it's not possible to estimate when full transportation services will be available or when the backlogs will be cleared. But we will continue to actively seek out and utilize alternative transportation routes and methods to the extent they are available to continue servicing our customers. With that, I'll now pass the call to Ray.

Raymond Ferris, CEO

Thank you, Chris, and thank you all for joining our call today. I will reference some specific slides from our webcast during my comments. To build on Chris's remarks, I can confirm that the transportation challenges in Western Canada have been unprecedented in both scale and duration, leading to a difficult operating environment in the fourth quarter, which has continued into Q1. Throughout this period, our team has demonstrated resilience, diligently navigating these challenges while minimizing disruptions related to COVID from the recent wave. Although the lack of transportation due to extreme flooding affected nearly all our Western Canadian operations, it had the most significant impact on our British Columbia lumber, plywood, and pulp shipments in the central Cariboo region. Given these circumstances, I am proud of what our employees and teams have achieved, particularly the BC and Alberta teams for their patience and commitment to adapting to rapidly evolving and uncertain conditions. In this context, we are pleased to report that Q4 2021 was another strong quarter, and 2021 marked a record year for West Fraser. It has been just over a year since our acquisition of Norbord on February 1, 2021, and after 12 months of combined performance, it is rewarding to see the benefits of our product and geographic diversity from the acquisition. Excluding the cash acquired at close, it's noteworthy that the EBITDA from Norbord in the first 11 months accounted for about 66% of the purchase volume at the time of closing. Similar to last quarter, I would like to highlight a few areas of our business. In Q3, we discussed our OSB and industrial strategies and their development over the last couple of years. I want to touch on our lumber team, which faced significant market and operational challenges in Q4; however, results improved substantially from the previous quarter, partly due to our U.S. South growth strategy. This growth, along with our operational strategy, has led to greater profitability through an increased percentage of premium grades of 2x4. This is significant as 2x4 often commands a premium price over wider dimensional lumber, supporting improved margins. As shown on Slide 5, our overall portion of 2x4s has increased by about 700 basis points, and our mix of better 2x4s has risen by approximately 600 basis points in recent years. Furthermore, the recently acquired Angelina mill is expected to enhance our performance in both 2x4s and premium grades. Our U.S. South growth strategy remains a primary focus for West Fraser. While we are encouraged by our results, we anticipate continued improvement in our U.S. South operating metrics as we implement our operational and capital transformation strategy. Another key area to highlight is our return on capital employed. Moving to Slide 6, West Fraser achieved $4.57 billion in adjusted EBITDA and $3.95 billion in operating earnings. This level of operating earnings resulted in a return on capital employed of 70%, marking the fifth year in the last six with returns exceeding 15%. These returns reflect not only healthy market fundamentals but also our ongoing efforts to lower costs and enhance margins through improved productivity and product mix in our key products, OSB and lumber. Transitioning to Slide 7, I want to emphasize West Fraser's commitment to sustainability and climate action. We are proud to announce that we have officially committed to science-based targets as part of the science-based targets initiative. We believe that a thoughtful ESG strategy is essential for building a financially resilient company in the long term. A crucial part of that strategy is setting clear, credible goals with well-defined metrics as part of our commitment to the environment and sustainability. On Slide 7, we detail that we are committed to reducing our scope one and two greenhouse gas emissions by 46% and our scope three emissions by 25% by 2030. Additionally, to meet these emission targets, we have committed to investing an average of around $50 million each year in projects aimed at greenhouse gas reduction, totaling about $400 million before 2030. By aligning our emissions reduction goals with climate science and the Paris Agreement targets by 2030, we are building upon our solid legacy of sustainability while enhancing social, environmental, and economic benefits in our communities. In summary, we are pleased with our results this quarter and this year, despite numerous market and operational challenges. After repurchasing $1.3 billion of our shares in 2021, we maintain a strong balance sheet with ample liquidity, enabling us to navigate future opportunities and challenges. We will continue to approach capital allocation in a balanced, disciplined, and patient manner, believing that this will increase long-term shareholder value. We have progressed with strategic capital projects while also pursuing growth through acquisitions, enhancing our resilience to meet customer needs and cope with market challenges. Looking ahead, while we expect some challenges in the first quarter due to transportation and logistics constraints, we remain optimistic about the medium to long-term outlook for our Wood Products business. Our diverse geography and products enable us to serve our customers and shareholders effectively. What excites me most is the depth, skill, capability, and commitment of our team, who are focused on reducing costs and improving margins through operational excellence, as well as capitalizing on strategic investments like our W. Sawmill, Chambord OSB, Inverness expansion, the recent gains upgrade, and our Allendale OSB acquisition, while also integrating and ramping up at the newly acquired Angelina mill. With that, I will turn the call back to the Operator for questions.

Operator, Operator

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

Sean Steuart, Analyst

Thanks. Good morning, everyone. A few questions. And first of all, thanks for the detail on the volume outlook for each of the segments this year. That's much appreciated. I want to start with North American wood product markets, I guess, for Chris McIver. Can you frame the current price surge for us? I guess the shipping constraints are clearly a factor, but can you give us a sense of demand pull across various end markets and perspective on where you think inventories are through the supply chain right now?

Raymond Ferris, CEO

Good morning, Sean. Thanks for the question. I might say that we have two different markets a little bit between OSB and Lumber. And certainly, in the fourth quarter, we saw Lumber demand seasonably slow, slower than it was. And then as we move through that quarter into the beginning of Q1, we've seen a significant uptick. On the other side, OSB seems to have been tighter throughout the whole period and we really haven't seen much of a slowdown at all. With regards to transportation issues, I think that's very regional, certainly in Western Canada, our ability to ship, and I assume our competitor's ability has been constrained. The southeast does not really have any transportation issues, so things are flowing pretty well. So we're seeing what we think is pretty strong housing and strong R&R demand going into 2022. We expect that to remain certainly through this quarter and likely through the first half of the year.

Sean Steuart, Analyst

And any perspective on your thoughts on inventories in the channels that felt not too long ago, at least in the repair and remodeling part of it inventories anecdotally, were getting full. That doesn't seem to be the case now, do you have any perspective on that?

Raymond Ferris, CEO

Yeah. Again, it's really difficult for us to know, but what we're hearing is that the wood and the panels that are going into the market are being consumed. R&R seems strong, it seems to have rebounded. Now, at these price levels, will we see it slow down a bit? We don't really know, but it did slowdown in the past. But right now it's pretty robust.

Sean Steuart, Analyst

Okay. Thanks for that detail. Next question is, there was a reference to fiber cost inflation in the U.S. South though it's marginal at this stage, that is consistent with what we're hearing from some of your competitors. Can you help quantify that pressure and what you might be expecting on that front for 2022?

Raymond Ferris, CEO

I can address that. Sean is here as well. Good morning. We noticed a year-over-year decrease in our log costs in the South. This has largely been driven by weather events, affecting certain regions more than others. In some areas, we’ve seen very little change or modest increases, particularly where extreme weather and heavy rainfall have occurred. The issue hasn't been a shortage of timber, but rather a lack of contractor capacity to meet demand and restock inventory. Consequently, in a few regions, we've experienced more significant price pressures. Overall, the general trend in public information about log costs reflects this situation, but it’s not uniform. Certain areas are definitely experiencing higher costs than others.

Sean Steuart, Analyst

Okay. Thanks, Ray. I will get back into the queue.

Operator, Operator

Thank you. Next question will be from Mark Wilde at Bank of Montreal. Please go ahead.

Mark Wilde, Analyst

Thanks. Good morning. Ray, Chris.

Chris Virostek, CFO

Morning.

Mark Wilde, Analyst

I want to just to start out. Could you give us some guidance on where you see value potential from an acquisition standpoint? I'm just curious kind of, you've been in the European panel market for about a year now, but we're clearly seeing some more of North American lumber deals. Those have been increasingly away from the U.S. South. And then finally, just thoughts around Engineered Wood. So if you could just deal with how you think about relative value in each of those businesses right now, that would be helpful.

Raymond Ferris, CEO

We are considering who should respond to that question. I believe it's a discussion that requires some time, and I would like Chris to also share his thoughts. It's not simply a matter of choosing one option or the other. Currently, I view the U.S. South as one of the most appealing regions, which is receiving a substantial portion of our investment in our lumber strategy. We are making significant progress with our OSB in those areas as well. When it comes to fiber supply end markets, we value our European business, which presents its own unique opportunities. We are highly interested in exploring that region further. These three areas remain our primary focus. While there are other potential areas of interest from a value perspective for West Fraser, we would not overlook a customer to pursue a market. Our priority continues to be these three regions.

Mark Wilde, Analyst

That's helpful. And then Ray, lastly, we get news of another 150 million board feet coming out of the BC interior. Can you just update us on your current thinking around your BC footprint?

Raymond Ferris, CEO

No, thanks, Mark. The BC story continues to unfold. I think the recent announcements about old growth really are just a continuation of the last number of years. So those impacts are going to be additional to the ones that, quite frankly, may still be to come. I think we really don't know the impact to us, but there are still many moving parts to the old growth piece. And so we're very concerned. We think that somewhere between 5% and 15% of the AAC, the annual allowable cut, could be impacted on top of the things that we've seen in the past and may still yet to become. So look, I think I've been very clear. I think our view is the industry is going to continue to shrink and that West Fraser will also shrink. It's just simply the fiber is not there to support everything we do. We're working through that, and I think you've seen us take capacity out over the last few years and timing is always difficult to predict, but we expect over the next couple of years to be reducing our footprint to match the available economic timber supply.

Mark Wilde, Analyst

Okay. And then the last one from me, just when we think about these transportation and logistics issues in Western Canada, particularly around your lumber and panel business, would you say that it's had a disproportionate impact on export sales versus North American sales because it's more of an issue for kind of flows to ports like Vancouver as opposed to flows across Canada or down into the U.S.?

Chris Virostek, CFO

Sure, Mark. I'll give that a try. Anything aiming to reach Vancouver has been significantly impacted. We must also recognize the ongoing container shortage and congestion at the Port of Vancouver, which began in the middle of last year and is expected to persist through 2022, alongside the rail and hand truck issues we're facing. Additionally, there is a considerable challenge in transporting products from British Columbia to the U.S. and Eastern Canada. So, while it's slightly less challenging, it remains quite difficult.

Mark Wilde, Analyst

So it is an element in the equation in terms of what's going on in the domestic North America markets?

Chris Virostek, CFO

For sure it is. From Western Canada, yes it is.

Operator, Operator

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

Hamir Patel, Analyst

Good morning. Ray, you mentioned the growth of your 2x4 mix in the South. Just wondering if you could help us understand maybe just how your positioning there compares to the rest of the Southern industry?

Raymond Ferris, CEO

Good morning, Hamir. And thanks for getting on the call. So, first I'd say I think the point that we're trying to make is in the last quarter when we talked about OSB is that we're not just focused on the commodity piece; we're looking for those opportunities on the industrial and specialty side that are very steady and consistent at the peak of the cycle that may have lower margins, but through the cycle we think returns superior margin. So it was really just a strategy that we focused in the U.S., well, in Canada and the U.S. as far as that goes. When we're deploying capital, when we're looking at acquisitions, we're very much focused on both our cost and trying to make sure that we're in a position to maximize mill nets. So part of your capital strategy is to ensure that you can have some agility to either process different logs or create different products out of the same log. And so that can move around, but with the premium to 2x4, it can have a significant impact on results. So I can't speak to what others do, and I suspect some will be doing the same thing. But I just wanted to highlight that it's certainly a focus for us.

Hamir Patel, Analyst

Thanks for your insights. Regarding the softwood lumber duties, I noticed that in the recent preliminary announcements, West Fraser was the only company that experienced an increase in its rate. Do you anticipate that when the final rates are announced later this year, they will largely reflect the preliminary rates, or do you hope to challenge some of the methodology that may have led to the differing results compared to the rest of the industry?

Chris Virostek, CFO

Yes, Chris here. From our initial reviews, it appears that the final rates tend to be similar to the preliminary rates. Currently, we are seeing a significant difference between our rates and those of the broader industry, which should benefit us for about eight or nine months. Overall, I anticipate that these rates may start to normalize in AR3. We will certainly take the opportunity to appeal any aspects of these determinations leading up to the final assessment. However, having engaged in this process for three years now, I believe both sides are well aware of the issues, and we've not seen substantial movements between the preliminary and final rates in the early ARs.

Hamir Patel, Analyst

Thanks, Chris. That's all I had. I'll turn it over.

Operator, Operator

Thank you. Your next question will be from Paul Quinn at RBC. Please go ahead.

Paul Quinn, Analyst

Yes. Thanks very much. Morning, guys.

Chris Virostek, CFO

Good morning.

Raymond Ferris, CEO

Good morning, Paul.

Paul Quinn, Analyst

Just following up on the increase to a higher percentage of two-by-four. That 7% rise from 2016 to 2021, how much of that is due to your efforts, particularly from the mills? And how much is a result of mergers and acquisitions? I know Gilman was included, and that likely has a larger share of two-by-four in the mix, but could you clarify how that 7% breaks down between what your team achieved and what you acquired?

Raymond Ferris, CEO

Hey, Paul, good morning and great question. Chris or Chris here may tackle me and say something different or better. But I wish I could break that apart for you, but I just don't have that detail in front of me. But, quite frankly, I don't know. Maybe two by ten will become a premium again someday. I doubt that. It's really around, I think, trying to convey a concept that this is a big part of our focus and that we deploy capital to do so. Rather than get fixed on the percentage, it's more around the operating strategy of both trying to produce the right products in the right regions and is a key part of both our acquisition and our capital deployment strategy. So probably not a great answer for you, Paul, but maybe we can expand on that if you have a follow-up.

Paul Quinn, Analyst

Okay. Maybe I'll leave it there. Just on North American OSB, I appreciate the guide for shipment volumes in '21, just wondering how much Allendale is going to contribute to that in '22, and how much Allendale is going to contribute, and then what the incremental shipment increase from Allendale will be in '23?

Raymond Ferris, CEO

Well, 2022 was straightforward, and we don't anticipate any significant changes, essentially none. We're optimistic about getting things underway by the end of 2022, but I wouldn't expect any shipments yet. In 2023, I'm unsure if we provided any guidance, but it will be a startup year. I would expect it to follow a ramp-up pattern similar to Chambord. We're quite satisfied with our progress at Chambord, and typically, I think of Chambord as a good reference point for 2023 regarding Allendale.

Paul Quinn, Analyst

Okay. And then just on the European OSB that the shipment volume in Q4 was a surprise to the downside for us and even understanding the drier build at GENK. So it seems like the market weakened off in Q4, just wondering, you've given us guidance on $1.1 billion to $1.3 billion square feet in '22 here. How confident are you on that number and what the upside in shipments set of Inverness?

Raymond Ferris, CEO

Yes. The gain took about three weeks to achieve. With only two OSB mills in Europe, this situation has a significant impact. Towards the end of the year, we observed considerable price increases in Europe, making it somewhat challenging to analyze all the factors involved. There may have been a slight effect on the marketplace, and we did notice a seasonal slowdown as the year concluded. The weather was quite different from previous years, which adds to the difficulty in distinguishing the effects. However, the beginning of the year looks similar, and I can assure you that our European team is feeling optimistic about our current position. We believe we are in a favorable situation and expect it to align with our expectations.

Paul Quinn, Analyst

Okay. And then just lastly, just on lumber M&A opportunities. I mean, you guys have been over to Europe a number of times for the last decade. Anything over there that you see that could come forward?

Raymond Ferris, CEO

Well, Paul, I mean, we're looking everywhere. So I guess the short answer would be I'm sure there is. But, you know, we look at everything that comes up and if we think that it's something that can make our business better, we're going to spend some time on that. I would say the bulk of the opportunities are still in North America, but we're keeping an eye open in both areas, and I would just say, stay tuned. We like both regions.

Operator, Operator

Thank you. Next question will be from Mark Wilde of Bank of Montreal. Please go ahead.

Mark Wilde, Analyst

Thanks, just a couple of follow-ons. First, Ray, we've heard some stories about pretty significant COVID impacts on different operating facilities late in the fourth quarter and in through January. I'm just curious about what you experienced, both at the end of the fourth quarter and what you've seen so far in the first quarter.

Raymond Ferris, CEO

Thanks, Mark. Look, we probably understated that. Certainly, this fourth wave, the way it moved through and it was similar in the U.S. as it was in Canada. It came very hard, very fast. We saw a significant impact in our operations. Now, we didn't lose significant production. We certainly lost some shipping, but what it had an impact on was a lot of absenteeism, a lot of overtime, and a lot of people moving into jobs that perhaps they hadn't done very well and weren't there, so it had an impact on productivity to a certain extent across the company and in virtually everywhere we operate. I hear similar stories, if you will, on other impacts, but for the most part, it was business as usual. Except this wave was certainly unique compared to the past waves. Now, it's also coming down very quickly. The impact in Europe was certainly less than what we saw in North America. But we're quickly seeing that wave behind us and don't expect to see any impact due to that in Q1. And in Q4, it was a major issue for the management to get through.

Mark Wilde, Analyst

Okay, Chris, I'm curious about the issue of high prices and demand destruction. Based on what you observed last year, what are you monitoring to understand this better?

Chris Virostek, CFO

That's a good question, Mark. We closely monitor our VMI pools to understand our customers' usage. So far this year, the demand for both panels and lumber has remained very strong. We maintain close communication with our customers to anticipate any changes. While we recognized the trends last year and could have responded more quickly, demand has remained very robust this year.

Raymond Ferris, CEO

Hey, Mark, I want to add to that. Looking back over the last few periods, we've observed price fluctuations and some market softening. We've been managing our production to ensure we only build a certain amount of inventory, and the system has its limits on how much it can absorb. Reflecting on five years ago, the industry could respond quickly in terms of supply and shipping volumes. In the past, during dips, I noticed that the influx of wood didn't arrive at the speed or pace needed. So, that’s my observation. Our main focus is on shipping what we’re currently producing.

Mark Wilde, Analyst

Okay. And last one, I don't want this to sound subversive, but just sitting here, you're one of the largest lumber producers in the U.S. If you had a U.S. domicile, could you actually participate in the U.S. discussions around the lumber trade issue?

Raymond Ferris, CEO

No. We've got operations on both sides of the border. You're asking if we could be part of the coalition?

Mark Wilde, Analyst

Yeah. If you were headquartered somewhere other than Vancouver, if you were headquartered south of the border, could you then participate in the coalition and influence?

Raymond Ferris, CEO

Let's not take this as verbatim, but I don't believe so.

Mark Wilde, Analyst

It's striking to me, Ray. When we consider where capital is being invested in the U.S. lumber industry, it seems that most of it is actually coming from Canadian companies at this point.

Raymond Ferris, CEO

Well, Mark. Logic and rational thought often don’t play a role in discussions about trade in the U.S., so I would say the process is designed to prioritize those in the coalition. Anyway, it is what it is; we're working through it. At this stage, we're just managing the softwood lumber agreement or disagreement, if you prefer. There isn't much activity on that front. I believe the most significant catalyst for an agreement would be those focused on reducing inflation in the U.S. and any political pressure that may arise from that.

Mark Wilde, Analyst

Okay. Fair enough. Again, I didn't want to be subversive there, but I do want to also just echo Sean Steuart's comment about how much we appreciate the improved disclosure, including the segment EBITDA bridges that you're now including in the MD&A. So we much appreciate it.

Raymond Ferris, CEO

Well, Virostek forced me to do it. So glad to hear that.

Mark Wilde, Analyst

All right. Thanks. Good luck.

Chris Virostek, CFO

Thanks, Mark.

Operator, Operator

Thank you. And at this time, I would like to turn the call back over to our speakers for closing comments.

Raymond Ferris, CEO

Listen. Thanks for that great questions. I appreciate the comments and attending our call. We look forward to talking to everybody at the end of Q1.

Operator, Operator

Thank you, Mr. Ferris. 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.