Conifex Timber Inc. (CFF) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen, welcome to the Conifex Timber Q4 2019 Results Conference Call. I would now like to turn the meeting over to Mr. Ken Shields, CEO. Please go ahead, Mr. Shields.

Well, thank you, Valerie, and good morning, everyone, and welcome to this call covering our Q4 '19 and full year 2019 Results. Our Chief Financial Officer, Yuri Lewis, is with me and available to respond to questions you may have at the end of the call. The financial results we released this morning disclosed that we incurred a significant loss in 2019 due to a combination of operating losses and noncash write-downs of goodwill associated with discontinued operations. Looking at operating losses, these primarily reflect weak lumber pricing and the margin squeeze that impacted interior BC lumber producers. We responded by tightly managing controllable expenses and working capital, and by scaling back CapEx. Later in 2019, we indefinitely curtailed our Fort St. James and El Dorado, Arkansas mill. The operating loss of $40.2 million for 2019, primarily represents our Fort St. James and Mackenzie operations as well as corporate and unallocated items. We incurred an operating loss of $21.6 million from discounted operations in 2019. Turning to the nonoperating losses. These include the net results of the divestiture initiatives we arranged or completed in order to restore our viable ongoing financial position. We sold Lignum Forest Products and the rights to certain of our duty deposits in the first half of last year, and then as you're all aware, on November 1, 2019, we successfully concluded the sale of our Fort St. James business for approximately $38.6 million in gross proceeds. Referring back to the last call I had with all of you on November 15, 2019, we advised you that at that time, that based on the most up-to-date information we had reviewed, we believe, and I quote, "The sum of the price indications we expect to receive for our 3 U.S. mills is considerably greater than the amount we owe our bank syndicate." On February 1 of this year, we completed the sale of our U.S. sawmill business and used the proceeds to fully repay the bank syndicate. At that closing date, lumber and corporate segments were debt-free, and we had approximately $20 million of unrestricted cash. Also at that date, our present long-term debt is represented by approximately $63 million in nonrecourse power generation loan. And on a consolidated basis, at that date, we had net debt of approximately $43 million, which translates into a net debt to capitalization ratio of approximately 25%. And while it's highly disappointing to report losses of this magnitude, I have to let you know that I'm extremely proud of how the Conifex team responded to these difficult industry conditions and I'm very pleased with the team's success, divesting assets and repaying our lumber segment loans. I'm particularly proud of the work that CFO, Yuri Lewis; and VC of Finance, Jordan Neeser; and other team members completed in connection with the U.S. divestitures. And as we indicated, that with so much of the heavy lifting done, Yuri Lewis believed that it was an appropriate time to consider a retirement that she had in the back of her mind for some time. So we formally announced her retirement yesterday, and she's left us in strong hands because Jordan Neeser, our VP of Finance, will be appointed to the role of CFO effective April 1. And on our next call with you, it will be Jordan and I that are together on this call. Responding to the feedback that we recently received from several of you, we're going to use our time this morning to talk about the outlook and prospects for our Mackenzie lumber manufacturing business and our power generation business. We have -- we wish to remind you that we will be making forward-looking statements and references to non-IFRS measures, and we therefore call your attention to the disclaimer on Pages 1 and 2 of the MD&A dated March 10, 2019, that we released this morning. Turning to power generation. Now that we've sold our U.S. mills, a majority of our investment in long-term fixed assets is accounted for by power generation. And as you see from our results, the business continues to provide a stable and predictable cash flow. But because this business also provides societal and environmental benefits, it's an important reason why we believe Conifex is well positioned to help further the province of BC's strategic objectives with respect to carbon mitigation and the enhanced fiber utilization. The business achieved EBITDA of $13.9 million in 2019 versus $14.1 million in 2018. We expect similar results in 2020. Slightly over 1/2 of this EBITDA is presently utilized for debt service, while the balance is available to shore up our lumber operations. Looking ahead to when there's evidence that sustainable cash flow generation has been restored in the interior BC lumber industry, we believe that the discretionary EBITDA from power generation will provide us an opportunity to review initiatives to further enhance shareholder value, such as funding the share buyback program. Turning to lumber manufacturing. On our last call, we reviewed our expectations for capacity and log cost reductions in the interior region of BC. We explained why we believed cash flow generation was bottoming out and transitioning towards more investor-friendly economics. We continue to explore opportunities with the segment. In Q4 of 2019 and Q1 of 2020, we saw further evidence that BC lumber producers are managing their business in a more financially responsible manner. For example, one major player publicly disclosed that it has adjusted it's BC capacity to more closely align with the available timber supply, and that it has gone further and implemented variable operating schedule at several BC operations to further adjust to the economic available log supply. So log costs are coming down in BC because there's less demand for purchased wood now that manufacturing capacity has contracted. And furthermore, there's a greater likelihood that SPF lumber prices will average out at above-normal levels due to the more favorable supply-demand balance that I referred to. At Mackenzie, we operate a 2-line sawmill with 240 million board feet of annual capacity. Our SPF dimension lumber is sold in the U.S., China, Canada and Japan. The mill is supported by a forest license with a total allowable annual cut of 632,500 meters in the adjacent Mackenzie timber supply area. We also own 50% of another forest license with a total AAC of 300,000 cubic meters. We are confident in our ability to sustain sawmill operations since we draw on the TSA with the second-largest allowable annual cut in the interior region of BC. Of more importance, though, is that the harvest level in Mackenzie has been exceeding local sawlog consumption. And this has resulted in around 1 million cubic meters of sawlogs each year being shipped out of McKenzie South to fiber-deficit sawmills in the Prince George region. Looking at our mill, our lumber production in the first half of 2020 is being adversely impacted by the tight liquidity conditions we experienced in the second half of 2019. Simply put, we have too little financial resources available to us to build log depths up to the levels necessary to support full operating rates. Accordingly, we expect our Mackenzie sawmill to operate at about 2/3 of capacity in the first half of 2020 and then ramp up to 90% plus of capacity in the second half of 2020. Besides the reduction in cash flow resulting from lower production in the first half of 2020, our unit logging and our cash manufacturing costs per 1,000 board feet of lumber are at above normal levels since we have not yet able to spread our fixed costs over the full production potential of our harvesting and manufacturing business. While our EBITDA will be modest in the first half of 2020, we expect a much stronger second half. Lumber and log production should both be higher, which means that our unit costs are expected to be lower. Additionally, lower stumpage rates take effect on July 1, while lower duty rates on U.S. exports take effect around the middle of August. We continue to explore other opportunities with the Ministry of Forests, the district of Mackenzie, local First Nations groups, and other Mackenzie stakeholders to identify initiatives available to us to further reduce delivered log costs. Turning to corporate costs. We've taken many steps to bring our corporate and administrative costs in line with our smaller operating footprint. Our MD&A indicates that these costs amounted to $7.1 million in 2019. On an annualized basis, these costs are expected to be something like 50% lower in the first half of 2020 and perhaps as much as 75% lower in the second half. The lower costs are primarily a function of lower headcounts and the discontinuation of nonmission-critical corporate services. The steps we've taken to streamline our management structure are an important factor behind the aforementioned reductions in corporate costs. And while it is always difficult to see management partners transition to retirement or to new careers, I'm pleased with the depth of the management bench we have in place at Conifex and the team's capability to guide our future operations. I'm also inspired by the sense of unity and commitment to improved performance that our current management team has demonstrated. In summary, we believe Conifex has turned the corner for 5 main reasons: one, our corporate and lumber segment net debt has been eliminated; two, the sawmill industry cash flow cycle in BC is moving in our favor; three, our per unit log and cash conversion costs are poised to decline; four, we have dramatically reduced corporate costs; and five, we expect to benefit from lower duty rates and lower stumpage rates. Against that background, we'll call our prepared remarks to a halt, and we are very pleased to respond to any questions analysts and shareholders may have. Thank you, and I'll turn the meeting back to Valerie.

[Operator Instructions] Our first question is from Roshni Luthra with CIBC Capital Markets.

I just had a question about your CapEx this year. What are you expecting to spend in 2020?

In 2020, we're expecting to spend approximately $2.75 million. About 46% of it is routine maintenance, such as motor rebuilds, et cetera, and about 54% of it is a series of high-return capital, individual capital projects, primarily designed to either improve throughput, lumber recovery or grade recovery.

Okay. And then just talking about BC fiber costs in 2020, you do expect them to be lower, obviously, after the July 1 recalculation. But do you know what you maybe expect them to be this year, like being quantified?

Well, we have some further cost-reduction initiatives, that we're exploring that path. But for the time being, we're fairly confident that we've got in the first half of the current year probably a 6% reduction in delivered log costs. And in the back -- compared to the average that we incurred in 2019. And then in the back half of 2020, we think it could be as much as a 12% reduction once we get our logging activity ramped up.

[Operator Instructions] Our next question is from Paul Quinn with RBC Capital Markets.

Ken, just a question on, I guess, lumber markets here. We've seen Western SPF come up nicely. Part of that was, I guess, through rail and transportation bottlenecks and prices have come off. What do you expect prices to be for the balance of the first half of the year?

Well, first of all, Paul, it's probably easier to predict -- stock prices are as easy as it is to predict lumber prices. But one of the fundamental differences that I observed between the stock market and the lumber market is that when there's a disruptive event, equity markets' trading volume skyrockets and cash lumber market transactions essentially are almost curtailed. So we don't have a real good indication as to what the true cash market is today because when the -- when things started to unwind 10 days ago, most interior BC sawmillers had 3 or 4 week order books, and some of them had some price protection in the form of the future markets transactions that they'd entered into. So there hasn't been a whole bunch of urgent need to sell lumber in the cash market from what I see. And so I think that we'll have a better indication probably one week from today because there should be more normal sales, some of the producers will have to start taking orders. And then, of course, Paul, I think we get the housing starts figure next Wednesday morning. So I think what the prices end up doing in the second half of next week will be a pretty good indication as to what we can expect through the first half of 2020. For budgeting purposes, we're still roughly in line with the [ FTA ] number of around $400 for the year. If we were having this conversation 3 weeks ago, we would have pointed out that futures supported average price realization is materially above that. And today, it looks like the futures would suggest that $400 is a bit ambitious. But for planning purposes, right now, we're still using $400, but we update our cash forecast on a monthly basis to make sure that our financial integrity is maintained.

Okay. And then expectations for -- on the bioenergy side this year?

Sorry, I didn't quite hear you.

Sorry, the expectation on the bioenergy side this year?

Yes. Well, I said that we did $13.9 million of EBITDA last year and $14.1 million the year before that. And I don't see any reason -- there's nothing apparent to us at this time that would suggest we're going to be materially different than the traditional bands that we've reported.

Okay. And just lastly, we've seen a market drop in pulp prices and I suspect there's a number of BC interior pulp mills that are negative here. Are you seeing any pullback in sort of orders on the chip side?

We haven't, but we wouldn't really expect to see curtailments until there was greater certainty that the weather is warmer and the mills are less at risk by taking downtime.

[Operator Instructions] There are no further questions registered at this time, I would like to turn the meeting back over to you, Mr. Shields.

And I'm going to turn it over to Yuri Lewis for her closing remarks.

Thank you, everybody, for your support over the years and certainly our tenure here. And we look forward to handing -- to my impending retirement and handing things over to new Conifex management team, including Ken, of course. So thank you, everybody, for your support.

Okay. Enjoy the rest of your day, everyone. Thank you.

Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.