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

Good morning, ladies and gentlemen. Welcome to the Q2 2020 conference call. I would now like to turn the meeting over to Mr. Ken Shields. Please go ahead, Mr. Shields.

Well, thank you, Atlanta, and good morning, everyone, and welcome to our call covering our Q2 2020 results. Our Chief Financial Officer, Jordan Neeser, is with me this morning and available to respond to questions at the end of the call. Before jumping into a review of our recent results and performance targets, we wish to reemphasize that our #1 priority continues to be protecting the health and safety of our employees, visitors and their families at all locations we operate. The men and women at our harvesting locations, sawmill site and power plants deserve the credit for enabling us to successfully overcome challenges resulting from the unprecedented global pandemic. We are proud of the fact that no Conifex employee has been infected and owe our frontline employees an enormous debt of gratitude for restoring productivity and extending our record of improved overall safety performance. Let's quickly deal with the housekeeping item and review 3 key points about the financial information we typically refer to on these calls. First, we will be making forward-looking statements and references to non-IFRS measures, and therefore, call your attention to the disclaimer on this on pages 1 and 2 of our MD&A dated August 11, 2020, that we released this morning. Second, our Q2 results and results for the comparative periods last year have been reclassified to exclude the contribution from businesses we sold or wound down last year as well as the 3 U.S. mills we sold in January. Third, we will be making references to adjusted EBITDA from continuing operations, which excludes, first of all, onetime restructuring costs incurred or provided for as a consequence of the aforementioned downsizing. And it also excludes the noncash impact of foreign exchange translation gains or losses on the U.S. dollar-denominated long-term debt we repaid in early February. Coming to the main purpose of our call today. It's to, number one, update you on the prospects for our core business in Mackenzie BC; and second, to review our financial condition. The Q2 collapse in lumber prices caused by COVID-19-related economic disruptions led us to curtail our sawmill operations for 12 weeks out of the 13-week Q2 reporting period. We restarted our sawmill back on July 6 because that's when we became convinced that lumber prices were likely to remain at levels that would enable us to sustain positive EBITDA generation from our Mackenzie sawmill complex. Our power plant produced solid results in Q2, generally consistent with prior second quarter achievements. The plant commenced its usual seasonal curtailment late in April of this year, and power generation is scheduled to resume shortly after the middle of the month. We expect solid EBITDA generation from our power business throughout the balance of this year. The performance indicator we paid the most attention to by far in Q2 was our cash position. Even though our sawmill complex sat idle for 12 weeks, we are pleased that our quarter-end cash balance of $11.5 million was only $600,000 lower than at the beginning of the quarter. We minimized cash usage by, number one, the positive cash flow generated on our take-or-pay power contract; two, the initiatives Jordan and I reviewed with you on our last call, such as eliminating all nonessential controllable expenditures, scaling back capital outlays and actively managing working capital investment levels; thirdly, we have taken and we have additional steps underway to lower our admin and corporate costs; and lastly, we had $2 million in benefit from the Canadian Emergency Wage Subsidy program. These factors combine to produce a modest, and in our opinion, an entirely affordable adjusted EBITDA loss of $1.1 million for the quarter. Looking ahead, we plan to operate at a sum of 12 weeks of the 13-week reporting period and expect lumber production to approach 50 million board feet in Q3. Shipments will be a bit lower than production as we rebuild finished lumber inventories that were depleted in Q2. Q4 should be sequentially stronger in terms of both production and particularly in terms of shipments. Any number of unanticipated production and/or shipment disruptions could hold us back and prevent us from achieving the aforementioned targets. In addition, potential government responses to an active virus add significant economic operational uncertainty to cash flow generation at our Mackenzie sawmill. Lumber industry conditions and cash flow generation can both change quickly. As a reminder, at targeted operating rates, every USD 10 change in lumber mill net sales realizations varies our operating income by approximately USD 2.2 million or close to CAD 3 million on an annual basis. On our last call with you, we stated our objective to emerge as a stronger company once lumber markets normalize. We'd like to review 2 factors that are expected to improve our ranking on the global softwood lumber industry cost curve. The first is the reduction in export tariffs from 20% to 8%, expected to take effect when preliminary duty determinations are finalized in November. The second factor is expected to take effect later in 2021. As I'm sure all of you are aware, the mountain pine beetle infestation started in the central region of the interior BC about 20 years ago and migrated to other regions over the following years. Our industry responded by focusing harvest on beetle-killed stands in order to keep the non-pine stands in the bank for future harvest. Because of our northern location in Mackenzie, the beetle arrived in our area several years after it attacked the pine inventory in the more southern regions. As the shelf life of the early-attacked dead pine stands was reached, the requirement to focus a harvest on dead pine stands was relaxed. This is about to happen in the Mackenzie timber supply area. The harvest partition currently in effect for us and other licensees operating in Mackenzie limits the harvest of live, uninfested trees to 2 million cubic meters annually and 2.5 million cubic meters of dead trees. Last year, the Chief Forester acknowledged that a continued focus on dead, dying and damaged timber may no longer be economically justifiable, and she commissioned a review of the timber supply in the Mackenzie timber supply area. The review is presently underway, and we expect that licensees will be entitled to harvest a more favorable mix of healthy versus damaged timber when the Chief Forester releases her new harvest determinations sometime next year. The effect of this existing harvest partition on us is that a heavy portion of our sawlog requirements are presently sourced from damaged stands. As a result, a well above normal portion of our annual production is low-grade lumber that typically sells at discounts of around USD 100 per 1,000 board feet compared to the prices available from selling construction and premium-grade lumber. This morning, I noticed that Western SPF 2x4 #3 sells for $520 per 1,000, while 2 [ and better ] sells for $727. So you can see that there is a discount on lower grade product of over $200 per 1,000 board feet. By the end of 2021, we expect to transition to a greener harvest mix that's reflective of the profile of the timber inventory remaining in the Mackenzie timber supply area. A change in sawlog diet has the potential to merely -- to materially improve our lumber grade outturns, the potential to boost our overall lumber sales price realizations and EBITDA by at least USD 20 per 1,000 board feet, and thereby move us to a more favorable spot on the global lumber industry cost curve. Turning now to a review of our finances. Our gross debt totals approximately $66 million, mainly represented by a long-term power loan with limited resource to our lumber operations, a fixed rate of interest and a lengthy amortization period. After deducting cash balances, we ended Q2 with net debt of approximately $48 million and a net debt to capitalization ratio of 30% and available liquidity of $11.5 million. Looking at our finances, we differ from the other public SPF lumber producers in 3 main respects: first, a majority of our investment in fixed assets and all of our borrowings are associated with our power business, with its stable and predictable cash flow streams and the remaining fixed price take-or-pay contract with a term of 15 years. Second, our lumber business is debt-free. We, therefore, have no requirement to direct any future sawmill cash flow to pay interest, to repay principal, to fund pension deficits or to fund capital expenditure commitments. And thirdly, we believe we are the only public lumber producer in North America without credit facilities available to help fund seasonal fluctuations in noncash working capital balances. To bring us into line with industry practices and to provide an additional cash cushion for us in case we need one, we are presently liaising with prospective lenders to arrange an ABL facility. Some of you have asked us what we intend to do with the cash we are capable of accumulating if lumber prices remain elevated. This topic also surfaced at our Board meeting yesterday. Our leadership team was asked to present its thoughts and recommendations for reviewing consideration by our Board the next time the Board meets. We understand that a number of factors need to be taken into account to arrive at recommendations concerning capital allocation priorities. One factor, of course, is the need to maintain our strong balance sheet position. Another is the need to fund projects that are necessary to remain compliant with enhanced safety and environmental regulations. A third is the need to fund smaller quick payback projects that improve operating reliability. Since an important portion of our manufacturing costs are fixed or semi-fixed, there is a need to fund projects that enhance operating reliability. And this enabled us to dilute our unit costs by spreading them over an annual production base that's in line with our stated capacity. Beyond these priorities, we have to consider what represents an appropriate balance between investing in our business and returning capital to shareholders. Many of you would be aware that our shares traded an approximate 60% discount to our book value, while other public SPF lumber producers trade at an average premium of 20%. We recognize that returns on shareholder investment in the interior BC lumber sector have recently been lower than in completing -- than in competing supply regions. We also recognize that investor expectations for lower returns typically lead to a more modest trading price relative to book value. However, we believe our return on shareholder investment is poised to increase over time as we move to a greener log diet as further capacity rationalization takes place in the interior BC supply region and as export duties are either reduced or eliminated. Accordingly, we believe that our shares presently trade at a material discount to what we estimate our fundamental value to be. This is why we are seriously evaluating the suggestion that several shareholders have passed on to us to implement a share repurchase program. In closing, we believe our company is well positioned with a strong safety culture, robust and improving fiber availability, industry-leading power generation assets and an entirely manageable debt load. We thank you for taking the time today to learn more about Conifex, and we would be pleased to respond to any questions analysts or shareholders may have. So we'll turn the meeting back to Atlanta, our operator.

[Operator Instructions] The first question is from Hamir Patel.

Ken [ and Jordan ], obviously, you had a record lumber prices at the moment. You touched on some of the pricing dynamics to bear in mind in the -- for the next few quarters with the low-grade mix. What -- based on the length of your order files and if prices hold steady here today, what's kind of maybe a reasonable range for potential EBITDA for Conifex in the third quarter?

Well, Hamir, I'm sure you can appreciate that it is fairly volatile. Jordan and I, we believe that we've used very conservative expectations for Q3, and we've got -- for reviewing our financial situation, we've assumed that there's some softness in prices that developed in Q4. And the only thing I can tell you is that I think I saw some recent investment research report that indicated that for the full year, we were -- the consensus was that we had something like $6 million to $8 million of EBITDA, and Jordan and I would be disappointed if we didn't achieve at least some of that.

Okay. That's helpful. And just in terms of your production geographic mix as you've ramped up, are you -- how -- what's your ability to maximize that North America return? Are you still shipping, offshore? Can you just maybe give us a sense as to where the wood is going at the moment?

Sure. I think our Q3 and Q4 numbers will indicate that we have something like 5% of our output going to Japan. We've got customer base there that's been very loyal and have paid premium prices to North American prices for virtually every quarter we've been in business, except the most recent one. So we're still going to meet that customer demand. About 25% of our lumber is evenly split, 12.5% to Canada and 12.5% to China. And China, of course, is mainly the low-grade 2x6 that we produce. And so we think we've got at least 70% going into the U.S. market.

Okay. Great. And just maybe a final question for Jordan. Should we expect any government grant benefits in Q3?

We're looking at it now. As you may know, the rules changed slightly in the period of July through the end of the year. And with the restart of the mill, we're certainly expecting a significant run-up in revenue and accordingly disqualifying us from any further subsidies. So there may be a small amount in Q3, but certainly not to the $2 million that we saw in Q1 -- I mean in Q2.

[Operator Instructions] The next question is from Paul Quinn.

Maybe if you could -- you talked about the mix change within the Mackenzie TSA. Maybe you could give us a percentage of current dead, current live, and what that associated stumpage rate is on both and what your blended is?

Sure. Okay. I'll take that -- a shot at that. Our current harvest mix for this year will be about 45% green, and that was at times earlier in this year, we were as low as 30% green. And as we end the year, we'll be at about 50% green. And we think it should improve a bit in the early part of 2021 from that. We're finding that there is a differential between the green stumpage rates and the stumpage rates on the dead and dry, and we try and balance those 2 sources so we don't end up with a big stumpage bill at the end of the year. In terms of the remaining timber inventory in the timber supply area, what happens when a timber supply review is undertaken, that they go and they assess all of the harvestable timber inventory that's on the forestland base. And the current guesstimate, the last number I saw, Paul, was that there was something like 112 million cubic meters of green timber and maybe 15 million of dead and dry. So if those numbers prove to be accurate -- and we haven't yet got the data package from the minister for us as to what their assessment is, but it could support a harvest going forward that is dominated by green timber. And green timber, of course, besides the higher grade out-turns, you have fewer disruptions when you're processing green logs so your sawmill runs better, your lumber recovery factor is higher, and you've got less breakage and disruption in your harvesting business. So we see that 2021 will be a transition year as we wind down the salvage obligations we have and transition to a harvest mix that's more representative of the remaining inventory in the TSA.

Okay. Yes, I just found the timing quite interesting when they do the review, and a lot of it would have been uneconomic at last year's lumber price. But I suspect all of the debt is totally economic at today's lumber price, right?

Well, what happens is that there's an economic shelf life consideration. It depends on the price of lumber, but there's also a biological shelf life. So as stands blow over when they've been dead for 12 or 15 years or as they're impacted by forest fires, there's a loss in the remaining get-time inventory from those natural causes. So not all of the dead pine stands are going to continue to be available for harvest because of those factors that I mentioned.

Okay. And just sticking with non-pine deal, you mentioned further BC interior capacity reductions. What do you actually think those to be?

There was some work done a number of years ago that's predictive on, I think, something like 5 or 7 mills. And my guess is that there's 2 or 3 left to go. As you correctly pointed out, Paul, that these elevated lumber prices will keep certain mills operating with a damaged log diet. So that will extend the life of mills in certain locations, but it is a correction on lumber prices. It will be similar to what it did this year and in the back end in 2019 and accelerate mill closure.

Okay. And then maybe just lastly, I think BC Hydro has been in the news a lot the last couple of months on changing the way they're doing business with independent power producers. I'm just wondering if you could remind us what your -- the length of your contract is left and whether any of those changes that they've done affects your contract going forward?

We're not aware of any change in any of the term -- in any term of our contract, and it's got a 15-year remaining life.

There are no further questions registered at this time. I would like to turn the meeting back over to Mr. Shields.

Okay. Well, just a final thank you for your interest in our company, and we very much look forward to reporting our -- what we expect to be a material rebound in cash flow generation when we announce our Q3 results. Thank you, and enjoy the rest of your week.

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