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

Good afternoon, ladies and gentlemen. Welcome to the Conifex Timber Incorporated Q3 results conference. I would now like to turn the meeting over to Mr. Ken Shields. Please go ahead, Mr. Shields.

Well, thank you, Justine, and good afternoon, everyone, and welcome to this call covering our third quarter 2020 results. Chief Financial Officer, Jordan Neeser, is with me and available to respond to questions you may have at the end of the call. Before moving ahead, we wish to reemphasize that our #1 priority continues to be protecting the health and safety of our employees and their families. The men and women at our harvesting locations, sawmill sites and power plants deserves the credit for ensuring a safe work environment during this unprecedented global pandemic. We are very proud of the fact that no Conifex employee has been infected, and we owe our frontline employees an enormous debt of gratitude for restarting our plants and concurrently extending our record of improved safety performance. Let's quickly deal with 3 housekeeping items. First, we will be making forward-looking statements and references to non-IFRS measures and, therefore, call your attention to the warning statements set out on Pages 1 and 2 of our MD&A dated November 10, 2020, that we released an hour ago. Second, our results for comparative periods have been reclassified due to the contributions from businesses we sold or wound down in 2019 and again in January of this year. And third, we will be making references to adjusted EBITDA, which excludes onetime restructuring costs incurred or provided for as a consequence of the aforementioned events. The main purpose of our call today is to, number one, update you on our performance following the restart of our sawmill complex and power plant; number two, share our performance and financial expectations for the balance of the year; three, review our finances; and four, summarize the rationale behind our decision to proceed with the normal course issuer bid. Turning to our third quarter results. We restarted our sawmill complex on July 6. Hourly production improved as we progressed through the quarter. Third quarter lumber production was 48 million board feet. After rebuilding inventories to a more normal level, our shipments came in at 39 million board feet. Following our seasonal dispatch period, we restarted our power plant in the middle of August, and that plant quickly regained and achieved its targeted production level. For the quarter, we reported net earnings of $2 million, equivalent to $0.04 per share after a provision for noncash income taxes. EBITDA was $7.6 million. Our Q3 EBITDA and pretax income were both held back by $2.6 million in losses on lumber futures contracts. Let me explain the background. In Q2, we committed to a robust summer logging program to support our lumber production through the second half of 2020. Back then, our liquidity was modest and was expected to remain modest until we had sufficient time to arrange an ABL facility or sufficient time to generate additional cash flow from operations. Accordingly, we used lumber future contracts to protect a portion of our second half 2020 lumber cash flow because we wanted to prevent unfavorable changes in lumber prices from putting us in a weakened liquidity position. During Q3, as we gained lumber price protection benefits by building up our lumber credit file, we reduced our exposure to future contracts. But as all of you would be aware, lumber future prices skyrocketed over the period we built up our order file, and the aforementioned losses were realized. Looking at cash usage associated with our Q3 production ramp-up, we invested $12 million in inventories and receivables in the quarter. We also funded $2 million in reforestation activity and $1 million in capital expenditures. Despite some aggregate outlays of $15 million, our quarter end cash balance was only $5 million lower. And we ended the quarter with unrestricted cash of $6.4 million. The net income and EBITDA we reported are after expensing CAD 3.7 million in duty deposits in the quarter. We now have USD 6.8 million on deposits that are potentially reimbursable to us. Turning to our fourth quarter outlook, we expect stronger results in Q4, even though our costs are likely to be higher and even though benchmark prices will likely average out at a lower level. The main factors supporting an improvement in our results are, number one, lumber production is expected to increase; and secondly, shipments are expected to increase by an even greater amount and match the higher production; number three, we're entering a quarter of seasonally higher power prices and cash flow generation; number four, we have a new residual chip sales contract in place, and we will commence delivering residual chips in the next few days. If you look into the details of our financial statements, you will see that we did not record any material revenue from the sale of residual wood chips in the third quarter. And the last reason is that we do not anticipate any material losses from any lumber hedging activities we may consider or undertake. For all of these reasons, we expect improved EBITDA and net earnings in Q4. We also expect our unrestricted cash balances to be fully restored to the levels we reported at the end of Q2 and Q3, even after allowing for funding the seasonal build-up in log inventory. But of course, any number of unanticipated production and/or shipment disruptions could hold us back and prevent us from achieving these targets. An additional consideration is that potential government responses to an active virus adds significant economic and operational uncertainties. As we witnessed in Q3, lumber industry conditions can change quickly. As a reminder, at our targeted operating rates, every USD 10 change in lumber mill sales realizations varies our operating income by USD 3.2 million or close to CAD 3 million on an annual basis. Turning to our finances. Our gross debt totals approximately $65 million, mainly represented by a long-term power loan with limited recourse to the lumber operations with a fixed interest rate and the benefits of a lengthy amortization period. After deducting cash balances, we ended the quarter with net debt of approximately $65 million and a net debt-to-capitalization ratio of 32%. We also had available liquidity of $6.4 million. However, on October 13, we arranged a $10 million revolving credit facility secured by our lumber receivables inventory and equipment. And with this extra cash cushion, our pro forma liquidity has risen to $16.4 million. We differ from the other public SPF lumber producers in 2 main respects. The first is that a majority of our investment in fixed assets and all of our borrowings are associated with our power generation business with stable and predictable cash flow streams from a fixed price take-or-pay contract with a remaining term of approximately 15 years; and secondly, aside from some equipment leases, our lumber business is debt-free. We have no requirement to direct any future sawmill cash flow to pay interest, to repay principal, to fund pension deficits or to fund any material capital expenditure commitment. During our last call, I indicated that our Board of Directors would review the merits of launch in a normal course issuer bid at the meeting of the Board that was held this morning. Our Board concluded that we will seek regulatory approvals for an NCIB, and we hope to have the bid approved and in place by the end of November. Our analysis indicates that we can afford to fund a stock repurchase program and concurrently maintain our strong lumber business balance sheet and also fund projects that are necessary to remain compliant with enhanced safety and environmental regulations as well as projects that have quick payback opportunities for us. And that also improves our operating reliability. We plan to launch the NCIB because we believe our shares create a material discount to fundamental value. Here are the 2 main reasons why we have this belief. Firstly, we trade at a 50% discount to book value, while other public BC-based SPF lumber producers trade at premiums to book value of between 10% and 75%. And while we recognize that returns on shareholder investment in the interior of BC lumber sector have been lower than in other [ supplied ] regions, we also recognize and appreciate that investor expectations for lower returns typically lead to more modest trading prices relative to the underlying book value. However, we believe that 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 region of BC and as export duties are reduced or eliminated. The other main consideration was that given our present equity market capitalization, the implied value of our company on a per unit of lumber capacity basis is way, way below the price we received for sawmill dispositions we recently successfully completed. Against this background, we trust you'll agree with us that share repurchases, A, represent a good use of the surplus cash we anticipate generating under current and immediately foreseeable lumber market conditions; B, can be undertaken without compromising our ability to meet the reasonable expectations of all other shareholders; and C, are in the best interest of Conifex shareholders. In closing, we believe that our company is well positioned with a strong safety culture, a high degree of fiber self-sufficiency, near-term opportunities to improve fiber quality and product mix, industry-leading power generation assets and an entirely manageable debt load with its dependent debt service obligations. We thank you for taking the time today to learn more about Conifex and would be pleased to respond to any questions analysts or shareholders may have. Against that background, we'll turn the meeting back to Justine, our operator.

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

Ken, what level of correction volumes are you targeting for 2021?

For 2021, we are certainly anticipating to capture as much as 240 million [indiscernible] board feet. And we'll have more confidence in that number if we reach our target of around 55 million board feet in the current quarter.

55 million, 54 million. Okay, that's helpful. And then, Ken, can you speak more about that residual chip contract? Are you able to say who that's with? And maybe how pricing compares with your prior arrangements?

Well, first of all, Hamir, we can't discuss pricing. And secondly, there's only one major pulp company operating in the Northern interior region of BC in the region where we operate. So you can have a good guess and say who the contract would be with.

Okay. That's helpful. And Ken, just the last thing I was wondering was, I've noticed some producers in Québec have been able to use their duty deposits as collateral for financing. I know you guys kind of pioneered actually monetizing duty deposits fully. But are you -- do you see a path where you could also use them as collateral for some of your lending needs?

The impression we have is that the province of BC and the Ministry of Forest are very cautious in terms of proceeding with any initiatives that may draw the attention of the U.S. coalition. And Hamir, with our essentially debt-free lumber business with the exception of leases and with the cash buildup that we’ve had in the 5 or 6 weeks since the end of the quarter, we're not investigating any opportunities to borrow against our duties. Our duties, as you're probably aware, are USD 6.8 million or approximately CAD 9 million at September 30 because -- and that's the refundable portion that we're entitled to. But because 100% of our production is subject to duty, unlike the other public companies, we expect our duties to grow at a more rapid rate than is true for the other public companies as we move forward.

And Ken would you then maybe look to potentially monetize your duty deposits to finance some of the buybacks?

No, I think that, Hamir, as we look at the trade style, as you have written about, there's been a rapid escalation in stumpage rates in Alberta. We're experiencing significant stumpage rate increases in BC. We're still [ relying ] behind those cost increases is that there's powerful evidence being built up that log costs in BC are higher than in the U.S., not lower. So as we see it, that really undermines the heart of the U.S. coalition's argument in support of duties and tariffs on Canadian shipments to the U.S. And so we're feeling more optimistic about a resolution of the trade dispute because of these divergences in log costs on both sides of the border.

Our next question is from Paul Quinn.

On the new residual chip sales contract, are we expecting more money or less money than we had under the previous one?

We are expecting slightly better terms than under the previous one, and the additional flexibility we have, Paul, is that when pulp prices are very low, residual chip prices in the interior of BC are very low. And we continue to make a lot of money from our power generation business. And so we can very profitably use the chips in our power business if we're unsettled with the price that's available from selling residual chips on the open market. So we've got a bit more flexibility because of the power plant. And we don't detect any material disadvantage to [ opt-in ] Mackenzie because as I'm sure you know from the comments on some of the calls from the pulp producers that have mills in our general area, there has been a shortage of residual chips, and there’s been a movement to having pulp producers obtain more of their fiber requirements from more expenses in forest sources rather than residual chips.

Okay. And then in terms of the fiber requirements for the biomass facility, what percent right now is chips?