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

Good afternoon, ladies and gentlemen. Welcome to the Conifex Timber Inc. 2021 Q1 Results Conference Call. I would now like to turn the meeting over to Mr. Ken Shields. Please go ahead.

Well, thank you, and good afternoon, everyone, and welcome to this call covering our Q1 2021 results. With me today, we have Chief Financial Officer, Winny Tang and Operations VP, Andrew McLellan. So I'm going to make some opening remarks, and then I'll hand the call over to the 2 of them, and then I'll have some closing comments, at which time all 3 of us will be pleased to respond to your questions. Before moving ahead, first, we wish to reemphasize that our #1 priority continues to be protecting the health and safety of our employees and their families. And the men and women at our harvesting locations, our sawmill site, our power plant, they all deserve the credit for ensuring a safe work environment during this unprecedented global pandemic. Second, let's quickly deal with the housekeeping item. 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 the MD&A document that we released earlier today. Turning to our first quarter. Net earnings were $4.5 million or $0.10 per share, and EBITDA was $9.7 million. And I know many of you've skilled, acknowledged and our core products analysts on this call were expecting stronger results from us in the first quarter. One reason, our Q1 results came in below consensus was that we expensed 13 weeks of power plant costs that produced electricity for only 6 weeks. On our last call, we alerted you that the proceeds from our business interruption insurance claim will likely be booked in Q2 or Q3 of this year. Had we booked what we estimate the insurance proceeds to be, Q1 EBITDA would have been right in line with consensus. The other reason that our Q1 results came in below consensus was that we only shipped 10 weeks of the lumber we produced in the 13-week reporting period. Although Q1 lumber production climbed to 51 million board feet, shipments of 37.8 million board feet were much lower. Our ratio of SPF shipments to production was 74%, far below the 90% shipment to production ratio BC's 2 largest SPF producers averaged in Q1 of 2021. Clearly, [indiscernible] rail car delivery shortfalls were more pronounced in the Mackenzie region than in other parts of the province. To mitigate the buildup in finished lumber inventories, our sales and logistics team stepped up truck deliveries. And by doing so, we incurred extra delivery costs in the quarter. Subsequent to the quarter end, we've shipped the lumber that was built up. The mill net selling prices we realized on these shipments were $200 per 1,000 board feet higher than we achieved on our Q1 shipments. The key point here is that besides lowering revenues, rail car shortages added to our costs and lowered the mill net selling price realizations we recorded in Q1. Had we achieved a ratio of shipments to production in line with the 2 majors, we would have exceeded consensus Q1 EBITDA forecast. We are encouraged that to date in the current quarter, rail car deliveries have improved and [ weekend ] shipments have consistently exceeded production. Should this continue for the next few weeks, our lumber production and shipments are expected to be in balance by the time we report results for Q2 in this year. I now have the pleasure of turning the meeting over to Andrew McLellan, our Vice President and General Manager, Northern BC Operations for context.

Thank you very much, Ken, and good afternoon, everyone. Let's start with lumber. Our Q1 lumber production was 5% higher than Q4 of 2020. However, our shipments were approximately 23% lower. On my last call with you, I explained how we and certain other sawmillers in the Northern interior region of BC experienced challenging weather conditions last winter, which led to log harvest and delivery shortfalls and retarded lumber production in the first half of 2021. We plan to boost lumber production as soon as we have the benefit of summer log deliveries starting next month, and we continue to anticipate our full operating rate will exceed 90% of our 2 shift rated capacity of 240 million board feet in 2021. Any number of pandemic related or unanticipated production and/or shipment disruptions could hold us back and prevent us from achieving the production target. However, on a full year basis, 2021 lumber production is anticipated to be 70% higher than our 2020 results. The BC Ministry of Forests has a timber supply review underway for the Mackenzie timber supply area, and the Chief Forester expects to release a new harvest level determination sometime around the end of the year. We have 2 major studies underway at present that are related to this coming announcement. One, focusing on the characteristics of the sawlog supply we expect to process over the next decade and beyond at our sawmilling facility and a second study focusing on the potential to boost our lumber production capacity at Mackenzie by approximately 25%, lower our cash conversion costs as well as improve our lumber recovery and grade out-turns at our Mackenzie facility. We expect to sell our plants for expanding and modernizing our Mackenzie sawmill site shortly after the release of the new harvest level determination. I'll turn now to the power generation business. Our power plant continues to achieve its daily power production targets since the plant restarted in late February. And at this time, I'll turn the discussion over to my colleague, CFO, Winny Tang. Thank you.

Thank you, Andrew, and good afternoon, everyone. And just so we're turning to finance. Overall debt at our quarter end totaled approximately $62 million. This is mainly represented by a long-term power loan with limited recourse to our lumber operations, a fixed interest rate and a lengthy amortization period. After deducting cash balances, we ended quarter 4 with net debt of $49.9 million, a net debt to realized -- capitalization realized ratio of 29% and available liquidity of $16.4 million. The $10 million revolving credit facility we had arranged late last year remains undrawn. In December 2020, we had commenced our normal course issuer bid, which allowed us to repurchase and cancel up to 2.9 million shares. To date, we have repurchased and cancelled 922,800 shares at an average price of around $1.60 per share. We view share buybacks as an appropriate use of the excess cash we anticipate generating in Q2 through to the balance of the year. We continue to believe our share price trades well below our estimate of fundamental value. I will now turn the meeting back to Ken.

Well, thanks, Winny and Andrew. Just as a reminder, we differ from the major public SPF producers in the sense that we pay duty deposits on nearly all our lumber shipments. The other public SPF producers do not. Accordingly, duty deposit expenses impact our pretax earnings to a much greater expense than the other public companies. For example, we achieved pretax income of $6.3 million in Q1 of this year after expensing $2.5 million in duty deposits. For us, duty deposit expenses represented just under 40% of our pretax income, while it ranged between 3.5% to 5.2% of pretax income for the larger, more diversified SPF producers. It follows that if there is a resolution of the trade dispute and furthermore, duties are eliminated, it's clear that the impact on cash flow generation in our company will be considerably greater than for the other public companies. As a [ corrarity ] to this point, we are building an off-balance sheet asset in the form of potential duty refunds. And these duty refunds will likely represent a greater proportion of our equity market capitalization that is true for the larger, more diversified companies. We now have USD 12.3 million on deposits that is potentially refundable to that. Given our expectations for lumber prices and shipments for the balance of 2021, this number will likely exceed USD 20 million by the end of the year. This will represent a materially higher percentage of our present equity market capitalization and is true for the other companies. While we appreciate that the timing of the settlement and the likelihood of a full or partial refund of duties is highly uncertain, history suggests it's highly likely that our balance sheet will be further strengthened at some future date. Before turning the meeting over to your questions, we are pleased that we have the ability to release our inaugural ESG report this afternoon. All of us at Conifex are very proud of the track record we've compiled in terms of each of the metrics covered in the report. In closing, lumber markets are strong, and we expect to report record Q2 and full year earnings for the reasons set out on Slide 11 of the presentation we released an hour ago. So thank you for taking the time today to learn more about Conifex. We're pleased to answer any questions you may have. So we'll turn the meeting back over to Roxanne, our operator.

[Operator Instructions] We will take the first question. Hamir Patel.

Ken, can you -- you brought up a point about your duty burden being higher than some of your peers. I guess I'm just curious, in this very strong market, what is even compelling you to sell into the U.S.? I'm assuming there's no Canadian discounts. So why can't -- why wouldn't you try place all the products domestically?

Well, first of all, when we reviewed that this morning at our Board meeting, we found that the mill net sales price realizations depending on the product were pretty similar between the 2 markets. And we're selling roughly 80% in the U.S. The customers that we have in the U.S. have been loyal to us for a long period of time, effectively lumbers on allocation and the people that had been supporting us through good and bad lumber markets are being served now. We have about 8% of our lumber going to Japan is a definite lower realization on Japanese lumber prices because those prices are set up in advance. And as you well know, cash lumber prices have increased $500 per 1,000 Board feet in the last 5 weeks, and we'll be up a game when they're reported tonight. So Japan has low realizations, but it typically has fully competitive realization. So that's how we're looking at the business, Hamir.

Okay. And that's helpful. Andrew, I was -- wanted to follow-up on the capital projects that you mentioned, a potential capital project at Mackenzie, which could potentially drive a 25% capacity increase. What would -- if you were to go down that road, what would be the CapEx and timing of when -- how quickly that production growth would come on?

So with -- at this point, Hamir, we're engaged with an engineering firm in preliminary design, and general arrangements are available. And we're currently working on identifying lead time for equipment. So it will be a bit early for me to give an indication in terms of timing our capital at this point. But we have committed the funding to do the front-end engineering work and come up with those answers likely in Q2 or Q3.

Great. And just so last one for me. Ken, the premier, they've made some -- a lot of comments about how you want things to evolve in BC with forestry policy and tenure. And just curious to get your thoughts as to how that potential changes could impact Conifex and your lumber basket specifically?

Okay. Well, that's a very meaty question that you've posed, Hamir. Here is our take on the situation. There are 2 important announcements expected later this month. One, is the release of the intentions paper, which I think will provide more detail on some of the comments of the premier made at the [indiscernible] convention in the early April. And the second is the -- a lot of the harvest in the Prince George timber supply area, which is the largest TSA in the interior region of BC. And about 3.5 years ago, the Chief Forester concluded that the harvest level needed to be established at a considerably lower level than it was previously, but there was still some pine beetle salvage harvest activity underway. But the ministry has never disclosed how they intend to divide up the harvest between BC Timber Sales, between First Nations and what portion would be remaining for licenses. So it seems clear to me that certainly Conifex's expectation is that in order to remain at your present level of fiber self-sufficiency, you're going to have to -- have some log purchase agreements or arrangements with First Nations. So the effect on BC -- in BC, one thing we know for sure is that the harvest levels are going down over the next few years because the salvage programs are close to being exhausted. And the second conclusion is that for many companies, their degree of fiber self-sufficiency as measured by the 10 years under their controlling direction as a percentage of the total log requirements, that degree of self-sufficiency is going lower. And there will be a heavier reliance on purchases from other tenure holders, namely BC Timber Sales and First Nations. So that's what we see happening, Hamir. And that's why we have -- as Andrew explained, we're commissioning these reports, so we can come up with an ideal optimization plan for our Mackenzie site, but it's important to us that we know more about the volume and characteristics of the fiber available to us through Mackenzie before we can finish up our engineering work. So that's why it will be late this year, likely following the release of the PSR review before we can precisely set the specifications for a modernization and upgrade and before we can estimate what the costs are. But we see no reason why we would be out of line with the industry in terms of modernizations and upgrades typically have a 3 to 5-year payback in terms of EBITDA, and we should be in that range based on everything I see today.

[Operator Instructions] We will take the next question. Marcus Campeau at RBC Capital Markets.

Just with the midyear stumpage revision coming up. Do you expect that to impact your production costs at all? And if so, is there anything that you can do to help offset that?

We were, again, scrubbing those numbers this morning. We have estimated that our delivered log costs in the calendar year 2021 will be about just somewhere between 20% and 25% higher than in the previous year, and 2% or 3% of the increase is due to a greener, better augment. So we've got a slightly better quality log coming into the mill this year. And a bit of the increase is due to some general inflation in costs. But something in the high teens to the -- perhaps as much as 20% is due to escalating stumpage costs. That's how the numbers play out for us. And it's consistent with the possibility of a $30 per cubic meter increase in problems like stumpage rates taking effect on July 1.

Great. That's helpful. And then just on lumber futures, they took a bit of a dip today and caused some concern. What are you seeing in the market today? And do you think we've hit a turning point yet?

We had a discussion about that as well in our Board meeting today. And what we've found is at various points in time, the futures market [ pull back ] cash prices are closing down. And our sales desk reports that the cash market is stronger on Tuesday of this week than it was on Thursday of last week, where [indiscernible] reported the last cash crisis, even though the future set sold off the last 2 days. So there is a bit of a divergence there. We don't know exactly how everything is going to shake out through the balance of the year. But what we've experienced, of course, has been incredibly beneficial to context. On January 1 of this year, we had an equity market capitalization of $66 million at an enterprise value of about $115 million. And looking at where prices are at, I suspect that the [indiscernible] this year will be greater than the 66. And I don't know if we'll make it into triple digits or not, but it's a lot of number relative to the value that our equity base was recorded at the beginning of the year. So we're feeling very good about how things are shaping up and what intent -- the increased [indiscernible] of our network for [ being on ] company, and that's the reason why we will be back in the market on the buyback programs since the buyback period ends.

Okay. Sounds good. And then just on that share repurchase program, could you just remind us how you think about it? Do you have a target valuation that you're looking at or just taking the current market prices as fair value?

Well, one number that is often discussed is looking at book value because we find that a lot of forecasts have these companies, including us probably coming in at 3x earnings, perhaps even lower and not a terribly different enterprise value relative to 2021 EBITDA. So we look at book value, and our book value is going to be certainly -- by the end of the year, it's going to be above the current market trading price. The other lumber producers are at 60% to 80% premiums over book value. And so we don't have any trouble tracking or having a repurchase program that tracks our book value increase over time.

We will take the next question. [ Brian Potiker ].

So I'm curious as to -- and if you answered this previously, I got on the call late, but curious as to whether with these high lumber prices, you're hedging in any of those prices? And if so, could you give us a description of your hedging program?

Okay. Well, it's a matter of public record that I think we're sort of in the middle of the pack in terms of hedging. We lost approximately $900,000 on our futures positions in Q1 of this year, and we disclosed that. I'm aware of one other company that's lost a little over $1 million per sawmill on hedging and another company that did far worse than that. And I'm also aware of some companies that don't hedge. We think that we will talk -- we currently are hedged on a portion of our production. It's way less than 10% of our production. But I think that we are going to use hedges to achieve a better balance between log costs and lumber prices. So earlier, you heard that log -- that stumpage rates in BC were going up on material amount per cubic meter of loss effective July 1. So we don't want to find ourselves paying stumpage rates based on, say, $1,300 lumber and only be getting $700 or $800 for that number. So we think there is a business argument to be made to work to try and achieve a balance between your anticipated stumpage costs and the prices that are available in the market to be sure you can cover those higher log costs.

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

Okay. Well, thank you, Roxanne, for your service today. And Winny, Andrew and I, all thank you for your interest in Conifex, and look forward to speaking to you when we release our Q2 results. Enjoy the rest of your day. Bye now.