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

Good afternoon, ladies and gentlemen. Welcome to the Conifex Timber, Inc. Q3 2021 Results Conference Call. I would now like to turn the meeting over to Mr. Ken Shields. Please go ahead.

Well, thank you, Omar, and good afternoon, everyone, and welcome to our call covering our Q3 results. CFO, Winny Tang, is here with me in Vancouver; and Operations VP, Andrew McLellan, joins us from our Mackenzie site. And both of them are available to help me respond to questions that you may have later. Before moving on, we wish to reemphasize that our #1 priority continues to be protecting the health and safety of employees and their families. And the men and women at our harvesting locations, sawmill site and power plant deserve tremendous credit for ensuring a safe work environment and mitigating the risks arising from the recent upsurge in COVID infection rates in Northern BC. Let's deal with the housekeeping item. We will be making forward-looking statements and references to non-IFRS measures, and therefore, I call your attention to the warning statements set out on Pages 1 and 2 of our MD&A dated today that we just released. For the third quarter, we incurred a net loss of $900,000 or $0.02 per share. EBITDA was $3.3 million. Lumber production was held back by a 2-week market curtailment in late August. Lumber shipments were 15% lower than production, because we purposefully built up lumber inventories by around $5 million in anticipation of being able to attract higher sales realizations by liquidating the inventories in Q4, which is exactly what we're doing and is well underway. Our power generation business performed well in the third quarter and we expect another solid performance in Q4. Benchmark SPF prices were around USD 480 in Q3. And I agree with the analysts, who may be on this call, who have the opinion that prices at this level trigger operating losses of around $100 per thousand board feet of lumber produced at interior BC sawmills. But our consolidated results indicate that we shipped 34.1 million board feet in the quarter and achieved $3.3 million of EBITDA, which on a lumber equivalent basis, translates into an EBITDA of around $100 per thousand board feet. And this vividly demonstrates the mission-critical role that our green power generation plant plays in moving our Mackenzie site to a much lower ranking on the global softwood lumber industry cost curve. Stumpage rate increases took effect at the beginning of Q4, for this reason and also reflecting seasonal factors, we built up our log inventories by $14.7 million in Q3, and this is the main reason that our cash balances in the quarter declined by $12.5 million to $23.4 million. Looking ahead, we expect our financial results in the closing quarter of 2021 will be similar to our third quarter results. Although benchmark SPF prices will be higher in Q4, we expect our mill net selling price realization to be largely unchanged. Our shipments to the high-priced Japanese market will be a lower portion of our shipments in Q4 than in Q3. Well, as we all know, we have higher duty deposit rates kicking in, in December. And for those 2 main reasons, we expect our mill net sales receipts will not track the change in benchmark prices in Q4. Turning to industry development. One week ago, the government in BC announced its intention to defer 2.6 million hectares of BC old-growth forests. With respect to next steps, the ministry has indicated details of the old-growth, locations have been shared with First Nations rights and titleholders. And the province is requesting that First Nations indicate within the next 30 days whether they or not support the deferral. As you would all expect, our forestry team is hard at work evaluating how harvest levels in the Mackenzie TSA could be impacted by this development. More importantly, our forestry team is working on a priority basis with local First Nations and the Mackenzie TSA to ensure that we fully understand their perspective and to offer our support in the analysis of review underway. In the region where we built -- where we operate, we truly believe that it's entirely possible to adhere to best-in-class forest sustainability and conservation regime while concurrently maintaining good paying, family-supporting jobs for residents of indigenous communities. As we go into in some detail on Pages 14 to 16 of the MD&A we released earlier today, we explained how an error in a key ministry assumption underpinning a harvest determination led to unnecessary hardship for forest sector stakeholders as well as the local community at Mackenzie and nearby First Nations community. We also outlined how recent ministry disclosures provide us a strong indication that the upcoming harvest determination will enable us and other licensees to act as higher quality sawlog and provide good potential for sawmill complexes operating in Mackenzie to migrate to a lower ranking on the global softwood lumber industry cost curve. We trust you understand and agree with us that we have no choice but to put our sawmill modernization and upgrade plans on hold until we have solid evidence that the ministry has taken concrete steps to restore competitiveness in the Mackenzie timber supply area and the ministry is doing a better job meeting the competitiveness obligations legislated in the Ministry of Forests and Range Act. While we await the harvest level redetermination, we are taking advantage of an opportunity to explore how we can further enhance cash flow generation at our Mackenzie power plant site. I think the background of having a location in a relatively cooler climate, the availability of a lot of affordable and renewable power from BC Hydro as we move to its traditional resource sector is waning. Adding to that, we've got a large site relative to the portion of the site occupied by the power plant and we have a highly flexible and technical workflow at the power plant. For all those reasons, we concluded that our power plant site is ideally suited to host, and I emphasize the word, host, data centers or other high-performance computing operations such as cryptocurrency mining. The expertise of our power engineers and technicians operating on a 7/24 basis applies completely to this new business opportunity. Later this year, in partnership with the Tsay Keh Dene First Nation, we intend to post approximately 3 megawatts of bitcoin mining activity on a trial basis. Should we, as host, and the experienced bitcoin mining operator conclude that the trial has been successful, we plan to build and host a larger data center operation. We expect the initial capital outlay will be modest, because we're going to redeploy the legacy power transformer and other infrastructure components that presently sit idle at the site. The potential exists to build out our hosting business in phases and utilize a portion of the cash flow from the initial phase to financial development of additional hosting capacity. Although there's no assurance that we'll establish a material data center hosting operation, we're extremely excited about the potential and look forward to sharing more details with you on our next call early in 2022. As you've no doubt heard yesterday, our Board approved the commencement of a substantial issuer bid for 4 million shares or just over 9% of our capitalization at a purchase price of $2.25 per share. All the analysis we've undertaken concludes that we can afford to fund a substantial issuer bid at this quantum and concurrently maintain our strong lumber business balance sheet and also fund projects that are necessary to remain compliant with the enhanced safety and environmental regulation as well as smaller quick payback projects that improve the operational reliability at our sawmill complex. Obviously, we launched a substantial issuer bid, because we believe our shares trade at a material discount to an underlying fundamental value. Summing up, we believe that Conifex remains well positioned. We enjoy a strong safety culture, a very high degree of sawline private self-sufficiency compared to any other timber supply area in the interior region of BC. We've got near-term opportunities to benefit some improvements in fiber quality, availability and delivered cost. We own and operate industry-leading power generation assets. We've got exciting opportunities to diversify and strengthen cash flow generation. And at the same time, we have entirely managed our debt service obligations. So thank you all for taking the time today to learn more about our company. And Winny, Andrew and I will be very pleased to respond to any questions that you may have. So we're clearly leaving that to Omar, our operator.

[Operator Instructions] And our first question is from Paul Quinn.

Just maybe a question. It's been busy here, so I haven't read through the whole MD&A. But when are you expecting the AAC review on Mackenzie TSA?

We are expecting a public data package, the province says that it would have been delivered a few months ago. It still hasn't showed up. But that will include their base case. We expect the revised AAC determination to be available in Q1 of 2022 and then the apportionment decision later in 2022. And that apportionment decision is, of course, when they determine what AAC has allocated to First Nation, BC Timber Sales and the licensees. Paul, the current AAC is 4.5 million cubic meters. We expect the revised AAC will be about cut in half, because we're at the end of the pine beetle salvage program. So if it's cut in half, we are still very confident about our sawlog self-sufficiency, because the Ministry of Forest documents indicate that at capacity Canfor has a sawlog requirement of approximately 1.2 million cubic meters and the ministry documents put our annual sawlog requirements at 875,000 cubic meters or something like that. So we're just over 2 million of requirements. And even with a 50% reduction in the AAC, we still have sawlog availability that exceeds the full capacity requirements of the sawmill capacity that's in place with the TSA.

Okay. Any indication that Canfor is looking to start up at Mackenzie now?

Well, Paul, it's hard to speculate and they're a company that has disclosure obligations that there's some material developments. But the local people indicate to me that there are new occupants at that site and another portion of the site might be dismantled, but that's just hearsay from people at Mackenzie. You have to ask them what the status is.

Okay. And then over to the new development on bitcoin mining. If the trial is successful, how do you suspect we model that in for '22?

Well, that's a tough question. Paul, we're at such an early stage. But I can share with you, this is a personal target. This is not a Board-approved, management-opined, and we haven't scrubbed all the numbers, but we've spent something like $100-plus million to develop a power plant. And we regularly commented that it had $14 million of EBITDA potential. And my personal objective or target here is, assuming the tests work out and our partner wants to move forward, that we think we've got a shot at really spending 1/3 of the money we spent on the power plant and maybe getting EBITDA that's potentially very close to what we had at the power plant. Those are some of the personal objectives that I've established for this initiative.

So just -- so I understand that right, that's incremental to the current power agreement that you have with Tsay Keh Dene?

Completely incremental.

Okay. And then we've seen lumber prices in your area move up sharply off the lows in August. Now they seem to be rolling over here. What's your expectation for the balance of the year, Ken?

Well, for the balance of this year, I don't expect much change from where we're at. But Paul, next year, I am probably a bit more bullish than the consensus forecast. And my positive view is a reflection of 2 factors. I don't think people that studied the supply/demand balance for SPF lumber fully appreciate how the higher duty rate impositions are going to shift the cost curve for SPF producers in Canada. So we probably have a steeper supply curve than what's in effect at lower duty rates. And secondly, we have the impact of harvest reductions certainly in the very short term while we sort through the old-growth development. And with the suspension of BCTS auction offerings, I think the sawlog availability and lumber production from BC will be lower in 2022 than most forecasters expect.

Okay. And then maybe a bonus question. Now that we're -- now you brought up softwood lumber, any movement on that file? Or do you expect any movement on that file going forward?

Well, first of all, I'm not aware of any communication from the government people. But I think that a base might be building for some meaningful discussions on this file, but we saw much of that, because when we're in the next period of review. There's every indication that both the countervailing duty rate and the antidumping rate will be materially lower than they're going to be when the new rates kick in at the end of [indiscernible]. And so they're with modest duty-related positions. There's less benefit to the U.S. coalition and there's a chance that they could conclude that the duty isn't helping very much. And there's a bunch of cash trapped in U.S. treasury and they may want to get a piece of that cash and support a [indiscernible]. So I think a year from now, I'd be pretty optimistic that something can happen. But in the immediate future, I think we're pretty much locked in to the current arrangement.

Your next question is from Roshni Luthra.

Ken, just wondering from the work your team has been doing, do you have any early indications of what the impact might be of the logging restrictions in your operating regions?

Well, we have what I'd call a guesstimate. And earlier, I talked about the expectation that we have, essentially that there would be a likely 50% reduction in the AAC that will be released if determined early in 2022. And if our local First Nation, two of whom have significant investments in logging equipment and want some revenues to start some programs to benefit their community. If on the outside chance that the local First Nation decided that they didn't want any deferral, there'd be no change from my earlier estimate of a 50% reduction in the AAC. If the First Nation decides that they want to keep harvesting in all of the old-growth areas that ministry mapping has identified, and everyone's got a lot of questions about the accuracy of the ministry maps. But if the maps -- if we make the heroic assumption that they're accurate, there might be, say, a 53% reduction in the harvest level, it'd be that order of magnitude. So we could get [ modest ] impact in the harvest in our area by a lot less than 10%. But maybe if there was a complete deferral, it would probably be [ a sniffle ] at 5%. But those are very preliminary numbers and they apply only to the Mackenzie timber supply area. They made no comment on other timber supply areas in the interior BC.

Thanks for that color. And then just looking at 2022, can you provide any preliminary CapEx figures for next year?

We have -- typically, we do have our budget and business plan pretty well finished at this time of the year. But as I'm sure you can appreciate that for the last 8 days, we have down tooled on our budget and business planning process, and the focus exclusively is on attempting to gain a better understanding of the new development funnel [ it was blocking ]. So I'm sorry, I don't have any guesstimate for 2022 that I can share with you at this time. Clearly, we think we're going to have a satisfactory level of cash flow generation, because we wouldn't have directed $9 million to repurchase our own shares.

[Operator Instructions] And the next question is from [ Mario Nuccin ].

Ken, thanks for the clarity and the update. My question was really around the economics of the bitcoin or data hosting add there. My question was answered in the question from the previous analyst there. So I'll get back in queue.

The next question is from Paul Quinn.

Ken, just a follow-up. I mean you've been around the BC forestry issue since you've been a teenager. So you've gone through a number of different governments and restructuring. Just wondering if you could give an overall comment of what do you think the current government is trying to do with the industry? And are they going to be successful at the end of the day?

Paul, so the reason you've mentioned, I have spent a huge portion of my career looking at timberlands and sawmills and chip bins. And accordingly, I haven't spent much time in Victoria. But the concern I have is that there are so many initiatives underway, whether it has to do with caribou protection, First Nations reconciliation, old-growth preservation, carbon mitigation, responding to climate change. And you know the old adage, "If you try and prioritize everything, you end up prioritizing nothing and nothing gets done." So that would be the concern that I would have. What's your impression, Paul?

I'm just wondering with all these cuts to the harvest level, whether the industry can ever get to be competitive and return the cost of capital. It's just pushing the cost curve higher and higher in BC. And I'm just kind of nervous for the BC-based companies like yourself.

Yes. Well, in our case, Paul, the feeling I have is that I am very pleased and proud with what our leadership team and employees have accomplished. So when you do have time to read the MD&A, remember that we fibered up our mill with over 50% beetle-damaged, dead and dry wood last year. And that really hurt us in unit log costs and it created lots of production disruptions, which hurt our cash conversion costs and we had a way above normal amount of low-grade lumber, which trades at a steep discount to construction grade lumber. So as I look forward, Paul, the way the numbers work, it's something like there's probably USD 60 of additional duty deposit costs in 2022. There's probably CAD 90 on stumpage release. And in our case, if we could have the profile of the timber inventory, rather than subsequently just proven harvest partition that's been mandated, we could potentially improve our cash margins by as much as $100 per thousand board feet. So I don't want you to view our recent margins as indicative as to what we're capable of producing or we're harvesting the profile of the remaining timber inventory. We'll have the ministry estimate of the characteristic of the timber inventory to be available in the next few weeks.

Well, let's hope we get access to the full profile. We'll see if that happens. Just on the bitcoin, can you identify your crypto partner who's got the expertise?

We cannot, because we're subject to a nondisclosure agreement. But clearly, if we get through the trial phase, that will be publicly disclosed. But they're experienced in this and they've got solid financials.

[Operator Instructions]

Omar, it sounds like we might be at the end of the call.

Yes, sir. We have no further questions at this time. Back to you.

Okay. Well, listen, those of you that listened in, thank you so much for your interest in Conifex. And feel free to reach out if there are other questions that come to mind that you'd like some help on. So enjoy the rest of your day, and so long until our next call.