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

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

Thank you, Eric. And good afternoon, everyone, and welcome to this call covering our Q4 and full year 2021 results. Our Chief Financial Officer, Winny Tang, is here with me in Vancouver while Operating Head, Andrew McLellan, joins us from Northern BC. The 3 of us are available to respond to questions that analysts and shareholders may have upon the termination of our call. Before proceeding further, we all wish to reemphasize that our #1 priority continues to be protecting the health and safety of employees and their families. All the men and women at our harvesting locations, sawmill and power plants deserve the credit for ensuring a safe work environment. They've mitigated the risks associated with an upsurge in COVID infection rates through their strict adherence to our robust COVID safety protocol. They allowed us to deliver positive EBITDA in Q4 of 2021 and solid net income in the opening 2 months of 2022 with no safety violations, workplace transmissions or downtime. Let's quickly deal with 1 housekeeping item. We will be making forward-looking statements and references to non-IFRS measures and therefore call your attention to the warning statement set out on Pages 1 and 2 of the MD&A dated March 7 that we released an hour or so ago. Turning to our financial results for the year. We achieved EBITDA of just under $52 million in 2021, which is equivalent to $1 million per week. The net cash we generated in 2021 was employed in 2 main areas. Number one, we spent $14.3 million repurchasing shares. And second, we invested $25 million building inventory. The $17 million we invested in log inventories was planned. We entered 2022 with both a larger and a lower cost inventory than we had 1 year ago. This investment supports our target to achieve a 90% capacity utilization rate at our sawmill complex this year. Unit cash conversion costs are expected to benefit from our ability to spread fixed costs over a larger production base. The $8 million increase of lumber inventory was unplanned and entirely due to well-publicized disruptions in rail car supply. Shipment deferrals were the main reason we and other interior BC lumber producers reported Q4 EBITDA that was below analyst expectations. For the year, we earned $0.60 per share and increased our book value per share by $0.72 from $2.51 to $3.23 per share. The book value increased by an additional $0.12 per share reflecting the cancellation of shares that we repurchased at a discount to book value. We also deposited around CAD 11.6 million in duties and that brought our potential duty refunds up to USD 19.4 million, which is equivalent to roughly CAD 0.50 per Conifex share before any allowance for pullbacks on potential duty refund or potential tax provisions on duty refund. Since our last call, many of you on the line have contacted us and asked what's happening in BC with respect to sawlog availability, regulatory development and cost competitiveness. We intend to use our remaining time to share our view on the first 2 topics and then to outline what we believe to be the single best opportunity available to us to improve our competitiveness at our MacKenzie site. First, dealing with sawlog availability. The projections the Ministry of Forest released a couple of weeks ago indicate that the interior BC sawlog target is projected to decline from 35.7 million cubic meters in their fiscal year ending March 31, 2022 to 31.4 million cubic meters next year and 30.2 million cubic meters the following year. If the ministry's projection proves accurate, interior BC lumber production is expected to decline by approximately 1.4 billion board feet. This anticipated contraction in supply offsets much of the new capacity coming onstream in the U.S. South and in our view, it contributes to a near-term supply-demand balance that favors softwood lumber producers over consumers. We believe we are extremely well positioned in terms of our access to future sawlog. Our operations are [ strategically ] based in the MacKenzie timber supply area. The land base in MacKenzie TSA is about equal to the combined land base in the states of Vermont and New Hampshire. We operate the only sawmill located on this large land base. We believe that the standing timber inventory in the MacKenzie TSA is capable of supplying sawlogs in perpetuity that are at least double our present and immediately foreseeable log consumption. Our key point is that Conifex enjoys a degree of regional fiber self-sufficiency that is unique to the interior region of BC. This explains why we got plans underway to modernize and expand our sawmill complex provided the conditions are [Technical difficulty]. Over the past few years, the ministry has imposed several new policies on the forest sector operators in the interior region of BC. Since the key features of many of these policies remain undefined and unimplemented, it is impossible to assess how forest sector operators may be impacted. With this unprecedented regulatory uncertainty, we have no choice but to put sawmill modernization and expansion plans on hold until a few things happen. Number one, the Office of the Chief of Forests released its public discussion paper informing shareholders of its findings regarding the economically available timber supply, possible future harvest level as well as log quality considerations in the MacKenzie TSA. We're also waiting until the ministry advises us at the outcome of its consultations with First Nations whose traditional territory lies in the MacKenzie TSA. We need to hear back about what their findings have been with respect to old-growth ecosystem conservation, wildlife protection set asides and other factors that impact future harvest levels. Another item we're waiting on is some understanding of how the ministry intends to address its need to restore competitiveness in the MacKenzie TSA and therefore meet the requirements set out in legislation, more specifically Section 4 of the Ministry of Forests and Range Act, and I quote, "to encourage a bigger, efficient and globally competitive timber processing industry in British Columbia." The last item that we're seeking additional input on is the process that the ministry intends to follow to ensure that future harvests are allocated or a portion in a just and equitable basis amongst licensees in the MacKenzie TSA. So that's a recap of the regulatory uncertainty and what we are waiting for. And in our case despite major capital expenditures being on hold for a year or perhaps longer while the preceding topics are addressed, we continue to fund capital expenditures necessary to remain compliant with safety and environmental obligations. We also spend money identifying and preparing sites for future harvests. And lastly, we do undertake smaller, rapid return, quick payback projects designed to improve the reliability of our sawmill operation. So with the major capital projects in our traditional business on hold, we're focusing our efforts on a new opportunity we identified to enhance both the level and stability of future cash flow generation at our MacKenzie site. If everything comes together as we think it can, we have an opportunity to lower our cash production cost by around $20 per thousand board feet of lumber produced and thereby position our MacKenzie site to generate positive EBITDA over an even wider range of commodity lumber prices. We'd like to take the next 5 minutes of our time to review one, the key features and strategic rationale for the new business opportunities we're exploring and 2, how revenues and EBITDA are generated in this new complementary business. Worldwide, the search is on for sources of green power that can run high performance computing operations to enable global computing requirements to operate in an environmentally and socially responsible manner. A one-time opportunity is available to us at Conifex is successfully link BC surplus hydroelectric power with our underutilized power assets at MacKenzie and produce a win-win outcome for us and all British Columbia. Power surpluses are anticipated to remain in effect in BC reflecting a combination of lower demand from forest sector contractions and activities coupled with new electrical supply coming on stream when the Tsay Keh project is completed. Against this backdrop, we joined forces with the Tsay Keh Dene First Nations. Our partnership plans to utilize our operating team and power expertise to redeploy power distribution infrastructure presently sitting idle in MacKenzie to develop a new business and that's the business that hosts HPC or high performing computer customers at an industrial scale data center our partnership plans to build and operate located adjacent to our power plant in MacKenzie. The institutional quality customer we are working with intends to install computer hardware and software it owns to power data center infrastructure we own. Our power plant team will assist with the installation of the equipment and provide operating and maintenance services to the customer. Initially we expect our data center customers will primarily install servers servicing the Bitcoin network. Bitcoin as you all know, has the largest market capitalization of all cryptocurrencies and is being widely adopted by institutional and retail investors. Once we have proven our capabilities at our additional data center sites, we have potential to host and support other high performing computer applications in the future such as Artificial Intelligence, machine learning or other blockchain network. The way this business operates is that hosts such as Conifex provide a full suite of services to customers to enable them to produce digital currency assets on a reliable and cost effective base. It is customary for hosts like us to charge cash fees that more than fully recover the operating costs we incur at the data center site. However, customers wish to ensure that their interests and the host's interests are fully aligned to ensure that both parties work collaboratively to maximize data center productivity and uptime reliability. This mutually beneficial alignment is achieved by having our customers agree to provide us an opportunity to earn additional fees tied to the performance and operating margin achieved at the data center. Performance fees are typically paid in the form of digital currency. The performance fees to which we are entitled and which we expect to earn in the future will be recorded at fair value on the day it's received. In our case, the trial program for us of 3 megawatts of capacity is underway and the results are encouraging. We should have sufficient information available to us to validate this business model in about 6 weeks, at which time we will provide shareholders additional information about the potential we have to build a data center with 25 megawatts of reliable electricity supply. Before turning it over to your questions, I'd like to advise that we're off to a good start in 2022. When we release our results for the first and second quarters, we expect to be able to demonstrate that our 2021 runway of $1 million in weekly EBITDA in our power and lumber business is being duplicated in the first half of 2022. We will keep you posted on our revenue and EBITDA diversification initiative as our plans evolve. So we thank you for your interest in our company and Winny, Andrew and I would be pleased to answer any questions you may have. So we'll turn the meeting back over to Eric.

[Operator Instructions] And we have the first question from Gabe Nicholson.

Can you hear me?

Yes, we can.

Okay. I am with CIBC Capital Markets. And I was wondering, this question is more for Ken. Ken, what impacts do you see stemming from the sanctions we've seen on Russian exports? Do you see any opportunity for Conifex there? And also how are you viewing the Japanese market at this point?

Okay. 2 good questions. First of all, if you drill into our detailed financial disclosures, you would see that the preponderance of our lumber 80% plus is directed to the U.S. and another 10% or so to Canada and the balance to Japan. So China has not been an important market to us recently. And the way the sanctions work, it appears that there'll be a fair bit of Russian lumber finding its way to China, which could very well have a depressing impact on lumber price. So we don't expect the geographic mix of shipments in our case to change at all and we think that the likely lower level of Russian shipments to some European markets may mean that there's less European product available for the North American market, which would help pricing in North America. In terms of Japan, we have an important customer base in Japan that is focused on the construction of retirement communities. They prefer the premium grades of lumber and they are very important offtake customers for the top 5% or 6% rate of returns that we achieve at our MacKenzie sawmill. And the prices in Japan, as you probably know, can delay the prices in North America and then get locked in for 3 months. So we're expecting further opportunities to achieve higher price realization in Japan in Q2 of this year and likely in Q3 as well.

Okay. And then this one's more on the supply chain front if I can ask a follow-up. Is that all right?

Yes.

Okay, great. So are you going to expecting any additional inventory builds in Q1 just based on what we're seeing with supply chain so far this year?

Yes, we are. The de novo reports we get, of course there's some volatility week to week. But I'd say a month ago, we were probably able to ship something like 45% of our weekly planer production and that might have edged up to something like 55% or so now through a combination of us engaging more trucks to deliver lumber and through some modest increase in rail car deliveries. So based on the numbers that I see, it is unlikely that the inventory buildup in finished products in BC, I don't see us getting back to normal by the end of June. I think it'll be end of Q3 before we get finished lumber inventories to normal levels here in BC.

Okay. Great. So this one probably can go more to Winny. I saw that your CapEx expenditures are kind of same as forecasting, but can you break down kind of that capital allocation this year? And then I'll leave it there.

For sure yes, I can take that. Most of our capital expenditures related to, as Ken mentioned, quick payback projects that we have at our sawmill to optimize our production there. For example, we did edge up optimization at our sawmill, which has improved our production capacity. As well we typically do major maintenance work at our power facility every year and that captures a big portion of the CapEx that we had completed in 2021 as well too.

And we're also going to add a bit to preparing harvest for future production so that in aggregate in 2022, we expect that our capital expenditures will be a lot closer to our noncash charges. And with our amortization running at around $10.5 million a year so it's quite possible that our CapEx in 2022 will be roughly in line with noncash charges.

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

Okay. Well, Eric, thank you for hosting our call today. And for those of you on the line, thank you once again.

I'm sorry, Mr. Shields, we just had 2 questions pop up. Are you still ready to take them? We have a question from a participant.

[ Ryan Davis ]. Just a brief follow-up on the capital allocation question. I was curious given your solid deleveraging, strong SIB takeup and relatively unique proportion of stable and potentially growing green power revenue, would you have any consideration to shifting the balance? So in other words, applying some portion of the annuity revenue to something like a base dividend or perhaps more broadly adopting something like a more overarching capital allocation framework like we're seeing at some of your peers?

Thank you for that question. The topic of capital allocation is regularly discussed at a Board level and I'll do my best to share with you what I believe the consensus is. We believe that our stock price is materially below the fundamental value of our company. We were pleased that we undertook a normal course issuer bid and a substantial issuer bid last year and we believe that we improved the fundamental value of our company for the shareholders -- the main shareholders by a considerable amount and we hope to grow it by the same amount this year. We are not prepared to consider relaunching a share buyback program until after we have the results from the trial program in our HPC business because if that turns out to be promising, we will have some additional capital expenditures above the level that we referenced earlier and we want to pin that down and we also want to know what our working capital investment is before we recommit to a buyback program. The advice we get from shareholders and from financial advisors is a buyback program is more beneficial to long-term shareholders than a dividend is and unless we have powerful reasons why that's not the case, we are a lot more likely to consider returning capital to shareholders through buybacks rather than dividends.

We have the next question from Paul Quinn -- sorry, from [ Rick Ugoli ].

All right. Can you hear me?

Yes, we can.

Okay. Great. Yes, you answered my first question about the buybacks. My second question was I know on previous calls you've kind of gone through each piece of the business and how much that is per share and I think you mentioned that duties were around $0.50 per share. How can we think about what percent on a base case we would get back from the company? I know that's really hard to project, but was just thinking we would just low to hear your opinion on the duties.

Well, on the duties, I think I mentioned that the refundable duties that are in place today are USD 19.4 million. The duties increased by CAD 11.6 million last year and this year the duty rates are a bit lower, but the lumber prices at least in the early going are going to be higher. So it's entirely possible that we don't rebuild our duties on deposit by the same amount as we did last year. And we end up then having something like $0.50 per share of potentially refundable duties today and we could add another $0.25 or $0.30 per share to that over the next 12 months. And then when you look at the timing of potential duty refunds, I'm certain about that and if there are duty refunds, we don't know what portion of the duties or the deposit will be retained by U.S. producers and other industry support programs. Last time 80% of the duties were returned to the people that deposited them. And then secondly, we are not sure what our tax position will be at the time duties are returned. Right now we have plenty of tax shelters that would avoid cash income taxes on duty refunds. But if it happens a year or so from now, we could be a lot closer to paying cash income taxes. So it's really hard to estimate. I think that we have got $0.60 a share today. In the next 12 months, we will probably make additional deposits that would cover any holdback in taxes. So as I look at our company, the $0.60 of off-balance sheet cash that's available, I think that our power plant is worth at least $1 per share. I think our working capital more than -- I forget what it's at, but our net working capital is a higher number. So the reason we like share buybacks is that we think there is virtually no value reflected in our stock price for either our [indiscernible] operation.

And the last question will be from Paul Quinn.

Sorry, I got on the call late so you might have answered this. But the sale of Canfor's assets in MacKenzie, is that going to affect you anyway? And when do you anticipate the restart of that mill given what you know of the group restarting it plus the assets themselves?

Okay. Well, Paul, I'm going to take about 2 minutes to answer that question. But first of all, we are pleased that that sale has gone ahead. We believe that having First Nations as partner and tenure holders in the MacKenzie BC will elicit more favorable consideration from the ministry as opposed to a company that has been taking many steps to lessen exposure to BC. So we think that we've got a greater commonality of interest with this new likely tenure holder and certainly current tenure holder in MacKenzie. Secondly, I don't know what Canfor has been saying about the intentions of the purchasing consortium to operate that sawmill complex in MacKenzie. But the last time I was in MacKenzie, it looked like the large log line was being packaged up for shipment to Louisiana. So that site is a large site and it's left with one small log line and I think that the economics to run a single line or a small log facility at a large site with high cost, it doesn't make economic sense. So based on everything I see, we do not anticipate that site will be restarted and we suspect that the new tenure holders will want to harvest in the MacKenzie TSA and find customers for the sawlog in fiber deficit analysis in [indiscernible]. The bottom line, we think it's good for our local fiber self-sufficiency and we think it's great that we've got tenure holders that are likely to receive more favorable consideration from the ministry.

Okay. And then last year in the summer prices got really high and basically we saw the consumer, especially in the RNR side, really back away from the market. What are you hearing from customers right now? Any worries about higher interest rates or inflationary pressures for them?

Paul, I'd like to be able to report that customers are addressing those 2 important issues that you mentioned. But the main message we're getting from customers are look, it's not even the 10th of March and I'm buying lumber from you today that you will ship in late April and it may show up in my yard in early June. And there's just a lot of frustration with the delivery and rail car shortfall. And so, Paul, the most common customer feedback is all focused on their frustration with the transportation delays.

Okay. And then just sort of byproduct revenue, why was that up so much this quarter?

Why was it up so much this quarter? I actually thought it wasn't. I didn't think it was a particularly great quarter. I know that we really built-up our chip inventories at MacKenzie as we got into late December and our chip inventory held at a nominal value. And I know that the chip pile is going down so that in the quarter we're in now that our byproduct revenues should be better than they have been recently. But...

And I'll just add a little bit to that as well too. Part of it of course was that in the third quarter, we had a few curtailments as a result of log costs and supply issues and so therefore we have quite as much byproducts generated at that time.

Yes. Sorry, I made a mistake. I'm not looking quarter-over-quarter, I'm actually looking full year so 2021 versus 2020. I guess that part of that is higher residual pricing because of higher pulp pricing?

Yes. And the planer trim waste, the proceeds that we get from selling that to a finger joint plant, it reflects what's happening to lumber prices so that would have helped us a lot last year, Paul.

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

Okay. Well, once again, everyone, thanks for your interest in Conifex. Enjoy the rest of your day. Bye now.

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