Interfor Corporation (IFP) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen, and welcome to the Interfor quarterly analyst conference call. [Operator Instructions] This call is being recorded on Friday, August 5, 2022. I would now like to turn the conference over to Ian Fillinger. Please go ahead.

Thank you, operator, and good morning, and welcome to everybody listening in on our call, and welcome to our Q2 2022 analyst call. Before we get into the report out, I would like to welcome Tom Temple to our Board of Directors. Tom is a seasoned industry executive, and we look forward to working with Tom over the years ahead. Today, with me have Rick Pozzebon, our Senior Vice President and Chief Financial Officer; and Bart Bender, our Senior Vice President of Sales and Marketing. Our agenda today will start off with myself providing a recap of our financial results, our strategic focus and our improvement efforts. I'll then pass the call to Rick, who will cover off financial matters. And then Rick will pass the call to Bart to cover off the market. Turning to our financial results. Our Q2 adjusted EBITDA was $429 million. We are continuing to execute on our strategic plan, and we are generating industry-leading lumber margins and returns on capital. I encourage you to look through the investor deck on our website and look at these metrics. Our improvement efforts, again, were balanced across the company as we made progress in all regions. For the fifth consecutive quarter our production volumes were again at an all-time high, largely due to the production quarter of our Eastern Canadian platform and the ramp-ups of our mills in DeQuincy, Louisiana and our mill in Eatonton, Georgia. We are proactively reducing inventory levels throughout the quarter by managing lumber production, and we achieved improvements in logistics and capacity availability. This, combined with seasonal impacts resulted in a significant reduction in working capital in the quarter. Our SG&A expense decreased quarter-over-quarter as economies of scale are being realized from our growth through acquisitions and our capital investments despite the persistent inflationary pressures. We continued with our CapEx improvement plans in every region spending $65 million in the quarter, up from the previous quarter. Turning to our financial capacity. We continue to have significant financial flexibility to consider several further capital deployment options, which Rick will cover off shortly, including $100 million SID buyback that we announced last week. I'd also like to provide an update on how the integration is progressing with our Canadian Eastern platform. Since the acquisition dates in February this year, the East region has contributed a robust $206 million of EBITDA in the first 4.5 months or approximately 42% of the $490 million purchase price. Our key focus areas in this region are to enhance our historical operating performance, identify further opportunities for operational improvements and synergy realization and assess potential long-term strategic investments. Turning to our strategic focus. We continue on achieving greater returns on capital through our unrelenting focus on operational excellence, and our balanced and situational-specific approach to capital allocation. As such, I want to outline a few key initiatives. We continue to optimize our portfolio, which included the sale of our Acorn mill on the coast of British Columbia. Our DeQuincy mill in Louisiana continues to progress well, and we have now fully moved to a 2-shift operation several months ahead of schedule. In Georgia, our largest capital project at our Eatonton Mill is now complete with very solid production, great outturn and cost performances thus far. In summary, our balance sheet is in great shape. Our returns on capital, ROCE are again, exceptionally strong in Q2 at 53% and year-to-date at 69%. We continue to work hard on our capital allocation discipline to ensure the best returns for our shareholders and we're continuing to see strong performances from our internal projects and our recent acquisitions. That concludes my opening remarks, and I'll now hand the call over to Rick.

Thank you, Ian, and good morning. First off, I'll refer you to cautionary language regarding forward-looking information in our Q2 MD&A. Interfor's second quarter was successful in many respects. Most notably, we continue to capitalize on our significantly increased scale and capabilities to produce and ship the most lumber in our history. We further enhanced the competitive positioning of our sawmill portfolio, including ramping up our DeQuincy sawmill to 2 shifts and completing the full rebuild of our Eatonton sawmill. And we also extended our track record of generating the best returns on capital in our industry through our continued focus on operational excellence and disciplined capital allocation. Our capital allocation in the quarter was balanced and driven by our focus on maximizing shareholder value over the long term. We continue to invest in significant capital upgrades to our sawmill portfolio in line with our multiyear plans, and repurchased over 1 million Interfor shares at an attractive valuation to complete our normal course issuer bid. We continue to see significant value in Interfor shares and last week announced our intention to commence a substantial issuer bid to purchase up to $100 million of Interfor shares within a tender price range of $29 to $34 per share. Assuming successful completion of this bid at $29 per share, Interfor would have then bought back and canceled over 24% of its shares within the past 2 years. Over this same span, we've grown our lumber production capacity by over 60%, and added significant diversification with our growth into Eastern Canada. In terms of financial results, Interfor generated adjusted EBITDA of $429 million in the second quarter. These exceptional earnings include $116 million from our recently acquired Eastern Canadian operations, which is net of $17 million of nonrecurring purchase accounting expense. Excluding this, total adjusted EBITDA would have been $446 million in the quarter. Earnings benefited from selling a record 1.1 billion board feet of lumber at historically strong lumber prices, while general cost inflation continued to be a headwind. Cash flow from operations was $218 million, with another $176 million generated from working capital reductions for a total of over $7 per share. The working capital reduction was driven by the collection of trade receivables, improved lumber shipment rates and seasonal reductions in log inventories. Our current lumber inventory level is now within our target range and we will continue to adapt our production rates to match demand as necessary going forward. Regarding capital allocation in the quarter, we invested $65 million into capital projects and returned $33 million to shareholders through buybacks. We ended the quarter with our balance sheet and a net debt to invested capital position of 5%, which is at the lower bound of our target leverage range. This leaves us with ample liquidity to continue pursuing our strategic plans, which include spending in the range of $275 million to $300 million on capital improvements for the full year 2022, which is up about $25 million over prior guidance. We'll also continue to be disciplined in looking for accretive lumber acquisition opportunities. To wrap up, I'll highlight 2 points. First, our business is well positioned operationally and financially to succeed through ongoing market volatility. And second, our record-setting financial results in Q2 have demonstrated the benefits of our strategic growth and portfolio optimization, including generating the best returns on capital in our sector. That concludes my remarks. I'll now turn the call over to Bart.

Okay. Thank you, Rick, and good morning, everyone. I'll provide an outlook on lumber markets through Q3 and into Q4. First, I'll start off with logistics. Our ability to service our customers has been challenging as equipment availability and labor continues to impact logistics capacity. Overall, I'm pleased with how our team mitigated the situation and with the progress we made through Q2 into Q3, our inventories have essentially normalized and the service levels from our carrier partners has improved. It's not perfect yet, but it's better in all of our operating regions. With respect to end market inventories, our understanding is that levels are holding at below historical lows and should be considered minimal. In terms of the markets, much like we discussed last quarter, there continue to be some uncertainties that is pushing our customer base to be cautious in their procurement strategy. Current demand levels remain quite good. The uncertainty this lies with what might be coming. Certainly, the overall fundamentals in the market continue to support medium-term solid demand for lumber. However, the impacts of affordability weigh on expectations. In particular, new home construction is facing affordability issues given house prices and interest rates that is impacting their ability to sell homes. The demand for homes remains. So we expect this situation to be resolved over time. Accordingly, housing starts is starting to show the impacts of this. However, given the fact that completion rates are so much lower than starts, the impact on lumber demand is, in our view, more tied to completions. Repair and remodel is showing signs of strength. There was a period in Q2 where high lumber prices seemed to slow demand. However, today, I can tell you, our sales through this segment of the market are encouraging. In the industrial and nonresidential markets, they're essentially holding and continue to be steady. Q2 marks our first full quarter with I-joist as a part of our product offering. Our distributors continue to support our production levels, and I'm encouraged by the resilience of this product. in the market, which is supported by high quality standards and excellent customer service. Overall, our outlook for the balance of the year is for less volatility in lumber prices at higher than historical levels. So with that, I'll stop there and pass it back over to you, Ian.

Okay. Thanks, Bart, and Rick. Operator, we're open to take questions from our analysts now.

[Operator Instructions] Your first question comes from Sean Steuart, TD Securities.

Sorry, guys. A couple of questions. Bart, I'll start with markets. And you noted that your inventory is at the level of normalized. You highlighted a sense that inventories at the buyer level are low. And I'm just hoping you can square that with the pressure we're seeing on prices right now. It feels like we're below cash cost for higher costs producers in BC at this point. How are you squaring good takeaway from repair and remodeling and what seems like tight inventories from your perspective with ongoing pressure on prices. Is this just a seasonal thing? Or is there more to it than that?

I think there's probably a bit more to it than that, Sean. When you think about the uncertainties that are ahead, people look at their inventories and they base what they feel is acceptable based on their consumption rates. And if they're expecting those consumption rates to fall, they'll adjust accordingly. And I really feel that that's part of this. And so people are prepared to take their average inventory levels lower in anticipation of a future decline. And I think that a lot of the interest that we're getting from our customers is they're particular on specification and they're very particular on shipment. Shipment is a big part of it. And that tells us that they don't have the inventories. They need the wood fairly quickly to meet the demand that they're continuing to see in the marketplace. And so I think until those expectations -- or sorry, those uncertainties are more known, we're just going to see a very cautious tone from our customer base.

Okay. And a question for Ian and/or Rick. I wanted to sort of wrap my head around the next leg of discretionary CapEx. This is obviously the busiest spending year. And I think the indication in your slide deck is that CapEx should moderate in 2023. Can you give us a better idea of what the next round of CapEx looks like for the company? Is it going to stay as focused in the U.S. South or is it more spread out? How should we think about that?

Yes, Sean. So Ian here, thanks for the question. We're have a great view of, obviously, our South Pacific Northwest in Washington and Oregon and B.C. mills. What we're working on pretty hard is the Eastern Canadian platform, looking at what strategic projects and discretionary projects could look like over the coming years. So I think to be able to answer that with a bit more clarity is probably a few months away as we go through our normal course planning exercises on fiber and synergies, et cetera, like that. So we're kind of November, January-ish, probably be able to provide better context on that. But I can tell you that there are several operations that are on our radar that we're working on currently with different levels of business cases and engineering and those types of things, but it's just a little early for us. But the guidance that's in the south that we've provided over the last year or so is still accurate and solid. And it's just the new platform that we've got in Eastern Canada that we're spending some time on now.

And the bump to CapEx this year, that's strictly capital cost inflation for these types of projects? Or is there any pull forward of project [ vision ] for 2023?

It's actually the first point you brought up is accurate. The second would be that after acquiring the Eastern Canadian platform, there was some capital spending that we did pretty immediately and some of it's been implemented and some of it will be implemented by the end of the year. So I would say the majority of that is inflation and new projects that were identified over the last few months.

Your next question comes from Mark Wilde, BMO.

Thanks. Good morning, Ian, Rick, Bart. And Ian and all the team, I really want to acknowledge, I think, an excellent job of capital allocation over the last couple of years. We've really been in a very unusual environment. And I think you've actually from a capital allocation standpoint, you've managed it very well. So with that said, I wondered just if you could give us some sense of where you think cash cost is sitting right now in B.C. and how that will change over the next couple of quarters as we see stumpage costs going down?

Yes. I don't know if we could share the exact number that we have in mind, but I think several -- your point of view are out there. But I don't know, Rick, if you have anything else to add. It definitely is the -- as you clearly identified, Mark, it is to the benchmark now. B.C. is the highest cost. And in these situations, that's where we think the downtime will come. Not necessarily with us, as you well know, our 3 operations in British Columbia are not in the same fiber basket as some of our competitors, and so we enjoy the ability to cut different species and stay off the random life price deck, a fair amount with Adams Lake Castlegar and Grand Forks. But Rick, anything else down there?

I'd say maybe it's important to look at where SPF prices have bottomed out recently in terms of what cash costs might do over the next couple of quarters, if you look at stumpage rates in the BC interior. They are about $60 per cubic meter in Q2. They're going up to about $90 in the current quarter. And then in Q4, down to about $50 per cubic meter. That will drive some reduction in costs throughout the rest of this year.

Okay. All right. That's helpful, Rick. And then can you also just help us with kind of what's going on with the log cost for you in the Northwest and the U.S. South? It does seem like in the South that we have finally hit an inflection point over the last probably 6 or 7 quarters. So I'd just be curious about what you're seeing in terms of log pressure there and again, down in the Northwest?

Yes. I mean, different dynamics, starting with the South, Mark. There -- in our platform there, one thing we do enjoy in some of our areas is some proximity advantages between operations. So when log costs tend go up in the south, to our opinion, is largely it's through some upset conditions, whether it's weather events, and that causes shortages at pulp mills or competing mills and then there's a short-term bid, if you will, or bidding war that goes up for a few weeks. And so where we have a cluster of mills, we're able to mitigate that. And so in some areas in the South, it's been pretty flat and in some cases, a little bit down. In other cases, it's gone up. And the when it does go up, we sense that it's not a fundamental shift. It's more of a situation or an upset condition that after a few weeks works itself out. So I think we're in pretty good balance and we just have puts and takes, but there's nothing material that's on our rader in the South. Pacific Northwest is actually, I would say, balanced also. We actually saw a log cost decrease this past quarter in the Pacific Northwest, which was great to see. And we don't see any major swings, up or down, coming at us. And I think the log cost decrease was around 3% or something if I've got that right in the Pacific Northwest. So fairly imbalanced and I think the growth that we've done is both in the Pacific Northwest with [indiscernible] if you look down the coast of Washington and Oregon, our mills and the log circles and competition circles are very strategically lined up in the Northwest, and that's helping us from Port Angeles all the way down to [indiscernible].

Okay. And turning to the sale of the prospective sale of the harvest rights, I'm sitting out here in suburban New Jersey. Is there any way you could help me to kind of frame perspective values when you sell harvest rights on the B.C. Coast?

Yes. I'll take a shot at this, and then if Rick or Bart have anything else to add. But the -- I'm glad you actually asked this question, Mark, you obviously pick that up, and that's great. So just the back story is Acorn was our last coastal manufacturing operation. And with that now off or out of our company, we're assessing a number of strategic alternatives for the coastal business, including potential asset and tenure sales. The -- I would add that any dispositions are subject to working with First Nations and consent from the B.C. government, and we've been advancing and have advanced talks with both of those stakeholders, and it's going very positively. From a timing perspective, we would say between 12 and 18 months for the process to unfold. And from a value, I think, to your question, it's a little bit hard for us to provide reliable guidance on this, but the disposition of the entire coast tenures is about 1.6 million cubic meters, and we would expect that to be significant and material. And then for context, our coastal assets if I've got this right, and the book value are at the end of Q2, around $94 million. So we'll continue to work on this. We think there's great value for our shareholders and we'll obviously announce anything significant at the right time.

Okay. Last question for me. I mean it's very impressive results coming out of Eastern Canada. I'm just curious, if you could help us think about the contribution from that high I-joist business because I mean I-joist prices the last 6 quarters have moved like I've never seen a move in my entire career. So I'm just curious about sort of what type of benefit you're garnering from that tightening in the I-joist market?

Pretty strong, Mark. I'll maybe leave it at that, but we're very pleased with the contribution from our I-joist plant. We control a lot of the input stock through MSR, great outturns from our internal operations in Ontario and Quebec. And we have an advantage, I believe, on that side of it, but we're very, very pleased with Sault Ste. Marie's contribution.

Any way to quantify just overall, like is it 10%, is it 20%, is it 30% of kind of the earnings stream right [ value in ] I'm just looking for kind of a rough order of magnitude.

Yes, I'd be a little hesitant to share that in this form, Mark, but I can say that it's -- we were very pleased with his contribution.

Your next question comes from Hamir Patel, CIBC Capital Markets.

Ian, there may be some pulp mills that come up for sale in Ontario. Just given some of the codependency you have in Eastern Canada, is Interfor starting to move beyond the lead with lumber approach to also potentially include pulp assets into the mix of potential targets?