Interfor Corporation (IFP) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen, and welcome to Interfor Quarter Analyst Conference Call. [Operator Instructions] This call is being recorded on Friday, the 4th of August 2023. I would now like to turn the conference over to Ian Fillinger. Please go ahead, sir.

Thank you, operator. And thank you, everyone, for joining us this morning. With me today on the call, I have Rick Pozzebon, our Executive Vice President and Chief Financial Officer; along with Bart Bender, our Senior Vice President of Sales and Marketing. First off, I'd like to welcome Nicolle Butcher to our Board of Directors, and we look forward to working with her and her contributions over the years to come. I'll start off by providing a brief recap of our quarter, and then I'll pass the call over to Rick and Bart. Turning to the last quarter, we experienced production cost decreases, price stabilization and record shipment volumes, which all contributed to an adjusted EBITDA of $41.9 million, an improvement over the previous quarter. We also continued to advance on our key multiyear capital project in the U.S. South, which are focused on delivering significant returns. With respect to our outlook, recent housing data has shown modest improvements, including in the single-family sector. And it appears that strong underlying demand for housing continues to outweigh the impact of higher interest rates, and homebuilding activity has been resilient so far. On the supply side, both North American production and European imports are easing, adding tension to the lumber market while creating a positive supply/demand situation. I'll now turn the call over to Rick, who will walk through the financials. Over to you, Rick.

Thank you, Ian, and good morning all. Please refer to cautionary language regarding forward-looking information in our Q2 MD&A. From an overall perspective, Interfor's Q2 results represent significant and ongoing improvement since the fourth quarter of last year. In terms of earnings, adjusted EBITDA improved 61% quarter-over-quarter to $42 million. Revenues benefited from an 11% increase in lumber sales volume combined with a 2% increase in the average realized lumber sales price with both driven by strengthened end use demand. At the same time, costs benefited from continued moderation of log costs to better reflect current lumber prices and a $27 million reduction in the valuation reserve previously recorded against inventories. Q2 results were also positive in terms of cash flow on our balance sheet. Cash flow from operations totaled $123 million, including $97 million from inventory reductions. These inventory reductions reflect a conscious management effort to reduce working capital investment on a sustained basis going forward, especially at the operations we acquired last year in Eastern and Atlantic Canada, which presented significant opportunity. For context, our total lumber inventory volume at the end of Q2 represented a 24% reduction year-over-year on a pro forma basis, including all acquired operations. And we also reduced our total Canadian log inventory volume by 24% over the same period and on the same basis. The positive cash flow from operations led to our net debt to invested capital leverage ratio dropping to 29.6% at quarter end. With all else being equal, we expect further leverage reduction over the next few quarters, with the collection of pending income tax refunds totaling approximately $100 million. In terms of capital allocation over the remainder of this year, our 2 key priorities are to continue reducing balance sheet leverage into our target range and to continue investing in U.S. sales-focused organic growth and optimization. We continue to anticipate total capital expenditures of about $210 million for 2023, of which the majority relates to discretionary projects in the U.S. South with attractive returns. As our balance sheet continues to delever, we will remain open to evaluating other attractive capital allocation opportunities that fit with our strategic plan. To wrap up, our second quarter results were another step in the right direction. Looking ahead, we will continue to focus on generating the best returns on capital in our industry and on maintaining balance sheet flexibility to navigate market volatility and that [ can queue ] onto our strategic plan. That concludes my remarks. I'll now turn the call over to Bart.

Thanks, Rick. I will provide some comments on our market outlook for the remainder of 2023. Although some of the macroeconomic factors relevant to our business remain uncertain, there are several reasons to feel optimistic as we work our way through the balance of 2023 and head into 2024. U.S. single-family starts for May and June are encouraging. Both represent a March shift from the previous 12 months. The homebuilders in the U.S. are all reporting encouraging results in their quarterly earnings report, and guidance supports a continued trend for the balance of the year. With many existing homeowners having relatively competitive mortgage terms, the number of existing homes for sale remains low, which supports newly-constructed homes taking a larger share of home sales going forward, a benefit for the overall demand for lumber. Builder sentiment remains strong and trending upwards. Our box store comparables remain favorable and point to a steady repair and remodel market going forward. All of these factors, coupled with the other fundamentals such as underbuilt housing, demographics, age of homes, home equity, et cetera, leave us feeling optimistic of improved lumber demand going forward. In our Q1 2023 quarterly market outlook, we discussed improving I-joist demand. This trend has continued through Q2, and the outlook remains favorable for Q3 and Q4. In terms of lumber supply, North American production has tightened in the first half of 2023. Curtailments and, most recently, wildfires have impacted operating rates. And in turn, shipments in both Canada and the U.S. have declined. We expect this trend to continue as the industry works through the longer impacts of the wildfires in both the Canadian East and West. In-market inventories remain at the lower end of historical norms. And as Rick mentioned, we have driven all -- driven our overall inventories down by 24% year-over-year. We expect that as lumber demand increases, lead times to supply will trend upwards. This will put pressure on distributors of lumber to purchase for immediate needs plus additional volumes to grow inventories needed to offset greater lead times to restock. Overall, we're encouraged with the market direction and look to work our way through Q3 into Q4 and finish the year with momentum. With that, back to you, Ian.

Thanks, Bart. Operator, we're at the point to take any questions.

[Operator Instructions] Your first question comes from the line of Sean Steuart from TD Securities.

Bart, I'll start with a question just following up on your comments on the market. Your positioning -- your take on channel inventories as still being below normal, and maybe I'm paraphrasing. But just your perspective on market -- lumber markets stalling the last few weeks and weakening, I guess, a little bit this week. Are you attributing this to summer slowdown, given your perspective that inventories are still lean through the channel? Wondering if you can contrast those 2 things against each other and help to explain why we've seen things stall a little bit the last few weeks?

No problem. Sean. Good questions. Definitely, I think volatility is always one of those things that's going to remain, and so we're not going to escape that. But if you sort of step back and you look at Q2, and historically, Q2 has always been a quarter where supply chain issues seem to be at its lowest. So I think we're pretty fluid in getting demand to market or our supply to market. When you look at the summer, I mean, obviously, we dealt with some adversity on weather pretty much across North America. If you look at the U.S. South, I mean right now, we've got people in Phoenix putting up with 110-degree weather. And you're not going to see the pace of building that you would normally at -- when that kind of thing goes on. And so I do think that that's probably part of it. And again, I've got to highlight the supply chain side. Everyone talks about the improvements, and that's a real thing. They have improved. And so getting resupplies pretty quick for our distributors, and I think that garners a different approach to the market.

Okay. That's helpful. A question on working capital. You guys gave us good detail on how much log and lumber inventories are down year-over-year. Are you guys at bare minimums at this stage? Is there any room for further reductions at this point?

Sean, it's Rick speaking. Yes. We're currently, in terms of lumber inventories, around 18 to 19 days of production. If you think on the margin, there's still a little bit to squeeze out there, but we're pretty comfortable where we're at.

All right. Just one last one. Ian, this process for potentially selling the tenure on the coast. Can you give us a little bit more detail what's involved in this subdividing process and your conversations with the Ministry to get approval? How long are you guys thinking to resolve this?

Thanks, Sean. I mean it is a file that we're working on. We've been on the coast for 60 years. So the complexity of dealing with all kinds of different stakeholders, including the government, is not always on a time line or pace that we move at. But all conversations with the government have been supportive in British Columbia. Our vision of how this could unfold is very consistent with the government mandate, and so I would say that we're confident in the partnership and leadership that the government is showing to date, and we just continue to work on that. The time line is just quite hard to predict, and I know it's really hard to model. But we have transacted on a couple of tenure sales in the past. And we feel that we've got good counterparties lined up, and we'll just continue to work on it. And it will be a slow trickle in, we believe, over quarter-to-quarter, and we would include when we're successful on sales in our quarterly reports.

Your next question comes from the line of Paul Quinn from RBC Capital Markets.

Just trying to determine how much more strength we need to see in the Canadian U.S. housing market to be able to tighten up this lumber market. Is your feeling that prices could move materially higher if we get to kind of 1.5 million starts next year? Or how do you guys see the way unfolding going forward?

Yes. Paul, it's Bart here. I mean, certainly, we've been encouraged with what we're seeing on the housing starts. We've got the single-family piece that's creeping up from a low of 60%, getting up into 65% now of the starts. Obviously, that's a boost for lumber demand, and so we think we're going to see more of that as things move along. When you look at the big builders and the things that they talk about, it's pretty encouraging. And most, if not all, are talking about improvements going forward. So it's hard to put a number on it, but I think it's probably more a percentage of single family to the multifamily that needs to come up. And yes, we just need to continue on with what we're doing. [ That ] will come.

Sorry, Bart. I would just add on the supply side, Paul, as you well know, I mean we're seeing a dramatic reduction in the imports from Europe into the U.S., which is super encouraging, given that it was quite high, and now it's a steep drop-off. So that with curtailments and some permitting curtailments, and we still believe there's more to come out. I think just it kind of adds to your comment around the 1.5 million and Bart's comments around the market on the supply side, contracting in a couple of areas is, I think, at 1.5 million, that's -- used to be a great number. And just given these dynamics, who knows what the market will do, but I think the fundamentals are lining up pretty nicely.

Okay. Then just wondering, given the current conditions, are we going to see any change in your production profile in the back half of the year from the front half of the year?

I would say that given the curtailments that we have taken in the first 6 months, particularly around balancing the inventory that Rick had talked about and then the market weakness, we probably, given everything equal today, should see a production increase going forward in the last half of this year.

Your next question comes from the line of Ketan Mamtora from BMO.

Maybe to start with, Bart, can you talk a little bit about how are the inventories from the European imports, where are there right now? I know the actual volumes have started to come down. But is there still a lot sitting around the Eastern Seaboard?

Yes, it's definitely moderating for sure. I mean, obviously, we saw some fairly significant increases on what was the imported tail end of last year and beginning of this year, and that was all about the correction of the supply chain constraints that were happening over in Europe. And so a lot of that wood make its way to market. I will say that quite a bit of that wood, it was aged. So you could tell it was sitting on the docks whether in Europe or in the U.S. for some time, and so that's one issue that the industry and the markets are working through. I can tell you the -- and, well, you see the stats as well. The imports that are coming in have dropped dramatically, and our intel tells us that there's potential for further declines. So it's just a matter of time before everything cleans up. But we're certainly hearing a lot less about imports today than we were, call it, Q1. So a definite improvement.

Got it. That's helpful. And then can you give us a quick update on sort of how you guys are thinking about the multiyear CapEx program that you have talked about in the past? Is there any sort of -- are you reassessing in terms of kind of how you should approach it, given a market backdrop which is quite fluid?

Ketan, Ian here. Thanks for the question. Our adjustments to the CapEx -- strategic CapEx plan is largely unchanged since our last call. So the key projects in the U.S. South are moving along. And we continue to stay committed to those and feel that in the long term -- medium term and long-term those will obviously pay off nicely for us. So no update or changes expected in the CapEx plan from last quarter.

[Operator Instructions] Your next question comes from the line of Hamir Patel from CIBC Capital Markets.

Ian, do you expect Interfor will be selected as a mandatory respondent in the trade case from the ongoing review? And do you see any risks there, just given the approach that commerce previously took with the other Eastern producer that was previously selected?

Yes, Hamir, I mean we scenario planned for this. So is Interfor ready to respond and take on the work that is required if we are selected? So we're in really good shape that way. Obviously, we're continually running models. So we don't see a big risk coming at us either way, whether we're selected or not, and I don't really have much more to comment on that.

Okay. Great. And do you have a sense of the timing as to when maybe a determination would be made there and when would that potentially take effect?

No. No, I don't actually. It's not this year. So it would be -- I guess it would be next year or the year after, but I don't have the exact timing there, Hamir.

Okay. Fair enough. And just the last question I have is on the fiber cost side. How do you see costs playing out across your different operating regions over the rest of the year?

Yes. Well, obviously, in B.C. -- and Rick, you can jump in if I missed anything. B.C. was -- the stumpage adjustment was great for us as it sort of realigned log cost to current market conditions. The B.C. government's move to a shorter time line on stumpage adjustments, we think it's positive and something that we've been working with our partners with and government to make happen for many years. So that's great. But yes, in our other jurisdictions, they're holding or reassessing downwards. So we're confident that given the market condition today, we're seeing the right trends in log costs across our system.

And Hamir, it's Rick. Exactly what Ian said, the B.C. interior -- we expect stumpage to come down another, say, $10 to $15 a cubic meter in Q3 versus Q2. And we're also going to see some benefit in Quebec from fire salvage timber. So there'll be a reduction in stumpage rate likely at the end of Q3 into Q4 and beyond of about $5 to $10 a cubic meter.

There are no further questions at this time. I will now hand over to -- the call to Mr. Fillinger. Please continue.

Okay. Just to wrap up, thanks for your interest in the company. And as usual, feel free to reach out to any one of us at any time. That concludes our call, and have a great weekend.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.