Louisiana-Pacific Corporation (LPX) Earnings Call Transcript & Summary

Good afternoon, everyone. I just want to thank everyone for participating and listening to DB's industrial and basic materials conference today and tomorrow. My name is Kyle White, and I'm the Senior Associate on the Paper & Packaging team under Debbie Jones here at Deutsche Bank. For this time slot, we are pleased to have Louisiana-Pacific, ticker LPX, a leading manufacturer of building materials and engineered wood products, primarily producing siding and oriented strand board. With us from the company, we have CFO, Alan Haughie; and Director of Investor Relations, Aaron Howald. The format for this presentation will be a fireside chat. [Operator Instructions] And then with that, thank you, Alan and Aaron, for joining us. Hope you are doing well. And I just want to hand it over to you for any kind of quick prepared remarks you want to make.

Okay, great. Thanks, Kyle. This is Aaron Howald. As Kyle said, good morning or good afternoon, depending on where in the world you are right at the moment. It certainly has been an interesting couple of months. We are fairly pleased and pleasantly surprised at the degree to which the housing market seems to have, so far, at least, weathered the storm and rebounded quite nicely in the past couple of months. We can talk about some of the factors that drove that, including some of the ways in which our products and our geography have somewhat insulated us from the worst of this. Happy to take any questions that anybody has. Alan should be back momentarily. He had to step out just at the last minute, but he'll be back in a second. But yes, really, we're just happy to have your participation and glad to take any questions that anybody may have.

Sounds good. I guess we'll kind of start with some of those factors you're talking about. I was hoping you can kind of just give us an update on current trends you're seeing this quarter, in April and May, particularly in Siding and OSB, how volumes trended in these categories. And then kind of if you can compare that to some of the expectations you and the management team had going into this quarter and from your last earnings call, the last update we had.

Sure. So a lot to unpack there. I probably won't remember all of those, but you can remind me as I go which elements of that I may have missed. So if we go back in time to, call it, mid-February of this year, which seems like an eternity ago, we were -- we had, had about 3 months in a row of seasonally adjusted housing starts above 1.5 million. The Expectation across the industry was that Q2 was going to be one of the strongest quarters we've had in a while. OSB prices had climbed through the early part of the year to around $300 per thousand square feet, which is more than a 50% increase over the prior year. So things were looking really quite good. And then a funny thing happened on our way to a great quarter. So the -- look, demand fell off pretty steeply late March or early April. We announced at the end of March that we were taking 100 million feet of production capacity out of the OSB business for the month of April and 50 million feet of capacity out of the Siding segment for the month of April. And both of those numbers work out to roughly 1/3 of capacity, about 30% of capacity on an annualized basis. And that was in response to demand that we were seeing at the end of March, beginning of April, that was just almost a complete standstill. I mean not only were people slowing work on existing projects, but much as we were, many of our customers were concerned about cash and liquidity and were very reluctant to take inventory positions in an environment like that. And so not only did ongoing work slowed down, but replenishment of inventory slowed down pretty significantly, too. And really, depending on your source, the general consensus is that the housing market kind of bottomed sometime in the second week of April, and then has been on a fairly steep recovery since then. Just for LP, in terms of what we have seen with regard to that volume, we have added back essentially all of the downtime that we took in April, we've returned it to the Siding segment. In the OSB segment, it's north of 80%. So in May, we ran not at 100% capacity, but at very close to what we ran in March. So it was about a 6-week gap really where we saw that expectation for near-term future demand fall off and then rebound quite steeply. And the whole industry kind of feels like it's got its fingers crossed and hoping that the housing pipeline isn't draining, and there's about to be an air pocket in demand and that there isn't going to be a secondary wave of infection. But so far, the data seems to be indicating that demand is real and the infection rate continues to slow, and we've seen demand rebound quite sharply. We've seen OSB prices begin to -- are nearly back to where they were before they started falling in response to COVID. And that's despite not just LP, but many of our competitors putting back in the production volume that they had taken out for April. So it feels like demand is real. It feels like the -- in contrast to the last crisis, this could be a housing-led recovery instead of a housing-led recession, and we're cautiously optimistic that, that trend will continue.

Sounds good. It sounds a lot better than kind of the sort of the downside scenario analysis that was provided on the last earnings call. Sounds quite a bit more optimistic there. Just curious, is this demand that you're talking about, is it pretty broad-based nationally? Or is it regional and some pockets much stronger than others?

Well, there is certainly a set of regional differences. The markets that are strongest at the moment are sort of the southeastern corridor of the country, and there are several factors that are driving that. So those are states. And so think basically Texas and then east all the way to the Atlantic. Those are states that had and continue to have, thankfully, relatively mild negative impacts from COVID. Those are also states that have, just because of the weather, they have a longer building cycle. And so they can start earlier in the year than northern areas. Those are also states that never declared housing not to be essential. So housing was allowed to continue even when the demand wasn't always as strong in that region. That's the part of the country where the housing starts per capita is stronger than it is in other parts of the country. So there is a -- it's a strong housing market to begin with. And it's a region where most of our OSB mills are located and where we have pretty strong market penetration in the Siding segment. And so if the southeastern corridor of the country is strong, that's generally a good thing for LP because it allows us to be geographically well positioned to appreciate the upside. And at least, in this crisis, we were reasonably insulated in that region from the worst of the downside, particularly in comparison to places like California and New York and Washington State and some places like that, that basically shut down housing and ceased most economic activity. So yes, there were some geographic advantages in terms of where the recovery started earliest. And those locations, fortunately, are places where LP has a strong presence.

Got it. It sounds like you -- I mean, in terms of what you're talking about here, it sounds like a pretty V-shaped kind of recovery in housing or, I don't want to put words in your mouth, but just curious if that's what you're seeing. Or do you think it's going to be a more gradual kind of recovery in housing starts?

Well, I'm not sure what letter of the alphabet I would ascribe, but if you look at OSB prices, the recent several weeks' increase in OSB prices is similar in slope to what we saw in Q1. That's just one proxy for market recovery. I would love to see weekly granularity of the housing start data that the Census Bureau published for April because my guess is that a significantly outsized proportion of the actual starts from the month of April were in the last 2 weeks of the month. And if that's true, then if you saw the weekly numbers within April, you might be able to see that dip and then rebound. And if that's true and if that continues, then May could be quite a steep bounce as well. Now let's just assume just for the sake of argument that we went down for a month and back up for a month in a nice perfect symmetrical linear V, that still might not put us where we would -- where we expected to be at that time based on our expectations in January or February, right? So even if it's a V-shaped recovery, we still will have lost volume and lost time. And if labor continues to be a constraint to homebuilding, we may struggle to make up the lost volume that happened in the quietest portions of early April to sort of mid-April. So even if it's a V-shaped recovery, that doesn't mean that by the end of June, we're just going to be looking at each other and breathing a sigh of relief and saying, "Boy, I sure am glad that's over." So look, we don't have a whole lot of data yet. I would love to see the May starts data from the Census Bureau right now, but early indications, based on OSB pricing, based on the volume that we're seeing, yes, we're very pleasantly surprised with where we are, certainly compared to where we expected we would find ourselves this time a couple of months ago.

Got you. And then you talked about downtime. It sounded like you're already kind of at normal production levels for Siding and no longer taking downtime there. And then you're at 80% for OSB. Just kind of what's the plan or expectation when you get back to 100% on the OSB side?

Yes. I think, right now, we have only 1 OSB plant that is not operating at 100% capacity other than Peace Valley, of course. Peace Valley is a mill that we idled late last summer and that mill remains idled. We have -- I think the situation right now is we have 1 mill that's taken -- that's still taking weekends off. And the plan might sound a little flippant or oversimplistic, but the plan for production volume is, we're going to let our customers tell us how much to make. We are -- we produce in response to demand, not opportunistically in response to price. Although price movements are a proxy for that demand, we've continued to see strong demand. And so we have added that production capacity back. So look, in the OSB business, there is not a whole lot more that we could add before we would have to either think about restarting Peace Valley or think about adding OSB production back to the siding mills and either of those moves would require us to believe that demand is strong and also likely to be sustainable for quarters at a time, not weeks or months. So in terms of OSB capacity, we're just about tapped out and any additional volume would really require high levels of confidence that there is no second shoe about to drop in terms of the secondary wave of infection or some other sort of head fake in terms of industry demand. In the Siding business, look, we just converted a mill in Dawson Creek, and so that segment has a fair amount of capacity above current demand levels. And so in terms of capacity utilization there, it's just ongoing growth in for demand to that product. We suspended guidance for volume growth for 2020, but our long-term target remains 10% to 12% growth rate. So we expect to achieve that over the long term.

Got you. Just shifting a little bit going to kind of repair and remodel end market. Just what's your overall exposure to that end market? And then how has repair and remodeling kind of held up during this crisis and this time? And how is it trending recently?

Sure. So the Siding business is about 40% repair and remodel driven. OSB is almost entirely new construction. Siding is about 40% new construction, about 40% R & R and about 20% everything else, with sheds being probably the largest single thing within that remaining 20%. I'm sure everybody on the call is aware of the huge amount of volume and activity in the larger home centers, Lowe's, Depot, Menards. Those places are on fire, and a fair amount of volume that leaves those stores goes into DIY projects and then some of those projects are repair and remodel. Some of them are people building their own sheds and outdoor storage facilities and those kinds of things. And look, I think Lowe's and Depot are reporting more than 10% year-over-year same-store growth rate. So we're fortunate to be a part of that as well. I think part of that is a shift from -- and this shift is probably temporary with regard to R&R. The shift from professionals to DIY as a lot of jurisdictions homebuilding was deemed essential, but repair and remodel wasn't. And so some people just sort of took those marginal products on projects on themselves that thought they could get done. And so we're seeing some evidence of that at those home centers. But our visibility into exactly where those products go after they leave a Lowe's or Home Depot is not great. So we can't be certain exactly where it's headed. And R & R is inherently a difficult thing to measure. Most of the indices are total expenditure, and they include all kinds of projects, kitchen and bathroom and all kinds of things that LP doesn't participate in. So it's a little bit difficult to know exactly what's going on there. But long story short, anecdotally, we're hearing evidence of strong R & R growth and -- particularly in DIY, and we're seeing our retail volumes quite strong.

Got you. And I know it's relatively early still in this kind of pandemic, but just curious if you have any kind of interesting statistics or anecdotes in terms of the expectation or anticipation of any fundamental shift in housing or other consumer behavior as a result of this pandemic that could impact your business long term and fundamentally?

Yes. As you said, it's very early in this process, and so most of this is anecdotal and speculative. But I've had a lot of conversations with people over the past couple of months who are sheltered in place in big cities and in apartment buildings with hundreds of their closest friends. And it just doesn't feel as safe or as isolated as many of those people would like to feel at a time like this. And so -- and another thing we're seeing is I had lots of conversations with people who have -- whose businesses are thinking about, do we really need an office as big as the office we have? Do we really need a location that's as central as the location that we have? And so there are some signs that we could see a longer-term shift away from urban cores into suburbs and more rural areas. We could see more working from home and people who work from home are much less dependent on a specific location. We could see, I think, a shift from multifamily to single family. And another shift we could see is, if you look in the New England area, something like 2/3 of all COVID deaths happened at long-term care facilities, nursing homes, rehab centers, places like that. And both -- me personally, my mother is in one of those facilities in Pennsylvania. She got COVID. She's fine, thank goodness, but many of the residents in that facility did not recover. It causes some questions about the long-term safety of that kind of a scenario and maybe the preference for aging in place. Maybe a lot of people will think, maybe their parents would be safer living with them and having professional care in the home. And so if more people are working from home and more people are aging in place and more people are living in single-family homes than multi and more people are living in rural than in urban, all of those trends would benefit single-family home construction and certainly would benefit companies that either provide that construction or provide products for that construction. And so look, we have very, very few data points to support any of these anecdotes, and it's early in the process. But one data point that is interesting is that while the total starts were down pretty deeply for April, fortunately, permits were quite a bit above starts. So that might allay some fears that the pipeline is emptying out. But within the April starts, something like 75% or 76% of them were single-family starts and only about 25% were multifamily, and that compares to kind of a longer-term average for the past several years. We've seen a 30% to 35% multifamily. So why that matters for LP is a really easy rule of thumb is per start, a single-family home consumes about 3x as much OSB as a multifamily home. And so the amount of volume of OSB that will be consumed if -- let's just stay -- starts stay the same, but we see a long-term shift of increase of, say, 5 percentage points, the mix of those starts that are single family, that will have a materially positive impact on OSB manufacturers. And so any of those trends that lead to more homes being built, more single-family homes being built and homes being built that are larger to accommodate multi-generational housing and/or working from home, all of those trends, if they materialize, would be positive for LP and for companies like us.

Got you. So if I -- how do I take kind of that thesis? And we are starting to see more and more evidence of it with more companies, these tech companies allowing their employees to permanently work from home and kind of the younger generation realizing that they don't need to pay the high cost of apartments in large urban areas, and they can work from home in the rural area. If that thesis is -- holds true, how do we take that in the context of kind of the transformation that LPX has been going through over the recent years in terms of moving away from OSB and into kind of Siding? I know you guys -- you just talked about the recent conversion. And then it's also -- the next question is, when is another conversion coming from OSB and Siding? Just curious on, does that impact that transformation plan at all, this thesis?

Not at all. If anything, it reinforces it. Look, I mean the siding products go on to new homes as well. And if the repair and remodel trend continues, our pre-finished siding products are specifically targeted at R & R. And so that's nothing but positive for the Siding business. Look, as we continue to convert mills from OSB to Siding, we could restart Peace Valley, convert 2 Aspen mills from OSB to Siding and have about the same amount of OSB capacity that we have right now. So we have the ability to supply a growing market with more OSB if customers demand it. And look, if -- let's say that we struggle to meet the demand for OSB as an industry, when that happens, usually prices go up. And every dollar of OSB price increase just falls straight to our bottom line because it has essentially no impact on our cost to manufacture. So arguably, if we convert mills from OSB to Siding in an environment where single-family homes are growing and OSB demand is increasing, that will be good -- that will be very good for the company because it will constrain commodity OSB production, which tends to lead to price appreciation. And so what you'll see is a higher and more stable revenue and margin numbers for LP than you would expect to see from a company that was a pure commodity play that rode an OSB price spike and made an awful lot of money in a short period of time, but then followed that by a longer period of breakeven or worse results as OSB prices fell again through the next cycle. So if anything, it reinforces our strategic transformation and gives us reason to accelerate.

Got you. And you touched on this a little bit earlier, but I'm just curious how is the pricing environment for OSB? What are you seeing currently and expecting in the near to medium term?

Well, trying to predict OSB prices is almost as difficult as trying to predict housing starts. But -- so the most recent data point we saw was that last Friday's print was flat. So Random Lengths Prices didn't change last week. Now there are a lot of things that can drive that. If you read their explanation, it sounds like the primary driver for that is that order files are getting longer. And why that matters in terms of Random Lengths Prices is that Random Lengths is basically a journalistic entity that aggregates information about recent open market sales and then reports the price trends that they're hearing in the market. When order files get extended, the volume of open market transactions can fall pretty significantly. And sometimes, there just aren't enough transactions for Random Lengths to meaningfully interpret what's happening in the market. And that may have been what caused the price plateau. So long order files plus hesitancy to take inventory positions can lead to no impact at all for our contract volume. That volume remains high, but a decrease in open market volume such that Random Lengths just doesn't have any data to report. So we'll see what happens tomorrow with the mid-week print and Friday at the weekend print. But so far, that trend remains robust.

Got you. Just kind of taking a step back here, and there's been a lot of focus and consumer awareness on sustainability in recent years. And I'm just kind of curious, has this had an impact at all in LPX? Is this kind of an area of focus for your customers, stakeholders or even shareholders?

I think we have a really good story to tell from a sustainability standpoint. We -- every stick of wood that we harvest is harvested sustainably. In the south, we consume Southern Yellow Pine to produce OSB, and we replant as we go. In the north, we consume Aspen, and Aspen is actually a colony, not to get too deep into the botanical sciences here, but Aspen is a lot like grass. You cut it, it grows back. The act of cutting it stimulates the roots to regenerate like grass or like bamboo. So we measure what's called a growth-to-drain ratio in all of our wood baskets, and basically, the short version is that the total biomass of wood in -- of trees in the areas where we're harvesting is going up as we harvest, in large part because of how we manage those harvest, and it's all certified by the Sustainable Forestry Initiative. And we -- there is no sizable waste stream of solid waste that leaves our plant. The tree comes into our factory and that tree leaves as a combination of heat, steam and finished goods. We produce something like 95-ish percent of the BTUs we consume, but with -- in the form of biomass by burning the bark that comes in on the trees. And our products, of course, are wood that go into homes that can last a century. So there's really good sequestration there of the carbon. We've -- I've gotten a lot of questions recently about supply chain risks as a result of COVID and sustainability there, and we haven't seen anything at all. If anything, our raw material prices have fallen a little bit as some of our chemicals have crude oil as precursors. And so crude oil prices have fallen, which means our raw material prices have fallen. There has been -- there have been many articles recently about whether people have -- whether ESG-focused portfolios have fared better in this crisis or whether maybe ESG is a luxury good in this crisis. I don't really have a position on that other than LP has a great story to tell, and we're happy to tell it and keep telling it. And I don't get a whole lot of questions specifically about that from investors, but we're happy to answer the questions that we do get. And I think most of our answers speak to a good job that we're doing as a steward of our resources.

Could I ask what -- this is Alan here. What prompted the question?

We've had a more and more focus in questions coming from Paper & Packaging on ESG, particularly on the sustainability side when you're talking about packaging and materials there. So I was just curious, really, if you guys as well. It's not that you're necessarily packaging, but just curious if you've been seeing kind of a heightened awareness from investors or even stakeholders that are pushing you to do more on ESG, just kind of really why. And then we also have kind of a SASB event later on today with the conference, too.

Yes. I certainly think that -- I would argue that LP's sustainability position in record is better than you would think and that we actually have a little bit of a job to do to communicate that far more effectively than the zero communication we do at the moment.

Yes. I mean I think that's what a lot of companies are dealing with, is that there's so much information, so many different data points. Like what do you actually look for? There is a lot of different firms out there trying to measure it, but which one is -- what's more sustainable? And it's a tough answer right now that I think companies and investors are all grappling with right now. So just curious to see what you guys are hearing as well.

Well, look, we're in the fiber business. Everything we make is based on wood fiber, and so we are very highly motivated to make sure that we have a fiber supply ahead of us for the indefinite future. And the way to be sure of that is to be good stewards of that resource. So we're doing everything we can to make sure that as we harvest, we're more than adding back what we take away.

Yes. Makes sense. We have a few more minutes here. I guess kind of just kind of wanted to -- for you guys to describe LPX's kind of capital allocation plan and the phasing that you have related to that. What are your kind of capital allocation priorities and long-term leverage targets? And then kind of what are normalized CapEx levels that investors should expect for the company going forward?

Well, the short version is that our CapEx strategy hasn't changed. We continue to plan to return half of the cash that we earn after investments and maintaining our assets and pursuing our strategy to shareholders via dividends and buybacks. We -- while we don't currently have any plans to buy back shares in 2020, we still have authorization to buy back $200 million worth of it. And in Q1, we satisfied that 50% number with dividends. In terms of a long-term capital expenditure plan, we were planning to spend $130 million to $140 million this year. And in response to the uncertainty about demand expectations related to COVID, we cut that down to -- we cut that roughly in half to $70 million. Most of the projects that came out of that portfolio were projects aimed at increasing capacity, increasing efficiency and speed, things like that, which seems less necessary in an environment where demand was so uncertain. As the housing industry continues to recover, we could have a different view towards increased capacity and efficiency, and we may add those projects back. In terms of long-term liquidity, look, we reacted in -- out of an abundance of caution early, by drawing on our revolver and borrowing about $350 million and securing the ability to borrow further than that. I have been getting questions in the past few weeks like, did we borrow too much too early and did we cut CapEx too deep too quickly? And I'd love to get those kinds of questions because it implies that I'm not the only one whose outlook has become more positive than it was a month ago. And so look, we're evaluating all of our options with regard to whether that borrowing continues to be necessary, whether we should add capital back to our portfolio. And we are continuing to look for interesting and strategically synergistic opportunities for M&A and other investments as we go like we have -- like last year, we purchased 2 different pre-finishing facilities for our Siding products. So that product line will grow by adding new regional pre-finishing capabilities. So we continue to look for locations that can be the next steps for that growth trajectory. But really, our strategy hasn't changed. What has changed is the near-term expectations for cash generation. And so as those expectations change, we get back to thinking more about adding more CapEx back and investing more in other ways to drive our strategy and potentially repurchasing shares.

So well, that's all my questions. And I do believe our time is up. I really want to thank Alan and Aaron, both of you, for joining us and LPX as well. And for those on the line for listening in, I really appreciate it.

Yes, it's a pleasure speaking to all of you. And if you have any other questions, don't hesitate to reach out.

Thank you. Have a good day, everyone.

Thank you.

You, too.