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

Good day, and thank you for standing by. Welcome to the First Quarter 2023 Louisiana-Pacific Corporation's Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Aaron Howald.

Thank you, operator. Good morning, everyone, and thank you for joining us to discuss LP's results for the first quarter of 2023 and our outlook for the second quarter. As the operator said, my name is Aaron Howald, and I am LP's Vice President of Investor Relations and Business Development. I'm joined this morning by Brad Southern, LP's Chief Executive Officer; and Alan Haughie, LP's Chief Financial Officer. During this morning's conference call and webcast, we will refer to an accompanying presentation that is available on LP's IR web page, which is investor.lpcorp.com. Our 8-K filing is also available there along with our earnings press release and other materials. Today's discussion will contain forward-looking statements and non-GAAP financial metrics as described on Slide 2 and 3 of the earnings presentation. Rather than reading those statements, I incorporate them herein by reference. The appendix of the presentation also contains reconciliations that are further supplemented by this morning's 8-K filing. And with that, I'll turn the call over to Brad.

Thanks, Aaron, and thank you all for joining us to discuss LP's results for the first quarter of 2023. Q1 demonstrated the value of our strategy in a challenging operating environment and an uncertain housing market. Compared to the first quarter of last year, single-family housing starts fell by almost 30% and commodity OSB prices fell by more than 75%. Despite this decline, we maintained flat Siding sales and generated positive EBITDA in our OSB segment, outperforming the underlying market. We are currently seeing encouraging signs of strength in housing, including improving commodity prices. And I am confident that LP's businesses will continue to outperform the market. Page 5 of the presentation shows highlights for the quarter. In sum, a much softer housing market drove OSB prices far below last year's levels, with the obvious impact on sales, EBITDA and cash flow. Inflation appears to be easing somewhat. The cost for resins, [indiscernible] and freight remain elevated, pressuring margins. LP's businesses responded by outperforming the market, and we continue to invest in our growth. $584 million in sales was about half of the amount from Q1 of last year, with the vast majority of this difference the result of lower OSB prices. EBITDA of $66 million and earnings per share of $0.34 were much lower than last year, again, due to the difficult comp from last year's very high OSB prices. However, our results were above our previous guidance due to disciplined and efficient operations in OSB and flat Siding revenue. LP invested $114 million in CapEx in Q1, mostly for the conversion of Sagola to Siding. Alan will discuss cash flow in more detail in a moment, but LP ended the quarter with $126 million in cash and just under $700 million in liquidity. Safety and OEE were key highlights for the quarter. Safety and efficiency can never be taken for granted, especially in a difficult operating climate of a soft market. This makes our safety and OEE performance in the quarter to be remarkable. Both businesses saw a 2 percentage point increase in OEE, and both businesses had a single recordable injury in the quarter. Our goal, of course, is 0 injuries and 2 injuries in the quarter is 2 too many. But while we work to continuously improve mill safety, it is nice to pause and recognize exceptional performance. In the Siding business, our Dawson Creek and Tomahawk mills each achieved 1 million injury-free work hours. And in OSB, the first quarter was the best quarterly [ sector ] results for the segment in more than 4 years. We obviously prefer the cash flow to higher OSB prices generated in the first quarter of last year, but it is gratifying to see the value generated by our OSB strategy even in a weaker market. Structural Solutions averaged 46% of OSB volume in Q1, but exited the quarter well above 50% where it has remained. Structural Solutions contributes incremental margin regardless of commodity prices. In terms of capacity, rather than oversupply in soft market, we took market downtime managing our capacity flexibly. And despite the market-related downtime, as previously mentioned, we improved operational efficiency performance in OSB. As a result of this relentless focus on execution, the OSB segment stayed EBITDA positive despite the lowest prices we have seen since before COVID. I am very proud of the OSB team for the resolve and teamwork demonstrated by their Q1 performance. On Slide 6, you can see an update on Siding product mix and growth relative to the market. On a trailing 12-month basis, single-family starts in the U.S. were down 18%, but Siding volume grew by 7% and prices were higher by 13%, driven by list price increases and improving mix. The pie charts on the right reinforce the improvements in mix within the quarter. While SmartSide volume fell by 9%, ExpertFinish volume grew by 26%. I should point out, just for avoidance of doubt, that while these 2 charts are on different time frames, with one being trailing 12 months and the other being Q1, the results are broadly the same over a variety of timescales. Any way you look at it, the story is basically the same. SmartSide is growing faster than the underlying market. And within that, the mix of ExpertFinish and other higher value-add products is growing faster still. To illustrate this, Slide 7 shows normalized growth of volume and revenue for SmartSide Strand Siding relative to single-family housing starts over a longer period of time. As you can see, LP SmartSide is consistently growing well above the underlying housing market. So we're taking share, expanding addressable geographies and market categories, introducing new products and increasing our focus on the less volatile R&R market segment. The reason for this is clear. LP SmartSide is the best Siding product available. It looks great, has the durability of supporting 50-year warranty, is easy to install, is carbon negative and is available primed or prefinished at a price point that delivers value to installers and homeowners. As a result, we believe we have a long runway for growth ahead of us in Siding. To meet this demand, LP will continue to invest in capacity. Slide 8 of the presentation provides an update for our capacity plan for Siding. I am happy to announce that LP's former OSB mill in Sagola, Michigan, pressed its first board of SmartSide in March. Sagola's conversion adds 330 million square feet of Siding capacity, bringing total Siding capacity to about 2.3 billion square feet and reducing total OSB capacity to about 4 billion square feet. Speaking of investing in Siding capacity, you may have seen our recent press release announcing that LP reached a definitive agreement to acquire the Wawa OSB mill from Forex. I'm happy to announce that the transaction was approved last week and closed yesterday. This investment contributes to our Siding strategy by adding to our conversion options and increasing our runway for future growth. Wawa is ideally located with access to labor, logistics and ample sustainable Aspen fiber and we are thrilled to engage with our new employees, the local community and First Nations there as we begin planning for the project to convert Wawa to manufacture SmartSide. When converted, Wawa will become LP's largest single line Siding mill, adding roughly 400 million square feet of capacity and bringing total Siding capacity to about 2.7 billion square feet. We will provide more details as the project evolves. And with a purchase price of $80 million, our estimates of conversion costs and the lower execution risk associated with the existing facility, we believe this project will generate a higher return than the previously announced expansion of our Houlton main facility, which is why Wawa will jump the line ahead of Houlton's line 2. We still plan to expand Houlton after the Wawa conversion as customer demand continues to grow. Converting Wawa and expanding Houlton would bring total Siding press capacity to 3 billion square feet, and the remaining conversion and expansion options we have already discussed could eventually bring total Siding capacity to about 5 billion square feet, more than double our current size. And this is just press capacity. We are continuing to invest in growth of ExpertFinish or prefinished siding with our newest facility in Bath, New York, coming online in Q3 of this year. We are investing in our strategy for Siding and Structural Solutions, and we are confident that both have a long runway for future growth. While we are seeing encouraging signs as housing starts so far this year have been above full year consensus, the housing market is not out of the woods quite yet. Single-family starts were down nearly 30% in Q1 with inflation and mortgage rates impacting affordability, and Q2 is looking roughly the same. However, the encouraging signs in housing are beginning to be reflected in our order files. While channel inventories in Siding remain elevated, as is typical in the months following the end of the managed order file, we are past the Q1 peak in inventory. The Siding order file has seen a notable uptick in recent weeks. And OSB inventories are leaner as demand and prices have recently improved. The macroeconomic environment remains challenging and near-term uncertainties remain in the housing and R&R markets we serve. But we remain very confident in our strategy, our execution, our high-performance carbon-negative products and, most importantly, all of LP's people will help us continue to outperform the underlying housing market, gain share and expand the markets we serve. And with that, I'll turn the call over to Alan to discuss LP's results in more detail.

Thanks, Brad. As outlined already, the U.S. housing and the broader macroeconomic environment are significantly more challenging than at this time last year. But I'm happy to report that LP responded by focusing on the factors within our control. We exceeded all components of our first quarter guidance, while the market numbers dominating the quarter are the 29% drop in single-family housing starts and a nearly 80% drop in North Central Random Lengths prices for commodity OSB. I'll refer to Slides 9 and 10 in the presentation to describe just how LP's Siding and OSB segments navigated the quarter before moving on to discuss LP's liquidity and capital allocation, including a little more on Wawa. Slide 9 shows the first quarter year-over-year revenue and EBITDA comparison with the Siding. The volume was down 9%, a spread of 20 points over the drop in single-family starts. And this is due to the combined effects of ongoing share gains, expanded addressable markets and the fact that the majority, about 60%, of Siding products serve the repair and remodel market and shed applications. And while overall volumes may have declined, ExpertFinish volumes did not. Rather, they increased by 26% year-over-year, which also helped the mix component of price. The $27 million reduction in volume at roughly a 50% variable margin cost the segment $14 million of EBITDA. Siding's average selling prices were 10% higher than the first quarter of last year. Roughly 6 points of the 10-point increase are from list price increases, namely the combined effect of this January's increase and last year's midyear increase, with the rest coming from favorable mix and lower rebates. So as expected, higher prices helped offset the volume drop and as it turned out, they completely offset it. This was also a quarter of heavy investment in future capacity. Mill conversion costs were up $6 million year-over-year, but I need to dissect that statement. This year, we actually incurred $10 million converting Sagola to Siding, but at the same time last year, we incurred $10 million converting Houlton to Siding. So one $10 million conversion cost was basically replaced with another. All that shows up on the waterfall, therefore, is $6 million of unabsorbed operating cost of Houlton, while we proceed with what is turning out to be a slow ramp-up given current market conditions. But this means that the business is actually carrying $16 million of embedded cost, that is $10 million of Sagola conversion plus $6 million of uncovered costs of Houlton, all in the interest of future growth. And this cost is about 5 percentage points of EBITDA margin in the first quarter. A second margin headwind came from raw material inflation. Compared to the first quarter of last year, inflation cost Siding $14 million of EBITDA. Now inflation ramped up quickly during the second quarter of last year. So while prices remain elevated, we do expect year-over-year comparisons to begin to ease going forward. So again, in a quarter of high inflation, much lower housing starts, lower volumes and the impact of converting and ramping up Sagola, the Siding segment delivered $67 million in EBITDA for a margin of 20%. And to demonstrate the long-term potential of the segment, even with [indiscernible], adding back either the $16 million of mill ramp-up and conversion costs or the $17 million of inflationary impact revealed an EBITDA margin of above 25%. The OSB waterfall on Slide 10 is inevitably dominated by price changes. This year, the bar as red and given that prices have returned to earth and one of the largest number on the bar by far is the $470 million drop in revenue and EBITDA due to these lower prices, it's also where I'll spend the least time. Rather than price, the story of the quarter is how well the team responded to this much softer environment by managing with efficiency and discipline and delivering positive EBITDA in this very challenging environment. The majority of LP's OSB is consumed in new residential construction and disproportionately by single-family home construction. With single-family starts down 29% in the quarter, LP's OSB volume was down proportionately. Production was lower year-over-year by nearly 300 million square feet, which is about 30% of nameplate capacity, including $100 million down due to the conversion of Sagola from OSB to Siding. The remaining volume reduction of roughly 200 million square feet resulted from LP's market curtailment, which to minimize the cost and trade impact on the OSB network, we've concentrated in our highest cost and most remote mills. While commodity volume was essentially flat, Structural Solutions volume was down 154 million square feet. Now this may be a reflection of increased price sensitivity among builders looking for ways to keep homes affordable for their customers. However, our price realization was very strong, in large part because Structural Solutions prices held up significantly better than commodity prices. So while commodity prices were down 76% year-over-year, Structural Solutions prices fell by only 58%. And so in this market, the OSB segment managed both capacity and costs with both discipline and focus to generate this positive $5 million of EBITDA, which brings me to cash flow and capital allocation. Returning now to Slide 11. LP began the quarter with $383 million in cash and generated $66 million of EBITDA. The first quarter of every year is typically one of working capital build and the $144 million of outflow due to working capital breaks down roughly as follows: $45 million of log inventory was gathered in preparation for spring breakup in Northern mills, together with $25 million of finished goods build across the network for a total $80 million of inventory build. We also paid about $60 million in year-end accruals, including $30 million of customer rebates. All of this is typical first quarter activity. After paying $33 million in taxes, we had an operating cash outflow of $119 million. The first quarter's capital spend of $114 million will most likely be our heaviest in 2023 due to the inclusion of the Sagola conversion and the Bath, New York, prefinishing facility. The resulting drop in cash of $257 million still left LP with $126 million of cash at quarter end. The second quarter is shaping up to be very different for capital allocation, so perhaps a preview is in order. As is typically the case, in the second quarter, working capital should be a source of cash, largely due to inventory consumption. And CapEx should also be lower than the first quarter by about $20 million. And as Brad mentioned, LP recently announced the acquisition of the Wawa OSB facility from Forex for $80 million. This has been financed entirely using existing funds. So we're very excited about this acquisition, which significantly enhances our Siding growth strategy, and we're very happy to have the Wawa employees join our team as we prepare it to be on our next Siding [indiscernible]. We also made the difficult decision to close Entekra. We're disappointed that the deteriorating housing environment in Northern California necessitated this action, and we regret the impact that the closure will have on the Entekra team. But ultimately, we determined that LP's capital is better invested in our core businesses. As a result, in the second quarter, we expect to report a noncash write-down of remaining Entekra assets of roughly $25 million as we wind down the business over the course of the quarter. Which brings me to guidance on Slide 12. The housing market remains uncertain despite green shoots as the spring building season ramps up. Publicly traded homebuilders have referenced encouraging strength in their order patterns. However, with total starts down, this can only mean that smaller builders are seeing reduced demand. Mortgage applications remain quite sensitive to interest rates and stubbornly high prices presents continued challenge to affordability. As a result, we still lack sufficient clarity to offer full year guidance. Our best read of our current order files suggests that Siding's second quarter revenue will be similar to that of the first quarter. And this would mean volumes being down year-over-year but substantially outperforming the anticipated drop in single-family housing starts. Year-over-year price increases will, again, partially offset the volume drop such that second quarter revenue for Siding is expected to be no worse than 5% lower year-over-year. For OSB, prices have improved recently such that if we assume prices hold flat at current levels, the OSB business would expect to see revenues of about 20% sequentially higher than the first quarter. This assumes increased operating rates based on current demand. Under these assumptions, LP's total EBITDA for the second quarter would be at least $80 million. So let me conclude with this. LP's strategy is to grow the specialty components of our business, thereby reducing our dependence on cyclical housing starts and volatile commodity prices. With OSB prices where they were over the last 2 years, almost any strategy would have resulted in tremendous cash flow. Perhaps a better test of our strategy is a market more like the one we have now. A 30% drop in single-family starts presents a truer test of whether SmartSide can continue to outperform the market by taking share without simply relying on the rising tide of housing. It's also an opportunity to demonstrate that LP's OSB segment can break even at recent low prices by the combined effects of disciplined capacity management, efficient operations and maintaining a consistently positive incremental contribution from Structural Solutions. And lastly, it's a test of LP's capital allocation and business development strategies as well as our resolve to use our strong balance sheet to invest in these strategies when opportunities arise, not simply when we're flushed with cash. The first quarter of 2023 was the first such test and, surely, it won't be the last. But LP responded by demonstrating our commitment to our strategy and the value it can deliver. And with that, we'll be happy to take your questions.

[Operator Instructions] Our first question comes from Mark Weintraub with Seaport Research Partners.

A couple of questions on Siding. One is, you talked about some positive indications order file-wise, but it doesn't look like you're assuming much in the way of volume improvement from the first quarter to the second quarter. First of all, is that -- am I right making that assumption? And maybe if you could provide a little bit more color on the thought process there, if that is indeed the case.

Yes, Mark, you're right. And while we are seeing some strengthening in the order file, we are still working through elevated inventory levels within the channel. And so the revenue that our channel partners are seeing is not yet fully impacting our order file. And we believe it's going to take most of Q2 to work through that elevated inventory level within the channel.

Okay. And then you mentioned that there was about $10 million in start-up costs in the segment in the first quarter. Is something along those lines? Or what's anticipated for the second quarter? Really what I'm sort of trying to figure out is why the $80 million guide, and I realize it's $80 million plus for the second quarter, given that we're going to be higher presumably in OSB, you talked about the 20% improvement in revenue. And I guess I would have thought that we get some -- well, again, maybe specifically what -- is there also start-up costs in Siding in the second quarter?

It's a great question, Mark. There are some start-up costs in Siding in the second quarter, but they are -- they will be lower than the first quarter. And yes, to sort of offset, to answer the question, there is inevitably some conservatism built into the $80 million.

Our next question comes from Ketan Mamtora with BMO Capital Markets.

Brad or Alan, can you give some additional color on how the shed business did in Q1?

Sure, Ketan. I would say the shed business is probably one of our slower-performing segments right now. There was, I would say, of all the segments that we've played in during COVID, I do think there was some pull forward demand in shed. We have seen some more recent recovery there. But as a mix of our portfolio, it's certainly underperforming at the moment, the rest of that portfolio.

Understood. And then switching to the Wawa conversion. Alan, is there any way to think about, at a high level, how would you have us think about the additional conversion cost that might be there for this -- for the conversion to Siding?

Yes. We're still working through -- obviously, we have only just acquired it yesterday. Obviously, we did some due diligence. So we're still working through what those numbers would be. But if you think about the fact that the return, the IRR of this project is -- will be similar to the Houlton 2 conversion, and this will be slightly bigger, then there's obviously going to be some sizable conversion CapEx. The moment we have those numbers nailed down, we'll be happy to share them just as we did with the Houlton 2 numbers, but it will be sizable.

Got it. Okay. And how are you thinking about the timing of the Wawa mill at this point?

Totally thinking that it would be Q4. At current model, just to give you a benchmark, Q4 2026. I got a strange -- Aaron is pulling a face at me...

I might as well share the room.

It will be demand dependent...

It will, of course, but that's our working model right now.

Sorry, which year did you say, Alan?

2026.

2026. Okay. Got it.

Our next question comes from Paul Quinn with RBC.

Just wondering what the state of Wawa is. I mean I know the company was trying to convert it back from the power plant. Is it functioning OSB mill at this point or is it closed? Or how much work is entailed to get it back to an OSB mill?

Yes. I'll take that. This is Aaron. It's going to be a substantial amount of work to get it to the point that it's a functioning OSB mill. The advantage for us is that the current state of the construction project is kind of ideal for us to step in and redirect that conversion so that we can convert it efficiently to Siding. So it's not currently producing OSB. It would be a while before it could if we plan to do so. But we've got a fair amount of work to do to kind of complete the project and complete it as a Siding mill.

Okay. That's helpful. And then just over on ExpertFinish, great to hear that it's up 26%. Just wondering what percentage of overall Siding volume that represents now? And what's the operating rate for the ExpertFinish lines that you've got going right now?

The operating rates for the lines are pretty low. While we continue to -- a, from an OEE standpoint, we're learning how to produce that product. But also the capacity there is relatively inexpensive. So we're ramping into that. And certainly, when we have the Bath mill on in Q3, we're going to have plenty of capacity there. There has been times in our order file, especially last year, where we were constrained with ExpertFinish capacity. And while those can be tight now currently, we're okay as far as that balance between capacity and sales at the moment. But we certainly need the Bath, New York, line to come on and we need to be running those lines better. And then as far as your question on mix of ExpertFinish, it's about 9%.

Okay. That's great. And just with respect to your BuilderSeries line, one of your competitors back in the market with their [indiscernible], just wondering if you noticed any drop in order file on that, given also the weak single-family build.

No, I would say not. We have not seen a drop in the order file, but I would directly attribute to that. I will say the competitive environment for new deals has certainly stepped up, the competitive nature there, given that reintroduction, but not necessarily, as far as I know, translated into a loss of any volume we had secured previously.

Okay. Great. And the last one for me. Just on South America. Can we expect any change through the balance of '23 from that segment?

Yes. I think it's, I think, pretty consistent with how it performed in Q1. I mean there'll be some ups and downs as we go through the year, and we're hoping to see some strengthening in the other underlying economy, especially in Chile throughout the year, but we're not ready to call that right now.

Our next question comes from Susan Maklari with Goldman Sachs.