PotlatchDeltic Corporation (PCH) Earnings Call Transcript & Summary

All right. Good morning. So today, we have PotlatchDeltic, Mike Covey, Chairman and CEO; as well as Jerry Richards, the CFO. And we'll just basically go straight into Q&A here.

So I guess, starting out, if you could really just talk about 2019, and ultimately, what went better than expected? And also, what were some of the surprises coming out of the year?

For 2019?

Yes.

Well, the biggest surprise, by far, was really the collapse in lumber pricing from 2018 to 2019. Depending on how you measure it, lumber prices dropped from a peak of around $500 a 1,000 board feet in 2018 to the as low as $300 a 1,000 board feet in 2019. So from '18 to '19. So that's really hard to recover from. We saw a terrific drop in our EBITDA from our Wood Products business because of that as well as a little more weakness in our northern log prices, which are indexed to the price of lumber. So that was the biggest headwind that we faced. The biggest -- upside surprise that we had is we had a fantastic year in our Real Estate business. Not only the legacy business that Potlatch has owned for a long time, but the PotlatchDeltic business, which is really now centered in Central Arkansas around Little Rock with residential, a lot development in a master-planned community called Chenal Valley outside of Little Rock as well as commercial real estate there, and some rural land sales all did really well. So it was a mixed bag. The other headwind that we had in 2019, which we hope we don't face this year, is really wet weather in the South. And -- but hopefully, the worst of that's behind us.

And as you're looking to 2020, I mean, what's most encouraging on the outlook? Would you say it's inventories in the chain, the outlook for operating rates in lumber, the pace of pricing or certainly anything else?

Well, the pace of pricing has been really positive so far this year. We've had 10 consecutive weeks of increases in the Random Lengths Lumber Framing Composite. Even again today, the mid-week price for Random Lengths rose another $5, I think, so that's 10 weeks in a row. Lumber prices are up over the fourth quarter, about $50 per 1,000 board feet, depending on what metric you look at. And so obviously, given our large leverage to the lumber market as a timber REIT, that's very positive for us. We said in our first quarter earnings call that we expect lumber prices to be up in the first quarter, about 6%, and we're certainly very confident that we're going to see at least 10% in the first quarter. So they've moved up faster than we thought, which -- just to put some parameters around that, a -- as you probably know, a $10 change in the price of lumber translates to about $12 million in EBITDDA on an annualized basis for PotlatchDeltic. So we've seen lumber prices go up for our company, about $40 a 1,000 board feet since the fourth quarter. And on annualized basis, that's about $48 million a year, which if you look at what our EBITDDA was in Wood Products last year. That's a significant step change.

And then next, as we kind of move over to Potlatch's strategy. I mean, how does Potlatch's value return mesh with its growth investments and other efforts to drive improvement in earnings?

Say the first part again.

So essentially, just as you think about value return, how does that mesh with kind of the growth investments that you're making and also other efforts to drive improvement in earnings?

Well, as we think about kind of capital allocation and how we drive value for the company, there's a number of levers we can pull. The largest one that we've really focused on since the merger with Deltic, which obviously was a big kind of step change for us is really improvements in the manufacturing facilities that we have. We allocated a lot of capital to that last year. In total, I think we spent $68 million, roughly half of that was in Wood Products. The other half was in our Timberlands business, and that was for 2 purposes. Really, one was to improve the productivity and efficiency of primarily the Legacy Deltic mills; and second was to invest in civil cultural investments on the Deltic timberland, which had not been done to the level that we thought was appropriate and prudent. So that's been a big focus. We focused on bolt-on acquisitions. Those have been small acquisitions that we can make adjacent to the land that we own, and those have been kind of hit and miss, but we were able to add a few of those to the portfolio last year. You want to speak to the debt repayment we did in refinancing?

No, you bet. So other things from a capital allocation standpoint in 2019 is we had $40 million of debt that was coming due or scheduled to come due in December, and we're able to refinance that. And just to put it in context, I mean we took advantage of some really low rates and that cost on that debt is about 2.5%, so well below kind of what our dividend yield is. So it certainly made sense. Probably the other thing in terms of use of cash is we repurchased about 25 million of shares. So one of the things being leveraged to lumber is our stock price is highly correlated to the price of lumber. And when stock -- when lumber price is down, our stock price goes down. The value of the company is actually pretty stable. I mean, most of it's embedded in the trees and doesn't bounce around, but that provided an opportunity to buy some shares at an average price of $37 a share. And maybe to put that in context, the merger that Mike referred to was $1.4 billion merger it was an all-stock deal, and we issued stock at $52 a share. So we felt like that was a prudent use of some of our cash last year.

Okay. And with regards to the Timberlands business, what opportunities do you see to further enhance the value of that business over time?

Well, the core Timberland business?

The core Timberland, yes.

Well, the biggest thing is we -- yes, the engine that drives the cash flow from the timber business is harvest levels. Our sustainable harvest levels fluctuate between about 5.8 million and 6.6 million tons per year, and we can flex up and down within that band. In 2020, we expect that we're going to harvest 6 million tons of timber. And that's roughly 50% sawlogs and pulpwood in the South and a very heavy concentration, almost 90% sawlogs in the Northwest. So investments that we can focus on that drive harvest rates higher, that improve the productivity of our land, are timberlands, those are all things that are a key focus to us. One of the kind of interesting things that we've been able to do to unlock some value post-merger with Deltic was -- Deltic had a concentration of endangered species, Red-cockaded Woodpeckers that were scattered through their ownership, we've been able to -- with the help of the Fish and Wildlife Service, capture and relocate those birds and move them to a conservation area that Potlatch had established many years ago, and frees up more land for harvesting that was constrained in the past. So that's just one small example. Other examples are -- is really especially with a larger footprint in the south in Arkansas, where we own almost 1 million acres, is really concentrating on getting the right log to the right mill and not optimizing the transportation network that we have across the South. So those have all been ways that we can really add value to the trees at the end of the day.

And with regards to Deltic Timberlands, how has Potlatch, I guess, one, been able to enhance the value of those lines? But also, have there been any best practices that have come over from Deltic that perhaps you've carried into the existing Potlatch acreage?

Well, the -- obviously, we've put the 2 organizations together with people from both companies, and there's been a really good discourse and interchange of ideas between the groups. One of the things that -- an opportunity that we had across all of our ownership in the south was to increase the use of genetically improved seedlings. Trees that are -- seedlings that will grow much, much faster with better quality over the time, and that's one of the things, since the merger, that we've really focused on. Now that's a very long-term investment. We're not going to see the fruits of that for 25 years, but we think it has -- rates will return that are kind of low double digits. And that's very attractive in our business. So that's just 1 small example.

Okay. And then Potlatch has also talked about certainly liking its position in the U.S. South and growing in that area, and it seems like the emphasis has more been down there. And ultimately, what do you like about the U.S. South and particularly where you're located? And then how does that kind of set your strategy for potential future timberland acquisitions?

The company's footprint is largely focused in Arkansas with just under 1 million acres. We've got timberlands as well in Mississippi and in Alabama and a little bit in Louisiana. What we like about that area is, especially in parts of Mississippi and Alabama, we've got really high-quality sawmills as customers. West Fraser has a large footprint, Interfor, Canfor, a number of others that have invested a lot of money, and you certainly want to sell logs to the people who are going to be the low cost producers, and we think we're well positioned with many of those companies, international paper on the pulp side of things. So that's one thing that we like about it. The other thing is we're in a little bit of an unusual position. We own 3 southern Yellow Pine sawmills in Arkansas. We consume about 2.5 million tons of logs in those mills. And we sell about 2.1 million tons on the open market. So we're kind of agnostic in the environment with -- that we're in, whether or not Southern Yellow Pine timber prices increase or stay the same. We've had the advantage in the last few years of really high margins in the Southern Yellow Pine lumber business and been able to capture that. Whereas if we were just strictly a timber seller, we wouldn't have had the kind of upside that we've had with the positioning that we have with both manufacturing and timberlands.

Okay. And then kind of moving on to Wood Products here, just quickly. What are your kind of longer-term plans for this business? I mean, clearly, you're very exposed to lumber. Is there any thought to moving into some of the other grades? Or even within lumber, potentially targeting some of the, I guess, a very -- a variety of different types of studs and sizes and mix there? I mean, what is kind of your view there? And how you evolve that?

Well, we have a really a pretty unique lumber business. So we're a top 10 lumber manufacturer in the country with 1.2 billion board feet of capacity. And it's really kind of nice because about 1/5 of it is in Western species and Inland construction lumber from Idaho. Another 1/5 of it, roughly or a little bit more is from studs and the Great Lakes, both in Minnesota and in Michigan. And then finally, the rest of it's in Southern Yellow Pine construction lumber across our 3 mills in the South as well as people forget, and we don't talk about it as much, we have a large industrial plywood plant as well in Idaho, where we manufacture industrial plywood for the RV, boat, furniture markets. It's not for residential home construction. So we've got a well-diversified portfolio of lumber. It's geographically diverse, and we think is well suited for that. We continue to invest in projects to expand our capacity in our existing mills. This year, we're going to grow about 40 million board feet, I think, is our projection just from organic growth with the facilities that we have. So we're going to go from 1.2 billion to 1.24 billion board feet approximately. We do not have any plans to build greenfield sawmills. Organic growth is going to be limited to capital investments that we make in the facilities, the ones that I've just kind of described. And we'll look for opportunities to execute transactions like what we did with Deltic, where we not only can have a manufacturing footprint grow, but have a timberland footprint grow at the same time. And we'd love to do that more in the South as well.

And in the long term, do you see kind of logic to potentially acquiring the sawmill on the outside, if not greenfield opportunity?

No, well, not necessarily. We have focused and said, we're fairly well balanced with the mix of mills that we have with the amount of timber that we harvest and where we harvest it, and to go buy a stand-alone sawmill is really not what we think is in the best interest of our shareholders. If shareholders want more exposure to lumber, there's pure-play lumber companies that can do that. We think our niche is in this mix of both timberlands, real estate and Wood Products manufacturing. So anything we do to expand our lumber footprint meaningfully will probably come with either real estate or timberland opportunities at the same time.

Okay. In the Wood Products business, I mean, certainly, earnings can be very volatile through this cycle. Obviously, some periods it's very good. Other periods, maybe not as good. How has Potlatch's business evolved such that in the future, the business will perhaps strap less cash than during a downturn than it has in the past, I guess, particularly the 2009 time period?

Well, I mean, all of that comes of -- really is focused on trying to be a low-cost producer in a commodity market. And one of the nice things about the Deltic merger is, in particular, one of the Deltic mills was a very low-cost mill. It is the lowest cost mill we have in our entire Wood Products system today. So that's certainly helpful as we -- hopefully, we never face another period like 2009, the downturn. But even last year, we saw a lot of weakness in the Wood Products business. And with the exception of really just one of our mills, all of those were cash flow positive through even the downturn in 2019. So I think we're well positioned there.

Okay. Great. I just want to check with the audience. Are there any questions at this point? All right. If not, I guess, kind of the next question, I mean, just as you think about investments in the business, I mean, what sort of returns do you target with those investments?

Well, it's -- I think it's -- they're really kind of project-specific and business-specific rates of return, if you think about our weighted average cost of capital, it really varies across the business segments that we have, it's lowest in the Timberlands business, probably highest in the Wood Products business and Real Estate, depending on what we're doing, it's probably in the middle. So we target kind of 20% returns in our Wood Products business as a kind of a minimum hurdle rate for discretionary capital investments that we're going to make. Obviously, we have to do repair and remaintenance things that don't have to hit those hurdle rates, but discretionary investments that we make to expand capacity, increase efficiency, lower costs, reduced labor, we look for 20% returns in those kinds of businesses. And in our Timberlands business, it's kind of high single digits. If you want to add to that?

That's perfect.

Okay. And how are you viewing share repurchases as an option at this point, given kind of where the stock stands?

Well, it keeps going down most weeks. So I would have -- we purchased, as Jerry said at the outset, $25 million worth of stock at $36 a share, roughly, which we think was a significant discount to the net asset value of the company, and we intend to be opportunistic about our purchases. And certainly, if the stock gets back in that kind of zip code, it's something that we would look at. We feel we have surplus cash on the balance sheet today. Jerry can talk a little bit about that, if you'd like, but we will be opportunistic about those. And as the stock has drifted below $40 with the coronavirus contagion a bit here. Certainly, repurchases rise higher in the opportunity set than they were before that.

And just quickly on that coronavirus, how do you view -- I mean, it -- there's clearly not a direct impact, but how have you guys been assessing internally what impact that may have down the road?

Well, you really have to start with a look at the supply chain for Wood Products, and it's a global business, even though we talk about North America or the U.S., it's a global business. The way that it's going to find and disrupt the North American Wood Products business, whether it's timber or lumber is really going to come from movements of products that typically have gone to China being forced back here. So the things that we would worry about the most would be lumber to before construction type lumber that's being directed currently from Canada to China or from other parts of the world to China, maybe even Central Europe. And if that market really backs up, it could cause that lumber going to be redirected and find a home in the United States. That's the risk. And of course, that depends on price, depends on logistics and transportation issues and all those cost factors, but that's really the -- as we think about the implications for our business, it's really on the lumber side. We don't really see it as much on the timber side. We don't export logs. We're not on the West Coast. We feel like we're fairly insulated from that, but we could certainly feel that if lumber got redirected. I think that the saving grace in that a little bit, is a lot of the lumber that's going from Canada to China today, and not all of it, but a lot of it is lower quality, that's not going to find an acceptable market or use in the United States, it's going to China for a reason. So it isn't like you can just automatically redirect it and send it to Home Depot or send it to a construction site in the U.S. There's some reasons it wasn't here to begin with. It's from beetle-killed lumber in British Columbia -- beetle-killed timber in British Columbia that is either blue stained or cracked or checked. So that's the reason that's gone to China to begin with. I think the lumber that's coming from Central Europe is largely the same way. It's coming from salvaged timber in Central Europe, and it's got defects and other things that aren't going to be as readily accepted here. So we don't feel like the sky is falling, but obviously, it's a risk factor.

Okay.

There's a question.

Yes, go ahead.

Just on that point, sort of like the global impacts. Could you talk a little bit about how do you see -- or what impact you would see, if any, from the expected reductions in tariffs on -- in Canada -- Canadian lumber?