PotlatchDeltic Corporation (PCH) Earnings Call Transcript & Summary

Good afternoon. We are pleased to host Eric Cremers, President and CEO of PotlatchDeltic; as well as Jerry Richards, Vice President and CFO. As many of you know, Eric Cremers has been with PotlatchDeltic since 2007, and was appointed President and CEO of the company effective January 1 of this year. Eric will begin with a quick overview of the company, and then we'll jump into questions. Eric?

Yes. Thanks, John, and good morning or good afternoon depending upon where you're at. As John mentioned, I'm Eric Cremers, I'm the Chief Executive Officer for PotlatchDeltic. And joining the call is Jerry Richards, our Chief Financial Officer. Just by way of background, PotlatchDeltic is the third largest timber REIT. We have an enterprise value of around $4 billion. And off of that timber REITs, we like to say that we are the most leveraged to lumber. So if you like housing, you like lumber. We're the most exposed to lumber business and to lumber -- theatrics of lumber. We also happen to have the best balance sheet in the industry. So if you take a look at the company, we've got 3 main business units. The first one is our Timberlands division. We have 1.8 million acres of Timberlands located in the Pacific Northwest as well as the Southeastern U.S. And you can break down that acreage into 1 million acres in Arkansas, about 600,000 acres in Idaho and 100,000 acres each, Mississippi and Alabama. And with that acreage, we sustainably harvest about 6 million tons per year, up 4 million tons in the South and a little less than 2 million tons in Idaho. Our second business unit, our Wood Products division. We have 7 mills that manufacture [ worn ] plywood. Now of those 7 mills, 6 lumber mills, they're located in St. Maries, Idaho, Bemidji, Minnesota, Gwinn, Michigan, and we have 3 mills in Arkansas in Ola, Waldo and Warren, and produce around 1.1 billion per feet per year. We're the tenth largest lumber producer in the United States. And as I mentioned, we also happen to have one plywood mill. It's an industrial grade plywood mill, and it's also located at St. Maries, Idaho, next to our sawmill. Finally, the last business unit that we have is it's a real estate unit, and it's got 2 product offerings. So the first one is we sell rural land. We sell about 20,000 acres per year of higher and better use acreage at values that are far greater than what that land really worth, if it was held in a timber-growing state. And then the second component of our real estate business is our developed business. We own a master plan community just outside of Little Rock, Arkansas called Chenal Valley, where we sell residential lots and commercial acres at attractive margins. So capital allocation is extremely important to us, returning cash to shareholders. It's a very important part of our capital allocation plan. Our dividend is well supported. We saw currently yields around 3 [ Brent ]. We've increased our dividend around 32% since 2012, with no interruptions along the way. And also, we've bought back about $46 million worth of stock over the past couple of years at an average price of $35 per share compared to where the stock is today at around $52 or $53. So we think we're pretty good at the capital allocation gain. Our balance sheet is in excellent shape. We're in [ grade ] by both the main rating agencies. And as I mentioned earlier, with our [ data ] enterprise value at just 13%, we have the lowest leverage of the Timber REITS. And that gives a lot of flexibility going forward. The last thing that I want to mention to you in these introduced remarks is that we just published our inaugural ESG report last year, and we'll update that. We'll provide a new one in May of this year. And it's gaining traction. European ownership of our stock was 5%, 6% a year. And today, it's up to 11%. Now most people would acknowledge that the European [indiscernible] community is a little bit further along the ESG path than domestic investors. So we think we're getting good traction. We've got a great story to tell. So John, I'm going to pause and let you fire away with your questions.

All right. Great. I'm actually going to sum it back to you. I mean, basically, if you could just give us a sense for your near and long-term vision for the company, that would be great.

Yes. So as you mentioned at the outset, I've been CEO for about, gosh, 2 months now. But I've been with the company for 14 years. I was the CFO for 7 years and then its Operating Officer for 7 years. So my vision, really, it's to -- I want to grow the company like kind of any CEO would want to grow it. But I want to grow it in a shareholder-friendly sort of way. The way that you grow in this industry, primarily, is through M&A. And if you want to make needle-moving changes in growth, that's what you have to do. So my plan is to grow the business, grow it in a shareholder-friendly way. And sometimes, that means just have to be patient and [indiscernible]. And I'll give you an example, [ PotlatchDeltic ] merger that we consummated about 3 years ago, a complete home run for the company. We exceeded our synergy targets, our earnings targets, it was just a fantastic merger. We had identified Deltic as the optimal merger target for us some 3 years prior to actually getting the deal done. So we had to be patient. We had to wait for the stars to align. But when they did, we took advantage of the opportunity and we pounced. So what I say is we want to grow the business but grow it in a shareholder-friendly way back to what my vision is.

That's very helpful. Then just with regards to 1Q guidance, it looks like you're expecting EBITDA to be around the $164 million that you achieved in 4Q with that average lumber prices ultimately expected to be about 20% to 25% higher than in 4Q. On that point, I was wondering if you could talk about how 1Q has progressed so far, realizing you only shared earnings just a couple of weeks ago.

Yes. 1Q has progressed better than we had expected it to. I think at the time of our Q4 release, we indicated lumber prices were going to be roughly 20% to 25% higher than Q4 lumber prices. And in fact, we're up [ $0.35 to $0.40 ] is our current outlook for Q1 lumber prices relative to Q4. And I know Weyerhaeuser just put out quarter-to-date, where they're at in terms of inter lumber prices, and we're similar to them, maybe a little bit ahead of where Weyerhaeuser is comparing quarter-to-date just the Q4 prices. So our EBITDA is likely to be stronger in Q1 than we had indicated back in Q4.

That's very helpful. How has lumber demand held up so far? I mean, especially since we've seen some colder weather lately. I was wondering if you can just kind of talk about the demand side of things and how it looks there. And then also, we are entering the typical spring building season. And so I was wondering if you can talk about whether or not you started to see that demand start to flow through.

Yes. I guess I would use one word to describe lumber demand, and that's insatiable. We're seeing demand very, very high, both for repair and remodel channels, like it was in Home Depots and that sort of channel. But also for new house starts, housing starts have really supplied the upside this year. And frankly, we ended the year -- the industry ended the year with very low levels of inventories. So with demand being as strong as it is, you've seen prices going up. Now [indiscernible] in North America is running as hard as they possibly can. I can virtually guarantee that. And I can tell you that everybody is trying to think through their expansion opportunities. But it's hard to flip a switch and you don't just flip a switch and get more lumber [indiscernible]. And these things take time and [indiscernible]. And this will just have to put itself out over time.

Okay. And could you provide us a sense for where your inventories stand in the channel and also broadly some color on order files, and we have read Random Lengths and it sounds like most people are generally booked through the end of March, at least. So if you could kind of talk about where you guys are?

Yes. So it's similar. We've got very low inventory levels right now. Anything that we can ship, we're basically shipping. And I would say order files are stretched out to about 4 weeks, which is pretty far for us. We don't want to get too far out in the order file curve because we've got to make sure that our production matches what we're seeing. So we've got to be careful with that, but we're about 4 weeks into the future right now.

Got you. And what about inventories in the channel?

Oh, at very low levels, very low levels. As I said, demand is insatiable. So builders are scrambling to buy lumber, to come to projects that they have on file and repair and remodel projects continue. It's a really good environment.

Okay. And then I was wondering if you might be able to provide any sense on -- recently, obviously, we saw like some outages in the U.S. South and Random Lengths talked about this as well. Could you provide us an update on ultimately how Potlatch's operations fared during that quarter weather that kind of problem of the area?

Yes. It's a great, great question. [ On our end ], we were impacted by that, really [ weather ] that rolled through Texas and, of course, Arkansas right next door. And so our 3 lumber mills were basically shut down for about a week, I'd say, either due to lack of water or electricity or natural gas. It's always something at each of the mills. So we lost about 10 million feet of production. So we had given guidance that we were going to ship about 260 million to 270 million feet in the quarter. Our guess is we're going to be about 10 million feet below that, when we actually produce our results for Q1. Now our expectation is that as we move through the year, we will make up the 10 million-foot shortfall. So nothing catastrophic, but certainly, the lumber mills were impacted. The other thing worth mentioning that because of that tough weather that rolled through Texas, and we had some wet weather at in Arkansas, our harvest volumes are going to be a little short too, maybe 50,000 tons. Nothing [indiscernible] in. Similarly, we expect to make up 50,000 tons as we move through the year.

Got you. That's very helpful. And then just with regards to kind of the 2021 outlook, a question we've ultimately gotten from investors is along the lines of -- there's no denying Potlatch has impressive results over the last few quarters, but I'm worried about Potlatch, buying Potlatch at a peak, and especially if lumber prices drop over the course of the year. So what would ultimately your response be to that question, should you get it?

Well, I think the way I would argue is that what's your outlook for the future? And our view is that lumber prices are going to settle out here at relatively high levels. I mean, nobody can predict the future perfectly, obviously. But we think we're in a really strong demand environment, not just in the near term, but the next several years. We see housing starts moving [ significantly ] higher for lots of reasons. The U.S. is underbuilt after the great financial crisis, point number one. You've got the millennial [indiscernible] award that age group is at peak levels of home-buying years. [indiscernible] has really pushed people out of the cities into the suburbs, into single-family houses. So some reasons to believe that this is a multiyear run here, especially with interest rate being so low. So we see this continuing for many, many years. And as I mentioned earlier, mills of America are running as hard as they possibly can given the strong pricing and margin environment that we find ourselves in. So if you want to expand capacity to that growing demand, which demand is growing about [indiscernible] board feet per year right now, you got to expand mill capacity. And that takes, to build a new mill, it's roughly $200 million and takes about 2 years to get it done. And oh, by the way, you put these mills in really small towns generally in the rural Southeastern part of the U.S. Hard to find people, hard to find good labor. So what I would tell you is that I think supply is going to be challenged to catch up to demand. But certainly, the industry is trying to do what it can to take advantage of the opportunity.

Got you. And that 2-year time frame you provided, so like if people -- if investors were to think about the typical time from permitting a mill to gain a construction up and running. Is that 2 years about kind of a reasonable estimate there?

Yes. It's about 2 years and $200 million more or less. And I think why -- back to your question of why PotlatchDeltic [ aren't we at ] peak values? I honestly think this time may be different. And the reason why I say that is in prior price runs in lumber, prices would roll over when whatever caused the price run was over and done with. So I think Canadian [ issues ] a few years ago, think forest fires just a year or 2 ago. Prices will tend to run-up real fast. And then once the issue is resolved, prices will come back down again. This one is really more of a demand story. We've not seen a demand story in this industry since the great financial crisis. So I really feel like this time it's different.

Okay. Next, I'd just kind of like to talk a little bit about the impact of the pandemic, and I know you've talked about this a little bit on your calls. But how would you help us estimate the loss on lumber production associated with the pandemic in 2020? And then, has Potlatch been able to run its mills more full out lately? Obviously, you had the disruption recently because of winter weather in the South. But broadly, what operating stands do you have right now? And if you're running at 90%, 100%. If you could kind of share some comment there, that would be helpful.

Yes. So COVID did impact the whole productivity. Given a point in time, we had a lot of people that were absent because they had COVID or because they were contact-traced out of the mills. I have to peak -- the peak -- in terms of how bad it got was [ at one ] mill, we had nearly 50 people out. We're roughly 150 people at that mill. So 1 of 3 employees did not show up. So we're informed when 1 out of 3 employees don't show up. So production was impacted, I would say, the second, third and fourth quarter of last year, roughly top 5 million to 10 million feet per quarter. But I would tell you, as we move into 2021 here, the absenteeism rate has gone down dramatically. And I would say the issue maybe 1 million or 2 million feet a quarter, it's really come down quite a bit. So we'll see, hopefully, some of their production shipments this year versus last year.

Okay. And did Potlatch incur much in the way of incremental spending last year because of COVID?

Yes. I mean, it was about -- I think we added it up the other day, it was around $2 million incremental spending for cleaning supplies and what not.

Okay. All right. So that's not significantly material. Okay. Very helpful. And then next, kind of moving on to innovation and sustainability here. What are some of the most common questions you get on sustainability? And how do you respond to those questions typically?

So I'm going to let Jerry Richards, again, our CFO, answer that question, Jerry?

Yes. There's -- actually, it's a great question, John, and very topical. As Eric talked about in his introductory comments. It's been a real increase in interest, certainly over the last 2 years in ESG, and particularly the E part of ESG for us as a company. And as Eric mentioned, we put out our first full ESG report in September last year, that's available on our website. We're in the process of working on the current report, which we plan to publish in May. In May, it will be kind of a normal rhythm now that we kind of have that base you're reporting under us. In terms of things that investors are focused on, I will give you an anecdotal piece of information here to kind of frame it. But traditionally, most of our investors have been focused on business fundamentals, along the lines of the questions you posed in this webcast thus far. But more recently, even some of those traditional analysts and shareholders have been really focused on ESG, even here in the U.S., an example would be 2 intense back-to-back meetings during the summer with a large shareholder, like I said, they've really been focused on business fundamentals in the past, and it was all about forest management practices, talk to me about certification, what potential revenue streams, and I'm already kind of teeing up the other themes I'm going to share here. So when you fast forward, it's really about, what are you doing to try to take advantage of potential revenue streams? What might those look like? When might they come to fruition? And what I can say is there's a lot of energy and work going into that question. We do have history of selling carbon credits. We have 16,000 acres in Arkansas that's been set aside for the Red-cockaded Woodpecker to provide habitat for an endangered species. And because we're not harvesting on that property, that's part of the management plan and the design, we're able to measure the carbon sequestration capacity of that forest. And then we've sold at various points in times, carbon credits into the California market for companies that need offsets. And I will tell you the price for those carbons hasn't been significant. But like I said, it's incremental revenue on land that we're not harvesting. So it's been in the up to $10 per ton range, give or take, depending on when we sold them and what supply and demand was. Now what we're doing is we're actually measuring the carbon sequestration capacity of other parts of our forest is in order to set a baseline because the way the future revenue stream works is what are you going to do incremental to your normal harvest regime and timing. So for example, if you're planning to harvest, a tractor in the South at age 25, but you're going to delay that to age 30, for example, you just created additional incremental carbon sequestration for those 5 years that you delay that harvest. So that creates a potential revenue stream. Now I will say that even though there's a lot of energy, and we're encouraged, there's a lot that needs to happen. Markets need to develop, you need public policy changes. There is a lot of lobbying and dialogue going on. And a lot of other work. But certainly, over time, it feels like this is an interesting opportunity, and it will take time to develop.

Got you. And I think as of the last sustainability report, you mentioned that Potlatch quest was about 5.2 million metric tons of carbon dioxide. Is that correct?

That is correct.

And I assume there will be some updates because I think that was 2019, if I'm not mistaken, that report. So I assume that you'll provide...

Yes. So you are correct, John. And the way it will work is the report we published was really for the year 2019. The report that we issued in May will be for the year 2020. So certainly, it will provide updates in terms of -- if there's been an increase in the capacity of the forest to sequester carbon, you'll see that in that report. The other thing that you'll see when we publish in May is really an overall progression as well. We look at the 2019 report as kind of setting a base, but over time, you'll see us expand our goal set. You'll see us expand the disclosures. Greenhouse gas emissions, for example -- is one example, and there's a number of other corporate objectives that -- we have a 5-year plan, and you're going to see us add, like I said, to the set of goals and the progress that we're making in those goals over time.

Okay, great. We'll look forward to having that release. If you just want to -- just wondering if you want to talk about anything else from an ESG perspective that investors might want to focus on? Otherwise, we'll kind of move on the next topic.

I think we're good to move on.

Got you. And then now moving on to kind of capital allocation and some of the other kind of key themes out there. Starting out, Potlatch has more than $250 million in cash on hand, at least as of the end of 4Q. Also like 2021 is up to be another good year of free cash flow. So on that point, I was wondering if you could remind us of PotlatchDeltic's capital allocation priorities and for dividends, share repurchases, M&A and debt paydown, stand in the queue?