PotlatchDeltic Corporation (PCH) Earnings Call Transcript & Summary

Glad you're here for our next presentation with PotlatchDeltic. We are delighted that Eric Cremers, President and Chief Executive Officer of the company; and Wayne Wasechek, CFO of the company are here for our discussion. We thought it might be a good idea maybe to start with kind of an opening comment or 2 from Eric just on the business, the industry, and then we'll get into Q&A. So Eric, take it away.

Yes. Thanks, George. And joining me here is Wayne Wasechek, our CFO, and he'll handle some of the questions. So we're a timber REIT. We have about a $4.5 billion enterprise value. And what comprises our timber REIT really are 3 different business units. First one is the timberlands. We have 2.1 million acres, roughly 600,000 acres in Idaho and about 1.5 million acres spread throughout the southeastern part of the United States. And with those acres, we harvest about 7.5 million tons of logs per year. Our second business unit is Wood Products. We have 6 lumber mills and 1 plywood mill in our Wood Products division. We produce about 1.2 billion board feet of lumber per year. And we also have an industrial-grade plywood mill that produces plywood for high-end applications like boats, RVs, truck trailers, that sort of thing. Then the final business unit that we have is our real estate business. You can imagine of those 2.1 million acres that we own, some of that land might have more value sold to somebody else for conservation or somebody trying to protect their view shed or for development, what have you. The value for that land could be higher in that kind of an application as opposed to it being used for timberland. And so we sell roughly 1% of our acreage every year in those higher value type opportunities. And we sell that land at roughly 3 to 5x what the underlying value of the land would be if we kept it for timberland. We also have a master planned community as part of our real estate business unit. We sell about, oh, anywhere from 100 to 150 residential lots in Chenal Valley. It's a master planned community in Little Rock. And we also sell about 5 to 15 acres of commercial land in Chenal Valley at really high prices. Got a great balance sheet. We're investment-grade rated, 20% debt to EV. I think the one thing that makes us unusual relative to our peers is that we're the timber REIT that's most leveraged to lumber. In other words, our earnings go up and down pretty dramatically with lumber prices. And we actually like that as a strategy because we're very bullish on the outlook for lumber. Lumber prices troughed last year, but they're headed higher. They're headed higher as we speak right now, not just because of the tariffs that Trump is threatening, but for a lot of different reasons, we're bullish on the outlook for lumber. And just to give you a sense of it, for every $10 change in lumber prices, our P&L is impacted about $15 million at the EBITDA line. And that's significantly higher than either Rayonier, which really has no exposure to lumber or to Weyerhaeuser, which is, I think, roughly 30% exposed. So with that backdrop, I'll pause there, George, and let you ask your questions.

Thanks, Eric. And thank you, Wayne, again for being here. We want to make this interactive. So if you have questions, please fire away. One of the things that the company has obviously talked a lot about is the Waldo project. And so if you can remind us a little bit about what the profile is, I think you're going to get an extra 80 million board feet. I think your processing costs come down something like 30%. And in terms of earnings benefit, I think, through the mid-cycle, what did you say, like $30 million, or something...

$25 million, $30 million of incremental EBITDA, yes.

So that's wonderful. Tell us what allowed you to do that project and get what looks to be a great return? And are there any other Waldo's in your back pocket that we'll see about in PotlatchDeltic over the next few years?

Yes, it's a good question. So Waldo is a small town in South Central Arkansas. We picked up that sawmill when we bought Deltic back in 2018. Waldo sits, that sawmill sits in a fantastic wood basket with an oversupply of large logs. And so clearly, the fiber was available for us to build a mill or expand our mill to significantly higher capacity levels. The mill had been running when we bought it around 200 million board feet. And when this project is fully complete, well, the project is actually done. We're ramping up production right now. When we finish ramping up production, we'll be at about 285 million board feet per year. Processing costs are going to come down 30%. Recovery will improve by 6% and recovery is a term that we use in the industry that represents the amount of logs that are needed to produce a given amount of lumber. And recovery is really important because 60% of the cost of making lumber is actually the raw material feedstock of logs. So that really matters. So we also had a fantastic workforce at the Waldo sawmill, and we wouldn't have undertaken this project at just any of our mills. It really -- we really -- to execute on a project like this, it comes down to people. It also takes the good wood basket. But -- so the project has been great. We're really happy we did it. We think when it's fully up to its boiler or nameplate capacity, I should say, it's going to earn us some incremental $25 million per year of EBITDA. Second part of your question, are there other opportunities? We're currently going through our mill network as we sit here today to look for other opportunities. We do believe there may be another opportunity. It's too soon to us to say definitively because we haven't finished our studies. But I think it's reasonable to assume that there will be another project announced at some point in the future.

Thanks for that, Eric. The question, right, the staffing, the workforce at any operation or any mill is crucial. And so what was unique about the particular considerations with Waldo's workforce that made it an appropriate added to the reason to make the investment?

Yes. So it was a workforce that was very loyal to that mill and to the company. And you can imagine across our mill network, every mill is a little bit different. But in particular, Waldo is -- the employees, they were very loyal to our workforce. I think they're also that mill is really important to the livelihood of those employees. And that group had been offered the opportunity to join a union over the years and it kept rejecting joining a union. And that encouraged us to think that these folks actually feel like they're part of the team. And that matters. You want a workforce that feels like they're part of the team, and that's what we wanted, and that's what we got with Waldo.

Thanks for that. One of the things also that we've talked a lot about at the conference is capital allocation. In fact, we had a separate panel on this yesterday. Certainly, that's something that Potlatch lives and breathes every day because of how crucial it is to the Timberlands business and timber overall. Can you -- if there is, a couple of 3 points that you think define how Potlatch looks at capital allocation, perhaps even if it's a little bit unique relative to the rest of the industry you see it, what would those points be if you want to relate them to potential investors?

Yes. I would say, first and foremost, on the capital allocation side of things, everybody wants to grow their business, right? We all want to get bigger, more powerful, that sort of thing. I think for us, what maybe makes this unique is that, on the acquisition front for timberland, we are very careful to not overpay. And we have seen this with others in the industry that -- I mean we're all bidding on the same properties, make no mistake. We're looking at a property, a competitor is looking at a property. We submit a bid, they submit a bid. Ultimately, we might lose that particular transaction, and we look at what the competitor is paying, and we're looking at it saying, how can they possibly pay that much for that piece of land. We valued it at x price, and they bid and paid x plus 25% or what have you. And we see this time and again in the industry where people are paying a lot of money for timberland, and we think it's below their cost of capital. we will bid to our cost of capital. We will not bid below our cost of capital under any circumstance. And I think people are kind of giddy about timberland as an investment vehicle. And there's lots of reasons why timberland is a great investment, too, by the way, diversification, inflation hedge, all these sorts of things. But at the end of the day, it comes down to -- we don't want to get the winner's curse. We don't want to be the company that wins the acquisition, but then ultimately suffers because we overpaid for the acquisition. So I think on the capital allocation front, George, we're always trying to grow our business, but we're only going to consummate deals if we exceed -- if the returns exceed our cost of capital. I would say on the share repurchase side of things, I've seen companies time and again blindly just repurchase shares regardless of where their stock is trading. And that's not how we operate. We operate with the philosophy of buying back our stock, but only when it's trading at a deep discount to net asset value. And I think we've been awfully darn good. If you look at our track record of when we buy back our stock or when we issue stock for acquisitions, we'll issue it at pretty high levels, and we'll buy it back at pretty low levels, which is what you want to do as a public company. So I think those 2 things make us unique in the industry.

Eric, can you remind us what the company's longer-term goal, if you've put it out, is for the dividend and its growth rate over time? Because, again, dividend is a way that if you're not careful, it can be sneaky, dangerous in terms of cap allocation and then ultimately, cost of capital when people start to worry about that. So help us understand how you look at dividend policy and the growth outlook?

Yes. We don't have a publicly stated goal for growing our dividend. We think it'd be very dangerous to state a goal because you don't know what the future holds. It could be a recession, it could be a great acquisition opportunity. You just don't know. So it's not feasible for us to try to project what our dividend is going to be. We do know today what our existing asset portfolio looks like, and we've battle-tested it with what do we think even in a down market, what kind of cash flow do we think we can generate to support the dividend. And that's how we arrive at our dividend, which today is $1.80 a share on a roughly $45 stock. We've grown our dividend roughly 50% since 2011. We last raised it in December of 2022. I think it was our last increase to $1.80 a share. We paused it there over the past couple of years. And frankly, the way we think about the dividend is there something inside the company has to change to justify us raising our dividend. There has to be an event. There has to be something that gives us the confidence that whatever dividend level we set, we can earn that dividend through the cycle because we certainly don't want to surprise investors with the dividend cut. And our dividend is sacrosanct. It's #1 on our capital allocation list of things to take care of. So right now, we've paused it. We've been in tough markets here the past 2 years. Lumber markets have been very choppy. And so I think the outlook is for much better times ahead. And hopefully, that will give us an opportunity to raise the dividend again. We'll see.

Yes. And please don't take the questions as why haven't you already? It's really just trying to reaffirm kind of what the fundamental underpinnings are. And the company has done, as you pointed out, a good job in terms of it's capital allocation over time. So as I say that, I think on the last call, you talked about slow and steady capital allocation, reaffirming what you just said. And I think it was answering a question on buyback. And so if you believe -- I think you said on the call that you are at a fairly significant discount to NAV. Correct me if I'm wrong. We all like prudence. We all want prudence, but why not maybe pull the lever a bit more on buybacks given that statement?

Yes. We do operate with a slow and steady wins the race at the end of the day, especially as it comes to capital allocation. What I would say, we have full information on what capital allocation opportunities are available to us and the investment community and you don't have full visibility. For example, you don't know what M&A opportunities we might be working on. Well, if I see a great M&A opportunity headed our way, obviously, these things are discussed, negotiated in private. I don't know that I'm going to need capital to consummate that M&A transaction. So I'm going to have to reserve some firepower for something like that. Or if we have another Waldo expansion opportunity, that was a $130 million check we had to write. If we're looking at a project and we say, gee, here's a great opportunity coming our way, do I really want to -- which is the better return for investors? Is it buying back stock today and eliminating the dividend on those shares? Or is it to save it for the big large capital project like we're doing with Waldo? So we have near perfect insight into what our options are, way more insight than the investment community has. But rest assured, when we see that our stock is significantly undervalued like it has been, we will step forward and buy back stock, and we bought back $115 million, I think, in shares, 2.5 million shares over the last 3 years as we've been trading at a deep discount.

Thanks, Eric. Any questions from the audience for Eric or Wayne? Thank you very much. Can you just hold up for the microphone?

Maybe if you could just talk a bit about the long-term drivers of the lumber market. You said it's looking a bit better now. But in terms of the long-term structural drivers for the end use of the product and how they've trended over the last few years and how you expect them to trend in the next 10 years?

Wayne, do you want that one?

Yes, certainly, I'll take that. Yes, when you look at the fundamentals, we certainly think that for us, there's several long-term strong fundamentals for our industry. I think the 2 biggest demand drivers for lumber are the repair and remodel sector. That's about 40% of the lumber demand market in the U.S. The other 35% is new home construction. So those 2 sectors right there make up at least 75% of market demand. And when you take a deeper dive into each one of those, first, housing, you look at -- we think the U.S. market is underbuilt, 4 million to 6 million units. So certainly, there's a demand there that needs to be provided. Also, you look at the tailwinds from the demographics, millennial demographics in their prime home buying years looking for new housing. You look at where home equity is, there's really a lot of favorable fundamentals on the housing side. You look at repair and remodel, in the U.S. on average, the average age of the home is over 40 years. So certainly a need for repair and remodel on U.S. homes. Combine that with people have a lot of home equity that tends to be their biggest investment, wanting to continue investing in their largest investment. So there's, again, a lot of tailwinds for repair and remodel. And we certainly think that will propel our business in the longer term. Certainly, there have been more near-term headwinds, and we've seen kind of a downturn in the last couple of years, really driven when the fed pivoted and drastically increased rates, certainly, that put pressure on the housing sector, repair and remodel trying to finance repair and remodel projects. So we've certainly seen a pullback there. But like Eric mentioned earlier, we've seen prices, since the low part of last summer, increased $100 per 1,000 board foot. And that's really been a supply-driven shift in pricing. So given those low prices, we've seen a lot of capacity come out of the market. Last year, probably around 3 billion, 3.5 billion board feet of capacity came out. And that capacity, lower capacity, has really been driving where price is going. So we think that supply coming out of the market and then you combine that with these favorable fundamentals, certainly demand picking up. We think it will. I think that kind of reached an inflection point. And as more and more demand picks up, we think pricing will follow.

Wayne, on that point, are you surprised by where lumber prices certainly have started to pick up but they're still into the fourth quartile. And it would seem -- from a cost standpoint, it would seem like you would have further room for prices to have been higher already. So what do you think are some of the constraints why we haven't seen -- if you agree with the premise, you may disagree. But while we haven't seen higher lumber pricing, just based on the economics, based on the fact that prices are trading below upper end of the cash curve -- the cost curve.

Well, I think the bigger surprise before we talk about pricing would be just where capacity was. I think we were surprised to see that it took so long for capacity to come out of the market given where pricing was, been in this trough for the last couple of years. When we think about the cost curve, you have upper quartile, lower quartile mills, kind of first and all the way to fourth quartile. Fourth quartile mills -- in this pricing environment really struggled to maintain any sort of profitability, probably running at negative margins. I think that was really driven by 2 factors. One, certainly, there was strong cash flow generation with historic run-up in lumber prices during the pandemic period. So these higher cost mills living off that. Also, labor is a challenge. If you decide to curtail a mill, it's hard to get labor back. So I think certainly, a lot of mills delayed pulling out that capacity. So I think for us, really the big surprise is it took that long for capacity to come out of the market. Like I said earlier, once we saw that, we saw pricing at least improve, not certainly where it needs to be. The industry needs certainly higher prices longer term, but definitely an improvement. And we think that, yes, once there is capacity utilization, probably around 80%, high 70s, 80%. Once you get to maybe around 85%, that's where you really see strong pricing improvement in lumber. That's another, say, 1.5 billion board feet in the U.S. So we think once that happens, you really see a movement.

Thanks, Wayne. I'm trying to do the math in my head, but another 1.5 million homes would what be like 100,000 -- 1.5 billion board feet would be what, like 100,000 homes, I think, give or take?

Yes, that's right.

So actually, one last question on this. I had some other longer-term ones. To the extent that you see it, can you comment on how much competition you have with engineered products? Like is there a big overlap between engineered or not?

Very little.

Very little. So the fact that they've got some excess capacity they're dealing with, not an issue for you. In terms of value accretion regionally, to the extent that you can comment, where do you see value sort of CAGRs in the South versus the North? What do you typically bring in plain vanilla when you're assessing a new stand if you're looking at it?

I'd say probably the biggest difference is the natural climate solutions opportunities that tend to exist in the South versus in the Pacific Northwest. We're talking about solar farms. We're talking about lithium, carbon capture and storage, carbon offsets. All these things tend to favor, I would say, the southern part of the United States. Now all that being said, there is an oversupply of timber in the U.S. South, which on the one hand, that's going to hold back timberland cash flows. On the other hand, all this natural climate solutions stuff, solar farms, lithium, et cetera, that's going to raise cash flows. And if I think longer term about where converting is going to go in North America, it's really going to go into the Southeast. It's -- Southeast has got the lowest delivered logs in the free world, lowest cost delivered free logs in the free world. So that's where capacity is going to go and that -- as capacity goes there, it's going to tend to lift log prices over time. You don't see a lot of new mill construction activity in the Pacific Northwest.