Stella-Jones Inc. (SJ) Earnings Call Transcript & Summary

Good afternoon, ladies and gentlemen. Thank you for standing by, and welcome to Stella-Jones' Q1 2020 Earnings Conference Call. [Operator Instructions] Before turning the meeting over to management, please be advised that this conference call will contain statements that are forward-looking and subject to a number of risks and uncertainties that could cause actual results to differ materially from those anticipated. I would like to remind everyone that this conference call is being recorded on Thursday, May 7, 2020. I will now turn the conference over to Éric Vachon, President and CEO. Please go ahead, sir.

Good afternoon, ladies and gentlemen. I'm here with Silvana Travaglini, Chief Financial Officer of Stella-Jones. Thank you for joining us for this discussion on the financial results and operating results for Stella-Jones' first quarter ended March 31, 2020. Our press release reporting Q1 results was published earlier this morning. It, along with our MD&A, can also be found on our website at www.stellajones.com and will be posted on SEDAR today as well. Let me remind you that all figures expressed on today's call are in Canadian dollars unless otherwise stated. I will now begin with a brief overview of the first quarter. Today, we reported record first quarter sales, driven by strong growth across all product categories. Gross profit also grew as a result of higher sales, while EBITDA remained relatively unchanged compared to Q1 last year as it was unfavorably impacted by diesel derivative losses. Adjusting for these mark-to-market losses, EBITDA was $70 million, reflecting a solid start to the year. Total sales increased 14% to $503 million compared to $441 million in the same period last year. Excluding the currency conversion effect, pressure-treated wood sales grew $56 million or 13% and while sales for logs and lumber increased by $3 million. Utility pole sales amounted to $202 million, up from $171 million generated in the first quarter of 2019. Excluding the currency conversion effect, sales increased by a robust 17%, driven by both continued growth in replacement demand and improved pricing. Railway ties sales increased to $172 million, up from $162 million in the same period last year. Excluding the currency conversion effect, sales rose 6%, mainly due to higher sales prices. Volumes remained stable as higher shipments to Class 1 customers were offset by lower volume of the non-Class 1 customers largely related to the timing of projects. Residential lumber sales reached $71 million, up 25% from $57 million generated last year, led by solid demand, both in Canada and the U.S. Industrial product sales totaled $29 million, up 16% from $25 million recorded in the previous year's quarter. This increase primarily stems from stronger railway bridge sales. Sales in logs or lumber, a product category used to optimize procurement, amounted to $29 million, up $26 million generated in Q1 2019. The increase is mainly due to higher North American lumber market prices for most of the first quarter compared to the same period last year, while volumes remained relatively unchanged. Silvana will now provide further details regarding our results and financial position before I conclude with our outlook for 2020. Silvana?

Thank you, Éric, and good afternoon, everyone. Turning now to profitability. Driven by strong sales growth, gross profit increased 19% this quarter to $83 million compared to gross profit of $70 million in the first quarter of 2019. Despite the improvement in gross profit, EBITDA and operating income remained relatively unchanged compared to the same period last year at $63 million and $45 million, respectively, given a $7 million mark-to-market loss recorded in the quarter for diesel-derivative commodity contracts. Excluding the impact of the mark-to-market diesel-derivative commodity contracts, EBITDA for the first quarter of 2020 was $70 million compared to $60 million in Q1 of 2019, representing EBITDA margins of 13.9% and 13.6%, respectively. Net income for the first quarter was $28 million or $0.41 per share compared to $29 million or $0.43 per share last year. Adjusted for the diesel-derivative contract losses, adjusted EPS increased to $0.49 per share this quarter. Turning to liquidity and capital resources. Cash flow from operating activities, before changes in noncash working capital components and interest and income taxes paid, was $69 million in the first quarter. Together with an additional $108 million of borrowings under our credit facilities, we used this liquidity to support the normal seasonal working capital requirements largely in anticipation of increased demand during the peak period, specifically the second and third quarters. Stella-Jones ended the first quarter in a healthy financial position with access to $130 million in liquidity through a combination of cash on hand, syndicated credit facilities and an undrawn demand loan facility. As at March 31, 2020, Stella-Jones' long-term debt stood at $766 million versus $605 million 3 months earlier. The increase mainly reflects higher working capital requirements as the normal seasonal demand patterns and the unfavorable currency translation effect of $54 million on U.S. dollar-denominated long-term debt. As a result, as of March 31, 2020, the long-term debt to trailing 12-month EBITDA ratio was seasonally higher at 2.5x. Yesterday, the Board of Directors of Stella-Jones declared a quarterly dividend of $0.15 per common share, payable on June 26, 2020, to shareholders of record at the close of the business on June 5. 2020 will be the 16th consecutive year of dividend increases. I will now turn the call back to Éric for the outlook. Éric?

Thank you, Silvana. While first quarter 2020 results were strong, the impact of the ongoing COVID-19 pandemic and the weaker economic conditions in North America on the demand of the company's core product categories remains uncertain. We have, therefore, updated our EBITDA guidance to reflect either no improvement or a slight decline in sales volume for utility pole, railway tie and industrial product categories and weaker demand for residential lumber compared to 2019. We now expect EBITDA to be in the range of $300 million to $325 million, down $20 million from the previously disclosed range and EBITDA margin to be lower versus 2019. Our updated outlook is also based on a number of material assumptions, including the gradual lifting of government-imposed restrictions by the end of the second quarter, limited disruptions to our operations, no significant reduction in the demand for replacement maintenance programs of major railway and utility pole customers, limited impact on our cost of operations and stability in the current U.S. exchange rate. Even as we adjusted our guidance, it remains in line with the $313 million of EBITDA generated last year. While we remain in uncertain times, and that the impact of the current economic environment cannot be predicted, we believe that the resiliency of our business model and our solid balance sheet places us in a favorable position. We have the team, the products, the network and the financial flexibility to continue with fortitude as the North American leader in the pressure-treated wood industry. Our strategic vision focused on continental expansion remains intact, as we believe that the long-term fundamentals of each product category will remain strong. Our healthy position will allow us to continue to seek opportunities to further expand our presence in our core markets, both organically and through acquisitions to enhance shareholder value. This conclude our prepared remarks. We will now be pleased to answer any questions you may have.

[Operator Instructions] Your first question comes from Hamir Patel from CIBC Capital.

Éric, could you comment on how your tie and pole volumes have fared in April? And have you seen any change in pricing for those 2 categories?

So Hamir, I want to be cautious about April results as we're technically here to discuss Q1 results. But if I refer back to our general outlook regarding -- if I have to put both of them individually, for railway ties, we see no major pullback from Class 1 customers. Although we are seeing a bit of softness, thus the reduction in volume that has been included in our EBITDA guidance. With regards to utility poles, I guess what I -- the first thing that comes to mind really is the impact of the reduction of the price of oil. It had an impact on any oil-driven projects for -- or demand for utility poles that are related to those projects. And obviously, the current economic context and pandemic context has created a bit of softness demand on projects that would require transmission and distribution poles.

Okay. Great. That's helpful. And just turning to the res lumber business, quite a few R&R companies are going to have very strong demand in the category. I'm just curious, given your exposure largely to Canada, and I suspect, Ontario and Québec, where lockdowns more severe than the rest of North America. Have you seen your res lumber business regionally? Have you noticed some differences in April that you'd call out?

No. The -- it's a great question. The government-imposed restrictions, as you mentioned, on the construction business as well as on our customers, has created some challenges, I guess, for them to service their customers. I think the dealer network and the big boxes that we service have done an outstanding job trying to get product to the homeowners and to the renovators and the contractors. And we've been able to do a great job in April, but we're now looking at the months of May and June, which are the 2 strongest months for us for decking and fencing. And that's, again, related back to our outlook. That's why we used a bit of softness or cautiousness in our volume. It's difficult to predict how well our customers will be able to service the demand for the 2-peak months of the -- for the 2-peak months that are upcoming, knowing that there's some constraints around their ability to service clients.

Fair enough. And just a final one for me. Silvana, could you -- on the CapEx front, what would be barebones maintenance CapEx for Stella?

For barebones, we're estimating $20 million per year.

Your next question comes from the line of Walter Spracklin of RBC Capital Markets.

I guess my question comes back to CapEx budgets, starting with your railroad customers. I know that ties tend to be part of maintenance CapEx, and as a result, tend to have less variability. And I know you've softened volume but pretty much steady with last year in terms of your overall business activity. I know your competitors indicated at least 1 railroad is starting to cut their CapEx and perhaps, if not cut tie purchases or deferring them. To what extent do you think a railroad can defer CapEx -- or defer their capital investment in ties, if they have to? And to what extent is your current volume reduction really a function of the reduction in growth, ties as opposed to maintenance ties? Any color there would be very helpful.

All right. Thank you, Walter. I'll try to answer the best I can a lot in that question. And you can follow-up if I don't hit all the topics you had there. So our volume right now, we're looking at maintenance. So let's call it, no growth in all related to maintenance replacement. As most of our customers, we report on most of the Class 1s who have a CapEx budget that's set up for the year. The maintenance piece of it is typically a smaller part of it. And from what I understand, it's something that our customers like to execute throughout the year unless you really have to push it out. As you might have read, some Class 1 customers have actually stated that it would take the slowdown right now to increase some of their maintenance. So trying to answer -- to think about your question with regards to how much can you push it out, they can certainly push it out. I assume and I guess, it would have an impact on their ability then to run certain volumes of trains or at certain speeds on their rail lines, but now most likely being a great opportunity to do some maintenance. They do have some downtime.

And then I guess in the same vein, a lot of companies across all sectors are looking at conserving cash. And to what extent would you say the -- how would you answer that same kind of question with utility, your utility customers? I guess, safety is less of a driving factor of their motivation, and one would argue that they have much more flexibility to defer any major reinvestment or maintenance CapEx on poles? How would you characterize your conversation so far to date with your customers on the utility pole side, given everything going on with COVID-19?

So our major customers that we have under contract, I would say, during the month of April, have adjusted a bit internally the organization as we have. Some of them have slowed down slightly to adjust. Keep in mind that there's a lot of people working from home. It's kind of difficult to cut electricity to do maintenance. So they've been mindful of that. None of our customers have spoken right now about delaying CapEx. You're right that they could. They are in majority faced with aging infrastructure, and they're all mindful of executing that part of the maintenance. But you do hit an important point is that utilities do service end customers that might be -- that might have certain constraints on the cash right now. And so they might be a bit long. Our utilities, our customers might want to preserve their own cash, their cash inflow might be slowed down. And that was part of a -- bit of a consideration when we looked at our volume, some of the utilities sort of slowed down slightly. But we see that really as our assumption said, really, for the second quarter.

Your next question comes from the line of Michael Tupholme of TD Securities.

Éric, first question, just to clarify on the guidance of $300 million to $325 million of EBITDA. Does that include the unadjusted EBITDA of $63 million from the first quarter in that number? Or is it the adjusted number of $70 million?

No. $63 million. We -- I guess, when we talk about it, we call it out, but we don't necessarily do adjusted EBITDA. So it's based off the $63 million EBITDA.

Okay. And the derivative impact that you experienced in the first quarter related to the diesel contracts, I mean, I guess it's probably hard to call where oil prices go from here, but at the same time, given that we're at pretty low levels. Is it -- just directionally, is it fair to think about the situation for the rest of the year? Is it likely a situation where you're -- if prices have risen off kind of the lows and don't fall that down, we should not be seeing further mark-to-market losses in those contracts? Is that the right way to think about that?

Yes, exactly. So to your point, diesel prices have dropped significantly. And I think we've pretty much taken the biggest impact you could think of at this point in time.

Okay. In terms of the utility poles growth you experienced in Q1, organic growth, very, very strong. Can you break that down in sort of approximate terms between how much of that was volume versus price? It sounds like both were a factor in terms of driving that growth?

Right. Yes, I would -- as the percentages, so obviously, volume would have been a significant driver and pricing would come in second, call it as 60-40, 60 on volume and 40 on pricing.

Okay. And then when we look at the reduction in the EBITDA guidance that you announced, can you talk about which of your product categories would have been the greatest -- had the greatest impact in terms of driving that reduction. It sounds like you're cautioning on volumes kind of across all product category. But if it's possible to talk about, is there 1 or 2 that had a more significant impact in terms of driving the reduction in EBITDA guidance you gave?

The greatest volume decline, Michael, in our -- in scenarios that we're looking at, at both range or at both ends of that range are really with the residential lumber. As I mentioned earlier on a question, our customers have been challenged with stricter restrictions as far as being able to distribute. And as you know, big box stores or hardware stores in Ontario are actually closed, well, not too long ago, and we're only able to do curbside deliveries. And although they've been everything -- doing everything they could possibly do to service their customers, there has been some challenges there. Construction has also been tied down in Québec and Ontario, and there is some relief coming up. So as we're going through our scenario as a potential volume adjustments, I guess, residential lumber has -- that was -- has the greatest exposure to volatility, I guess, in the volume that can be serviced to the demand.

Okay. And I know you -- I mean, you're asked about April demand and volumes earlier in the call. Just trying to get a sense, when you took the guidance down, I mean, you did give us some of your assumptions in terms of FX and other things, and you talked about a gradual lifting of government restrictions by the end of the second quarter. But -- so that's helpful. But as far as the reduction you took in the guidance, is that based on the kind of what you saw in April across the business in terms of any changes in demand and you're sort of extrapolating that out over the rest of the quarter, and maybe assuming it deteriorates a little further? Or is this sort of all very perspective and you're just trying to take your best guess at what May and June are going to look like?

So the current pandemic and economic pullback, the pandemic, hopefully will be shortly lived. Economic pullback will most likely be a bit longer. So as we took a look at our all of our 3 product categories, we did the deeper dive to customer contracts and sort of try to figure out if there are certain concerns or issues that could put some softness in our sales, and that's truly how we went about it. And so we did use -- looking at -- obviously, the future is quite unpredictable, so we had to take assumptions. And I guess if you want to pick a point in time, we did our forecast maybe 15 days ago, and then we work with that set of numbers, but it's based off of assumptions of what we were reading into about the balance of the year at that point in time.

Sorry, based on conversations you have with your customers?

Well, conversations and our review of our customer base exactly. And I'm trying to understand how demand could fluctuate in the current context.

Okay. That's helpful. And then just lastly, as it relates to the outlook, there's no specific comment about any thoughts or changes in views on pricing. So is it the case that your views on pricing and what that would have done and contributed for the business this year, are those unchanged? Or have you modified those in any way?

The -- well, 2 things, actually on the pricing front, and it's a good question. So when we looked at our pricing for residential lumber, if you recall, at the end of the first quarter, there was a sharp decline in lumber prices in general markets. And we used that assumption of that low pricing as being the standard for the balance of the year, and we did, at that point, using that assumption, assumed that there could be some pricing pressures for the balance of the year.

Okay. But nothing on the ties and poles side in terms of the updated assumptions there?

Not on poles. We've had pricing gains last year, which obviously are flowed through into this year. The only item or thought I would add on the -- is on the railway tie side. We are seeing some more competitiveness on the non-Class 1 business at this point. So there could be a bit of tightening there in the back half of the year.

The next question comes from the line of Mona Nazir of Laurentian Bank.

So just firstly, on the revised guidance, I'm just wondering, what percentage is ultimately a sales reduction versus margin deterioration? Is there a heavier weighting on one of the sides? Or is it purely sales driven?

It's mostly volume, Mona. It's mostly volume. And you're right, we did -- there is a comment in there about a bit of margin erosion, and that's really driven by 2 things. One, what I just explained to Mike, Michael Tupholme, about using an assumption of lower lumber prices in the market that could lead to certain price deterioration in the year, and that we'll have to track. But also, we're seeing some fiber cost increases on the utility poles side, which we had considered some increases in our original guidance, but the increases are a bit more than what we thought originally. And now we'll have to wait for the anniversary of the contracts, if you want to be able to readjust the pricing. So I just want to be clear on the margin side. There is a bit of that there, but it's -- the guidance is mostly influenced by volume.

Okay. That's very helpful. And not to belabor the point, but I mean you just touched on having to reforecast and then reforecast and then re-reforecast in the current environment. And so when we're thinking about the guidance of $300 million to $320 million, and you touched on the residential side, and you haven't seen much decline on the tie side. But I'm just -- just for my own clarification, has there been some breathing room factored in? Or is it just based on how things were sitting 15 days ago?

Well, the breathing room is really between the 2 extremes of the scenario -- of the range, right? If we -- if our EBITDA for the year ends up at $300 million, we'll have had significant headwinds. And the upper range, obviously, we will have not seen as many headwinds as I just described. So I guess the breathing rooms come within the range.

Okay. That's great. And just lastly for me. In the last call, you touched on your continued desire to grow via acquisitions. And then in the current context, we're seeing a lot of change. I'm just wondering if that still rings true or with guidance down, M&A is on hold? Or inversely, if you could be opportunistic once this current COVID environment returns back to normal?

Right. Well, I think the guidance we provided today will lead and should guide everyone to the fact that we'll still be generating strong cash flows between now and the end of the year. The M&A projects that we had initiated, let's say, earlier in the year in Q1, have been paused or slowed down simply because right now we can't travel, due diligence is really restricted or face-to-face negotiations are obviously not happening. That being said, those projects we were working on are still very much alive and might be pushed out a quarter or 2. But it's still -- there's still products that we're looking at, and we do plan on utilizing our strong cash flow to be able to take -- to make a better opportunity of available transactions.

[Operator Instructions] Your next question comes from the line of Benoit Poirier of Desjardins.

Just to come back on the non-Class 1 railroads, you mentioned kind of a more competitive landscape these days, but are they taking advantage of the 45G Infrastructure Maintenance Tax Credit right now as a result?

Yes. I mean demand is healthy, and we're definitely very active on the quoting front. What we've seen is -- as we've been talking for the last 2 quarters that we've been replenishing railway ties in our inventory to be able to drive, so has the entire industry. And we're now seeing a lot of our competitors, the smaller traders and the bigger players in our industry with inventory and now wanting to, I guess, secure volume for the balance of the year and perhaps the aggressiveness in quoting now comes from a bit more the fact there are uncertain times in current economic conditions. There is strong demand. But I guess the traders want to secure the volume for the balance of the year.

Okay. Perfect. Okay. That's great color. And when we look at residential lumber, I understand the potential softness that might come in your biggest month. But on the other side, I was wondering if you believe that the pandemic might increase spending as more people stay at home this summer and look to invest in their backyard. I mean looking at pole sales, it seems that it's being up significantly year-over-year. So I was wondering if it sits on the other side, provide a positive read-through for the residential lumber?

The demand from the homeowners is definitely there. Industry data on decking and fencing is showing strong demand for that raw material. So it's definitely flowing through. We're being cautious in our approach simply as we're coming into the 2 strongest months of the year, where we're really hoping our customers can service all the demand to their customers with the constraint that's put on them right now. So you're right, there -- I'll say it differently. If tomorrow, all the constraints are lifted and we're back in "normal business," I would say that there will be strong demand for residential lumber, and we'd have good sales.

Okay. So it's more a matter of logistic constraint as opposed to demand, let's put it that way?

Yes, of course. I mean, I referred to it earlier. Yes, exactly.

Okay. Perfect. And could you talk about the opportunity to enlarge your residential lumber sales through programs with non-big box customers? It seems that over the past month, you've received increased interest from non-big box customers. So are you still showing some momentum on that side?

Yes. So for the year, we -- so we refer to those as the dealer networks or the non-big box, which is fine. We have secured volume for the year. So every year, between the months of October and, let's say, late November, the volumes and the contracts get established between the hardware stores or hardware chains and the suppliers, in this case would be us. So we secured more volume in the dealer network for 2020 than we would have in compared to 2019.

Okay. That's great. And is your guidance for CapEx, $45 million to $50 million still valid?

Yes. Well, Silvana has done a bit of work on that. Maybe, Silvana, you want to give some color on that?

Yes. So we maintained the guidance between the $45 million and $55 million. There is maybe some reductions that we are seeing, but that's getting compensated by the FX. So overall, we're maintaining the guidance.

Okay. And ERP system, would it be fair to say that the pandemic might have delayed this project a bit? Or it's still running ongoing?

Well, the Webex and the Zooms of the world are very useful. And so far, we've not delayed our time line on the project. It's a fair question. There might come a point in time if we can't resume face-to-face meetings and exchange, there might be delays. But for now, we're holding our schedule.

Okay. And last one for me. When we look in terms of working capital, I know there was a lot of inventory that was replenished back in Q4. Now that you expect volume to be a bit softer this year, how should we be thinking about the impact on the working cap, let's say, for the full year in terms of usage?

If you're talking specifically inventory, I would guide you maybe at around, let's say, a pull on cash, about $50 million, 5-0. I think it would be fair.

There are no further questions at this time. I turn the call back over to the presenter.

Thank you for joining us on this call. We look forward to speaking with you again at our next quarterly call.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.