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

Welcome to the Stella-Jones Q1 2021 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 Monday, May 3, 2021. I will now turn the call over to Éric Vachon, President and CEO. Please go ahead.

Good afternoon, ladies and gentlemen, and thank you for your patience during our technical difficulties. I'm here with Silvana Travaglini, Chief Financial Officer of Stella-Jones. Thank you for joining us for the discussion on the financial and operating results for Stella-Jones' first quarter ended March 31, 2021. Our press release reporting Q1 results was published earlier this morning. It, along with our MD&A, can be found on our website at www.stella-jones.com. and have been 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. Today, we reported all-time record first quarter sales of $623 million, up 23% year-over-year and EBITDA of $99 million. We had an exceptionally robust start to the year, fueled by record pricing and volume gains in the residential lumber product category and by our ability to adapt to the unprecedented lumber market conditions and capitalize on our extensive procurement network and source of supply to deliver strong results. Our results this quarter also benefited from a solid performance in our utility pole category, and strong railway tie demand tempered by pricing pressures in the non-Class 1 business. In anticipation of continued solid demand in all 3 of our core product categories, we used our strong balance sheet in Q1 to invest in working capital and in our network. Subsequent to quarter end, we also secured additional liquidity to enhance our financial flexibility for growth opportunities as we look to drive continued creation of value for shareholders. I would like to take this opportunity to thank our employees for their commitment in achieving exceptional first quarter results, and our suppliers and customers for their continued collaboration and support. I will now provide you with a brief overview of our first quarter results. Sales for the first quarter of 2021 amounted to $623 million, up from sales of $508 million for the same period in 2020. Excluding the negative impact of currency conversion, pressure-treated wood sales rose $102 million, while sales for logs and lumber increased by $36 million. Utility pole sales amounted to $206 million, in line with the same strong Q1 sales last year. Most of the sales increase was driven by upward price adjustments in response to raw material cost increases and a favorable sales mix, including the impact of greater fire-resistant wrap pole sales volume. Overall volumes were relatively unchanged compared to Q1 as more project-related volume this quarter was offset by lower maintenance demand particularly in the U.S. Southeast due to the extreme winter weather conditions. Railway tie sales were $158 million, down 8% compared to sales of $172 million for the same period last year. Railway tie sales decreased organically by $6 million or 3%. The overall increase in volume this quarter was more than offset by lower pricing, largely due to non-Class 1 business. Pricing headwinds and an unfavorable product mix explain most of the reduction in the sales price for non-Class 1 business, while some downward pricing adjustments in response to lower fiber costs unfavorably impacted pricing for Class 1 customers. Residential lumber sales rose to $166 million, up 134% from $71 million for the same period in 2020. This significant increase was largely driven by the exceptional rise in the market price of lumber. We continue to benefit from strong demand bolstered by an early start to the season for home improvement projects. Also, our ability to service our customers led to us winning a greater proportion of our customers' annual program. Industrial product sales amounted to $28 million, largely in line with the $25 million of sales generated a year ago. Our bridge sales were lower this quarter, mainly timing related, but were offset in large part by the increased activity and demand for pines. The sales of logs and lumber, a product category used to optimize procurement totaled $65 million, more than double the sales of $29 million generated in the same period last year. This increase is primarily due to the significant increase in the market price of lumber. Silvana will now provide further details regarding our results and financial position before I conclude with our outlook. Silvana?

Thank you, Éric, and good afternoon, everyone. Turning to profitability. Driven by strong sales growth, gross profit increased 35% this quarter to $112 million compared to gross profit of $83 million in the first quarter last year. Similarly, EBITDA and operating income rose 57% to $99 million and 82% to $82 million, respectively. This first quarter record profitability stems from the high market price of lumber, the continued strong residential lumber demand and the company's ability to increase its market reach in residential lumber. Improved pricing for utility poles and volume gains for railway ties also contributed to higher profitability this quarter but were offset by the pricing pressures for the non-Class 1 railway tie business. As a result, net income for the first quarter doubled to $56 million or $0.85 per share compared to $28 million or $0.41 per share last year. Turning to liquidity and capital resources. Cash flow generated from operations before changes in noncash working capital components and interest and income tax paid was $100 million in the first quarter. The increase in working capital decreased liquidity by over $200 million during the quarter. And this was largely due to the seasonal increase in working capital, a higher level of sales and the increased inventory costs stemming from the higher market price of lumber. During the quarter, we invested $14 million in capital expenditures and returned capital to shareholders by buying back 800,000 shares for a total of $37 million. There are 1.4 million shares remaining in the current Normal Course Issuer Bid program. As of March 31, 2021, Stella-Jones' net debt, including $137 million of short-term debt increased to $935 million. And the net debt-to-EBITDA ratio stood at a comfortable 2.2x. Subsequent to quarter end, we closed a USD 350 million senior unsecured credit facility, including a term loan facility of up to USD 250 million and a revolving credit facility of USD 100 million. This facility provides us with additional liquidity at very competitive rates to continue to execute our growth strategy. Yesterday, the Board of Directors of Stella-Jones concurred a quarterly dividend of $0.18 per common share payable on June 22, 2021 to shareholders of directors at the close of business on June 1. 2021 will be the 17th consecutive year of dividend increases. I will now turn the call back to Éric for the outlook. Éric?

Thank you, Silvana. Based on the strong quarterly performance and the expectation that the higher levels of pricing for lumber will continue to favorably impact the profitability of the residential lumber product category during the seasonal peak demand period, we now expect EBITDA to be in the range of $450 million to $480 million. This guidance anticipates headwinds of approximately $90 million in sales from the deterioration of the value of the U.S. dollar relative to the Canadian dollar. Excluding the currency conversion impact, we project sales growth to be ranging between 15% to the low 20% for 2021. We continue to expect utility pole sales to increase in the mid- to high single-digit range compared to 2020 as we project sustained growth in replacement demand including an increase in the value-added fire-resistant wrap pole sales, while sales for railway ties and industrial products are projected to be relatively comparable to those generated in 2020. For residential lumber, we are now forecasting sales to increase in the range of 45% to 65% compared to 2020, and this is driven by the current trend of higher pricing, which is projected to continue during the peak demand season. Please consult our MD&A for a full list of economic and market assumptions used to prepare this guidance. As for our priorities for 2021, we intend to be active on the acquisition front, focus on innovation, continue to improve our operating efficiencies and expand our capacity to sustain our profitability. We recognize the importance to integrate environmental, social and governance considerations in key business decisions and strategies. We are focused on enhancing our ESG practices, developing better strategies to meet our goals and creating superior value for all our stakeholders. This concludes our prepared remarks. We will now be pleased to answer any questions you may have.

[Operator Instructions] Your first question comes from the line of Walter Spracklin with RBC Capital Markets.

So I want to start in your tie business that have -- I heard some of the potential consolidation that's happening, particularly with Kansas City Southern and Kansas City doing their own ties in-house, came up on one of the conference calls. I'm just wondering whether you think that's a threat or an opportunity? Is it an opportunity that should KCS be acquired that you could look to purchase their tie business? Or is it a threat in that whoever buys KCS may look to more maximize the use of that business line within KCS? Just curious on your thoughts there, Éric.

Thank you, Walter. I think it's an opportunity. So we are important suppliers to both the Canadian National and the Canadian Pacific. Both of those entities -- of those companies, as you know, do not operate their own treating facility. I would believe that a consolidated group either way would probably lean more towards wanting to divest those assets. That being said, Stella-Jones operates a facility that is online with the KCS. And we do actually supply certain requirements such as bridge converts and certain tie requirements throughout the year to the KCS. So we are very well positioned to benefit from this merger.

Okay. Moving on staying with railway ties for a moment. You mentioned that last quarter that you would -- or I guess, the quarter progressed relatively comparable top line level for railway ties excluding ForEx. Just curious whether that view for the top line is changed with your first quarter results here?

Not at all. So we maintain our guidance for our railway tie product category to be comparable year-over-year. And we base that off the fact that all our Class 1 customers have indicated similar maintenance programs. And so although we're slightly behind after the first quarter, it's simply a question of timing of orders.

Okay. And like I asked on the last call, any reason why if there's been any possibility of deferral, they're probably doing it given the amount of traffic and congestion, it sets up quite nicely for next year potentially if it was deferred to see some of that volume come in, in 2022. Is that still the case?

Well, yes. What's encouraging is that the major railroads in North America are posting great results. Traffic is increasing on the rail network, which means more usage. It will lead to more maintenance. Also very much optimistic about infrastructure spend in the next year or 24 months in the U.S. whenever that build comes through. So I think if you look beyond 2021, the future looks relatively encouraging for the railway tie business.

Okay. And then last question here on your poles side. Mid- to high single digit had been the run rate. Kind of came in, in that first quarter here now. Based on what you're seeing in terms of customer indications, as we trend into the second quarter here, are you on pace? Would you say that, that mid- to high single-digit [ x for x ] for poles as well for this year?

Well, definitely. Lots of inquiries from the contractor side of the pole business. COVID has subsided to some extent in the U.S., we're seeing activities pick up. And just to remind also the listeners that we do expect selling a bit more volume off our fire-resistant wrap pole. So it looks very, very good for us for meeting our guidance for this year.

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

Eric, the residential lumber business continues to exceed expectations, and you're now calling for very strong year-over-year sales growth in the 45% to 65% range for 2021. Certainly sounds like you expect growth to continue to remain strong in the second quarter. But I'm wondering if you can talk a little bit about what you've built into the guidance or those expectations as it relates to residential lumber for the back half of this year?

So you're exactly right, Michael. Our revised guidance is not considering higher year-over-year pricing. And if you recall last year's trend, the first half of the year, I would say had lower sales price on a wood foot basis and that we saw prices increase in the second half of the year. So most of the gains would come in the first half of the year. Mind you, after that, when we look at the second half of the year, that's where I guess our range comes more into play and it really depends if lumber prices are going to subside to some extent or be maintained.

Okay. So that's the -- at the low end of your range, would that put you into a situation where your year-over-year growth organically in residential lumber turns negative in the third quarter?

Yes. It could slightly be negative, yes. A bit more towards the last quarter, obviously, when the prices were much higher than the third quarter.

Okay. Yes, fair enough. Now I'm just trying to get a sense for -- Yes, I mean there's still a lot of uncertainty and we don't know what that is right now, but that's helpful. On the utility pole side, it sounds like you're still fairly upbeat about the business. I'm just wondering, with respect to -- you saw some lower maintenance demand in the first quarter. And then part of that, I guess, was due to the weather events in the U.S. Southeast. Do you expect to see -- Have you already seen any kind of a pickup on the maintenance demand side in the early part of the second quarter? And does that -- do those weather issues in the first quarter, did they create a situation where you could sort of have some cash activity in the second quarter?

Oh, no. That is definitely adjusting in a sense to trend towards our guidance. What we saw in the first quarter is that the winter orders intense industry conditions, we signed this out, were not necessarily pole events. We didn't see poles breaking but power was out. So the maintenance crews were spending a lot of time reconnecting the grid and making sure that households and hospitals and domiciles got back their electricity, et cetera. So that's a bit of the reason for that slowdown when we refer to the weather event in the first quarter.

Okay. And then just in terms of -- I'm assuming is it fair to say you have now seen some pick back up in that maintenance activity?

Yes. Yes, so demand is adjusting back to our expectations. And that's why we're comfortable guiding to the mid- to high single digits for the year.

Okay. And then just as far as the new credit facility for your U.S. operations that you entered into subsequent to quarter end. Aside from the repayment of the bridge loan, what are the goals or intended uses of that financing? And I mean you can let us know what the thoughts are there, but you did mention M&A as part of your prepared remarks, I'm not sure if this ties back into that.

Well, so there's a few things, Mike. One, we do have part of our current facility to the $50 million tranche that's expiring in February 2022. So we're setting ourselves up to be able to accommodate that production. Secondly, when we look at our goal of wanting to sustain an EBITDA leverage from 2 to 2.5x, if we consider that we potentially want to execute an M&A, we need some dry powder ahead of us to be able to execute as such.

Okay. And then I guess just on that point, can you provide a little bit more of an update in terms of the M&A pipeline? I mean, again, you did mention that you intend to be active this year. But any commentary around timing and where you're at with some of the things you're pursuing?

Yes. Well, so the last time we spoke on this call, it was maybe about 6 weeks ago, I'd say, and so there's not much of an update with regards to M&A other than we'll keep progressing forward. These things are clearing up with regards to discussions with our targets. So we're moving on forward. We're definitely dedicated to expand our footprint and maintain our leadership position in the North American market.

Your next question comes from the line of Benoit Poirier with Desjardins Capital Markets.

Yes, just to come back on the railway ties. Could you talk about the continued pricing pressure experienced with the railway tie? And what is driving this pressure?

So most of the pricing pressure is coming from the non-Class 1 business. As we explained to some extent last year, we were very good last year in the back half of the year. As I explained, shared a bit of the orders where we wanted to ourselves, trying to manage our margin best we could. Right now, what we're seeing is we saw a bit of a more aggressive pricing again in the fourth quarter. The orders we took in the third quarter were actually now sold in the first quarter to the first half of the year. So it's a bit of a continued trend with regards to the pricing pressure. I think it's also related to availability of ties, which we're starting to see tighten up slightly because, obviously, large demand for grade lumber and for pallet stuff which is competing with the center and the loss of ties, which is actually a good thing. I think a bit of tightening the market will actually give us a chance to revisit pricing upwards, but that would most likely be in the second half of the year.

Okay. Okay. That's great. And just for residential lumber, could you maybe break down the component between pricing and volume? And also maybe for the quarter, but also with respect to the 45% to 65% with the mix overall in terms of pricing and volume?

Yes. So for our first quarter, the split is really 70% pricing, 30% volume. Our guidance right now is in better part related to pricing.

Okay. Okay. That's great. And for the new credit facility, any thoughts about the interest rate, whether it's accretive, a bit dilutive versus the previous terms?

Silvana, you want to take this one? You negotiated the agreement. I'll give you credit for doing a great job there.

So because it's -- the -- it's part of the U.S. fund credit system, the interest rates, even though they are pretty much sort of competitive at our current facility, we will benefit from patronage dividends. So overall, our pricing would be lower than what we have currently -- what we currently have with that facility.

Okay. Okay. That's great color. And in terms of working cap for 2021, any color given that you're building up inventory for residential lumber? What we could expect, let's say, working capital change for the full year, Silvana?

Yes. We're pretty much forecasting a similar spend as in Q4 of last year, given the strong residential lumber demand. We expect that we're going to have to build up inventory similarly like we did last year in the fourth quarter at higher comps. So if we would have to sort of take a guess, again, we would say that probably the buildup will be similar to Q4 of last year.

[Operator Instructions] Your next question comes from Hamir Patel with CIBC Capital Markets.

I wanted to get your thoughts about the sort of Biden infrastructure plan, some of the proposals that are out there. What sort of impacts and how meaningful do you think that could be for both tie and pole demand?

Well, it's a difficult question to answer, Hamir. What I've read so far, there's several areas in the current bill that offer opportunities for us to just talk about rail, railtrack maintenance and upgrades. It does talk about construction of new roads and road repair. Often when you roll the highways are fixed, utility poles are either changed out or added in the case of new construction. There are discussions about bringing broadband to rural areas. There's also a lot of talks or descriptions about encouraging green energy initiatives, which would obviously you would need some sort of electrical grid to bring the power into the network. So I see multiple aspects in the current bill where we could benefit from. Now we'll have to wait and see what the final bill looks like. I believe there's still a lot to be done until we see a final bill. But I think it is most likely encouraging for our future business given the large presence that we have in both ties and pole. We should at one point benefit from it.

Great. That's helpful. And I just want to come back to M&A. I know in the past, Stella has spoken about potentially considering a fourth pillar to expand into. Anything you could share there about where the Board is at in terms of that sort of process? And if you have any thoughts you could share on potential markets or product categories that could be of interest.

Yes. Most of that -- I mean, I can't divulge any details because we're -- we are having discussions. The Board has tasked me to come up with a strategic review for the next, let's say, 3 to 5 years, that's where we're going through our core products. And then as I mentioned in the prepared remarks, we're also looking at how we could leverage our strength as a company, our network or our customer base and so on to be able to see what could be a great fit for Stella-Jones into those areas. So I can't answer specifically, but I'm definitely being asked to explore and see if there's any great ideas to keep growing our business with -- within our categories, but something also within the adjacencies of what we do currently.

Okay. Great. Just a last question for me. The fire-retardant wrap poles. How -- what sort of proportion of your mix in poles you expect that to be in '21?

Approximately 5% of overall sales.

Okay. And where do you see that going there? Is there a max that just given sort of weather constraints maybe or max?

Yes. I mean 5-ish is our goal. I mean, I would specifically share that our expectation was for a full year of sales of that product to ship to our customers. A little bit of a slow start to the beginning of the year. But let's say, we think 5% is good. We could revisit this question in future quarters. We're definitely going to start introducing this product in other regions of North America where forest fires are a regular event. But right now, we're sort of projecting at a 5% level.

There are no further questions at this time. Mr. Vachon, I turn the call back over to you.

Thank you, Greg. And thank you everyone for joining us for this call today. We look forward to speaking with you again at our next quarterly call.

Ladies and gentlemen, thank you for your participation, this concludes today's conference call. You may now disconnect.