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

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to Stella-Jones Q2 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 Tuesday, August 3, 2021. I will now turn the conference over to Eric Vachon, President and CEO. Please go ahead.

Good morning, 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 and operating results of Stella-Jones' second quarter ended June 30, 2021. Our press release reporting Q2 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. Stella-Jones delivered strong performance in Q2. Marked by solid sales growth in each of our 3 main product categories. Volume gains in utility poles and railway ties, combined with record high prices of volume of lumber drove sales to over $900 million and EBITDA to a quarter record. Increased profitability translated into strong cash flow from operations, which allowed us to reduce the indebtedness incurred in Q1 for the seasonal build in working capital, invest strategically in our network, and continue to return capital to shareholders. Sales for the second quarter reached $903 million, up from $768 million for the same period in 2020. Excluding the negative impact of the currency conversion, pressure treated wood sales rose $136 million or 18%, while sales for logs and lumber increased by $64 million. I will now discuss in more detail the performance by product category. Utility pole sales increased to $236 million, up from $230 million in the corresponding period last year. Excluding the currency conversion effect, utility pole sales climbed $30 million or 13%, driven by improved maintenance demand for distribution poles, upward price adjustments, and better sales mix strengthened by added fire resistant wrapped pole sales volumes. This growth was partially offset by less project-related volumes. Railway tie sales reached $216 million versus sales of $225 million in the same period last year. Excluding currency conversion, railway tie sales increased $15 million or 7%, largely attributable to higher volumes for Class 1 customers due to the timing of shipments. The higher sales volumes were offset in part by pricing pressures for non-Class 1 customers, which eased somewhat during the quarter. Residential lumber sales rose to $330 million compared to $257 million in the period last year. Excluding the currency conversion effect, sales increased by $84 million or 33%, driven by the exceptional rise in the market price of lumber. This increase was partially offset by lower sales volumes stemming from softening customer demand. Industrial product sales were $36 million compared to sales of $33 million in the quarter last year, largely due to more timber and timing projects, offset in part by lower project-related bridge and crossing sales. The sales of logs and lumber, a category used to optimize procurement, was up threefold to $85 million compared to $23 million in the corresponding period last year. This exceptional increase was due to the rise in the lumber price of market during the quarter. Savannah will now provide further details regarding our results and financial position before I conclude with our outlook. Silvana?

Thank you, Eric, and good morning, everyone. Turning to profitability, driven by our strong sales growth, gross profit increased 50% to $197 million compared to gross profit of $131 million in the second quarter last year. Similarly, EBITDA and operating income rose 50% to $180 million and 59% to $161 million, respectively. The increase was largely driven by the rise in sales prices for residential lumber, which exceeded the higher cost of lumber as well as improved pricing and volumes saved through utility poles, partially offset by lower residential lumber demand. As a result, net income for the quarter increased over 65% to $115 million or $1.76 per share compared to $69 million or $1.02 per share in Q2 of 2020. Turning to liquidity and capital resources. We generated $173 million of cash flow from operations in the quarter, primarily driven by our significantly improved profitability. Our capital allocation approach remains focused on balancing growth and returns. During the quarter, we invested $16 million in capital expenditures and returned capital to shareholders by paying dividends of $24 million and buying back nearly 300,000 shares for a total of $14 million. There are now 1.1 million shares outstanding for repurchase under our normal course issuer bid. During the quarter, we repaid in full our short-term indebtedness and increased our long-term debt by $26 million. As of the end of the quarter, Stella-Jones' long-term debt, including the current portion, stood at $682 million. We maintained a strong financial position with a low net to debt trailing 12-month EBITDA ratio of 1.7x and had available liquidity of $395 million. Subsequent to the quarter end, the company obtained a 1-year extension of its unsecured syndicated revolving credit facility to February 27, 2026. Yesterday, the Board of Directors of Stella-Jones declared a quarterly dividend of $0.18 per common share payable on September 17, 2021, to the shareholders of record at the close of business on September 1. I will now turn the call back to Eric for the outlook. Eric?

Thank you, Silvana. We have revised our full year financial forecast to reflect the softening of residential lumber demand in the second half of 2021. We continue to foresee solid EBITDA growth in 2021 compared to 2020, but expect EBITDA to be in the range of $410 million to $440 million in 2021 compared to the previously disclosed guidance of $450 million to $480 million. The margin expansion realized in the first half of 2021 is projected to offset the margin compression expected from declining market prices of lumber until the company averages down its higher cost of inventory. As a result, the company anticipates EBITDA margins as a percentage of sales for 2021 to remain comparable to 2020. Excluding the impact of currency conversion of about $130 million on sales, the company is projecting sales growth in the low to high teens for 2021 compared to 2020. Residential lumber sales are forecasted to increase 15% to 20% compared to 2020, down from the previously disclosed forecasted increase of 45% to 65%. For utility poles, the sales growth forecasted remains unchanged. We expect sales to increase in the high single-digit range compared to 2020. We increased our sales growth expectations for railway ties and industrial products. We now project sales increase in the low single-digit range for both categories compared to 2020. Our priorities to create superior value for our stakeholders have not changed. We intend to be active on the acquisition front, focus on innovation, continue to improve our operating efficiency and expand our capacity to sustain profitability. On that front, in the coming months, we will be starting up our Kirkland Lake Ontario facility to support the strong growth in poles demands. The underlying fundamental of each of our key product categories remains strong, even as lumber market conditions normalize. We expect our residential lumber product category sales to benefit from strong and enduring customer relationships. For our leading utility poles and railway ties product categories, we are confident that they will remain the core drivers of our sustained growth. 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 Eric, perhaps to start on your guidance change with regards to residential lumber, that makes sense given where the market has been going. Just curious to size that. Are you assuming in that new guidance, a deeper decline in lumber pricing or in demand? Are you looking at it kind of where it ended the quarter? Just to get a flavor for the conservatism that you built into your guidance for residential lumber would be appreciated. Thank you.

Certainly. Thank you for the question, Walter. And the topic definitely deserves some discussion. So if we think about our Q2 results, a very strong result for the residential lumber product category, 2 dynamics were underlying in those great results. One is pricing or the pricing or sales prices that we were able to pass onto our customers were higher than expected, but they were also offset by lower customer demand. And it's really that lower customer demand trend, and when I'm going to talk about the customer, I'm talking about either the retail end customer at the retail level, and seeing that demand drop off, we're seeing that strength continue into the second half of the year. So I would say 2/3 of our guidance adjustment is related to the volume aspect dropping versus last year. The other aspect to consider is a sharp decline in the pricing of lumber at the tail end of Q2. That sharp drop has put some pressures on pricing that we're going to give to our customers, but we need a bit of time to average down our cost of inventory. So I would say 1/3 of our guidance decline is related to margin compression. So the sharp decline on pricing, obviously, prices have dropped over 60%, and we're now dropping our sales prices by that magnitude. But we are conceding some prices to customers, but the fact that we need to average down our cost of inventory, that'll take a while for us to be able to average down the cost, and therefore, there will be some margin compression.

Okay. That's great color. My second question is on your go-forward strategy, and I know you touched on it there in your closing, in your prepared remarks. But really what you've had here is a multi-quarter best described as a windfall that has cleaned up your balance sheet. Silvana pointing to 1.7x debt to EBITDA, $400 million in available liquidity. You've used a portion of that to buy back some stock and prime your balance sheet. I guess my question from here, and I know you mentioned acquisitions, but there have been very -- those have been kind of lower on the activity level there. Are you, armed now with this new windfall and the balance sheet it's created, can you go into the market now and become more aggressive with acquisitions, even if they're at a little bit of a higher price given some of the opportunities that are out there for growing your business? Or is there just not many opportunities there? And if not, what are you looking at in terms of capital return strategy? Are you looking at significantly increasing your payout ratio? Or are you ramping up your buyback? Curious to hear your thoughts longer term in terms of that strategy.

So thank you, Walter. So I'll answer the M&A part first and then follow-up with the second part. I guess it's a bit more on capital allocation. So on the M&A front, I'm happy to report, we're still discussing with the same companies that we were last quarter. We're progressing in our process. And I can't say much more than that, obviously, because otherwise I'd be announcing a deal, which I'm not. But things are progressing well and we're moving positively towards being able to complete a transaction by -- in a short period of time ahead of us. That being said, our leverage has been down or has been excellent. Our debt leverage has been excellent for several quarters. So we're definitely well positioned to be able to make an acquisition. And it's not really about the pricing for the deal, but more about just the process to get to being able to conclude a deal. So with regards to capital allocation, with the clarification we provided last year, I think we're going to keep being mindful of the free cash flow we generate. I think we have ample availability in our facilities to be able to execute on M&A, but also to be able to continue to return to shareholders in the form of dividends or share buybacks.

Your next question comes from the line of Hamir Patel with CIBC Capital Markets.

Eric, what sort of annual volume change is embedded in the res lumber sales guide of up 15% to 20%?

Yes. 30% of volume in the second half. So in the second half in our guidance, if you want, it's 30% of volume decline year-over-year.

And what was the volume change in the first half of the year?

I believe it was…

Year-to-date about 15% to 20%.

Up.

It is up.

Up, okay. And then down 30% in the back half. Okay. And as we look out to 2022, who knows where lumber prices go, but from a volume standpoint, what are you hearing from your key customers? Are they expecting volumes to be up year-over-year next year in '22?

So key customers have not started discussing 2022 yet. I guess maybe the best way to look at it, and you touched a bit on it, I think if we start pre-pandemic, so 2019 as a starting point, and to that I guess you need to factor 2 things. One, and you just mentioned it, is where is the price of lumber going to settle? I mean you see futures as well as I do around call it the $700 mark for next year. Compare that to our 2019 let's say call it baseline. I think the other thing we need to consider is the strong relationships we've developed in the last 18 months in the market with customers and new customers, and that would be sort of added volume to that baseline, if you want. So not I guess --can't quantify right now what it looks like, but that's how we're sort of thinking about 2022.

Fair enough. That's helpful. And just turning to the railway tie business, if I look at the untreated tie prices, it looks like some of those benchmarks are up low single digits since the end of Q2 and almost up double-digits year-over-year. So are you seeing that inflation on the raw material side? And can you just remind us how the passthroughs work in that category?

Yes, so we're observing exactly that. There is less availability of hardwood logs in the market right now. Well, there's less availability of hardwood logs, but the sawmills are also being offered a lot of money to cut pallet stock. So that's sort of prompting our industry to raise prices at the sawmills to encourage them to cut more railway ties. So you're completely right, we're seeing that situation occur. The consequence for that is obviously, and we've had this discussion before, we will see our average cost of inventory increase slowly as we procure month-over-month. And then we'll have the opportunity to execute clauses in our Class 1 contracts, if you want, and adjust the pricing accordingly. So there might be a little lag before we can adjust with the Class 1 customers. And with regards to quoting to the non-Class 1, that's really a quoting exercise. So every month, as we're seeing our cost of material increase, we will adjust our quotes to the market. So it could take another quarter to 4 or 5 months to be able to fully scope in the cost of that fiber cost.

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

Maybe just a housekeeping question to start. You've given us updated guidance not only for the EBITDA, obviously, but in terms of sales guidance and some details around the product categories. The new sales guidance, it's clear that that's organic growth guidance, low to high teens for the year. I'm just wondering, when you provide all of the product category sales guidance, is that also all on an organic basis?

Yes, it is.

Okay, perfect. Next question relates to your margins. And you've indicated that you expect full year 2021 EBITDA margins to be comparable to 2020's level. So that was about 15.1% last year. Obviously, margins have had some uplift as a result of strong residential lumber markets since the start of the pandemic in early 2020. I'm wondering, though, Eric, if you can talk about what you see as a sustainable normalized annual EBITDA margin for Stella-Jones' business as we look forward? So in other words, just trying to understand how we should think about a sustainable margin and then how that compares to this approximately 15% level you're guiding to for this year than you did last year?

And Michael, I would guide to that 15%. I think it's something that we can achieve where other parts of our business are still growing, right? Utility poles have had the high single-digit growth now for a couple of years. Our -- we've got some efficiencies in our facilities. So even though we're seeing some normalizing in the residential lumber product category, I guess it will resume to historical margins. But all in all, when you consider the whole of the company going forward into 2022, I think the 15% mark would be the margin to think about.

Okay. And also, fair to say even beyond 2022 as well?

Yes, yes, yes, definitely.

Okay. Perfect. The growth you did in the poles business in the quarter, strong at 13%. I guess 2 questions. Number one, are you able to break down where that growth came from? I mean you've indicated qualitatively some of the drivers. I'm just wondering how important or how much weight each of those carried, so things like improved maintenance demand and higher pricing and mix? That would be question one. And then number 2 would be, you've maintained your organic growth guidance for that product category in the high single-digit range. You did 13% though in the second quarter. So what is it? I think you're running kind of high single digits on a year-to-date basis, but that sort of implies maybe a bit of a slowdown from Q2, and I realize high single-digit is very good, but what would be the drivers for the slowdown from this 13% reflected in the second quarter?

So maybe a bit of color on the first half of this year, H1. For the year, if we combine both quarters, we're about a 9% growth. And that growth stemmed call it 30% from -- 30% from volume and 70% from pricing. So that's how that was comprised. And I think if you take a look at our whole year guidance, it will go to 50/50, so 50% on pricing, 50% on the volume. So I mean, we did slightly adjust, I don't know if you noticed, we went from mid- to high single digits to talk in our outlook about only high single digits. So I think it's -- it would be aligned a bit with the 9% we achieved in H1.

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

Just to come back on the residential lumber, could you maybe provide some color about the overall inventory levels of treated wood in Stella-Jones, but also at your customer level and how it could influence demand for 2022?

Great question, Benoit. So as I highlighted previously, demand in the second quarter was a bit less than what we expected. So we did finish Q2 with a bit higher levels of treated inventory than we would in normal years. So you're completely right in your, I guess on what you're thinking, is that we have a bit more inventory on the book than we usually have. And that's why we're sort of guiding to the fact that we'll have a bit of margin compression until we can average down our costs. So we've adjusted our procurement starting back in June, we've adjusted our procurement practices to be able to reduce our inventories. We're also working with our customers. So our customers don't typically hold a lot of inventory. We sort of hold it for them. So we're sort of working jointly here, looking at pricing or -- well, we don't think they do pricing, but they actually are looking at strategies to make sure that they have pricing that's attractive for the end consumer, bringing them into stores, and will help us, this will help us move inventory. I referred to, in the past, to a partnership with our customers, and this is where the partnership is being leveraged. Obviously, market prices of lumber have dropped 60%, and that's not -- we have not dropped our sales prices that much. So we're working collectively with our customers to be able to move that inventory. So to answer the second part of your question, with the volumes of sales we're still forecasting for the balance of the year, I strongly believe that we'll be able to reduce our inventory levels, average down our costs before the end of the year, and be ready to reset for a good 2022 season.

Okay. And then would it be fair that the implied guidance assumes that the inventory level would finish more at the normalized level at the end of the year, is it?

Yes. That is correct.

Okay. Perfect. And just in terms of working cap, how should we be thinking in terms of working capital consumption or release for the second half given the dynamics with the lumber price?

Yes. Certainly. I'll let Silvana answer that. She spent some time looking into that. We were anticipating the question.

Yes. So well, for the year, we would expect the change in working capital to be flat or contribute slightly. So definitely for the second half, we would expect a contribution. The main reason for that is that the typical build in inventory that we usually see in the last quarter of the year to support our salesforce in the following year, are expected to be offset by, as was just mentioned, the depletion of this higher level of residential inventory. Also impacting it is also railway ties. As mentioned also by Eric, the tighter availability of fiber might also not -- we won't have as much of a build because of that also for railway ties.

Okay. That's great. When you say flat to slight contribution, would you say positive or negative slight contribution, Silvana?

A slight positive contribution for the year.

For the year. Perfect. Okay. That's great. And just for utility pole, you already mentioned good color about volume and pricing. But I was curious to know if you're seeing a further acceleration of maintenance work in second half or the recent resurgences of the pandemic could slow things down again?

The portion of your question on pandemic is really difficult to predict. Right now, we're not seeing any size of demand slowing down. And I'd probably say the order book now sort of reflects a good part of the balance of the year. So I can't answer necessarily clearly on pandemic, that's really a bit of a wildcard. But right now, we're not, definitely not seeing that, Benoit. And maybe remind me the first part of your question? On, it was on volume, right?