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

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to Stella-Jones Q3 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, November 9, 2021. I'll now turn the conference over to Eric Vachon, President and CEO. Please go ahead.

Thank you, and good morning. I'm here with Silvana Travaglini, Chief Financial Officer of Stella-Jones. Thank you for joining us for this discussion of the financial and operating results for Stella-Jones' Third Quarter ended September 30, 2021. Our press release reporting Q3 results was published earlier this morning. It, along with our MD&A, can be found on our website at www.stellajones.com and will be posted on SEDAR today as well. We also published our 2020 environmental, social and governance report today. It can also be found on our website in our Investor Relations section under Environmental, Social and Governance. I invite you to read our report and learn more about the steps we have taken to refine our ESG strategy and build upon the integration of our priorities of environmental matter, environmental commitment -- sorry, products [ stewardship ], our valued employees and our governance principles. Let me remind you that all figures expressed on today's call are in Canadian dollars, unless otherwise stated. Before I review the results, I would like to touch on our recent announcements. Last week, we announced that we entered into an agreement to purchase the shares of Cahaba Pressure forest products and Cahaba Timber Inc. for USD 66 million and USD 36.5 million, respectively, subject to post-closing, working capital adjustments. Cahaba Pressure is an oil-borne preservative treater of wood poles, crossties and posts, and also provides custom treating services. Cahaba Timber is a waterborne preservative treater of utility poles and pilings and engages in a raw material procurement. Both facilities are located in Brierfield, Alabama. The combined sales of Cahaba Pressure and Cahaba Timber totaled approximately USD 97 million for the year ended 2020. Both entities were subcontractors of Stella-Jones, and our purchases represented approximately 20% of their annual sales. Both transactions are expected to close prior to the end of December 2021. We are very excited of these acquisitions that will expand our capability to supply the growing needs of North America's utility pole industry. In addition, we will further support the preservative offering to our customers and optimize the overall efficiencies of our continental network. Turning to our quarter. Our third quarter results reflect the impact of the normalization of lumber market conditions and the increase in the cost of untreated railway ties, which outpaced price adjustments. Sales for the third quarter of 2021 amounted to $679 million, down from sales of $742 million for the same period in 2020. Excluding the negative impact of currency conversion of $25 million, pressure-treated wood sales decreased $32 million or 5%, while sales for logs and lumber decreased by $6 million. More specifically by product category. Utility poles sales increased to $256 million compared to sales of $251 million in the corresponding period last year. Excluding the currency conversion effect, utility poles sales increased by $16 million or 6%, driven by improved maintenance demand for distribution poles and sales mix, including the impact of additional sales volumes for fire-resistant wrapped poles. This sales growth was partially attenuated by the decrease in project-related volumes. Railway ties sales were $179 million compared to sales of $188 million in the same period last year. Excluding the currency conversion effect, railway tie sales were stable as lower volumes for Class 1 customers, largely due to the timing of shipments, were compensated by continued strong demand and improved pricing for non-Class 1 customers. Residential lumber sales were $170 million, down from sales of $220 million in the corresponding period last year. Excluding the currency conversion effect, residential lumber sales decreased $47 million or 21%. While residential lumber pricing remain higher compared to the same period last year, it was not sufficient to offset the drop in demand. Industrial products sales were $32 million compared to sales of $34 million in the third quarter last year. Excluding the currency conversion effect, industrial product sales remain relatively unchanged. The sales of logs and lumber, a product category used to optimize procurement, totaled $42 million, down compared to $49 million in the corresponding period last year. Sales decreased mostly due to a reduction in lumber trading activity. Silvana will now provide further details regarding our results and financial position before I conclude with closing remarks.

Thank you, Eric, and good morning. Turning to profitability. Gross profit was $82 million this quarter, down compared to $147 million in the third quarter last year. This decrease in profitability is largely explained by higher fiber costs for residential lumber and railway ties, combined with lower residential lumber sales volumes. These factors were partially offset by the realization of higher pricing across most of the product categories. Gross profit for the quarter was also impacted by $7 million inventory write-down provision related to our residential lumber finished goods. Similarly, EBITDA and operating income decreased to $69 million and $51 million, respectively. Net income for the third quarter decreased to $34 million or $0.52 per share compared to $79 million or $1.17 per share last year. Turning to liquidity and capital resources. We generated $225 million of cash from operations in the quarter, primarily reflecting favorable movements in noncash working capital. During the quarter, we used the cash generated from operations to invest $14 million in capital expenditures and returned $38 million of capital to shareholders through dividends and the buyback of about 628,000 shares. In total, we repurchased 3.1 million shares at an average price of $45.40 under the NCIB program that expired on August 9. We also used our cash to reduce our debt. At the end of the quarter, Stella-Jones' net debt, including lease liabilities, stood at $679 million versus $745 million at the end of December 2020. We maintained a strong financial position with a net debt-to-trailing 12-month EBITDA ratio of 1.6x. And we had available liquidity of $540 million. During the quarter, we have paid a 1-year extension of our unsecured syndicated revolving credit facility to February 27, 2026. All other terms and conditions remain substantially unchanged. Subsequent to the end of the quarter, on November 8, the TSX accepted Stella-Jones' notice of intention to make a Normal Course Issuer Bid. Pursuant to the notice, Stella-Jones may purchase for cancellation up to 4 million common shares, representing approximately 8% of the [ public float ] during the 12-month period commencing on November 12 and ending November 11, 2022. Yesterday, the Board of Directors of Stella-Jones declared a quarterly dividend of $0.18 per common share payable on December 17, 2021 to shareholders of record at the close of business on December 1. I will now turn the call back to Eric for concluding remarks. Eric?

Thank you, Silvana. While we recognize that the quarterly results were lower than expected, I would like to highlight the solid year-to-date performance. Sales for the first 9 months of the year were up 15% organically compared to the same period last year, and EBITDA grew 10% to $348 million. The softer quarterly results has led us to revise our full year 2021 EBITDA forecast to about $400 million. Excluding the impact of currency conversion, the company expects sales growth in 2021 compared to 2020 to be in the low to high teens range. The company remains confident that it will deliver solid EBITDA in 2021, and that its EBITDA margin as a percentage of sales will be comparable to 2020. Based on current market conditions and assuming the conclusion of the acquisitions of Cahaba Pressure in Cahaba Timber, we're forecasting sales, EBITDA and EBITDA margin in 2022 to be comparable to the solid results expected in 2021. The company anticipates that the robust demand for utility poles and the contribution from the pending acquisitions will offset the normalization of residential lumber sales in 2022. Our priorities to create superior value for our stakeholders have not changed. We intend to continue to be active on the acquisition front, continue to improve our operating efficiencies and expand our capacity to increase our profitability. With our financial strength, scale and focus on execution and innovation, we continue to be well positioned to drive continued growth and generate solid returns for our shareholders. This concludes our prepared remarks. We will now be pleased to answer any questions you may have.

[Operator Instructions] Your first question comes from Walter Spracklin from RBC Capital Markets.

Yes. Thanks very much, operator. Good morning, everyone.

Good morning, Walter.

All right. So let me ask you, Eric, about the normalization comment and how that ties into your 2022 outlook. I know you benefited from a significant and a little bit hard to predict increase in demand. And now as that normalizes, that's also hard to predict. And of course, guidance is -- has had to move, alongside that difficulty to predict. My question, I guess, when you reference normalization, what confidence do you have when you go into 2022 that, that normalization has occurred and that the guidance that you provided for around $400 million or similar to last year or this year is -- what visibility and confidence do you have in that outlook?

Yes. Thank you, Walter. So you're completely right. The guidance review or adjustments that we've been making this year are mostly all related to the residential lumber changes we've seen in pricing and in demand. When we look currently at the forecast for volume for this year in 2021, I would argue that it will be most likely comparable to what we're seeing -- we have seen pre-pandemic in 2019, talking with our customers, contractors and different expectations for household improvements or forecast for the coming years, we feel that going into 2022, we'd be looking at these similar volumes in 2019. So when we talk about normalization is -- we went through this win at the high prices of lumber, which increased our pricing and our [ off-year ] sales. And then since July -- end of June or July, we've seen volumes normalize, if you want, and by that, I mean, being comparable to what we've seen historically. So right now, as we're sort of landing towards the end of 2021, we see volumes to be comparable, and that's how we're drawing our assumption that, for 2022, we will be seeing these similar volume levels.

Okay. That's very helpful. And this is my follow-up question with regards to the M&A pipeline. First off, you're including Cahaba in your EBITDA for next year. We've estimated that at about $18 million. If you could -- not sure if you can give us a sense of whether that's accurate or not in terms of how much that will be contributing to next year? And then just your overall thoughts on the M&A environment. I know there was a [ pole ] acquisition that you're zeroing in on. If you could update us there and just generally the overall pipeline would be very helpful.

Yes. Thank you, Walter. We have not provided specific guidance on EBITDA margins for the acquired companies of Cahaba. However, I can tell you, we've been in our traditional multiple range. We've always talked about a 6 to 7x traditional multiples. So I think that gives a good indication about how accurate your number is. With regards to the pipeline. So you referenced a pulled acquisition. So this would be one of them, the Cahaba Pressure and Timber combined would be one the projects we were working on since the beginning of the year that we've alluded to in previous calls. That being said, I did discuss in previous calls about potentially looking at several other projects, and we're still actively discussing with potential target acquisitions. Our balance sheet is strong. We definitely have the leverage to accommodate more M&A, and we remain focused on those projects.

Your next question comes from Michael Tupholme from TD Securities.

Just a clarification to begin with, the new 2021 EBITDA guidance of about $400 million, that includes the negative impact of the $7 million inventory provision taken in the third quarter?

Yes, it does.

Perfect. Second question, the various factors that have been pressuring results lately, so namely greater-than-expected margin compression for residential lumber, higher untreated railway ties cost and anticipated softer demand for Class 1 railway customers. To what extent do you see those factors continuing to pressure results in the fourth quarter?

So those 3 factors are incorporated in, I guess, the adjustments in our guidance. So when you look at -- consider the midpoint or the guide -- the EBITDA that you had previously -- or what we're talking about today. We're looking at the contribution for those 3 items to be part of the scenario. So I would say probably 50% of that is related to residential lumber. If you include actually the write-off that was not in our forecast, you could call it probably closer to 70%, 75% and the balance of that would be railway ties. Now I'd like to add the fact that although we've seen our fiber cost for railway ties increase, we do have the opportunity, in many cases, on a quarterly basis to adjust our pricing. So we have on October 1, a certain Class 1, and for others, we'll have another opportunity early in January. So we do feel that will subside over time.

Okay. So that was actually sort of going to be my next question -- the extent to which these factors are expected to be an ongoing issue into next year. You sort of answered it there, I guess, with respect to the ability to pass costs through on the ties side. But more holistically, are any of these factors going to continue to win results next year in a material way in your opinion?

No, I don't think so. And maybe it's an opportunity for me to talk a bit about the write-down. So for the third quarter, we did not see residential lumber volumes move as fast as what we wanted to. So at the end of September, we sort of took a hard look at our inventory position, the average cost and what we need or what we needed to achieve our December 31 goal of having the proper cost of inventory to be able to address 2022 in a more historical margin fashion, if you want. So that write-off gets us exactly where we need to be for the end of December. It's certain items that we've gone out to the market now and offer it at a very attractive price, which I would say are in better parts sold, as I speak today. So we're in very good shape to put this residential lumber inventory adjusted behind us.

Okay. That's helpful, Eric. Maybe circling back on one of the questions that Walter asked about the outlook you provided for 2022, which implies about $400 million of EBITDA next year. I think you touched already on your -- on some of your assumptions regarding the residential lumber business in terms of assuming it looks similar to 2019 levels. But can you talk maybe about some of the other assumptions you've made around the rest of the business? And I guess, beyond the specific assumptions, just your level of confidence in this number you provided for next year? And obviously, there are various risks and uncertainties and this year was -- that was very clear this year with the way the year played out. But to what extent have you buffered that number you've put out there? Is it a conservative number? Have you factored in various risks and uncertainties or how confident are you in that $400 million?

So let's start with the residential lumber part. We're talking about assumptions. There are a couple of assumptions that I would like to add to the comments. So we talked about similar volumes to 2019. Assumption, obviously, is FX. Price of lumber is quoted on their random length market in U.S. dollars. So obviously, there's a currency conversion potential impact. And lastly, there is the depressive lumber itself. The random length [ outage ] in 2019 was around $500 a [ 1,000 board foot ]. You are currently -- future's looking into early to late spring, since you'd be indicating pricing between USD 650 and USD 700 per [ 1,000 board foot ]. So I guess if you think about that delta of $150 to $200 per [ 1,000 board foot ], that is an assumption that could change over time. Back to your comment about the volatility, if you want, in the pricing. So other than that, when you think about our $400 million -- so we have, as we mentioned in our remarks, there will be a bit of a pullback on residential lumber, and it will be offset by 2 things. One is growth in utility poles. We've always guided to the -- to mid- to high single-digit growth. And I think we're all set up to see that continuing for coming years. So that next year is not an exception to that. And then obviously, with the conclusion of the Cahaba transaction, that sort of gets us more or less where we need to be.

Your next question comes from Hamir Patel from CIBC Capital.

Could -- I'm not sure if you have any indication yet from the Class 1s as to the volume commitments for next year. I know a couple outlined their intentions at an industry conference recently, but any color you might be able to share up about the sort of the picture across, maybe, from the Canadian ones as well?

Yes. So well, great question. As you might know, at the -- not all Class 1s were present at the conference this year. So we did get color from a certain number of them. We've seen them relatively -- slightly upbeat. I would probably say, not relative, but slightly upbeat. I mean most of them are up a few hundred thousand ties for -- in their annual maintenance program for the coming year. So I think that's positive. I think it's an indication of something that we've been talking about of increased traffic on the rail networks, obviously, that leads to more maintenance. And I think railroads have been focused so far this year, probably a bit more on executing on logistics and delivering products, and that's why we're seeing a bit of a slowdown in Class 1 maintenance in the second half of this year. But I think looking forward into the second half of '22 and going into further years, I do see the potential for maintenance to be up.

Great. And Eric, on your outlook, have you factored in -- well, I guess, to what extent have you factored in the U.S. infrastructure plan? And then specifically related to that, on the railway ties side, what I understand a lot of that investment is planned with [ Amtrak ]. And so if you could speak to -- not sure what their sort of wood or concrete tie mix is, but any color you might have there?

Certainly. To answer the first part of your question, the infrastructure bill impacts are not factored in our guidance for next year. Tough to say to what extent it could impact next year. And what I mean by that is by the time the program gets set up and -- or presented to the market and funds are allocated, could we see some effect in the latter part of next year? Yes. I think ultimately, yes, in 2023, we should see that impact our results over [ 60 per ] that demand come to our business. With regards to [ Amtrak ], they are a customer of ours. We do service them from time to time. They're part of our, again, I would say, the non-Class 1 commercial business, so it's a quoted business, but we have serviced that network in the past. And so I do expect that we'll be at the table discussing for that business.

Okay. That's helpful. And Eric, just turning to the [ pole ] side of the business. I know there's been some media reports lately of PG&E potentially spending $20 billion to underground a portion of their power lines. Are you seeing signs of any other utilities considering moves like that? And what's the sort of company's response given your -- some of the fire retardant poles that you have in the market now?

Well, first, we haven't seen any slowdown from demand from our customers and the plan for next year is still growth. That includes the fire wrapped products. So the press release you're referring to is the PG&E. It's -- I guess it's a product that they're studying internally. My understanding is that it takes a lot of planning and engineering to be able to -- I think it'll take several years to be able to execute. And I guess we'll see where that goes. We're good partners with those customers. And the project that they're announcing represents probably maybe 1/3 of their network. So there's still another great part of their network that will require maintenance and our products. So we're not necessarily concerned with that part. And last but not least, we're not seeing any other of our customers having discussions or thoughts about putting a certain part of their network underground.

Great. That's helpful. And just a last question from me for Silvana. Could you comment on -- for the CapEx for 2022? Are there any larger investments being considered to grow capacity at the existing assets and anything you might have planned at Cahaba?

So yes, for 2022, we could expect our CapEx to be above our range exactly to what you mentioned. We are looking at various initiatives to expand our capacity to support the additional [ pole ] growth that Eric just mentioned. And we do have some CapEx also dedicated to the conversion of our penta [indiscernible]. So in terms of amounts and timing, we're still in the process of completing our budget, so we don't have those numbers as of yet, but yes, we would expect it to be above $60 million. For Cahaba, nothing significant but pretty much in line with, I think, our overall, I guess, corporate percentage of maintenance annually is what we're seeing also at Cahaba.

I would add, Hamir, that the Cahaba assets are extremely good quality, very well maintained by the previous owners. So we're very proud to be able to add those plants to our network.

Your next question comes from Benoit Poirier from Desjardins.

Just to follow up on the previous question, Silvana. Could you talk a little bit about the working capital movement we might expect in light of the move in residential lumber for 2021 and 2022 at first glance?

Yes. So for the last quarter of 2021, as we've mentioned in the past, we are expecting a favorable working capital movement exactly, as you mentioned, that the [indiscernible], as we continue to draw down on our residential lumber inventory. And even still less of a build than in past years for railway ties given the tighter supply of untreated ties. For 2022, assuming no one expecting -- unexpected, I guess, margin movement, we would be budgeting a typical build in inventory to support sales growth over the following years. So typically, our $50 million or so, I think. At this point, given that we're still in the process of complete our budget would be our best guess.

Okay. Okay. That's great. And just in terms of share buyback, how should we be thinking about the allocation of capital going forward versus the M&A opportunities you might have for 2022?

So that's pretty consistent with, I guess, what we've been saying in the past. Obviously, the new program is there to be used. So we do expect to continuously use it, but always keeping in mind our target leverage ratio and to remain within our target ratio and prioritizing, obviously, the acquisition.

Okay. Okay. That's great. And any thoughts about the look of the fourth leg of growth. I'm just wondering how this initiative has progressed so far in 2021, whether you have a better picture on the ability to have the fourth leg of growth down the road?

Yes. So I'll take that question, Benoit. I think for the next foreseeable future, call it, 12, 24 months, there's still a lot of opportunities that are closer to our core competencies of wood treating. I think so -- you'll see our team being focused on M&A with that nature. Silvana spoke a bit about capacity expansion to address upcoming demand where M&A is not necessarily readily available. The other aspect that you're referring to is something that we're still studying and investigating and discussing with the Board, but I think for the next short while, you will still hear us talk about the treated lumber in all 3 of our product categories.

Okay. And last one for me. Could you talk about the penta preservative? I know there's change going on and it will eventually run down. So just to -- some color about the market acceptance for the other preservatives that will eventually replace the penta?

Yes, certainly. So the current manufacturer of penta is closing shop at the end of this year. We will be doing -- performing the transition away from penta in the next 18 months. We have sufficient supply to provide penta-treated poles to certain customers that are very much interested in taking that product for as long as we can provide it. We have discussed with all of our customers, their preferences for conversion, and there are of many avenues. Certain customers will move to waterborne preservatives, such as CCA. Other -- sorry, other utilities are discussing about the opportunity to move to DCOI, which is an oil-borne preservative such as penta. Last but not least, another option that is offered is a product called Copper Naphthenate that we also offer within our network. I would say, the interest for that product is lesser than DCOI at the time being. But we've got a plan laid out with most of our customers at this point. We have an 18-month plan to sort of progressively phase out certain plants and convert you into customers, and we sort of feel working collectively with those customers to be able to address it in an orderly fashion.

Okay. And with respect to those preservative, are there some additional cost to be expected or margins -- fair to expect that margins will remain about the same, given the change in -- with penta?

Yes. I suspect that the margins will stay similar. The -- in both cases, when we convert away from penta usually the customers will prefer to -- if you are an old -- if a utility prefers an oil-based preservative, you will most likely move to another oil-based conservative and the margin profile will be similar.

[Operator Instructions] Your next question comes from Maxim Sytchev from National Bank Financial.

Eric, I just wanted to circle back to M&A. And I guess my question on -- around this, are we in the process of identifying kind of needle-moving opportunities? Or how should we think about kind of the quantum of revenue contribution that could be coming from acquisitions over the, let's say, kind of, 12 to 24 months?

Certainly. So, Maxim, our industry in all 3 product categories have many participants, but family-owned business of various sizes. We've always said it varies between the $30 million to $100 million mark depending on the size. So to be respectful, needle-moving for Stella-Jones now sitting today at $2.7 billion revenue. You might argue that it's not necessarily moving, but this is how we build our network over the last 15 years by adding to our network, I think, these smaller companies consolidating our respective markets and becoming a strong presence for current customers and future customers.

All right. No, fair enough. And then -- I mean, obviously, as you mentioned, are there potential [indiscernible] being considered as we speak. But in terms of providing incremental services to your existing customers, is there some thought process on that front from a strategic perspective?

Yes, definitely. It's -- there are activities, products and services that are closely adjacent to what we do for which we do have internal expertise that discussion with customers would see us favorably addressing those. And back to Benoit's last question a few minutes ago when he was talking about a fourth leg. I know if you can talk about the fourth leg, but I think it's enhancing our offering to our customer base, if you want. But definitely, there are items in those categories that we're definitely looking into.

Right. I guess, is it fair to say that you're not committing yourself just to kind of like capital-driven businesses but also sort of a service type potential as well would make sense for you?

Yes. I mean we're not excluding anything at this point. If we have the internal knowledge and the capacity to execute, it is accretive to our margin profile, it's something that we'll definitely consider. So I'll be [ hard-pressed ] -- address a business that would lower our average EBITDA margins. So there's a few criteria that we're looking at, but we've always said it needs to be accretive. It needs to be somehow close to our core competencies, and we'll try to stick to those criteria.

Okay. That's great. And then maybe just a quick question for Silvana. In terms of synergies on the acquired assets, anything that you can suggest to us?

I think we are fairly confident as in the past transactions that we'd be able to pick up half a turn to a turn on the traditional multiple that Eric exposed earlier. So that would include any optimization of customers, of procurement and some SG&A synergies.

Okay. Super. And then last question, Eric, are you seeing any -- obviously, lots of discussions about supply chain bottlenecks, wage pressures, kind of labor availability and so forth. Anything you can share with us on these fronts?

Yes, maybe a few little things. Like any company in North America, holding on to your labor force is a bit more difficult. We have adjusted internally our wages to our employees and keeping very mindful of market dynamics on that front. But I think we're holding our own pretty well on that front. With regards to tightness, we didn't necessarily talk about it, but we are seeing tightness in the untreated tie market, so less untreated tie availability is putting some pressure on procurement. Nothing to be overly concerned about, but we are seeing some decline in our inventory levels since, let's say, the last few months. And I think it will subside somewhere probably early next year. So we're definitely adjusting to that. That being said, being mainly a black tie supplier, we have a large inventory at our facility. So we can definitely -- are in a good position to address that. Last but not least, which is not directly tied to us, but we are hearing certain utilities that are faced with the challenge to find complementary products that they need for maintenance and installation, cabling, hardware, transformers and things of the like. Nothing alarming, but we are hearing that general supply constraints in North America for all sorts of products is not -- is impacting to some extent that the -- or certain utility customers. So -- but nothing that would change our views on our guidance, but I'm just throwing it out there as I wanted to answer your question.

We have no further questions. I would like to turn the call back over to Eric Vachon for closing remarks.

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

This concludes today's conference call. Thank you for your participation. You may now disconnect.