Earnings Transcript for IFSPF - Q3 Fiscal Year 2024

Operator: Good morning. My name is Kelvin, and I will be your conference operator today. At this time, I would like to welcome everyone to the Interfor Analyst Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. [Operator Instructions]. Thank you. Mr. Fillinger, you may begin your conference.

Ian Fillinger: Okay. Thank you, Operator, and thank you, everyone, for joining us this morning. With me on the call, I have Rick Pozzebon, Executive Vice President and Chief Financial Officer, and Bart Bender, our Senior Vice President of Sales and Marketing. I'll start off by providing a brief recap of our quarter before passing the call on to Rick and Bart. Turning to our Q3 results, our adjusted EBITDA was negative $22 million during yet another challenging quarter that was impacted by continued weak pricing. During the quarter, we reduced production across our platform, including indefinite closures at two mills in our U.S. South region. During the quarter, we also announced plans to exit our Quebec region, selling our three manufacturing facilities, and closing our regional office in Montreal. These decisions have strengthened our portfolio by lowering both our production and overhead costs. We did see additional industry supply reductions made by other manufacturers, and believe about 10% of the industry capacity has been removed. The full impact of these supply reductions will come to light over the next two to three months. And I'll turn the call over to Rick, who will walk you through the financials.

Rick Pozzebon: Thank you, Ian, and good morning, all. Please refer to cautionary language regarding forward-looking information in our Q3 MD&A. Interfor continued to face weak lumber markets in Q3, and our earnings for the quarter reflect this. Despite the earnings weakness, we were able to generate positive cash flow from operations in the quarter as we collected on tax refunds and further reduced our working capital, while continuing to realize proceeds from the sale of non-core assets. As a result, financial leverage has remained relatively flat quarter-over-quarter at 36% while available liquidity grew to over $350 million. Looking through the third quarter, we are encouraged by the significant and mostly permanent lumber capacity cuts across the industry this year, as well as the U.S. Fed beginning to cut interest rates. These factors have contributed to steadily improving lumber prices since early July, which are now up over 20% since that time. With respect to Q3 earnings, Interfor generated an adjusted EBITDA loss of $22 million on total revenue of $693 million. Revenue declined by 10% quarter-over-quarter, driven mostly by a 10% decrease in lumber shipment volume, combined with a 5% drop in the average realized lumber price. On the cost side, reported production costs per unit of lumber sold were flat quarter-over-quarter despite the lower volume. Ultimately, a net loss of $106 million was realized in the quarter, which included non-cash impairments totaling $91 million associated with the previously announced sale of our Quebec operations and indefinite curtailment of our mail in Somerville, South Carolina. The company's financial position was supported by $38 million of operating cash flows in the quarter, driven by the receipt of tax refunds totaling $55 million and release of working capital amounting to $7 million. Looking ahead to Q4, we are seeing improved operating cash flows from the higher lumber prices. We have incremental tax refunds of $30 million already in hand and we expect over $30 million of cash to be realized from selling our Quebec operations and ongoing disposition of coastal B.C. forest tenures. Regarding capital allocation, we will continue to take a conservative approach focused on reducing our financial leverage. As part of this, we continue to expect capital expenditures for 2024 to be approximately $70 million, while our preliminary guidance for capital expenditures in 2025 is approximately $75 million. To wrap up, Interfor's Q3 earnings reflected a weak but improving lumber market. Interfor is well-positioned to benefit financially from the rebalancing of supply with demand that is taking place across the industry. That concludes my remarks, and I'll turn the call over to Bart.

Bart Bender: Thanks, Rick. I'll make some market outlook comments. We're at an interesting inflection point in the lumber market, which are now starting to show signals that we're leaving the trough markets behind and beginning the journey to a better supply-demand balance and ultimately higher prices. Timing really is of the essence with this. On the demand side of the equation, we know that there is pent-up demand with new home construction, particularly in multifamily, and additionally, we believe so in repair and remodel. Given the challenges in affordability, frankly, we're impressed with the resilience of housing starts. Clearly a signal that despite this affordability challenge, there continues to be decent demand for new homes, especially single-family.This will only improve as interest rates decline. On the repair and remodel side, rate lock on existing home sales is a constraint on move-up sales and the repair and remodel that comes along with that. This, too, will only improve as interest rates decline. Turning to the supply side of the equation, the amount of lumber curtailments has been significant, particularly in the back half of 2024. Both the U.S. South and British Columbia have shouldered a line share of these reductions. It's our opinion that the full impacts have not reached the markets. However, the expectation of reduced supply in 2025 is resonating with our customer base. Logistics capacity has been excellent and for the most part, consistent, which continues to allow shorter restocking lead times to our customers, which in turn means they can continue to lower their inventories. We think the industry is operating at the low end of historical inventory averages. As supply tightens and demand increases, you will see a multiplier effect in the market, with not only more demand to satisfy, but also a supply chain that will require more robust inventories to meet this demand. We expect this multiplier impact at some point in 2025. Looking into 2025, we are seeing more interest in secured supply in the form of volume contracts from our customer base. This is widespread across all customer types and supports our view that supply is balanced at a time when demand is expected to increase. I'll stop there and hand it back to you, Ian.

Ian Fillinger: Okay, thanks, Bart, thanks, Rick. So, operator, over to our Q&A period.

Operator: Thank you. Ladies and gentlemen, we will now begin the question and answer session. [Operator Instructions]. Your first question comes from the line of Matthew McKellar of RBC Capital Markets. Please go ahead.

Matthew McKellar: Hi, good morning. Thanks for taking my question. I'd like to start just by following up, on the comment Bart made around reduced supply resonating with your customer base and customers looking to secure more volumes for '25. Can you give us a directional sense of just how significant that change has been and how much more volume your customers are looking to secure year-over-year?

Rick Pozzebon: Yes, I'll be careful with that. I don't want to get into too much detail, but I will say that with the -- I suppose, significant curtailments of late that have come up, it's prompted a number of customers to express concern on supply of some products for next year. And obviously entering into programs and secured volume contracts is a way to mitigate that risk. I can tell you that we have entertained new inquiries and new programs and secured new programs in areas that we haven't been active in the past. So how that meters out, I suppose, across the business is a bit hard to say, because I can imagine our competitors are getting the same kind of inquiries and same kind of calls. But for me, what it does is it really shows that as we go into 2025, there is a, I suppose, an understanding with a good portion, not everyone, but a good portion of our customer base that at the current supply levels, there will be some challenges for some products in some markets, which is obviously a good thing.

Matthew McKellar: Great, thanks very much for the color. Last one, for me, Ian, I think you said you're estimating that about 10% of industry capacity has been removed. What is your sense of what share of that capacity could come back up over either the short-term or long-term if markets improve?

Ian Fillinger: Yes, hey, Matt, a good question. I would say, in our view, it's probably somewhere around that 50%-ish, somewhere around there. I think in the permanent sort of indefinite category, we're north of 3 billion feet as far as our tractor goes. Not perfect science, as you know, and it's hard to kind of fully understand what a competitor might do, but I'd say it's probably in that neighborhood between three and four that would be indefinite and permanent. What's significant is, of that, I think it's over 40% in the U.S. South, which is unprecedented, as you know. I think BC is probably number two, somewhere around 35% from an indefinite permanent. So definitely some positive signs from the supply side finally reacting to two years of pretty tough slugging on the lumber prices.

Matthew McKellar: Great. Thanks for the help. I'll turn it back.

Ian Fillinger: Thanks, Matt.

Operator: Thank you. Your next question comes from the line of Ben Isaacson of Scotiabank. Please go ahead.

Unidentified Analyst: Good morning. This is actually Victor jumping on for Ben. Could you perhaps [Audio Gap] explain what has changed since the e-com purchase, which is outside of the current market weakness?

Rick Pozzebon: Victor, on our end, you cut out, and we just heard e-com, and that was it.

Ben Isaacson: So- Sorry, my bad. Could you -- the question was, could you perhaps explain on the rationale for the Quebec transaction, specifically what had changed since the e-com purchase, which is kind of outside of the current market weakness?

Rick Pozzebon: Yes, I mean, we did put out a press release on that. So just to kind of give you the key points, but I mean, the fiber supply dynamic definitely changed for two reasons. One was the government outlook on environmental protection of some of the Quebec tenures, but also the record forest fires after the e-com purchase. The Quebec fiber supply, in our opinion is shrinking not just for us, but for competitors, and we've seen competitors having to curtail also in Quebec. And so the deal and the sale with the counterparty, I think, strengthens the counterparty's footprint, which is extensive in Quebec, versus our two mills and our one remand plant. So we saw that really on the fiber supply is probably the largest driver on that.

Ben Isaacson: Got it. Thank you.

Operator: Your next question comes from the line of Sean Steuart of TD Cowen. Please go ahead.

Sean Steuart: Thanks, good morning, everyone. Ian, a question on your Georgetown sawmill, and I guess your broader sawmill network in Eastern Georgia, how important is IP's fluff pulp mill for the residuals? I guess your Georgetown, South Carolina sawmill and any other sawmills that might've sold chips to that asset?

Ian Fillinger: Yes, early days, Sean, when a pulp mill drops, obviously it does have ripple effects. There's some positives on it also. It does release highly skilled workers, which is always nice to see if you're trying to deal with that. The pulp log also tends to grow into saw logs. And so from a fiber supply, it tends to grow in that area. But the real outlet is where does that chip go to? And we've already landed a supply agreement with another competitor mill in that region. And so I would say immaterial impact at this point, but we'll continue to monitor that. I think that the rationalization that we took in Georgia and South Carolina along the coast with Meldrim and Somerville does put Georgetown in a more solid position than having three mills along the coast and getting down to one. So I think that was a good move for us. And -- but we are paying attention to the recent announcement there with the pulp mill in Georgetown. But at this point, no material impact.

Sean Steuart: Thanks a lot. Question on the U.S. election fallout. Ian, any internal views are from your legal counsel on the potential if Trump proceeds with a blanket import tax of 10% to 20%, is the internal view that lumber would be exempted from that given the ongoing countervailing anti-dumping duties that are already being paid. Do you guys have a view on potential fallout from his wins?

Ian Fillinger: Yes, early days Sean, as you know, and there's all kinds of opinions, whether it was Harris or Trump as the President, I would say, probably that Q2 next year would be maybe a better time for us to give you a view of that. Right now, we're focused in on, what we've got. I would say that the platform we have, Sean, being in all regions, including Washington and Oregon and in the South and then across Canada, with a footprint. We're pretty diversified on pluses and minuses. And when you look at impacts of whether it's tariffs or future duties, in August next year the diversity that we have, not just by geography, but by product line, we're taking a view that generally it could be positive for us relative to some of these tariffs that are in place today and coming in the future. Just given A, where we're located and B, the type of products that we produce are a little bit different from what we see some of our other competitors doing.

Sean Steuart: That's great detail. Much appreciated. That's all I have.

Ian Fillinger: Great. Thanks, Sean.

Operator: Thank you. [Operator Instructions]. For your final question, we have Nikolai Goroupitch, CIBC Capital Markets. Please go ahead.

Nikolai Goroupitch: I hope you're doing well. My question here is sort of given the recent capacity rationalization and your current capital plans for '25 can you provide an idea of what level of lumber production you're targeting in next year?

Ian Fillinger: I don't have it right in front of me yet. But I mean, we've been, four plus somewhere around there, a billion board feet. So I would say it's somewhere that four or five.

Rick Pozzebon: I was just jumping in. Hi, Nikolai, this is Rick speaking. They'll likely be around four billion board feet just given where we're seeing lumber prices. But that'll be determined based on ultimately the markets at that time. And they're strong will be in that four billion board feet range if their lumber prices are weaker, could be less or similar to what we're seeing this quarter.

Ian Fillinger: Yes, if you kind of look at what we've been doing, it's been in a curtailed environment for the last couple of years. Can we throttle up or down around that four? Absolutely.

Nikolai Goroupitch: Okay, great. Thanks very much. And could you provide any more color on sort of the pace of monetization of the BC coastal operations and what you're expecting there? Any more detail there?

Ian Fillinger: Definitely, I can take that. We're seeing roughly $55 million of net proceeds over the course of this quarter and through 2025. In terms of the split, it'll be about roughly $5 million of net proceeds this quarter and then the remainder being $50 million throughout 2025.

Nikolai Goroupitch: Great, thanks. And my last one here, hoping you could provide some more detail on the R&R side. You mentioned things could be improving. Are you seeing anything incremental this quarter that gives you confidence?

Ian Fillinger: Yes, thanks, Nikolai. To me, it comes down to the interest rates and what we'll see from that side. I mean, we know that there's a significant rate lock in place that's preventing a lot of the existing home sales from happening. People are just staying. And we know that when existing homes are prepared for sale or have been sold, that there's usually an R&R component to that that follows. And so as that side of the market picks back up, we think that there'll be some unlocking of demand there. And then, of course, there's just simply the interest rates on what people, if they're going take on debt at all for an improvement project. There's just the interest rate that's associated with that. I think that it's important to highlight, we haven't been producing enough homes to satisfy the household formation rates. And so the deficit of homes continues to rise and the average age of the home continues to get older. I think we're at 44 years now. And so as that number continues to rise, so does the need of repair and remodeling and maintenance of those homes. And so, we think that those factors all blended together. And if we get ourselves into an environment where we're all expecting a decrease in interest rates, we could see some interesting increases on repair and remodel demand.

Rick Pozzebon: Yes, just to jump in, Nikolai, I mean, the U.S. South, if you think about that region just for a bit, I mean, that's heavy to the R&R market. And one of the opening questions was around curtailment. If you think about what's happened in the U.S. South from a curtailment perspective, it's around 40% of the permanent or indefinite curtailments in the industry have come from that region. I think that's going to put us north of a billion, maybe a billion three of production that's come out. Definitely will provide some tension in the R&R market with that volume out. It kind of point you in that direction also.

Nikolai Goroupitch: Okay, great. Thank you very much. That's very helpful.

Operator: Thank you very much. There are no further questions at this time. I'd now like to turn the call back over to Ian for final closing remarks. Please go ahead.

Ian Fillinger: Okay, thank you, operator, and thanks everybody for your time and interest this morning, and feel free to reach out to Rick, Bart, or myself anytime. Thank you. Have a great day.

Operator: Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.