Earnings Transcript for IFSPF - Q4 Fiscal Year 2023

Operator: Good morning. My name is Jenny, and I will be your conference operator today. At this time, I would like to welcome everyone to the Interfor Quarterly 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: 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, Senior Vice President of Sales & Marketing. I'll start off by providing a brief recap of our quarter, provide some comments on the market outlook and several strategic initiatives before passing the call to Rick and Bart. Turning to our quarter, our adjusted EBITDA was a loss of $51.4 million during a very challenging quarter that was impacted by weak pricing. To be clear, current pricing is generally below industry breakeven levels, which is simply not sustainable for any extended period of time. With that being said, we have a more positive outlook for the year ahead than we did a year ago. We feel housing demand has been relatively strong in the face of rising interest rates. Rates appear to have peaked and builder sentiment is improving and R&R remains steady. On the supply side, inventories at both the producer and supply chain level are low and operating on a just-in-time basis for shipments. And continued production curtailments are anticipated from the industry, especially if current prices continue. Despite our positive outlook, we intend to manage and continue to manage the business and our balance sheet conservatively. We have reduced our 2024 capital spending from our preliminary guidance set in November to $90 million. We think this is a disciplined move. With our internal CapEx team, we're able to quickly make adjustments, providing us with flexibility and control. At the same time, we continue to make good progress on the monetization of our BC Coast tenures. These and other notable cash inflows, such as tax refunds that Rick will discuss, are expect to help bolster our financial position over the next year, even without any meaningful operating earnings. 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 Q4 MD&A. From a high level perspective, Interfor’s Q4 financial results reflect further weakening of lumber markets as supply continued to outweigh demand. This weakening is evidenced by the framing lumber composite price dropping 12% quarter-over-quarter. Lumber prices are currently at an unsustainable level, as a significant portion of the North American lumber industry is likely generating negative EBITDA margins. I'll leave it to Bart to discuss the supply demand fundamentals in some detail, but speaking from a macroeconomic perspective, there are encouraging signs that haven't yet translated into increased demand and higher lumber prices. Notably, the trend of moderating inflation across the North American economy now has central banks contemplating interest rate cuts in the near-term. We've seen this reflected in significantly lower 30 year U.S. mortgage rates over the past three months. Lower mortgage rates will benefit housing affordability, not only in terms of reduced interest costs, but also in terms of supporting an increased supply of existing homes for sale. Turning to Q4 earnings, Interfor generated an adjusted EBITDA loss of $51 million on total revenue of $786 million. Compared to the previous quarter, revenue benefited from a slight 4% increase in lumber shipments, which was more than offset by a 9% decline in the average realized lumber price. On the cost side, reported production costs on the unit of lumber basis were essentially flat quarter-over-quarter. However, Q4 costs included a $14 million increase in the provision against inventories, whereas the prior quarter included a $3 million reduction. The net loss of $169 million in Q4 reflects several nonrecurring charges, including an $85 million provision to facilitate the ongoing monetization of our coastal BC operations and a $56 million charge to impair certain operating assets in the Pacific Northwest, which was driven by higher log costs and ongoing market weakness. In terms of cash flows, there was a $22 million outflow from operating activities in the quarter as negative operating earnings were partially offset by the collection of tax refunds totaling $30 million. Combined with capital expenditures of $40 million in the quarter, our net debt to invested capital leverage ratio ended the quarter at 32.8%. Looking ahead regarding capital allocation, we're taking a conservative approach, in light of the current lumber market weakness. Our primary focus over the course of 2024 will be on managing our balance sheet conservatively. In line with this focus, we have revised our expected capital expenditures for 2024 down to $90 million from $140 million previously budgeted. Additionally, we expect the collection of tax refunds totaling $68 million and the ongoing monetization of our coastal BC forest tenures over the course of 2024 to benefit our financial leverage. To wrap up, Interfor’s Q4 results reflect significant lumber market weakness, which we view as unsustainable for the industry as a whole. Fortunately, Interfor has a high quality, diversified portfolio of operations and is well positioned to successfully navigate through this period of supply and demand adjusting towards a sustainable balance. That concludes my remarks. I'll now turn the call over to Bart.

Bart Bender: Thanks, Rick. Turning to our lumber markets, the outlook remains uncertain for the short-term and encouraging for the medium to long-term. Rick covered the macroeconomic factors which bode well for lumber markets. Certainly, we feel better today about the economic situation than we did at this point in the last four or five quarters. Confidence and optimism exists with our customers and those ultimately using our products. When you look at the end use sectors of our business, really it comes down to new home construction, repair and remodel, industrial and non-residential sectors have shown steady lumber demand, whereas new home construction has been variable. Encouragingly, housing starts are showing an improvement trend, especially in single-family construction. We are optimistic that the spring building season will bring greater demand for lumber. However, the exact timing of this is less certain. All last year, the spring building season was less evident until later in the spring or early in the summer. At this time, the volume of European imports were more significant, which is not as relevant this year as those volumes have tapered off significantly. Overall, end market inventories remain balanced on the low end of the spectrum at today's level of consumption. Looking at the supply side of the equation, we're expecting more capacity to be idled, some of it permanently. Medium to long-term, the dynamics around housing age and inventory, household formation rates, household balance sheets will support robust markets for lumber. I'll stop there and pass it back to you, Ian.

Ian Fillinger: Okay, thanks, Bart. So, operator, we're ready to take any questions.

Operator: Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Your first question is from Ketan Mamtora from BMO Capital Markets. Please ask your question.

Ketan Mamtora: Thank you. Good morning, Ian, Rick and Bart. Maybe first question, you talked about pricing is at unsustainable level and that there's more curtailments that would be needed. I'm curious, can you talk about sort of your approach to production given market conditions right now, in terms of sort of how are you managing the rate at which you all are producing?

Ian Fillinger: Yes. I’ll – good morning, Ketan. So, Ian here. So, Ketan, we look regionally and mill specific on how each mill and region is operating. We have a scorecard that we look at every week that tracks P&L performance. And then if it's below cash costs, there's another threshold where you kind of look at what the shutdown costs would be, and then there's a lot of other factors that go into that regionally with things like full employment in the U.S. and risks to employees or contractors. So we have a pretty robust scorecard that we review as an executive team weekly. And we've been doing this for years and years, so it's nothing new for us, but very disciplined approach to run, don't run type situations.

Ketan Mamtora: Understood. And so, Ian, at this point, kind of all of the mills running across your different regions, are any of the mills running on reduced shifts? Or just can you give any sort of additional color?

Ian Fillinger: Yes, I would say, Ketan, that like our competitors, we're not different to the pricing environment and demand environment. So we've been running through the Christmas period, through January, fairly steady at most or all of our operations. Having said that, we're in a period where if there's a weakness or extended pricing environment like we have now, we'll look at those every week. And if it's a material event, we will for sure be putting that out. But like we said in our opening comments, most of the industry is having a pretty tough time. And if you even look at some of the decisions, the U.S. South isn't even safe in these situations. And there's been some competitors that have made some very prudent moves. And I think that's just a reminder that not all U.S. South mills are of the same quality. And so I think regarding our 13 mills down there, we're very confident in them. As you know, you've been on our tours down there, pretty solid assets. So I think my point here is, whether it's in British Columbia or Eastern Canada, Pacific Northwest or the South, it's the situation that the industry has been in 2023 hasn't been great, as you well know. Now, going forward, if you asked us a year ago how we feel about the outlook, we feel better today than we did a year ago, for sure.

Ketan Mamtora: Got it. No, that's helpful context, Ian. And then one for Bart. Bart, can you talk a little bit about what you are seeing on the repair and remodeling side in terms of kind of pull through and demand? We had existing sort of home sale data if you see they are at sort of multi year lows, what are you kind of seeing in your demand and what is your expectation for the year?

Bart Bender: Yes. Okay. So on the repair and remodel side, I mean, obviously we've got a fairly significant view through the business that we're doing with various customers that are targeting that segment of the marketplace. I'd almost look at it in two lights. One is the box stores. And what we're seeing from those folks has been incredibly steady business, frankly. Our programs have maintained their pace – maintained their pace throughout the year. And I can tell you so far this year, they've been the same. The other side of it is the customer base that's more focused on perhaps some of the seasonal product lines like treated wood and those types of things that would flow through the repair and remodel side of the equation. And I would say that typically you'll see a slowdown in late Q4 and early Q1 and sort of a buildup in what ends up being a fairly robust spring season. And what we're seeing so far that I would just say is typical and that we're expecting those markets to behave very similar to what they did last year. So really, when you think of all the end use sectors, repair and remodel is kind of the good news story. That's the one that's been very steady for us. It's the new home construction side that you see some variability.

Rick Pozzebon: Ketan, maybe I'll just kind of to build on Bart's comments. I mean, one metric that we look at in the R&R market is what's the status of the household balance sheets? And that tends to give us an indication in the R&R market. So very supportive of that end market, given the strong balance sheets that exist today, so I think in summary, our expectations should be fairly consistent, Bart, with 2023, absent of some major event happening.

Ketan Mamtora: Yes. Okay, that's helpful color. I'll jump back in the queue. Good luck.

Rick Pozzebon: Thank you.

Ian Fillinger: Thank you, Ketan.

Operator: Thank you. Your next question is from Matthew McKellar from RBC Capital Markets. Please ask your question.

Matthew McKellar: Hi, good morning. Thanks for taking my questions. First, I'd like to ask if you could just talk through how you'd expect fiber costs to trend by operating region over the next couple of quarters. And with that, whether you're expecting any significant impacts from fiber salvage activity as we progress through the year?

Ian Fillinger: Yes, so I'll take a kick at it. Rick, jump in if you think I've missed anything. But thanks for the questions, Matt. So if we kind of go by region, we're seeing in the short-term, some stumpage relief in British Columbia, which is very good. And as you know, we have three mills in BC. That's our total exposure in the Southern part of British Columbia that are very, very competitive. So that's great there. The next region, Pacific Northwest, we don't see any major swings up or down, so I think pretty steady. Eastern Canada, particularly in Quebec, we and others are enjoying a lower log cost at this point, as a result of the fire salvage going on. Our expectation, Matt, is that's probably run its course sometime in the summertime, so just keep that in mind. And in the U.S. South, we're very pleased with the log cost trend and our competitive benchmarking against the average log costs in those regions. So that would pretty much cover, I guess, the puts and takes through our platforms across North America.

Matthew McKellar: Great. Thanks for that. Maybe next, are you able to provide any color on what the moving parts are between the preliminary $140 million CapEx budget and the new revised $90 million budget? And maybe what your flexibility is like to bring some of those projects back if the outlook improves? I know you called out some ongoing cost inflation there, so just wanted to get your thoughts.

Rick Pozzebon: Yes, for sure, Matt. You were on our tour a year or so ago down in the South also, so I'll get a little specific. Our major focus on our capital is to complete our Thomaston project in Georgia. That's the largest project we'll have done in the history of Interfor. And the major phase that we're working on now should be commissioning shortly, going through testing and some startup over the next few months. So we're very excited to kind of get that one behind us. The other projects, the strategic projects that we developed in 2018 for a couple of the other operations down there. We have seen labor costs go up as far as contractors go. Equipment costs have gone up. Lumber markets have toned down. And so we have the engineering largely done on all of those, which is the first thing. And so we have those shelf ready. But I would say that we have a target range in internally on our balance sheet, and we're slightly above that now. And we've decided to be disciplined and make sure that we're not doing projects for the sake of doing projects and focusing more on the quality of the project and the quantity of the project. And I think it's important to Matt, to really also point out on our CapEx. Interfor generally over the last handful of years has outspent on a per unit basis. So production unit, fbm, more than our core competitors. So we've been accelerating capital for several years now. So I don't see any strategic compromise by throttling this back a bit and being prudent and given the market conditions and also finishing off our largest project. We have, like others, experienced longer start-ups and longer to get to pro forma than some of the other regions. However, our internal CapEx team, which you're aware of, we have, this allows us to put more people on these startups than rushing off to do another big projects. So our expectations are very high for our Thomaston operation this year.

Matthew McKellar: Great. Thanks for all the detail there. One last one for me, and this might be for Bart. I know you talked about European volumes being pretty steady into North America at a fairly manageable level. Would you expect any change there with some of the shipping issues in the Red Sea, in particular, just increased cost of shipping European volumes into Asia? Do you expect that to be a factor for the North American market or not particularly material?

Bart Bender: Well, I think it's always when you consider the options that the Europeans have, and where they can ship their wood. I think what's happening in any of the other more traditional markets is relevant. And so yes, the freight has gone up significantly for their Asian business. And so when they compare markets and where they want to ship their products to, they'll – that will be a consideration. I will say, though, that 2023, I mean we saw a pretty significant volume of the imports come in early in the year. I think this was just kind of clearing out the supply chain issues that they had late in 2022. And so we're not seeing that so far this year and don't expect to see it this year. And so we believe that once things kind of shake out and the volumes become more steady, more typical of what they are today, the delta between 2023 and 2024 is going to be more like in the range of say, the volumes that might have been imported in 2020 and 2021. And so that's about a 20% decline year-over-year when you do those comparisons. And that's kind of what we expect going forward.

Matthew McKellar: Great. Thanks for the help. That's all for me. I'll turn it back.

Ian Fillinger: Thanks, Matt.

Operator: Your next question is from Hamir Patel from CIBC Capital Markets. Please ask your question.

Hamir Patel: Hi, good morning. Ian, could you – could you speak to what impact you think the proposed BC Land Act changes may have on existing tenures for the industry? And also if you see that potentially delaying your coastal tenure sale process.

Ian Fillinger: Yes, for sure, good question, Hamir. I know it's been in the news, particularly in B.C. for the last period of time. But in many respects, the proposed changes are aligned with legislation that's already in practice. And sometimes that doesn't really get, as you know, the news headlines. So if enacted, we think that there won't be really any impact on the cutting permit approval process as we've been working under this framework for a number of years. So I would kind of start off with that. Our operational plans, permits are really been operating under this sort of environment for a number of years. I would think that the Minister of Forest has obviously got to take consideration of public interest in mind with First Nations and shared decision-making. But the industry has been working with First Nations and building relationships for many years and a lot of efforts gone into building those between government us, others that operate in the space. So we don't see any negative drawback on that. I know for citizens and foreshores and all the folks that probably haven't had the exposure or the partnerships that we have as an industry might be a bit more sensitive to it, but our foresters have gone through this very diligently and have really provided us with comfort that it's business as usual for us.

Hamir Patel: Great. Thanks Ian. And just the last question I had for Bart. Bart, can you give us a sense as to where you think inventories are for lumber across the channel?

Bart Bender: Yes. I would say often think of them as balanced, but I think you have to frame that up in the context of what that means and I would say, based on sort of our historical levels, we see them in the sort of the lower end range. And I think what's kind of happened here is that supply has been available, so our customers have gotten pretty comfortable with the lead times that are in place today. And so based on the consumption that they see, they're able to drive down their working capital and inventories because they've always gotten restocked fairly quickly. And so I think that that's where the comment of being balanced comes in, where it where the comment of being on the low end comes is when that's not the case. And so a little uptick in demand. Perhaps some supply-side dynamics that might come into the equation. That's when those inventories will become a little bit more critical, I think, in the channel.

Hamir Patel: Great. Thanks. Thanks, Bart. That's all I had. I'll turn it over.

Operator: Thank you. [Operator Instructions] Your next question is from Sean Steuart from TD Securities. Please ask your question.

Sean Steuart: Thanks. Good morning. A couple of questions. Ian, I wanted to follow up on the CapEx budget reduction and you're positioning it as capital cost inflation, which is understandable and not hitting your return hurdles. Is there any line of sight on this inflation peaking at this point? When I look at some broader indices for steel or other, I guess, major component pieces, it would look like that started to crest. Are you getting any sense that you're going to see potential relief on those cost inputs for capital projects?

Ian Fillinger: I hope so, Sean. I mean I think a lot of the pricing that our suppliers do as they often look at what the last transaction price was on a mill and then kind of value their equipment based on that. So there were some high points on transactions that have happened over the last couple of years that have given equipment suppliers confidence to raise prices in addition to their material costs going up. So I would think that, that's going to get tapered. The labor costs are not going down. And so when you hire a mechanical or structural steel contractor or civil contractors come in, those prices are not coming down. They’re often driven by labor and per hour rates. So I don't see a lot of that. Yes, I would say though, Sean, like I've pointed out we have outspent on our capital program against a couple of our core competitors over the last several years. So it's a natural tapering down that we'll see in Interfor going forward. But also the balance sheet at Interfor, when we set internal targets and we have one on that, and we'll make decisions in addition to whether it's completing a project, that is a factor also. So it's – I would say it's a combination of both, and we don't take it lightly, but we definitely want to drive down our net debt to invested capital and we'll pull the levers to do that. And once we get it back into our target range, we have a lot of flexibility to deploy capital in a more ways than we have today. So, we want to get there, and part of that is looking at the projects, making sure the paybacks and the start-up curves and expectations are realistic, and we always look back at our last project and kind of go. Okay, well, let's use that as the start-up for the next one. And so I feel really good about what we're doing, and I think it's timing-wise great. And the benefit is we're also taking action on the balance sheet because of this. So I'll leave it at that.

Sean Steuart: Okay. That's useful context. Thanks. Second question on the remaining Coastal tenure sales. The remaining 1.4 million cubic meters of AAC. Any reason that valuation on those potential sales would differ materially from what you were able to secure for the November sale. I appreciate it was a smaller tenure. But any differences in B.C.'s mix yields for that chunk versus what you're going to be targeting selling over the next couple of years?

Rick Pozzebon: Good morning, Sean. It's Rick speaking. On that we don't expect any material change in terms of the valuation, there's several transactions we're working on at the moment, and we're comfortable with where those valuations are turning out. And our expectation is over the next 12 to 24 months, we'll realize the full benefit of those tenure sales in line with the recent valuations you've seen.

Sean Steuart: Thanks for that, Rick. That's all I have. Thanks, guys.

Rick Pozzebon: Thanks, Sean.

Ian Fillinger: Thanks.

Operator: Thank you. Your next question is from Ben Isaacson from Scotiabank. Please ask your question.

Ben Isaacson: Morning and thank you and Good to be on the call. Your mentioned that were below industry breakeven levels [Technical Difficulty]. How much more capacity cuts do we need to see? And in your experience, do you think that [Technical Difficulty] response you're seeing is normal what you…

Ian Fillinger: Ben, we got about half of that. You were cutting out.

Ben Isaacson: So I'll just kind of sorry, can you hear me?

Ian Fillinger: I'll read back what I heard, which was what kind of rationalization or curtailments are we seeing or expecting? When we go through the data from 2023, we see somewhere in the neighborhood of north of 2 billion board feet that actually was curtailed during 2023, which is not insignificant. And I think so far in the first five or six weeks of 2024 it's somewhere in the neighborhood of 800 million board feet. And we applaud those decisions. We think that more will come out sooner than later. And we expect that we'll be looking at that closely also over the next month or so. And if prices can continue to show no appreciation, then I would expect capacity be curtailed throughout the industry. And at this point, we don't have anything material to discuss on that. But if we get to that point then we'll definitely let our folks know, and the Street. But we're not at that we don't have anything today, but I would caution that saying that I think there's more to come.

Ben Isaacson: That's helpful. I'm sorry, if you couldn't hear me before. You had previously talked about lumber capacity, like your growth plan of about 7 Bbf by 2027. Is that timing still on the table? And if so, how does the scaling back on CapEx impact the cadence of that capacity ramp? And maybe as part of that, with the move to $90 million on CapEx, how much of that is growth versus sustaining?

Ian Fillinger: Yes. So our 7 billion by 2027 is really an internal target that we were shooting for. I would say that those targets move a little bit here and there, but we are a growth company, and we've been the most aggressive on growth over the last few years in the lumber space. We tend to see ourselves as being able to pick up assets that are mid-quartile and spending time on them to make them top quartile. So that strategy hasn't changed. I would say that consolidation and the number of potential deals that are on the table today versus where they were two years ago is slim to none. And so I think we just have to be responsive to what's out there, making sure that we're disciplined in our growth, but we're not holding ourselves. There's nothing in our performance reviews that say we're going to get to 7 billion board feet. It's more can we pick up an asset, own it for a period of time and then get the return and the margin out of it. So I would taper down the 7 billion for sure. And just probably look at it as we'll be opportunistic, but there's nothing on the table today. And as far as our CapEx growth goes, our major project really is the Thomaston, which is I forget how many – how much the capacity is, but it's essentially doubling that one mill. But Rick, did you have anything?

Rick Pozzebon: Yes. Ben, its Rick Pozzebon. Just in terms of the $90 million, it breaks down to about $50 million for sustaining CapEx and $40 million for growth CapEx. And as Ian mentioned, the $40 million of growth CapEx is primarily weighted to our Thomaston project to get that across the finish [ph] line.

Ben Isaacson: That’s great. Thanks so much, guys.

Rick Pozzebon: Thanks, Ben.

Operator: Thank you. There are no further questions at this time. I will now hand the call back to Mr. Fillinger for the closing remarks.

Ian Fillinger: Okay. Just to wrap up, Thanks, everybody for your interest in our company, and feel free to reach out to myself, Rick, or Bart at any time. And operator, this concludes our call.

Operator: Thank you. Ladies and gentlemen, the conference has now ended. Thank you all for joining. You may all disconnect.