Earnings Transcript for STLJF - Q3 Fiscal Year 2023
Operator:
Good morning and thank you for standing by. Welcome to the Stella-Jones Third Quarter 2023 Earnings Call. [Operator Instructions] I would like to remind everyone that this conference call is being recorded on Tuesday, November 7, 2023. Please note that comments made on today’s call may contain forward-looking information, and this information, by its nature, is subject to risks and uncertainties. Actual results may differ materially from the views expressed today. For further information on these risks and uncertainties, please consult the company’s relevant filings on SEDAR. These documents are also available in the Investor Relations section of Stella Jones website at www.stellajones.com. We have prepared a corresponding presentation, which we encourage you to follow along with during this call. I’ll now pass the call over to Eric Vachon, President and Chief Executive Officer of Stella-Jones. Eric?
Eric Vachon:
Thank you, Shirley. Good morning, everyone and thank you for joining us today. With me on today’s call is Silvana Travaglini, Senior Vice President and Chief Financial Officer of Stella-Jones. Earlier this morning, we issued a press release reporting our results for the third quarter of 2023. Along with our MD&A, it can be found in the Investor Relations section of our website at www.stella-jones.com as well as on SEDAR. As a reminder, all figures expressed on today’s call are in Canadian dollars unless otherwise stated. During the third quarter, we made notable progress in our growth trajectory, generating strong sales growth and a record increase in profitability. Our results speak to the continued positive momentum and performance of our infrastructure-related businesses as well as our residential lumber business, which delivered results in line with our expectations. While our organic growth so far has been supported by favorable pricing dynamics, 2023 has also been a year where we focused on building additional capacity and inventory levels to take on more demand from our customers and meet their long-term needs for our infrastructure products. We are doing this with ongoing investments and acquisitions to support our growth while ensuring predictable and consistent customer service. Let’s take a closer look at the performance of our key product categories during the quarter. Building on the momentum it has generated since the start of the year, our utility pole product category continued its strong performance during the quarter driven by favorable pricing dynamics and a continued increase in production volumes. In Q3, we benefited from added bandwidth stemming from a number of capital projects, which I’d like to provide some color on. Since January, we concluded 3 utility pool-related acquisitions, adding pole treating facilities and pollpilling operations to our expansive North American network as well as securing fiber supply. The latest of these acquisitions was Baldwins 2 treating facilities in Bay Minette, Alabama and Wiggins, Mississippi. We’ve also made important inroads in bolstering our assets on the procurement front, with the addition of pulp-peeling facilities to optimize efficiencies and enable us to deliver on growing demand. Our own new peeling facility in the rest, Mississippi became operational in June, and our Enfield North Carolina facility is set to be commissioned earlier next year, both focused on augmenting our sudden yellow pine offering. Additionally, we are targeting the commissioning of another peeling facility in Cabins, British Columbia in 2024, which will serve to further support our Western species operations. These facilities, along with our new treating operations acquired from Baldwin are presented by the yellow dots on the map you see on the current slide. Significant investments have been also made to upsize treating equipment at a number of our core trading facilities through 2023, further building out our production volume capacity. These projects and initiatives showcase our proactive and thoughtful planning and execution in building a robust procurement and manufacturing platform, which in turn will allow us to further reap the benefits of favorable conditions and enhance our leadership position. The added capacity provided by these capital projects in Q3 and throughout the year allowed us to grow our inventories to the levels needed to deliver on long-term sales commitments to our utility customers and secure agreements with new customers. We don’t take it for granted that our teams can quickly ramp up existing capacity or commission facilities on time and on budget because sometimes not everything goes as planned. To add in, a portion of our Silver Springs manufacturing operations in Nevada was damaged by fire during the quarter. Fortunately, there were no injuries following the incident and work is already underway to repair the damaged equipment. We have been able to adjust production and to continue serving our customers with the help of our extensive network while repairs are ongoing, a testament to our agility in responding to unforeseen situations. Moving on to railway ties. This product category experienced a strong quarter with increased sales, which speaks to our continuing ability to pass along price increases to our customers. The limited supply of untreated tie inventories in 2022 has impacted sales volumes so far in 2023. Having replenished our untreated tie inventory by June of this year, we now find ourselves standing at an optimal level of dry inventory, which sets us up to meet customer demand as we move into 2024. However, in 2023, volumes are expected to remain lower, which will result in a year-over-year low single-digit sales growth in line with our guidance versus the mid-single-digit growth realized so far this year. Sales volumes for residential lumber were higher this quarter compared to the same quarter last year, which is indicative of our proven ability to supply consistently to big-box retailers. Even considering the decrease in lumber pricing year-over-year, our residential lumber product category is performing within management’s expectation and in line with our stated guidance. Let me now take a moment to discuss ESG Stella-Jones. During the quarter, we published our fifth annual environmental, social and governance report, which is now available for download on our website. For the first time in our company’s history, we have formalized our ESG strategy titled Connecting our Sustainable Future. This strategy is the product of extensive listening and data collection across our organization and has measurable targets across 6 key strategic topics. These topics include climate change, greenhouse gas emissions as well as health and safety, an area where we have made great strides so far in 2023, namely through initiatives such as our safety matters because you matter campaign. Before I turn it over to Silvana to provide a more detailed overview of our third quarter financial results, let me provide a brief update on our efforts to phase out the wood preservative pent-up through our network. Pentachlorophenol or [indiscernible] is an oil board preservative, which is being discontinued across North America. In the United States, our phase-out of Penta is largely complete, which places us well ahead of the 2027 end date required by the United States Environmental Protection Agency. In Canada, operations were required to cease use of Penta by October 4 of this year. Our team has gone to great lengths, leveraging our network and internal resources to adjust our Canadian offerings to ensure continuity of supply for our utility customers. We have been at the forefront of the industry with respect to this transition and are working collaboratively with utilities to tailor solutions to meet their requirements. I am very proud of our team for their tireless efforts towards addressing this phase out the culmination of many years of hard work. With that, I will now hand it over to Silvana.
Silvana Travaglini:
Thank you, Eric, and good morning, everyone. Our strong start to 2023 has carried into Q3, which featured another quarter of solid organic sales growth, a record increase in EBITDA and EBITDA margin and a notable contribution from acquisitions. Sales in the third quarter reached $949 million, up from $842 million last year. This increase was driven by organic sales growth of our infrastructure-related businesses of 17%. The sales also benefited from the acquisition of Texas Electric Cooperatives in November last year, the more recent Mardin acquisition as well as the positive effect of currency conversion. Pricing gains for utility poles, railway type and industrial products as well as volume gains for residential lumber largely explained the increase in sales, which was mitigated in part by a decrease in residential lumber pricing. Utility pulp sales grew to $438 million in Q3 compared to $331 million for the same period in 2022. The increase was largely explained by organic sales growth of 21% and the contribution from the acquisition mentioned moments ago. The organic growth was driven by higher pricing as sales volumes remained relatively flat compared to last year. As Eric mentioned, in the quarter, we focused on increasing capacity and building inventory to support long-term sales contracts, which currently represent over 70% of our utility pole business. Sales of railway ties increased by $31 million to $230 million compared to $199 million last year. Organically, sales were up $26 million or 13%, all attributable to favorable pricing. Volumes were relatively unchanged in Q3 compared to the same quarter last year. The lower non-Class 1 volumes stemming from the limited supply of untreated tie inventories in 2022 were largely offset by higher Class 1 volumes, mainly attributable to the timing of shipments. Class 1 volumes in 2023 are expected to be unchanged versus 2022. Residential lumber sales of $202 million decreased $24 million compared to the same period last year. While sales volumes were higher in the third quarter of this year compared to the same quarter last year, the volume gains were not enough to offset the lower pricing attributable to the decrease in the market price of lumber. The overall decrease in sales was, however, in line with expectations as we continue to project $600 million to $650 million of annual sales for residential lumber. Turning now to profitability. EBITDA increased to $193 million in the third quarter, up from $119 million in the same period last year. This increase was largely explained by the margin expansion of our infrastructure-related businesses, particularly utility poles as well as the EBITDA contribution of our acquisitions. As a percentage of sales, EBITDA also benefited from the higher proportion of utility pole sales this quarter, representing 46% of total sales compared to 39% in Q3 last year. EBITDA margin expanded to 20.3% or record improvement this quarter from 14.1% in Q3 of last year. Year-to-date, our EBITDA margin stood at 18.5%. We now expect the EBITDA margin for 2023 to be closer to the 18% mark. Looking forward into 2024, the uncertain effects of external factors such as the higher cost of capital and increased supply from the utility pole industry may impact our current level of EBITDA margin. With this considered, we remain confident in achieving the 16% margin objective stated in our guidance. Net income in the third quarter was $110 million, up 69% compared to last year, while earnings per share was up 79% to $1.91 per share. Earnings per share also benefited from the ongoing share repurchase program. During the quarter, we used the cash generated from operations of $130 million to maintain and upgrade our assets, expand and secure production capacity, which included acquiring the utility pole manufacturing business of Baldwin as well as return capital to shareholders. During the 9 months ended September 30, we returned $145 million to shareholders through dividends of $40 million and share repurchases of $105 million. Since the beginning of the current normal course issuer bid program, the company has repurchased 2.2 million shares at an average price of $57 per share. Yesterday, the TSX accepted our notice of intention to proceed with the new NCIB program, which we announced in a dedicated press release earlier today. Pursuant to this NCIB, Stella-Jones is authorized to repurchase up to 2.5 million common shares, representing approximately 5% of the public flow. These repurchases will take place over a 12-month period ending in November of next year. At quarter end, we had $271 million available under our credit facilities and maintained a solid financial position with a net debt-to-EBITDA ratio of 2.4x. Our strong balance sheet and ability to finance our business plans, meet working capital requirements and maintain and upgrade our assets to consistent cash flow generation and available credit facilities reflect our disciplined financial strategy. Yesterday, our Board of Directors announced a dividend of $0.23 per common share payable on December 21, 2023, to shareholders of record at the close of business on December 4. In summary, our strong operating and financial performance positions us well to achieve our long-term growth plans while returning near-term value to our shareholders. I will now turn the call back to Eric for his closing remarks.
Eric Vachon:
Thank you, Silvana. Much of our efforts this year has been focused on meeting demand as well as preparing for long-term growth. It’s been thus far a year of building and setting up the business for the future. And we’ve done that through a combination of capital investments, acquisition and ongoing organic growth. 24 months ago, we had the foresight to target acquisitions that provided us with opportunities for enhanced pool procurement, drying and treating while investing in capital projects to build upon an already strong foundation, which has proven to our customers our will and capacity to meet their requirements. We believe these strategic decisions helped enable us to capitalize on additional opportunities going forward. As we approach the end of the year, we are confident in the sustained growth of the company and are staying focused on our 3-year financial objectives. Stella-Jones has built its reputation on servicing its customers. They recognize the quality of our work and our ability to adjust to their needs, which is anchored by our strong procurement, manufacturing and distribution network. We take pride in knowing that our customers can rely on us for quality of products, certainty of supply and timely service and that we play a key role in the development and maintenance of a robust North American infrastructure landscape. With 9 months of operations behind us in 2023, I’m very pleased with our performance, both as a business and collectively as a team. I often say that our people are our most valuable resources. And so I wish to thank our more than 2,800 employees across North America, who consistently bring their very best for Stella-Jones and its customers. Through our products, we are building a strong, resilient future together, and I look forward to us maintaining our position as a leader in our space. With that, I will open up the lines for questions.
Operator:
Thank you, Eric. [Operator Instruction] Our first question is from James McGarragle, RBC Capital Markets. Please go ahead.
James McGarragle:
Hey, good morning and congrats on the very strong results.
Eric Vachon:
Thank you, James.
James McGarragle:
I have a question on margins. And I know you guided to the 18% this year. You pointed to some uncertainty looking ahead due to the potential cost inflation. But anything to call out specifically in the quarter? I mean, looking ahead, it seems like mix should continue to shift toward poles, that pricing will remain solid. So that said, I’m just trying to understand the puts and takes and to what extent these margin levels could potentially be sustainable?
Eric Vachon:
Right. So for the quarter, obviously, as Silvana pointed out, we did have a very strong mix towards utility bold, which helped the average EBITDA margin profile. Going forward, in our prepared remarks, we did speak about uncertainties in the future. What is the cost of capital increasing for our customers, which might change their behaviors or slow down the growth rate at which they are doing their maintenance. But also as an industry in my different travels, I’ve seen more availability of products from suppliers and to competition. So capacity has been brought online, which would in turn potentially bring some pricing pressures for the spot market business. Now we do highlight that 70% of our business is under long-term contracts for utility poles, which sort of shields us to some extent. But it doesn’t show us on the 30% piece where we could see some pricing pressures into the future, so still very comfortable with us achieving the 16%, very, very confident with that going forward. But I also want to sort of provide some insight as we see it today, and we will be obviously providing updates on that in future calls as we see the next quarters be fulfilled.
James McGarragle:
Thank you. And just one more for me. So on the railway business, your competitor last week, they were talking about some significant issues in their Thai business due to cost inflation. And your results today makes it seem like you’re dealing with these cost inflation issues much more effectively. But with your guidance for sales of low single, sorry, does that include any of the pass-through of cost inflation going forward? And what type of upside could that represent if you’re able to more effectively pass on some of that relatively tight cost inflation going forward?
Eric Vachon:
So as we see year-to-date, after 9 months, our growth is 8%, which is driven by pricing. So obviously, cost of untreated ties in the last 18 months have increased at the sawmill level. So we’ve been successfully passing through those cost increases throughout the year. But our guidance to the low single digits is more volume related. Our Class 1 programs for this year remain consistent with year-over-year, but we’ve seen most of our Class 1 customers complete their maintenance at the end of September. So our Q4 volumes for railway ties would be lower, I guess, than what we’ve seen previously or update after 9 months, thus bringing us to the single-digit growth, the lower single-digit growth, I mean.
James McGarragle:
I appreciate it. I will tune the line over. Thank you.
Eric Vachon:
Thank you, James.
Operator:
Thank you. Our following question is from Benoit Poirier, Desjardins Securities. Please go ahead.
Benoit Poirier:
Yes. Thank you. Good morning, Silvana. Good morning, Eric. Congrats for the strong achievement. Just to come back on the railway ties, could you provide some color on 2024 following the RTA conference, but also related to the 1 million additional ties that will go out for sale to non-Class 1 customers. I’m just wondering whether we could expect double-digit growth for railway ties in 2024 on the back of this additional capacity.
Eric Vachon:
So, thank you for the question, Benoit. Obviously, our inventory position today positions us favorably to address the spot market. So, we have been very focused this year on servicing our long-term agreements with our Class 1 customers. But you are completely right that the gain that we have seen in sales are driven by pricing, offset by volumes as we didn’t have sufficient dry inventory. So, going forward into next year, we are definitely well positioned and we are addressing that market. And we are working diligently at that. So, I would expect next year, if I look at a crystal ball, could our pricing be relatively stable for the year, assuming that tie prices don’t change too much. I think that would be a fair assumption. But I do expect our volumes to increase next year with regards to the non-Class 1 business.
Benoit Poirier:
Okay. Perfect. And just for the utility pole, it looks like the demand environment still remains pretty strong with Hydro-Québec that wants to double electricity production and add basically 5,000 kilometers of transmission line by 2035. Do you have a sense of the wood pole requirement for this particular opportunity?
Eric Vachon:
So, we are a supplier to Hydro-Québec. They have not quantified that for us as of today. But you are right that in their announcement last week, which was $150 billion to $180 billion of investment, if I recall, about $45 billion to $50 billion is dedicated to the reliability of the network. So, I do think that there will be significant investment as we see with many other utilities in North America, but if we are speaking in this particular case about Hydro-Québec, I do think we are well positioned to benefit from any increased demand for maintenance or expansion of the grid network.
Benoit Poirier:
Okay. And last one for me. Could you provide an update on where you are related to the $115 million growth CapEx and whether additional CapEx is needed to grow above the mid-single digit growth that you are implying in 2025, especially in light of the strong market environment for utility folks?
Eric Vachon:
Right. I will ask Silvana to comment on that part, Benoit. Thank you.
Silvana Travaglini:
So far Benoit, the $115 million as of the end of September, we have approximately $80 million of that get done as we had noted in when we had presented our full year guidance that most of the $115 million would be front loaded. So, there is about $30 million left between Q4 and next year to complete that program. So, pretty much in line with that. And yes, as we had noted that this CapEx program is really to meet the demand that we have currently in our radar. So, any additional infrastructure-related demand would go above that. So, we would need additional capacity in order to be able to service significantly additional demand from infrastructure money.
Benoit Poirier:
Okay. Thank you very much for the time.
Eric Vachon:
Thank you, Benoit.
Operator:
Thank you. Our following question is from Hamir Patel, CIBC Capital Markets. Please go ahead.
Hamir Patel:
We will start on the poles side, could you scale how much additional pole volumes you will have available next year just based on the capacity initiatives that you have underway?
Eric Vachon:
Yes. So, I will try to try to figure out because we typically measure everything in cubes, right, so which does it necessarily…
Hamir Patel:
I guess I meant just like the volume percentage increase.
Eric Vachon:
Yes. So, call it, 10% to 15% additional capacity would be available for next year.
Hamir Patel:
Okay. And Eric, on the res lumber side, your volumes were actually up in the quarter. I think some of your peers were down. Do you think you can continue driving volume growth in lumber in ‘24? Just wondering what you are hearing from your retailer partners.
Eric Vachon:
Right. So, your question is spot on. I mean we debriefed earlier this week with several of our customers on the year and their expectation for next year. There is positive momentum from our customers at the very least to be able to hold these volume gains into next year with potentially slight upside. Obviously, that their views on it, but I would be very pleased if we would be able to hold the current volumes into next year. And I think that’s quite feasible. And that would still bring us within our guidance in our 3-year objectives.
Hamir Patel:
Great. Thanks. I will turn over.
Eric Vachon:
Thank you, Hamir.
Operator:
Thank you. Our following question is from Michael Tupholme, TD Securities. Please go ahead.
Michael Tupholme:
Thank you. Good morning.
Eric Vachon:
Good morning Michael.
Michael Tupholme:
Good morning Eric. Can you talk about when you will start to lap the pricing increases that have been benefiting your results and continue to do so this quarter in both utility pools and railway ties? So, when you will be facing essentially tougher year-over-year comps and fully lap the benefits you were seeing this quarter?
Eric Vachon:
So, I would say at the end of this quarter, we will have lapped this, I guess 20%-some organic growth, which is driven by pricing. And going into next year, then we would be looking at what would be more normal increases compared to the historical trends. But yes, I think this year is – at the end of quarter was where we would be lapping it, but still foresee some pricing uptick, although small going into the future.
Michael Tupholme:
Sorry. And just to be clear, when you say end of the quarter, you are talking about the end of Q3, it’s now fully lapped and we can see it come down in Q4, or are you still have those benefits in Q4?
Eric Vachon:
I am sorry, Q4. Q4. Sorry, the end of the year, December 31st we will be pretty much lapped on this 20% organic growth piece.
Michael Tupholme:
Okay. And that’s on the poles side. What about on the railway ties side, where again, in the quarter, I think you were up 13% on organic basis oil pricing?
Eric Vachon:
Yes, oil pricing. I think we are pretty much there at this point. At the end of Q3, at the end of September, I think we have done all the catch-up that is related to the increased cost of railway ties. We have been seeing railway tie prices being relatively stable now for the last five months, six months, I would say. So, we are pretty much done with those increases.
Michael Tupholme:
Okay. And then just going back to the utility poles because if I think about your comment about having largely lapped those pricing gains by – or pricing increases by the end of the year, maybe still some additional ones next year, but it doesn’t sound like to the same extent, but then your production capacity is up, which should allow some volume growth. Thinking back to your multiyear guidance or objectives, you have talked about, I think 20% CAGR in utility poles over the first couple of years of your 3-year plan. So, I guess we should see a significant improvement or a step up in your volume gains next year in poles and then just a lower level of pricing gains.
Eric Vachon:
Yes. I agree with that statement. We will see volume gains into next year. And I guess back to my capital cost comment earlier, can that sort of that grow slip into early ‘25, we will have to see. So, I guess that’s part of the reason why we added a bit of that color. Obviously, our customers are living interest rate increases like everybody else in – on the planet, I guess. But all to say, there is still strong momentum for maintenance to be done and quite a positive sentiment with our customers that there is a lot of work to get done.
Michael Tupholme:
Do you have a sense for – again, a lot of the gains recently in utility poles have been coming on the pricing side and you will have the increased production capacity to better capitalize on volume gains next year, give a sense for what the growth rate in terms of volumes is within the broader utility pool market given the replacement cycle, given some of the other drivers related to energy transition and things of that nature? Just again, what overall kind of volume growth is looking like in the industry at the moment?
Eric Vachon:
Very hard to answer the question, Mike. There is no industry association that sort of collects all the data to give us some insight. I guess we really see what our customers are sharing with us. Obviously, there are some indications through different announcements. I believe last week, the U.S. Federal Government announced three major transmission projects. So, those are all kinds of infrastructure money getting spent. Obviously, it will take a time to plan out and execute on it. But it’s really hard to say where that growth percentage is for the total industry.
Michael Tupholme:
Okay. Fair enough. So, a question – next question related to your comments around the strong margins this year, but still comfortable with 16% as we get into next year in 2025. On the basis of some of these uncertainties you called out. I think you specifically mentioned besides the higher rate environment, which could impact capital spending decisions, you talked about the possibility of spot market pricing pressures on the 30% of your business that’s not under long-term contracts. Have you seen any evidence to suggest there is pressure already in spot market pricing in utility pools, or is this more just a potential risk as we look forward?
Eric Vachon:
So, no evidence as of today of the pressures. So, it is a bit, I guess an assumption or as sort of looking into the future. But talking with suppliers and understanding what our competition is doing, the industry is investing. There is obviously strong demand throughout the industry. And as we have been doing for the last 24 months, investing and acquiring, wanting to see those opportunities for the long-term business, we are seeing fiber being made available on the market. So, I guess my suspicion is at one point, our competition or treated than the industry will want to move their inventory, and we might see some pricing pressures. But for now, no evidence of that.
Michael Tupholme:
Okay. That’s helpful. And then there was an announcement yesterday by President Biden, about $16.4 billion of new funding for 25 passenger rail projects on Amtrak’s northeast corridor. I know a lot of your business has historically been obviously on the railway ties side dominated by Class 1 activity. But can you comment on the extent to which you see that as a fit opportunity for Stella-Jones, and if that could result in incremental sales volumes within your ties business relative to what you might have been able to do absent that announcement?
Eric Vachon:
Yes. Our exposure to Amtrak is very small. It’s less than 1% of our sales. They buy a variety of products. So, I don’t want to see that the Amtrak piece, the railway, I don’t see that as being a big impact for us.
Michael Tupholme:
Okay. That’s helpful. Alright. Thank you.
Eric Vachon:
Thank you, Michael.
Operator:
We have no further questions in the queue. Thank you.
Eric Vachon:
Well, thank you, Shirley, and thank you everyone for joining us today. We look forward to updating you on our fourth quarter and year-end results in the New Year.
Operator:
Ladies and gentlemen, this concludes today’s call. Thank you for participating. You may now disconnect your lines.