West Fraser Timber Co. Ltd Common stock

Good morning ladies and gentlemen and welcome to the West Fraser Q4 2022 results conference call. At this time all lines are in listen only mode. Following the presentation we will conduct a question and answer session. Instructions will be provided at that time for you to queue up for a question. If anyone has any difficulties hearing the conference, please press star zero for operator assistance at any time. During this conference call, West Fraser's representatives will be making certain statements about West Fraser's future financial and operational performance, business outlook, and capital plans. These statements may constitute forward-looking information, or forward-looking statements within the meaning of Canadian and United States securities laws. Such statements involve certain risks, uncertainties, and assumptions which may cause West Fraser's actual or future results and performance to be materially different from those expressed or implied in these statements. Additional information about these risk factors and assumptions is included both in the accompanying webcast presentation and in our 2022 annual MD&A and annual information forum, which can be accessed on Wes Fraser's website or through CDAR for Canadian investors and EDGAR for United States investors. I would like to remind everyone that this call is being recorded today, Wednesday, the 15th of February, 2023. I would now like to turn the conference over to Ray Farris, President and Chief Executive Officer. Please go ahead, Mr. Farris.

Thank you, Michelle. Good morning, and thank you, everyone, for joining our fourth quarter 2022 earnings call. Joining me today are Chris Vrostic, our Senior Vice President, Chief Financial Officer, Chris McKeever, our Senior Vice President, Marketing and Corporate Development, and Matt Tobin, our Vice President of Sales and Marketing, and several other members of our executive team. I'm going to begin with a brief overview of West Fraser's fourth quarter and full year 2022 financial results, and then I'll pass the call over to Chris Vorostek for some additional comments. West Fraser generated $70 million of adjusted EBITDA in the fourth quarter of 2022, as we experienced weakening demand across several key products. particularly in North America, where rising mortgage rates impacted near-term housing affordability. This weakness was particularly evident in our lumber segment and was partially offset by positive EBITDA contributions from our engineered wood products and our pulp business. Overall, however, 2022 is a strong year of performance for West Fraser. as we generated $20.86 of diluted earnings per share and over $3.2 billion of adjusted EBITDA, representing a 33% margin. In the fourth quarter, we invested nearly $150 million back into the business through capital expenditures. We repurchased $117 million of shares and returned $25 million to shareholders through dividends. For the full year, We repurchased nearly 2 billion of shares through our normal course issuer bids, a substantial issuer bid, and now the company has now repurchased approximately 39.7 million common shares since early 2021, representing about 73% of the shares issued with the Norboard acquisition. We have been disciplined in our approach to capital allocation and have preserved capital In the event that we have a down market like the one we are currently experiencing, it is this discipline that has positioned us to be able to execute on our strategy and invest and improve our assets through all market conditions. As we look ahead, our balance sheet remains strong and continues to offer significant financial flexibility, which is a key priority of our capital allocation strategy. Without short or review, I'll turn the call over to Chris. for some additional detail.

Thanks, Ray, and good morning, everyone, and thanks for joining. And a reminder that we report in U.S. dollars, and all my references are to U.S. dollar amounts, unless otherwise indicated. Our North America EWP segment generated $109 million of adjusted EBITDA, down from $215 million in the prior quarter. This result benefited from a $14 million insurance recovery that partially offset repair costs and loss margins charged to earnings in previous quarters, stemming from unscheduled downtime at one of our OSB mills. The lumber segment posted negative $77 million of adjusted EBITDA, declining from $160 million in the third quarter, a period that included an $81 million recovery of export duties associated with AR3. Note that these fourth quarter lumber segment results include a $39 million inventory write-down, which we recognized as lumber prices reached a near-term low at the end of the year. Also of note, in the absence of these Q4 inventory write-downs, our BC business in the aggregate was profitable in the quarter due to our downstream integration in MDF, plywood, and pulp. The pulp and paper segment generated $15 million of adjusted EBITDA in the fourth quarter versus $29 million in the prior quarter. while in Europe adjusted EBITDA rose to $30 million in the fourth quarter from $24 million in the third quarter. Price declines were the largest driver for the sequential EBITDA declines across our North American lumber and engineered wood products businesses. We generated $147 million in cash from operations for the quarter, though our cash balance net of debt, while still at a very healthy level, decreased modestly quarter over quarter from $625 million from $789 million as we allocated $142 million to share repurchases and dividend payments and spent $149 million on capital expenditures in the quarter. In terms of our outlook for 2023, we are providing initial operational guidance for the year as detailed in our earnings release and on slide 6, including ranges for key product shipments and our planned capital expenditures. With that overview, I'll now pass the call back to Ray.

Thanks, Chris. Although too difficult or difficult to predict, we believe that in the near term, we expect that the business will continue to experience challenges ranging from the risk of resurgence in inflationary cost pressures, ongoing and continued labor constraints, and the potential for dampened product demand owing to overhang of housing affordability on the housing and wood building products industries. Inflationary cost pressures have been moderating across much of our supply chain for raw materials such as energy, resins, and chemicals, and we expect this trend to continue throughout 2023. On the demand front, There may be early indications that demand conditions are improving as the cadence and magnitude of mortgage rate increases has eased somewhat, which is particularly relevant for the use of our products in new home construction. With respect to market fundamentals, I'd like to share with you slide seven, which highlights the challenges that the North American lumber industry has faced and continues to face in terms of supply. We have now been through a period in which four of the last six years have experienced strong lumber demand and pricing. Yet the growth in North American lumber supply has been effectively zero. We often speak about the many constraints that the lumber industry faces when it comes to adding capacity. And the first and foremost of these is fiber availability. As this slide indicates, While the U.S. South remains a critical area of supply growth within North America and a key region for Wes Fraser's growth strategy, shrinking fiber baskets in other regions, most notably British Columbia, have offset U.S. South growth in recent years. In our view, these fiber and supply challenges will persist for the foreseeable future. And as such, we remain optimistic about our U.S. growth strategy with respect to long-term prospects for our lumber business. Nonetheless, we remain very attuned to the potential risks that West Fraser faces and will continually and diligently manage our operations accordingly to meet available customer demand with our geographic and product diverse operations. Executing on our core strategy to be low cost, to reinvest in our operations, and to continue to prioritize financial discipline, which we believe will allow us to be well positioned to capitalize on the more favorable supply and demand fundamentals we expect to see for our products over the medium and longer term. Importantly, our team has a proven track record of managing through market cycles, and we will continue to focus on being a low-cost producer. of wood building products. With another fiscal year behind us, I would like to provide an update on our track record on return of capital employed. Moving to slide eight. Our strong performance in 2022 underpinned by adjusted EBITDA and operating earnings of $3.21 billion and $2.56 billion respectively drove a ROCI of 28% for the year. Notably, including 2022, the company's ROKI has now exceeded 15% in six of the last seven years and has averaged more than 25% since 2016. Attractive returns like these are a reflection of our continued attention to managing costs and expanding margins through product mix improvements and as well as our product and geographic diversification. We believe these strong returns and performance are underpinned by the continued gains we have made in our environmental, social, and governance efforts in 2022, such as committing to the greenhouse gas emissions reduction targets through the Science-Based Targets Initiative, which demonstrates our commitment to sustainability leadership and contribution to global climate action. I am pleased to see that much of the work of our team is done to improve these attributes and disclosures is now being more broadly recognized externally. Slide nine highlights several of the organizations that provide ESG ratings of West Fraser. And in many cases, we are not only scoring well, but showing improving trends. Although we have more work to do, we believe this will continue to be an improving and very good story to tell as we move forward. On slide 10, The culmination of supportive industry fundamentals and our execution performance are reflected in the attractive returns generated for West Fraser shareholders over a number of cycles, as you can see. With a total annualized return in excess of 12% since 2006, which includes share price appreciation and reinvested dividends, we are proud of what the West Fraser team has been able to accomplish. In closing, While demand markets were challenging in the fourth quarter and there are near-term uncertainties across our business, we remain confident in the foundation we have built and our strong momentum. And as I alluded to earlier, we've been through industry cycles before and believe we have the talent, assets, and financial flexibility to handle both the challenges and opportunities ahead. whether they be in the near, medium, or long term. We remain optimistic about the continued growth and demand for the types of sustainable and renewable wood products that West Fraser manufactures and for which the company is known. Finally, I want to share that my friend and colleague, Chris McKeever, West Fraser Senior Vice President of Marketing and Corporate Development, will be retiring at the end of March. Chris has had a long and distinguished career with the company, spanning more than 32 years, during which he has made significant contributions to West Fraser. Chris, you will be missed, and we look forward to hearing and congratulate you and hearing about your adventures as you move forward. With that, we'll turn the call back to the operator for questions.

Thank you, sir. Ladies and gentlemen, we will now begin the question and answer session. If you would like to ask a question, please press star followed by the number one on your telephone keypad. If your question has been answered and you would like to withdraw from the queue, please press star followed by the number two. And if you are using a speakerphone, please lift the handset before entering any keys. Your first question will come from Ketan Mentora of BMO Capital Markets. Please go ahead.

Thank you and good morning. Rhea, I was just curious how you are thinking about timing of restart of the Allendale OSB mill. The release talked about potential restart in Q2. So if you can just help us understand Would that still depend on where demand is, or are you planning to go ahead with a restart in Q2? Thank you.

Good morning, Ketan, and thanks for the question. Our purchase of that asset and our reinvestment strategy is a long-term consideration. You know, our restart that we expect in, I think, at the end of Q2 2023 really has only been pushed out by supply chain issues. We're quite pleased with how the team has performed and how the capital and preparing for a restart has gone. So, you know, we remain committed to that long-term investment strategy. And look, as we think about how we run our business, it will always be about finding the way to make sure that we meet available customer demand in the best way possible. But I think it's important to note that Allendale, we see, is an important part of that portfolio mix As we ramp that up over the next two or three years, we see it as being one of our best positions and lowest cost assets that we'll have.

And so we remain committed to that at this time. Got it. That's helpful.

And can you provide a little bit of perspective in terms of what you are seeing with current demand It seems like most home builders are pointing to a better than expected start to January. I'm not asking for specific January numbers, but in terms of what you are hearing from your customers as we start 2023.

We've got Chris McKeever on the line. Mr. McKeever, would you like to take a shot at that?

Sure. Thanks, Ray. Good morning, Ketan. I think what we're hearing is very similar to what you're hearing. Firstly, our business both on panels and lumber is stronger than we probably thought it was going to be right now. It's held up very well. We're beginning to hear that the builders are actually seeing things better than what they expected. Our takeaway on the lumber side and panels we see customers keeping their inventories pretty lean, and they'll come in and buy, and then they'll back away a bit. So I think it's very early to make any sort of forecasts as to what's going to happen in the balance of the year, but I would say demand is better than we expected at this time.

Okay, now that's helpful perspective. Thank you, and I'll jump back in the queue.

Your next question comes from Hamir Patel. of CIBC Capital Markets. Please go ahead.

Good morning. I just want to follow up on that question about the demand. Chris McKeever, with respect to that R&R channel, do you expect demand there to be up this year or are you building in a decline because you've seen a wide range of forecasts for R&R activity for 23?

Good morning, Hamir. I think it's a pretty difficult question for us. We really don't put out forecasts as far as where we think the markets are going to go. I would say that it's holding up better than we expected and they continue to tell us that they expect business to continue much along what we've seen in January. Beyond that, I really don't know.

Fair enough.

Thank you. I'd just add a comment there, Mayor. I think that's very true. I think everyone's visibility is about the same. I think it's so early in the year to get a sense of where interest rates are going to go and whether it's a recession, shallow, deeper recession, I think that will be the primary driver of short-term demand for our building products. It's going to be interesting to see how it plays out.

Fair enough. Ray, we've seen some of your peers announce some permanent mill closures in BC for both lumber and pulp. How much more lumber and pulp capacity do you think needs to come out of the province and How do you think Wes Fraser fits into that?

Wes Fraser Well, thanks, Yamir. I have no idea what others will do. I think over the last number of years, we've continually shaped and positioned our assets to the available timber supply. We will continue to do that. And, you know, much of this depends on policy decisions that continue to, the impact of those policy decisions sometimes is still yet unknown what impact that will have on going forward. And as those decisions will adjust our capacity as necessary, whether that's up or down. I kind of leave it at that. It's really a provincial decision on how much fiber they want to make available to the industry.

Right. Okay. Thanks, Ray. Just the last question I had was on mass timber. I know the company always gives a slide there about the long-term potential there. I noticed the 2035 demand base case there has been reduced from, I think it was about 5 billion last quarter to just over a billion this quarter. So can you speak to maybe what made you reset your expectations there?

Great question here. I'm supposed to know the answer, but I don't think I do. So, you know, it's probably an SLV or softwood lumber board data. But what I would say is we're big fans of the mass timber market. We've been big supporters of helping develop that market through participation in industry associations like the Softwood Lumber Board and others. We think, and I think you're seeing that, we see that continuing to grow in certain segments of the building sector and whether it whether it's $2 billion or $5 billion, I don't know, but I do think it's another indication of more around the growing demand for wood products. I think just those sustainable environmental carbon capturing attributes of wood products, I think mass timber is just one example. People are familiar with it, but that's how it I'm not sure exactly what the final number will be.

Fair enough. Thanks, Ray. That's all I had. I'll get back to you.

Your next question will come from Sean Stewart at TD Securities. Please go ahead.

Thanks. Good morning, guys. A couple of in-the-weeds questions. The carbon allowance gain on sales in Europe you had this quarter, can you give us some context on that item and any element of recurring gains going forward related to that?

Hi, Sean. Thanks for that. Yeah, I would say probably not be thinking about that as a recurring item here. Confluence of events over the last couple of years in terms of energy consumption and energy pricing in the markets there. enabled us to generate a bit of a windfall on that in 2022. But I wouldn't suggest you should be baking that into long-term run rates in terms of earnings potential for us or the generation of those credits over the longer term.

Okay. Thanks for that, Chris. And with respect to the Caribou curtailment you guys outlined a few weeks ago, Any context you can give us on the expected earnings impact in 2023?

Not at this time.

Okay. The rest of my questions have been answered. Thanks very much, guys.

Ladies and gentlemen, as a reminder, if you would like to ask a question, please press star 1 at this time. Your next question will come from Paul Quinn at RBC Capital Markets. Please go ahead.

Yeah, thanks. Morning, guys. I guess I'll put McKeever on the hot seat here just because he's fading off into the sunset. But, Chris, maybe you can sort of describe what you're seeing in terms of M&A opportunities for West Razor. Is that increased with the drop in lumber prices, or is it sort of status quo?

Good morning, Paul. Firstly, we don't really answer any questions around M&A, but what I would say is that we're always in the market looking at opportunities in North America and in Europe and other spots. And I would say that it's sort of business as usual as we sort of go along, but there's nothing specific.

Have you guys noticed any more equipment available in the industry? It's guys that are looking to build either sawmills or OSB mills. Have they backed away given the difficult conditions presently?

I can take that one, Paul, and good morning. Generally, I would say we're seeing some signs of... you know, supply chain getting better. But it's more looking down the road than, you know, right in front of us today. So with respect to equipment availability, you know, specifically to, say, capital, that still remains challenged. Again, as you look out, say, a number of months from now, it looks like it's improving. But in the short term, it's – It's still quite constrained. And I don't have any visibility to what others may or may not have done around orders. But for us, it's business as usual. We're moving ahead with everything that we have planned and trying to move up what we can and adjusting to whatever the constraint might be on a particular item.

All right, then just lastly, you've got on slide seven sort of your expectation in the 2023 outlook on fiber costs, near-term log costs expected to moderate in the U.S. South. Just wondering, you know, can you quantify moderation? Is that a 5%, 10% drop? And does that change the outlook for the closure at Perry?

Yeah. So generally, you know, I would say in North America, most of our regions, we've seen some moderation in fiber costs, and including the US South, and including the area around Perry. But look, we made that decision not as a, you know, with, you know, with a view to, you know, the next year, the next six months to a year sort of thing. So I can't give it to you in a percent because, A, because, you know, the court is not done and so things can change. And, you know, it varies widely between regions, quite frankly, very region specific. And, you know, to a great extent, the Perry decision was very region specific.

All right, that's all I had. Best of luck, guys. Thanks. Thank you, Paul. Thanks, Paul.

At this time, there are no further questions, so I would turn the conference back to Mr. Ray Ferris for any closing remarks.

Well, look, thanks, everyone, for taking the time out of your schedule to join us on our call, and we'll look forward to talking to you next quarter. Thank you. Thank you, operator. Thanks.

Ladies and gentlemen, this does conclude your conference call for this morning. We would like to thank you all for participating and ask you to please disconnect your