West Fraser Timber Co. Ltd Common stock

Good morning, ladies and gentlemen. Welcome to West Fraser Q1 2023 Results Conference Call. Please note that all lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you'd like to ask a question during this time, simply press star, then a number 1 on your telephone keypad. If you'd like to withdraw your question, please press the star followed by 2. 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 future results and performance to be materially different from those expressed or implied in these statements. Additional information about about these risk factors and assumptions is included both in the Accompanying webcast presentation in our 2022 annual MD&A in Annual Information form, which can be accessed on Wes Fraser's websites, Arthur Seder for Canadian investors, and Edgar for United States investors. Thank you, Mr. Chris Varastic. You may begin your conference.

Thank you, Julie. Good morning, everyone, and thank you for joining our first quarter 2023 earnings call. I'm Chris Verostik, Chief Financial Officer of West Fraser, and joining me today are Ray Ferris, our President and CEO, and Matt Tobin, our Vice President of Sales and Marketing, and other members of the executive team. I'll begin with a brief overview of West Fraser's Q1 2023 financial results, and then pass the call to Ray, who will give an update on the business, as well as provide a few concluding remarks before we transition the call to Q&A. Our comments today will be brief as we recently provided a company update at last week's Annual General Meeting. As a reminder, we report in U.S. dollars and all references today will be to U.S. dollar amounts unless otherwise indicated. West Fraser generated $58 million of adjusted EBITDA in the first quarter. largely comparable to the $70 million of adjusted EBITDA generated in the fourth quarter, which included a one-time $7 million benefit of carbon credits from our EU business, as well as a $14 million insurance recovery from our North American engineered wood business. Our North American EWP segment generated $31 million of adjusted EBITDA, down from $109 million in the prior quarter. This Q1 result included a $15 million inventory write-down, while the prior quarter had benefited from the $14 million insurance recovery just noted. The lumber segment had zero adjusted EBITDA, improving from negative 77 million in the prior quarter. You recall that prior quarter included a $39 million inventory write-down, recognized as lumber prices reached a near-term low at the end of last year. The pulp and paper segment generated $7 million of adjusted EBITDA in the first quarter versus $15 million in the prior quarter, while in Europe, adjusted EBITDA was $20 million in the first quarter down from $30 million in the fourth quarter, a period that had included a one-time $7 million benefit from the sale of carbon credits. Price decreases were the largest driver of the sequential EBITDA declines across our lumber and North American EWP businesses. Cash from operations was a use of $198 million for the quarter, though our cash position remained very healthy. Cash net of debt decreased to $309 million in the first quarter from $625 million last quarter as we paid $25 million of dividends, spent nearly $100 million on capital expenditures, and invested seasonally more than $200 million in our working capital build. In terms of our outlook for 2023, we are reiterating our operational guidance for the year as detailed in our earnings release, including ranges for key product shipments and our planned capital expenditure. Capital allocation is an important part of how we run our business every day at West Fraser. Our capital allocation strategy is a durable, three-pronged approach where we reinvest in the business, maintain financial flexibility that allows us to pursue inorganic and organic strategic growth opportunities, and return excess capital to shareholders. This strategy has served us well over the years, and frankly, we think it is this balanced and prudent approach that has put us in a position of strength today, despite softer market conditions. Let's dig into the specifics for a moment. Since 2016, a period that has seen both up and down cycles, we have generated more than $8.5 billion of cash from operations. Nearly one-third of that cash flow has been invested in the business through capital projects and acquisitive growth. Approximately 10% has been allocated to repay debt and build a cash buffer, and more than 50%, or nearly $4.5 billion, has been returned to shareholders through share buybacks and dividends. Slide 9 provides a snapshot of a few of our key balance sheet and liquidity metrics, further highlighting the success of our patient and balanced approach with capital. Note, West Fraser is rated investment grade by three key ratings agencies. We also continue to have strong liquidity, with combined cash and bank lines approaching $2 billion, and our debt ratios remain well within the bounds of our lending covenants. As we look ahead, West Fraser remains committed to investing in the business, and we have reiterated guidance of $500 to $600 million of capital expenditures in 2023, including an estimated $100 million that we plan to spend on the sawmill modernization in Henderson, Texas. With that overview, I will now pass the call over to Ray.

Thanks, Chris. As mentioned, in Q1 2023, we experienced soft demand, particularly in North America. as the rapid increase in mortgage rates in 2022 continued to have an impact on overall consumption. I will note that as the first quarter unfolded, we did see many of our production costs come down and the trajectory of our demand improve. This demand improvement was particularly true for our U.S. south lumber and OSB segments. which allowed us to return to a more normalized operating environment when compared to the significant production downtime we took in the fourth quarter. In Western Canada, and specifically in BC, where we have an integrated operating strategy, our business decisions can be more complex as we evaluate profitability in the aggregate across our lumber, pulp, plywood, and panels segments. while also trying to balance short-term decisions with the long-term considerations of preserving key aspects of our manufacturing, private procurement, and staff ecosystems. As a result, our overall BC business in the aggregate was profitable in the first quarter due to our downstream integration, as mentioned, with MDF, plywood, and pulp. In terms of our more important longer-term strategy, while the first quarter SPF production was slightly up in Q4, the historic downward trend in our BC production has been . From 2018 through 2022, our West Fraser BC lumber production declined by more than 40%, representing a reduction of nearly 1 billion board feet through that period, reflecting our continued adjustment to available economic fiber and customer demand. With ongoing government policies such as old growth deferrals, species at risk, and other potential further reductions due to policy, we expect annual level cuts to continue to be constrained. We reiterate our optimism about our U.S. growth strategy for the long-term aspects and prospects for our lumber business. With respect to outlook, the wood building products industry may continue to face challenges ranging from further rate hikes by central banks, ongoing labour constraints and the potential for muted product demand due to the apparent constraints that consumers face with regard to housing affordability, at least in the short term. That said, inflationary cost pressures have moderated across much of our supply chain for the raw materials such as energy, resins, chemicals and fibre and we believe this trend will continue through the remainder of 2023. On the demand front, We are seeing some positive signs in the spring building season, much to do with the public home builder commentary that is in the marketplace, and the upward trend in mortgage rates that we experienced much of last year appears to be slowing or easing. Both of these factors are helpful for driving new home construction and conception of our wood building business products. In closing, while near-term uncertainties exist across the industry and our business, we remain confident in the foundation we have built. We have been through these cycles before and it is not by accident that we have the talent, assets, and the financial flexibility to position us well to handle both the challenges and the opportunities that lie ahead. 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 to invest in and improve our assets through all market conditions, as well as be ready to take advantage of growth opportunities if and when they arise. As we look ahead, we will continue to focus on our core strengths of being low cost, remain true to our capital allocation strategy, and we look forward to a future with a growth in demand for the types of sustainable and renewable wood products for which West Fraser is known. With that, I'll turn the call back to the operator and we'll take Q&A. Thank you.

Thank you, ladies and gentlemen. Should you have a question, please press the star followed by the one on your touchtone phone. If you'd like to retry a question, please press the star followed by the two. One moment, please, for your first question. Your first question comes from Keaton Mamtora from BMO. Please go ahead.

Thank you very much. First question. I was hoping you can provide some additional color around timing of Allendale restart. I noticed that the release from last evening still says that it's a potential restart. Are there any indicators that you are watching or we should be watching that could have an impact on when the milk would start up? I know you've talked about potential at the end of Q2.

Well, good morning, Keaton, and thanks for that. So, yeah, our past guidance on that, I think, remains unchanged. You know, we're quite pleased with the progress that the team has made there, and we expect to start, you know, as we talk about it. I think what we've said is really at the end of Q2, early Q3, is kind of we're still on that same time frame.

Understood. Okay, now that's helpful. And then, you know, switching to capital allocation, you know, you guys renewed the NCIB late February, but, you know, haven't repurchased any shares since then. Were there any kind of blackout periods or anything else that I should be, you know, that we should be thinking about in terms of, you know, why you didn't repurchase shares?

Thanks for the question, Caden. You know, look, I think as we think about it, that program lasts for 12 months, and what we're able to uptake in the program this year is somewhat smaller in terms of share count than it's been historically, just because we've reduced the share count so much in the last couple of years. And so we'll look for those opportunities to step in when it makes sense for us. We consider all kinds of things, the macro backdrop, our liquidity, how things are trading. And so we've been quite disciplined, I think, about how we execute that NCIB over the last couple of years and will continue to do so. And the pace of those purchases can ebb and flow during the year. The renewal was the end of February, so really not that much time has passed since we renewed it at the end of February. I think that's about all we would say about that.

Got it. No, that's helpful perspective, Chris. And just final question before I turn it over. The 2023 CapEx, Chris, can you talk a little bit about, you know, what flexibility you have to either dial up or dial down, you know, depending on market conditions? And let's say if, you know, back half of the year turns out to be, you know, kind of softer, what flexibility do you have there? Thank you.

Chris and I are looking at each other, deciding who's going to answer this one. Chris can jump in here. Look, I think we have tremendous flexibility to go up or down based on our balance sheet and the capability of the company. I think we've demonstrated in the past that we can dial that up or dial that down based on what we think is in the best interest of everyone. Look, at this point, you know, we're full steam ahead and pushing to execute on all of our capital program. You know, we see these periods as the opportunity to get ourselves in good position to be ready for a turnaround. So it's, you know, at this point, it's full steam ahead.

I think what we've said consistently over the last couple of years as we've managed the allocation of the capital and those outsized amounts of capital that were generated in the last couple of years is we're going to be patient and thoughtful about this because we know that these market conditions won't last forever. And we don't want to be having to be in there facing a decision that we got to, because of market conditions, we got to turn down high return capital, we'd actually just as soon be doing some of that capital in weak markets and preparing for when things turn around, which they eventually will. I think the spend this year is really a reflection of, you know, we've got a lot of projects that we're quite excited to do, and we've preserved the balance sheet over the last two years, despite, you know, all the share buybacks and the activity that we've done. We've preserved the balance sheet and liquidity that we don't have to cut capex. We can continue to execute our strategy in good markets and in bad.

Got it. Now that's very helpful. Thanks, Ray, Chris. I'll jump back in the queue. Good luck.

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

Good morning. Ray, I was wondering if you have any thoughts as to what's driving the large premium we're seeing for Southern Yellow Pine to SPF?

Well, Hamir, well, good morning. And look, I asked the same question. I can give you what our best guesses are. And I think we'll be smarter as the next quarter unwinds. And so, look, I think it's been a surprise to us to see this gap. I suspect it's a surprise to many. And, you know, Our views are kind of this. I think, you know, look, you know, obviously it's been, you know, it's, you know, we see a bit of a slowdown on demand. And, you know, so the first one that we look at is that, you know, when you look at the robustness of the SYP, we really believe there's been a bit of product substitution because of the supply chain, which is People aren't really interested in taking risk on inventories. The supply chain, at least from our view, appears very lean. And that, you know, SYP is quite prompt and can get to the market very quickly, much more quicker than what we can ship it into the U.S. So we think that's one aspect. Look, I think it's also been a bit of a surprise to see European imports coming in to the level that they have. I guess we'll see how much legs that has. I think I would expect they're surprised with how low SPF has gone. So there's been a bit of an offset seeing European imports come in to the level that they have, at least early in the year. And then the third part is You know, I think there's been, you know, you see a lot of these announcements that come out of British Columbia. And it's a significant volume, both temporary and permanent, that's been announced. And for the stuff that probably wasn't announced. And that's a big number. But the market doesn't see the impact of those curtailments until really now or in the next month or two. and so, you know, that volume of wood had continued to flow, but, you know, as we get into the end of this, well, really over the next month or two, we expect to see that supply constraint and SPF kind of, at least out of Canada, hit the ground. So those are the three things that we look at, and we are starting to see that gap moderate, because it was, I think it was around, probably around 200 at one time, and it's certainly come off to that, but our thoughts would be is that it's a temporary dislocation, and expect over time for that to correct.

Okay, thanks for that, Ray. That's helpful. And then kind of sticking with BC, you know, it seems like there's a lot of pulp downtime coming throughout Western Canada, just given the decline in pulp prices. Do you think that's going to further weigh on costs for the BC industry? I'm just thinking if there's risks that chip prices fall materially here.

Well, Hamir, I think in BC, and I can only speak for us, I mean, we've announced our caribou curtailments. That's primarily as a result of not being able to find enough fiber, quite frankly, somewhat because of all the sawmill curtailments that have occurred. So I see... You know, I see, look, there's obviously a cost impact depending on where people are sourcing fiber and how far you're willing to go to do that. And I think we've made, you know, so we've made decisions around that. But I think it's less about cost. It's more about fiber availability at this point.

Great. Thanks, Ray. And just the last question I had on the OSB side, you know, we're seeing more idle capacity being produced. converted or plans to be converted to siting in coming years. Do you see any opportunities for West Fraser to participate in growth in that siting market?

Well, first of all, so I'd like to kind of just, you know, on the idle capacity, I think we're pretty excited about our Allendale facility and the position that we're in and our startup and where we think we're going to be on the cost curve and our strategy. On other products, I would say we like our product strategy, but look, we're always looking to find ways of growing our customer portfolio. With respect to siding, I can't comment on that. There's companies out there that do a pretty good job at that, but we're pretty comfortable with our strategy to date on OSB.

Fair enough. That's all I had. I'll turn it over. Thanks. Thanks, Yamir.

Your next question comes from Sean Stewart from 2D Securities. Please go ahead.

Thanks. Good morning, everyone. First question on the balance sheet. You touched on the ample liquidity position you have, but you are churning through it through this extended trough. Just wondering, Ray or Chris, if you can speak to your appetite for leverage on the balance sheet, updated thoughts on that front, and how potential M&A ambitions factor into that outlook for the company?

Sure. So I think what we've got to keep in mind about the first quarter, Sean, is that consumption of cash and liquidity in the first quarter is really around the working capital build and the log deck. So probably $200 million of that consumption was around that seasonal inventory build, and that typically unwinds in the second and into the third quarter. So probably some of that or a good portion of it gets clawed back here over the next couple of quarters. So we're pretty comfortable with where we think liquidity is going to end. You know, at the end of the year, even in a fairly conservative outlook for the markets. So, you know, I don't think, you know, the addition of leverage for us is a real pressing issue right now that we got to go out and secure leverage because of tightness of liquidity. You know, in respect of capacity, you know, what I would say is we're carrying the same debt level that we carried prior to Norbord. at $500 million US with a substantially larger company that's more diversified across products and geography. So we operated at that 500 number in a much smaller and much different environment. And so if the right opportunities are out there for us to continue to improve the company, I'm confident we'll find a way to finance those things the right way.

Yeah, I'm not worried about you guys hitting any liquidity wall, but trying to gauge the scale of the M&A opportunity you might look at vis-a-vis your current liquidity position. But I think I have a sense of that. One follow-up question on Allendale. As you think about the restart here in the coming months, and I appreciate this is going to be an extended ramp, but I believe one of the issues with that asset historically and that part of the South is acute labor constraints. How have things trended with respect to that variable and you're comfortable that the staffing is there as needed for an extended ramp up for that asset?

Well, A'shaun, thanks. I think we've got about 85 people on site, something like that right now, and it might be a little bit more than that. That's going actually better than we expected. And I can only take my hat off to the team that's worked extremely hard in the last year to get it to that stage. So, you know, if you'd asked me a year ago, I would have been cautious on my comment. I think, you know, we got a lot more confidence today than we did a year ago. We're seeing that as a much lower risk than we would have a year ago. But look, it remains throughout North America, and particularly the US South, skilled and unskilled labor is constrained, and you need to work hard to ensure that People want to come work for you and stay for the long term. So that remains the challenge. At this point, I wouldn't put Allendale at a different risk than any one of our other U.S. oath assets, quite frankly.

Okay. That's great context. Thanks, Ray. That's all I have.

Your next question comes from Andrew Kosk from Credit Suisse. Please go ahead.

Thanks. Good morning. I guess maybe a broad question, but it comes back to the balance sheet. You've got ample flexibility, you know, despite the market environment we're in right now. And you've mentioned mass timber in the past as really being a driver of wood products demand. To what degree or what extent do you find that market just interesting fundamentally, given the growth potential for you actually being involved in, you know, end market mass timber?

Well, good morning, Andrew. And so, just put it in context. So, West Fraser, you know, with really the softwood lumber board for the last dozen years has played a major role in developing those markets in North America. So, there's been millions of dollars, which we've been a big part of that, going into creating that opportunity. So, we're excited by I think mass timber is one example of the growing wood product demand because of its sustainability and ESG qualities and characteristics. That's it. That's why we talk about it. You look at the growth of mass timber in the last few years and it's exploding. We're very supportive of that industry and we see ourselves as someone that wants to supply those CLT manufacturing business. And whether we do or we don't, it's another area of example of growing demand. So I think that's the context of what I would say is now look, I think depending on who you talk to, how big will mass timber be? Our eyes are still focused on, you know, I think if it's wildly successful, it's going to be somewhere, and this really comes from SLB or FEA or others, but you're looking at somewhere between 3% and 10% of the overall market. So we'll see. It's still early stages, but we just think it's an example of wood products demand that didn't exist 10 years ago when we started thinking about where the future constraints are going to be on supply and demand.

That's helpful. So maybe just for an additional point of clarity. So on the CLT, not saying no to that industry, but it's just sort of early right now. It's stimulative for your core business, but it could be an interesting opportunity longer term should it become bigger.

I think that's fair, Andrew. Sure.

Okay. I appreciate it. That's it for me.

Thank you.

Ladies and gentlemen, as a reminder, should you have a question, please press star 1. Your next question comes from Paul Quinn from RBC Capital Markets. Please go ahead.

Thanks very much. Good morning, guys. Challenging quarter. Just wondering if European OSB prices have stabilized here. What's the expectation for the balance of the year?

Well, what I would say is that energy costs have come down. You know, and so, you know, that's helped kind of offset a little bit around fiber. And, you know, the market everywhere, including Europe, is still choppy, but it's held up better than what we'd expected, Paul. I think that's, you know, as far as, you know... you know, so it's hard to me to forecast, you know, what this is going to look like over the next few quarters, but I would just say when we look backwards in the last couple, it's held up better than we expected, and I guess, you know, we'll see what the balance of the year looks like, but yeah, I think that would be all I can say on that.

Okay, and then I'm looking for a sort of update on softwood lumber. I know the industry was trying to get to that on the agenda when Trudeau sat down with Biden. Where are we at on that and where are we at on the civil trade WTO NAFTA processes as well?

So, look, the WTO and litigation and trade processes, I mean, we need five experts to get in and unpack that. It's just incredibly complicated, but What I would say is, you know, we're disappointed that it really didn't become something that our political leaders really wanted to take forward. You know, and so I'll just leave that at that. There really isn't very much going on around, you know, so really it just continues to go along on really managing through the administrative review process on an annual basis today. And you've seen the disclosure in our statements. That describes it better than I ever will. But from a negotiation standpoint, there's not anything much going on that I'm aware of, and I don't have a strong view that it'll get resolved any time in the near future.

Okay, and then just lastly, just looking at your M&A opportunities here, what do you see in the marketplace right now? Are guys getting more realistic on pricing given the drop in overall commodity prices?

Yeah, thanks, Paul. You know, if I just reflect on the last few periods, I mean, Look, there continues to be opportunities out there to do things. I think our view is we're going to focus on quality and on things that we think we can execute and achieve meaningful synergies and have an opportunity to be in that first and second quartile type thing. You know, I would just say we continue to say no a lot rather than yes. So I would say, you know, I think it has been active and I'd say it remains to be active. I think when it comes to value, look, I think everyone or I say many have the same view on the future that we do and that they're bullish. And I would say expectations probably remain in that position. So I guess if they're stressed assets, that's something different. But I think most people are in pretty good shape and have, you know, I can't speak for others, but I would say experience would say people have a bullish outlook on the mid to longer term.

All righty. Thanks very much. Best of luck. Thank you, Paul.

Presenters, there are no further questions at this time. Please proceed with your closing remarks.

Well, listen, thanks, everyone, for tuning in today, and we'll look forward to talking to you at the end of Q2. Thank you.

Ladies and gentlemen, this concludes your conference call for today. We thank you for joining, and you may now disconnect your lines.