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Conifex Timber Inc.
8/10/2021
This conference has been recorded. Cette conférence est enregistrée.
All participants, thank you for standing by. The conference is ready to begin. Good afternoon, ladies and gentlemen. Welcome to the ConFX Timber Inc. Q2 2021 Results Conference Call. I would now like to turn the meeting over to Mr. Ken Shields. Please go ahead.
Well, thank you, Patrick, and good afternoon, everyone, and welcome to this call covering our first half 2021 results. I'm joined today by Chief Financial Officer Winnie Tang and Operating Head Andrew McClellan. After a few brief opening comments, I will hand the call over to Andrew to review operations and Winnie to review our finances. I then plan to review some important near-term developments that we believe will strengthen competitiveness and future cash flow generation at our McKinsey complex. We'll then respond to any questions that shareholders and analysts may have. But first, let's quickly deal with the housekeeping item. We will be making forward-looking statements and references to non-IFRS measures, and therefore call your attention to the warning statements set out on pages one and two of the MD&A that we released earlier today. For the second quarter, our net earnings were $26.1 million, equivalent to $0.56 per share. EBITDA was $37.8 million. This brought our first half results net earnings up to $30.6 million, or $0.66 a share, and first half EBITDA up to $47.5 million dollars. The sequential improvement in quarterly earnings was driven by dramatically higher lumber prices, improved lumber shipments as rail car supply normalized, and $2.8 million in business interruption insurance proceeds. The settlement we reached with our power generation plant insurer verifies the statements Andrea and I made on previous calls to the effect that neither employers nor gaps in maintenance procedures triggered their curtailment at the power plant. I'll now turn the meeting over to Andrew who will update you on our lumber and power business.
Thank you, Ken, and good afternoon, everyone. First, I wish to reemphasize our number one priority is to protect the health and safety of our employees, their families, and community members. Towards the end of Q2 and so far in Q3, Successfully achieving this objective became more of a challenge due to the heat wave in our home province. The result of wildfires led to harvest retailments triggered some shift cancellations at our sawmill in Q2. We also incurred extra costs trucking lumber to service our customer base when rail car supply was sporadic. We owe a debt of gratitude to our employees who helped us maintain a safe workplace amid COVID pandemic and helped mitigate disruptions in log and rail car supply. We also thank our contractors who made their equipment employees and . On my last two calls, I noted that the combination of heavy snowpack and wet weather last spring extended the spring breakup period and led to log harvesting and delivery shortfalls at mills in the Northern Interior Region of British Columbia. Consequently, our sawmill operated at 83% of capacity in the first half of 2021. Now that our log inventories are being replenished through our active summer logging programs, we plan to extend operating hours at our McKenzie mill later this month. Our MV&A disposes that we are targeting an operating rate of 90% in Q3 and an even higher rate in Q4. As always, any number of unanticipated pandemic or wildfire-related production or shipment disruptions could hold us back and prevent us from achieving these production targets. Our power business performed well in the quarter and continues to meet its production targets going forward. I will now turn the discussion over to CFO Winnie Tang. Thank you very much.
Thank you, Andrew, and good afternoon, everybody. We ended Q2 with cash of $35.8 million and available liquidity of $45.8 million. The $10 million revolving credit facility we arranged late last year remains undrawn. Growth debt at the end of the quarter totaled approximately $62 million, of which $59 million is limited recourse debt related to our over $100 million investment in green powder production. We also have obligations totaling $2.7 million for leased office spaces and mobile equipment. After deducting cash, we ended the second quarter with net debt of $20.1 million and a net debt-to-capitalization ratio of approximately 12%. Our lumber business is in an enviable financial position with nominal debt and significant cash balances. We deposited $7.8 million in duties in the first half of 2021, and we now have U.S. $16.3 million on deposits as potentially refundable. Our capital expenditures totaled just under $3 million in the first half of 2021, and we expect to expend a similar amount in the second half of the year. We also expect to pay minimal cash taxes this year and also into the next year as well. In December 2020, we commenced our normal course issuer bid, entitling us to repurchase and cancel up to 2.94 million shares. In the second quarter, we repurchased and canceled 1.45 million shares. Since inception, we have repurchased and canceled 2.38 million shares at a total cost of $5.5 million. Our average purchase price of $2.31 per share represents a 20% discount to our June 30th book value of $3.21 per share. Subsequent to the quarter end, we amended our credit agreement to allow us to repurchase and cancel up to $9 million of our shares between October 1st, 2021 and September 30th, 2022. For reasons that Ken will discuss, We believe our share trades well below our estimate of fundamental value, and we view the share buybacks as an optimal use of excess cash. I will now turn the meeting back to Ken.
Well, thanks, Andrea and Winnie. Since delivered log costs account for about three-quarters of the cash costs of producing lumber in the interior region of B.C., The competitiveness ranking of any sawmill complex is driven by the procurement costs and quality of the available sawlock supply. We think it makes sense to use the remaining time today to bring you up to date on our fiber supply situation. We've summarized key information about the McKenzie timber supply area in slides 7 and 8 in the deck we distributed. The Chief Forester has indicated that she expects to release and updated harvest level determination. And these are commonly referred to as allowable annual cuts or AAC determinations. But Sequence released a new determination for the McKinsey CSA before the end of 2021. Under the new AAC determinations, we believe we will have ample access to better quality soil. Here's why. First, let's discuss trends in log quality. As indicated in slide seven, the chief forester presently requires operators in McKenzie to source the majority of their cell lock requirements from dead and damaged pine stands. Last year, the ministry disclosed that 60% of the dead pine in the timber inventory in the McKenzie TSA had lost commercial value and was no longer suitable for lumber production. With this disclosure, it is evident that the shelf life of the remaining beetle damaged stands in the McKenzie TSA has expired. This explains why we expect to be able to access a higher quality greener log diet in 2022 and beyond. A greener log diet provides us opportunities to materially improve lumber recovery. Here, of course, we have fewer defects in the logs and more of each log is available as finished lumber. It also allows us to reduce unit cash conversion costs because we have fewer production jam-ups in our saw lines and our planing and finishing lines. And probably most important of all, it allows us to boost our lumber grade out turns, which leads to much higher average lumber selling price realizations. In this latter area, with a green log diet, we believe we can move about 10% of the output of the mill from low-grade lumber, which sells for something like a discount of $100 per 1,000 board feet below construction-grade lumber prices, we think we can move about 10% into a premium grade, which sells at about a $100 premium. So you can see that the effect of a greener log diet is for something like $20 U.S. or, say, $20 Canadian after duty, And with 200 million plus annual lumber capacity, that's a swing in cash flow generation of over $4 million a year. So this is why we're excited about this. And we believe that with the predetermination of the harvest level and mix that we will migrate to a lower position on the global softwood lumber industry cost curve. Let me talk a couple of minutes about log availability. Based on our review of the future AACs in the interior region of D.C. in general and in McKenzie in particular, we believe that the McKenzie TSA will likely contribute at least 6% of the total harvest in the interior region of D.C. Since Can-4 closed its McKenzie mill in 2019, we operate the one remaining sawmill complex in the McKenzie TSA. At capacity, our mill will consume about 2% of the Interior BC AAC. If the Can-4 mill restarts, at capacity it could consume about 2.5% of the Interior BC AAC. So, given that the McKenzie PSA is expected to account for about 6% of the total fiber in the interior of these seeds that consume only 4.5% of the fiber, it's apparent that surplus saw logs are available to us in McKenzie. And this explains the notes that we put at the bottom of slide six, which makes the statement that we have one of the highest degrees of timber self-sufficiency of any sawmill operator in British Columbia. So in anticipation of having clinical supplies of better quality saw logs, we've got three comprehensive studies that are underway. The first study examines the scope and scale of the potential modernization and expansion of our McKenzie Sawmill site. We believe we have a solid opportunity to boost lumber production capacity by about 25%, reduce cash conversion costs, and further improve lumber recovery, grade out turns, and sales realizations. Our objective is to identify a plan that enables us to sustain positive cash flow when lumber prices are at cyclical lows, and a plan that produces attractive returns on investment, even under conservative lumber price assumptions. The second study we have underway focuses on the diameter, class, quality, characteristics, and moisture content of the solid supply we expect to access over the next decade and possibly longer. This crucial information will help us specify machine center and dry kiln attributes and performance requirements for any modernization project. A third study that we have underway focuses on the potential to build and operate a log merchandising facility at our McKenzie site to process our internal requirements, but also to optimize the potential proceeds from the sale of surplus saw logs harvested in McKenzie and sold to fiber deficit sawmillers in Prince George. We expect to finalize these three studies shortly after the new AAC determination is announced. We also expect that any projects we may approve in the future will be phased in over time and funded through a combination of our cash balances, potential export duty rebates or refunds, and drawdowns under our existing credit facility. While we await the release of updated harvest level and mix determination, we intend to continue to repurchase and cancel shares. We have equity in a power plant that we value at over $1 per share, cash on our balance sheet worth over 80 cents per share, and duty refunds worth as much as 45 cents per share. This total is 225 per share. Our recent trading price is 50 cents per share lower than the total of these three items. Clearly, stock market investors presently accord a negative value to our tenures and sawmill complex, assets that we believe are valuable and that we are proud to own. Therefore, we continue to believe that our stock is undervalued by a huge amount given the robustness and quality of the timber inventory in the McKenzie TSA, and given the high return capital investment opportunities available to them. That sums up the key points we wanted to make. We very much look forward to our next call with you, and we would be pleased to respond to any questions shareholders and analysts have, so we'll turn the meeting back to Patrick.
Thank you. Please press star 1 at this time if you have a question. When prompted by the system, please clearly state your name to register your question. There will be a brief pause while the participants register for questions. Thank you for your patience. We'll take the first question. Please go ahead.
Paul Quinn, RBC. Sure. Okay, I'll ask you a question. Hey, again, now that you've got your balance sheet in good shape again, just what are you looking to do? Is it less – are you looking to get back into M&A, or is it more upgrades in the solo?
Paul, good question. To date, all of our study and analysis has been focused on – internal enhancement projects, optimizing our existing timber and sawmill and power plant space. We have not been looking for external acquisition opportunities. The rationale is importantly driven by the fact that when you remain with internal projects, you can control the scope and scale and speed of the funding that's required.
And so that's why we're continuing to look internally. Okay, and then maybe, you know, we've got a pretty hot summer going here. I just wonder what the update on fire situation is in McKenzie. Would he expect any shots to occur in Q3 here?
Good afternoon, Paul. It's Sandra McClellan here. We've been fairly fortunate with the conditions in Mackenzie and somewhat different than we've seen in the southern interior in BC. So we're not anticipating that we'll have anything out of the ordinary here in the back half of August or into September. We did have some disruptions in Q2, but it was limited to about two weeks of... shortfalls in all deliveries. We didn't entirely shut down all deliveries, but we had a two-week period where they were impacted by fires.
Okay, and then, Ken, you mentioned that log costs, BC interior, but 75% of cash costs. You obviously got hit with a huge run-up in stumpage on July 1st, and, you know, poised to see another price increase on October. Are you guys able to make cash at these levels of stump, especially given the quality of the fiber you're bringing in?
Well, let me mention a couple of things about that, Paul. And they're both very good questions. First of all, we found that the heavy snowpack and difficult weather conditions that we had in Q1 forced us to incur extra log costs, buying wood to make up for some shortfalls that we experienced and spending extra money buffeting up roads so we could haul wood when ground conditions were very wet. So as a consequence of that, our non-stumpage-related saw log costs in the second half of this year will be lower than they were in the first half, and stumpage will be a bit higher. So all the reviews and the scrubbing of numbers we've done indicate that we are going to have a modest single-digit increase in delivered log costs in the second half of the year compared to the first half. Coming back to the question that your second question is that I think, Paul, that if you looked at our operating earnings in the first six months of this year and divided it by 93.3 million board feet of shipments, you'd find that we had something like $450 of operating income per 1,000 board feet. and there's probably $25 or so of depreciation in that. But in any event, the operating income is right around $450. And through to last Friday, our average selling price realization was about $450 Canadian lower than it was in the first half of this year. So right today, we are... at approximate break even. And in the quarter to date, we would be slightly ahead of our cash costs. But now we're about to experience the sub-$500 benchmark price orders that we'll be shipping. So we've probably dipped into negative cash flow territory right now. But at this moment, We're continuing to, as Andrew said earlier, we've got a robust summer logging program that enables us to spread our fixed costs over a larger number of units. And we are also looking at adding hours to our sawmill complex and we think that will enable us to reduce our cash conversion costs a bit. So right at this moment, there's not an overwhelmingly powerful argument to take down time because it's not clear to us yet that the procurement costs would be materially different than our operating losses. But who knows what will happen. Our own view is that the correction of lumber prices has largely run its course, and that as we've got some seasonal improvement opportunities in shipments coming up, and as you and others have written about, there could be some restocking in certain lumber market segments. So we think lumber prices are more likely to go up from here and that there is an urgent need to consider downtime at this moment.
Okay, a fulsome answer. Maybe just lastly, I'm quite confused on your hygiene strategy. It seems like I've seen quarters where lumber prices are going up and you've had losses and lumber prices are going downward and you've had losses. So maybe you can just remind us what your hedging strategy is and when it's going to start to work for you, I guess.
I'm sorry, the monitor line disconnected.
Are we still on the conference? Please stay on the line.
You are now back in the call. Thank you for your patience.
Okay, well, good afternoon once again, everyone. It's Ken Shields. We've had an unusual development with the phone system here, and we got dropped from the call. So presumably you're still on the line. And I was in the midst of answering Paul Quinn's question about our hedging strategies. And it is, the background to our hedging strategy is that we did obtain some price protections, and then we experienced this incredible run-up in lumber prices, and we took significant losses in Q2, or pardon me, in Q1, We took further losses in April of Q2, and towards late May, early June in Q2, we unwound our positions, and we ended up covering our position at much higher than the $500-$600 level that they reached at the end of the quarter. And so there was a bit of a loss in Q2 in addition to Q1. We have no positions on the books now and we don't anticipate doing anything materially in the hedge market at this time. So, Patrick, are there other questions?
So, Mr. Quinn, do you have any more questions?
No, I'm good. Thanks very much, Patrick.
Thank you. I'm sorry about that. So we do have a next question. One moment. We'll take the next question.
Hugh Cooper. Oh, Ken, just two quick questions. First of all, how much is your tax loss carried forward in the US and what is left in Canada?
I can take that question. This is Winnie Kang. We have losses in excess of 100 million Canadian in the U.S. And in Canada, we had around 50 million at the end of 2020. And so we were able to utilize a large portion of that so far in the year. But we do not expect, though, to have any cash taxes payable for the current year.
Okay. Ken, I think I might have missed that, but I think you said you had roughly about $0.80 of cash. The duty refund roughly amounts to about $0.45. Your lumber operations were $1, and the biomass plant was $1?
No, we said the biomass plant was $1.
The $45 million for the biomass only?
Yes.
Okay.
For the equity in the biomass. And then there's 60 million of debt on top of that. So it's roughly $105 million. So it's... Seven times. Seven times even DA roughly. Okay. Yes. And so we said that we infer from that that our tenures and lumber business have a negative value built into the current stock price.
Okay. Okay. And how would you value your cut or whatever your reduced cut will be? Do you see that as an asset?
We certainly do see it as an asset in McKinsey. And we think that since we sold Kenyers at approximately $120 per cubic meter a while ago, We think tenure values have come down a bit in BC because of the regulatory uncertainty related to First Nations conciliation efforts and some of the objectives that are set out in the intentions paper that the Ministry of Forests issued recently gives the province more flexibility to wheel and deal in 10 years and to repurchase 10 years. So, you know, I don't know, $90 or $100 might be the going rate. And we've got presently 807,000 cubic meters of 10 years, 782,500 actually. So, and then, you know, sawmills are valued at... I don't know, $400. You saw mills, $400. You left the 1,000 board feeders annual capacity, and we've got a 240 million board foot mill, so there might be $100 million there or something like that. So, you know, to the nearest total dollar, there might be $2 a share or one above some of those other amounts that we discussed
Okay. Okay, thanks. That's it for me. Thanks very much, Ken.
Thank you.
Thank you. Once again, you may press star 1 if you have a question. There are no further questions registered at this time. I would like to turn the meeting back over to Mr. Shields.
Well, I just want to thank all of you for your support of Conifex and for bearing with us as we had this telephone interruption today. So thank you. We look forward to chatting to you in early November. Bye now.
Thank you. The conference has now ended. Please disconnect your lines at this time. Thank you for your participation.