Canfor Corporation

Good morning, ladies and gentlemen, and welcome to the Canfor and Canfor Pulp fourth quarter analyst call. A recording and transcript of the call will be available on Canfor's website. During the call, Canfor and Canfor Pulp's chief financial officer will be referring to a slide presentation that is available in the investor relations section of the company's website. Also, the company's We'd like to point out that this call will include forward-looking statements, so please refer to the press releases for the associated risks of such statements. And I would like to turn the conference over to Mr. Don Kane, Canfor and Canfor Pulps Chief Executive Officer. Please go ahead, Mr. Kane.

Okay, thank you, Operator, and good morning, everyone. Thank you for joining the Canfor and Canfor Pulp Q4 2018 Results Conference Call. I'll make a few comments before I turn things over to Alan Nicol, our Executive VP of Canfor Pulp Operations and Chief Financial Officer of Canfor Corporation and Canfor Pulp. Alan will provide a more detailed overview of our performance in Q4. Joining Alan and I today are Kevin Pankratz, Senior VP of Sales and Marketing, and Stephen Mackey, Senior Vice President of Canadian Operations. I would also mention that in January, Kevin Pankratz assumed the responsibility for the sales and marketing of our pulp group in addition to our lumber group, and Ryan Ewan, who has had several years of increasing responsibilities in our pulp group, was appointed vice president of pulp paper sales and marketing. Before I discuss the fourth quarter, I'd like to make a couple of comments about 2018. Canfor Pulp reported record operating income of $247 million and a return on invested capital of 37%. Canberra Corporation reported operating income of $609 million, the highest in over 10 years, and a return on invested capital of 19%. These results were achieved in a year which featured extreme transportation challenges, extreme weather events, significant forest fires, log supply constraints, significantly higher log costs, and market volatility. Despite these many challenges, our people performed exceptionally well under these difficult circumstances. During the year, we completed our $100 million investment in green energy upgrades at Taylor and Northwood. In addition, our $350 million board-foot, $125 million U.S. dollar organic capital program at our U.S. South operations remains on track to be substantially completed by the end of 2019. The spending includes large sawmill rebuilds at Camden, South Carolina and Moultrie, Georgia, a new planer at Fulton, Alabama, and continuous dry kilns at Darlington, South Carolina, and Urbana, Arkansas. Now turning to the fourth quarter, earnings were significantly impacted by a sharp decline in market pricing for both lumber and pulp with a consolidated operating loss of $79 million. For Canfor Pulp, the company had a challenging quarter, generating operating income of $16 million, which was down significantly from the third quarter, principally due to lower shipment levels reflecting repair work on our recovery boiler at Northwood and a natural gas pipeline explosion near Prince George. Total scheduled and unscheduled downtime reduced our MBSK production by 90,000 tons. Global softwood craft pulp markets are projected to remain steady throughout the first half of 2019, reflecting a forecast increase in demand in China, and reduce supply due to the traditional spring maintenance period for our pulp mills. Moving to our lumber business, we reported an operating loss of $88 million. Lumber production was down significantly in the quarter, reflecting a series of production curtailments in British Columbia and inclement weather in the U.S. South, which impacted log inventories, log profiles, and overall manufacturing costs. We have further curtailed our BC operations in Q1 by 90 million feet across our system, primarily at Bavinby, Houston, and McKenzie due to continued log supply constraints, significantly increased log costs, and market conditions. We will continue to review our operating rates as market conditions warrant. Current markets have been challenging. However, our outlook is for pricing to stabilize and gradually increase, which we have begun to see in early 2019. We expect a normal seasonal pickup in demand to coincide with relatively low inventory and supply chains and have seen strong increases in both our retail and builder business. Demand from offshore markets continues positive after a strong Q4 and expected to remain solid through the first quarter of the year. Overall supply continues to be impacted in BC with an estimated 1 billion board feet of announced temporary or permanent capacity reductions. We are encouraged that a memorandum of agreement for a new five-year term has been reached with the USW. The agreement includes seven of CanCorp's certified mills in British Columbia. The USW will be conducting ratification votes on the agreement over the coming weeks. In addition, we have three mills represented in the negotiation process being led by the Interior Forest Labor Relations Association. We remain optimistic that a settlement will be reached between the association and the USW. Transportation networks have been generally good, but we are seeing increased challenges due to significant cold weather in parts of Western Canada. With respect to our previously announced Greenfield Mill in Washington, Georgia, we are deferring any decision on this project to the end of 2019. This decision is based on challenging market conditions and inflationary cost pressures. In terms of softwood lumber agreement, there are currently no negotiations underway. In early December, a NAFTA panel was formed that includes three Canadian and two American panelists. We'll be following the decisions of the panel very closely. Finally, we are anticipating closing the VITA transaction shortly. We are extremely excited about our investment in Europe as it further diversifies our business from both a geographic and product profile standpoint, an earnings profile that is much more consistent than what we typically see here in North America. This purchase supports our long-term strategy of growing our high-value and non-commodity lumber businesses and further positions the company for strong, stable earnings in the future. I will now turn the call over to Alan Nicol, who will provide an overview of our financial results.

Thank you, John, and good morning, everyone. My comments will focus principally on our financial performance for the fourth quarter by reference to the previous quarter. And full details of our results are contained in the Canfor pulp and Canfor news releases, both of which were issued yesterday afternoon. As always, you'll find an overview slide presentation on both the Canfor and Canfor pulp websites in the investor relations section under webcasts. And the presentation highlights consolidated and segmented results, and I'll be referring to this presentation during my comments. For the fourth quarter of 2018, Canfor reported the shareholder net loss of $52 million, or 42 cents a share. down from net income of $125 million, or $0.98 a share, reported for the third quarter, and net income of $132 million, or $1.02 a share, reported for the fourth quarter of 2017. On slide three of our presentation, we highlight various non-operating items, net tax and non-controlling interests, which affect the comparability of our results between the quarters. In the fourth quarter of 2018, these items totaled $24 million, the largest being a $29 million expense related to counterfeiting and anti-dumping duty deposits. After adjusting for these non-operating items, the shareholder net loss was $28 million, or 23 cents a share, for Q4, compared to net income of $157 million, or $1.23 a share, for the third quarter. As highlighted on slide 6 of our presentation, the lumber segment recorded an operating loss of $88 million for Q4, down $237 million from the previous quarter. After adjusting for CVD and ADD, as highlighted on slide 5, as well as an inventory write-down of $37 million at year-end, the Q4 operating loss was $11 million down 203 million from a similarly adjusted operating income of $192 million in Q3. The major variance reflected substantially lower Western SPF and Southern Yellow Pine lumber prices, which translated into materially lower unit sales realizations. These declines were accompanied by higher unit log costs in Western Canada and lower production and shipments. The significant price erosion reflected slowing North American demand coupled with excess inventory in the supply chain. The North American random lengths Western SPF price averaged $327 per 1,004 feet, down some 32% from the previous quarter, while prices for other grades saw a more moderate correction. Southern yellow pine sales realizations reflected a 6% decline in the benchmark 2x4 price, but declines in wider width dimensions were more pronounced, some of which was attributable to seasonal factors. As a result of these weaker market conditions, as well as log supply constraints and elevated log costs, the company took approximately 100 million board feet of curtailment at its BC lumber operations in Q4. This was the primary contributing factor, accounting for a 12% decline in production and a 14% decline in shipment volumes in the current quarter. The higher unit manufacturing costs in Q4 reflected a 10% increase in Western Canadian log costs, resulting mainly from the timing of market-based stumpage increases, higher purchase wood costs and log supply shortages, as well as lower productivity in both regions, reflecting both the impact of curtailments in B.C. as well as weather-related challenges at the company's U.S. South operations. Log costs in the U.S. South remain stable through the quarter-month. Canfor's pulp and paper segment comprises the results of Canfor Pulp Products Inc. As highlighted on slide seven, the company reported net income of $14 million or 21 cents a share for the fourth quarter of 2018, compared to net income of $43 million or 66 cents per share for the previous quarter. As slide seven highlights, the Q4's financial results reflected the continuation of the scheduled maintenance outage at Northwood from the previous quarter. It previously announced repairs to Northwood's No. 5 recovery boiler, unscheduled downtime taken as a result of a third-party natural gas pipeline explosion in Prince George just early in the quarter, and to a lesser extent, several other operational challenges during the quarter, all of which reduced NBSK bulk production by approximately 90,000 tonnes. In addition, BCTMP production was impacted by a seven-day curtailment in late December as a result of reduced residual fibre availability. following various sawmill curtailments in the region. At the end of December and into January, the company experienced kiln-related operational disruptions at two of its MBSK bulk mills. While these challenges have now been resolved, the related production loss was approximately 20,000 tonnes early in the first quarter of 2019. Unit manufacturing costs in Q4 were significantly higher than the previous quarter as a result primarily of the lower Q4 production as well as higher related maintenance, energy and chemical costs associated with the unscheduled outages, particularly at Northwood. Sales realisations were broadly in line with the previous quarter, as weaker US dollar list prices to China were partially offset by higher list prices to North America and proportionately higher shipments to the US and, to a lesser extent, Europe. Operating income for the company's paper segment in Q4 was $4 million, up slightly from the previous quarter, reflecting solid operating performance of the company's PG paper machine and steady paper unit sales realizations. Capital spending for the fourth quarter totaled approximately $140 million and included approximately $100 million for the lumber business and $40 million in canned ore pulp. In 2018, capital spent totaled just over $400 million and comprised $272 million for lumber and $121 million for pulp. As Don mentioned, the company continues to execute on its $125 million U.S. dollar organic growth program, targeting an additional 350 million board feet of production in the U.S. South. And we remain on schedule to have this program substantially completed by the end of this year. Including organic growth, our 2019 forecasted capital spend is approximately $300 million, with approximately $190 million for lumber and $110 million for pulp. At the end of the year, Canfor, excluding Canfor Pulp, had cash of $246 million and drawn debt of $408 million. with $450 million of available liquidity under its operating line, as well as additional $100 million Canadian dollar and $100 million U.S. dollar term debt facilities, both of which are currently on draw. All of our operating and term credit facilities now go out to 2024 or later. It's currently contemplated that the FIDA acquisition price will be paid from the company's cash on hand, the additional term debt facilities, and the balance from the operating line. We are currently forecasting CanForce net debt to total capitalization at the end of Q1 to be approximately 30% when we typically have our peak log inventories. This is significantly below the level at which any financial confidence would kick in. While these debt levels are relatively high by CanForce standards, we anticipate a healthy reduction in the second quarter as our Western Canadian log inventory is consumed during spring break-up. Canfor Pulp had net cash of $7 million, with a fillable liquidity of $99 million at the end of the year. Net debt to total capitalization, excluding Canfor Pulp, was 7%, and on a consolidated basis was 6%. Yesterday, Canfor Pulp's Board of Directors approved the continuance of a quarterly dividend of 6.25 cents a share for the fourth quarter. And finally, by way of information, our earnings in 2019 will reflect the transition to new lease accounting standards, And as a result, our EBITDA is projected to increase by approximately $13 million for lumber and $1 million for pulp. And with that, Don, I'll turn the call back over to you.

All right. Thanks, Alan. So, operator, we're now ready to take questions from the analyst.

Thank you, Mr. Kane. Ladies and gentlemen, we will now take questions from analysts as stated. If you have a question, please press star 1 on your telephone keypad. If you're using a speakerphone, please lift your receiver and then press star 1. And if at any time you wish to cancel your question, please press star then 2. Please press star 1 now if you have any questions. There may be a brief pause while we wait for participants to register their questions. Thank you for your patience. And your first question will be from Sean Stewart at TD Securities. Please go ahead.

Thanks. Good morning, guys. Lots to get through. Just so I understand, the Western Canadian lumber production this quarter, you took 100 million board feet of downtime related to markets and fiber availability constraints. Your production was down 130 million board feet sequentially in Western Canada. Is the rest just holiday shuts, and that's the component we would expect to come back in Q1? Is that the right way to think about it?

Yeah, no, for sure, Sean. Maybe I'll get Stephen and give you a bit of an update on our current and forward planning here around the shutdowns.

Yeah, sure. Thanks, Sean. And good morning, Sean. Just in terms of the gap between the 100 million capacity reduction and the 30 million, the incremental 30 million that we were off there, some of that was just operational challenges related to the fourth quarter, winter weather, log profile and delivery issues, as well as as we work through the USW negotiations and some operating rate changes in terms of labor disruptions that were associated with those negotiations.

Okay, so the tough weather extending into Q1, if I'm thinking about 90 million board feet tied to weak markets and log availability issues, there could be incremental curtailments on top of that related to weather, that sort of stuff?

In terms of the forecast for Q1, I think what I would say there, Sean, is that we did take additional capacity reductions, as you say, for the 90 million. We have experienced some extreme weather conditions as we work our way through Q1 here that have had some impacts. And we've only just recently concluded and are pleased, as Don indicated in his comments, with the memorandum of agreement that we've signed that impacts the majority of our USW certified mills. So we're hoping that a lot of that will be behind us as we work through the balance of Q1.

Okay. I think you said Western Canadian log costs were up 10% sequentially. Yes. Can you give us a sense of how you're expecting your log costs to trend over the short to mid-term in Western Canada the next few quarters? Sure.

Sean Stephen here again. I'll tackle that one. We did see 10% as Alan referenced in the quarter-over-quarter increase in Q4. Really we're expecting those trends to kind of continue through the balance of 2019 comparative to what we saw in 2018. Q4 numbers were disproportionately a little bit high in terms of that increase as we prioritized shipments of some purchase wood and deferred quota deliveries to capitalize on a stumpage reduction that was coming due here in January. As you know, we are anticipating lower stumpage for the first half of 2019 as a result of the market conditions that we experienced in the back half of 2018, but then stumpage will increase again in the second half of 2019. So all in all, we do expect continued upward pressure on log costs in British Columbia, and we would expect that trend to continue until we see some material rationalization and permanent capacity reductions.

Okay, and maybe to that point, Stephen, you guys won't reference potential for permanent shuts, I suppose, on this call, but your thoughts on how much more supply in the interior needs to come out permanently across the industry to right-size the production base to the fiber resource going forward? Do you have any thoughts there?

Yeah, Sean is gone. And just on that, as we've kind of talked about before, our view has been and continues to be in total that we believe there has to be, you know, approximately seven to eight mills that need to go away, about two billion overall, roughly, in terms of production. So, depending on the size of the mill, it gives you a bit of a sense overall. With what we've seen so far between, like I mentioned, I think in my comments, maybe I didn't, but in terms of the permanent shots and what we've seen so far, some points to about a billion of that. A lot of that's not permanent, though, right? So we still think there's a fair bit of rationalization that has to take place. And certainly, you know, with the way things are looking right now and the challenges of British Columbia, we think that might be maybe advanced and we may see some of that. Not ourselves, but I think we'll see that across the industry more in probably 2019 than we would have originally thought.

Okay. I'll get back in the queue. Thanks very much. Thanks, Lance. Yeah. Yep.

Thank you. Next question will be from Keaton Mamtara from BMO. Please go ahead.

Good morning, Don Allen. Good morning, Keaton. First question, I just want to talk a little bit about housing. The cost of current is going on right now in the back half of last year. But in the last couple of months, rates come down a lot and we've had affordability issues last year. Can you talk about what you guys are seeing right now in terms of activity and your expectation for the spring season?

Go ahead, Jeff. It's Kevin Pankratz here and you're right we did see a little bit of a pause in Q4 on housing but our expectation is that housing is going to come in at around 1.26 for the year. I think we'll get the final results here next week on February 26 when we get the actual confirmation but that is our expectation and for 2019 based on Our intel and the conversation with customers, we expect to see a modest pickup for 2019, maybe approaching 1.3.

Stephen, maybe one thing to add, Kevin, to that is just because it's interesting and it's actually a bigger consumer of lumber is on the retail side. And we, you know, through the back half of the year and we're seeing that continue into Q1 also. It's some very positive numbers in terms of the DIY side of the business, the retail side of the business with the big boxes, and you know, the Home Depot and Lowe's and those types, and that's encouraging. And it's been significant increases there, more than we've typically seen in past years. So that gives us a fair bit of encouragement in terms of trying to gauge consumer confidence and consumer sentiment going forward. And so I guess that may be the only thing I would add to that in addition to the comments that Kevin responded to around the home building side.

Got it. That's very helpful. Can you also talk a little bit about offshore demand in China, both in Humber as well as in Pulp?

Yeah, well, maybe, Kevin, you can. Why don't you answer that one? Sure. Brian can talk.

Sure. On the lumber side here, we've actually seen some pretty good demand here really picking up in the Q4, where we've had significant increase in our shift and starting really being impacted in November and December. And based on our current order file, we have that trend continuing well into Q1 and into April. So pretty strong demand in order files in place for China from the lumber perspective.

Brian, maybe just a comment on the pulp side. Sure, Devin. Good morning. Yes, on the China side, we saw the market bottom out at the end of 2018. Since then, we've seen that the market has stabilized. And in fact, as China comes back to rebuild their pulp stocks, we've seen an uptick in software demand. So we anticipate that moving forward, optimistic that prices will be trending up.

Alright, that's very helpful. And then one last, you know, kind of clean-up question. This is regarding the duty. You saw a pretty sharp drop in Western SPF prices. Your volumes of SPF was also down quite a bit. Yet the duties were down only 2 million quarter over quarter. What am I missing?

Yeah, good question. Yeah, so it's a fair question. So the duties in Q4 reflected a higher ADD rate that applied not just to the border, but actually to the 18-month period under refugue. And that was largely a factor of dynamics in BC, principally the higher cost and the lower pricing. We did offset that, Clayton, as you probably gathered, by shipping more offshore, and obviously the production curtailments... reduce the amount of a shift in the quarter as well. So hopefully that helps answer your question.

It does. That's very helpful. I'll turn it over. Good luck in 2019.

Thanks very much.

Thank you.

Thank you. At this time, Mr. Kane, we have no further questions. I would like to turn the call back over to you, sir.

All right. Thanks, operator, and thanks to all of you that were on the call. We appreciate your interest in Canfor, and we'll talk to you at the end of Q1.

Thank you, sir. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. And at this time, we do ask that you please disconnect your lines. Enjoy the rest of your day.