Canfor Corporation

Good morning, ladies and gentlemen. Welcome to the Canfor and Canfor Pulp's second quarter analyst call. A recording and transcript of the call will be available on Canfor's website. During this 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 companies would 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. I would now like to turn the meeting over to Mr. Don Kane, Canfor and Canfor Pulp's Chief Executive Officer. Please go ahead, Mr. Kane.

Thank you, Operator, and good morning. Thank you for joining the Canfor and Canfor Pulp Q2 2019 Results Conference Call. I'll make a few comments before I turn things over to Alan Nickell, Executive Vice President 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 Quarter 2. Joining Alan and I today are Kevin Pankratz, Senior Vice President of Sales and Marketing, Stephen Mackey, Senior Vice President of Canadian Operations, and Brian Ewan, Vice President of Pulp Sales and Marketing. Starting with our pulp business, our mills deliver solid operating and financial performance in Q2, despite continued elevated global pulp inventory levels. However, as the quarter progressed, prices declined as a result of a sharp decline in demand, combined with above normal inventory levels in several key markets. The resulting price erosion, combined with the effects of widespread sawmill curtailments in the British Columbia interior, put a major strain on fiber supply in the interior of BC and led to our decision to take phased curtailments over the summer at Northwood, PGI, and Taylor. These curtailments will assist us in achieving sufficient chip supply through the fall and the winter. In addition, we expect to see a modest increase in pulp prices in Q4, and into 2020 as global inventory levels move back into balance, which will support improved earnings in the fourth quarter. Moving to lumber, I'll start with our B.C. business, which continues to face significant challenges due to very high log costs and depressed market pricing. This has resulted in significant curtailments in the B.C. industry, including Canfora. In June, we announced that our Wavenby mill will be permanently closing and announced an agreement to sell our forest tenure in Wavenby to Interfor for $60 million. The tenure transfer is subject to approval by the Minister of Forests, and we are working to meet all obligations for a closing in Q3. Also in June, we announced significant curtailments at all but one of our BC sawmills. The majority of the downtime was in June and July and will result in reduced supply of approximately 200 million board feet. Last week, we also made the difficult decision to indefinitely curtail our McKenzie mill and permanently reduce our Isle Pierre mill from two shifts to one. This will enable Isle Pierre to better align its production capacity with a sustainable, high-quality fibre supply in the region. We deeply regret the impact all of these closures and curtailment announcements are having on our employees, contractors, families and the local communities. This is a very difficult time for our people and the communities, and we thank them for their dedication and support through these difficult times. At our current operating rate, our regional production exposure is 45% in British Columbia, 5% in Alberta, 32% in the U.S. South, and 18% in Europe. SPF pricing continues to be weak as the market continues to be oversupplied. We believe that many of the permanent curtailments announced in the last number of months are just now becoming effective. As a result, we forecast that supply will be in a much improved balance later in the year. In addition, the very wet weather conditions, which were pervasive across much of North America over the winter and spring, appear to be improving and we anticipate increased demand in the fall. These two factors lead us to believe pricing for SPF will show a gradual improvement over the balance of the year. Housing starts have remained challenging due to an acute shortage of labor. However, we believe market participants are actively working to develop labor solutions in order to meet underlying demand. Offshore markets have suffered from high inventory levels as well, and pricing has also been relatively weak. We expect that to resolve over the course of the next number of months, particularly in Japan. Demand in pricing in China is expected to improve towards the end of the year. Southern yellow pine prices faced less of a supply issue and have rebounded somewhat in recent weeks as demand has improved. Our European business continues to run very profitably, consistent with levels seen in 2018, and we expect European SPF prices to moderate slightly in Q3 and Q4, driven by the weakness experienced in other markets, but this will be somewhat offset by lower log costs. At the end of May, we closed the first phase of the Elliott acquisition, and we now have a 49% ownership position in that company and expect to complete the final phase in May of 2020. We remain focused on continuing to reduce our debt levels and continuing to strengthen our balance sheet. Overall, despite the challenges we're experiencing in British Columbia, we continue to expect gradual improvement over the year, and we will continue to benefit from our geographic and product diversification. I will now turn it over to Alan Nicol to provide an overview of our financial results.

Thanks, Don, and good morning, everyone. As Don mentioned, the Canfor and Canfor Pub quarterly results were released yesterday afternoon. These results come together with our quarterly overview slide presentation in the investor relations section of the respective companies' websites. In my comments, I'll expand on a number of Don's points and also speak specifically to several quarterly financial highlights. Our lumber segment reported an operating loss of $61 million for Q2, an improvement of $17 million from the previous quarter. Results included a net duty expense of $45 million, restructuring costs of $12 million, and a $25 million reversal of our previously recorded inventory write-down provision. After taking account of these items, our operating loss was $29 million. Lumber segment results in Q2 continue to reflect challenging market conditions and elevated log costs in British Columbia. The company took close to 150 million board feet of curtailment in BC and announced additional permanent and temporary reductions in Q3 as Don has outlined. Average Western SPS sales realizations reflected a 10% decline in pricing across most dimensions. This more than offset modestly lower unit log costs and a seasonal decline in cash conversion costs. For the US South, record rainfall and severe flooding across that region delayed the start of the typically busy spring construction season, tempering demand and contributing to lower lumber sales realizations in the quarter. Despite these conditions, however, our US South operations continued to deliver solid results again this quarter. As Don also noted, our newly acquired European lumber business performed well in Q2, with lumber prices and demand remaining relatively stable in that region. Operating income before amortization in the quarter was over $30 million before adjusting for acquisition-related items. Our pulp business also had a solid quarter in Q2 with Canfor Pulp reporting operating income of $18 million. After adjusting for an inventory write-down at period end, the company reported operating income of $32 million for Q2, an improvement of $14 million from the previous quarter. Our manufacturing costs benefited from improved operating rates at our mills and also reflected scheduled maintenance outages at Intercon and Taylor. Average pulse sales realizations showed a moderate decline quarter over quarter, but prices deteriorated as the quarter progressed, with prices in China falling 17% through May and June in response to significantly lower demand and continued elevated inventory levels. Most of the effects of this price erosion will be reflected in our Q3 results, given the timing of shipments versus orders. The tough market and fiber-related conditions resulted in us implementing phase summer curtailments at our InterCon and Northwood NBSK mills and our Taylor BCTMP mill, reducing Q3 production by an estimated 75,000 tons of NBSK pulp and 25,000 tons of BCTMP, respectively. Yesterday, we announced an extension of our curtailment at Taylor until September the 9th, further reducing BCTMP production by 25,000 tons. Capital spending for the second quarter totaled approximately $82 million and included approximately $58 million in the lumber business and $24 million in Canfor pulp. For 2019, we're currently anticipating total capital spend of approximately $185 million dollars for Canfor and $95 million for Canfor Pulp. We anticipate much lower capital spending in 2020 following the completion of several major upgrades and projects in both companies in 2019. At the end of the second quarter, Canfor, excluding Canfor Pulp, had net debt of approximately $960 million and available liquidity of $290 million. Canfor Pulp ended the second quarter with zero net debt with available liquidity of just under $100 million. And lastly, Canfor Pulp's directors approved the continuance of a quarterly dividend of 6.25 cents per share for the second quarter yesterday. And with that, Don, I'll turn the call back to you.

All right. Thanks, Alan. Operator, we're now ready to take questions from analysts.

Thank you. We will now take questions from financial analysts. If you have a question, please press star 1 on your telephone keypad. If you are using a speakerphone, please lift your receiver and then press star 1. If at any time you wish to cancel your question, please press star 2. Please press star 1 now if you have a question. There will be a brief pause while participants register for questions. Thank you for your patience. Your first question is from Mark Wild from BMO Capital Markets. Please go ahead.

Good morning, Don. Good morning, Alan. Good morning, Mark. I want to thank you guys for including more VITA details in the commentary this time around. I wondered, just starting on VITA, if you could give us some sense of the impact of those VITA outages on the third quarter financials. It looks like it's about three weeks across the system there.

Yeah, that'd be about right, Mark, for sure. For the most part, yeah, close to three weeks. And probably the second half impact that we're just from a revenue standpoint, we believe it's going to probably reduce the revenue by about 5%. That's what we're at this stage of the game. That's what we're anticipating.

And what about the kind of just the financial impact from having them out? Because it's basically a quarter of the quarter. So do you take all of the hit on that in the third quarter, or do you amortize the summer outage costs across the year?

Yeah, largely it will be borne in the third quarter. So I think for your purposes to do what you're suggesting, I think it's appropriate. A third would be a reasonable assumption, a third of the quarter, that is.

Yeah, okay. And then just in addition, we've been thinking about VITA as doing something around $145 million for the full year. Is that... Is that still a good number based on what you see right now for 2019?

Yeah, so the way I'd answer that, Mark, is certainly for the first half of 2019, our results are very consistent with that number that you mentioned. We do see, as Don mentioned, a little bit of pressure on the pricing side. We will hopefully get some abatement on the log cost side, so maybe a little bit less than that, but certainly for the first half of this year, we're very much in line.

Okay. And then just turning to the pulp business, I just wondered, given the closures that we're seeing in terms of the sawmills up in BC, Don, does this change the competitive landscape for kind of the Western Canadian pulp business? And do you foresee downsizing in the industry as a result of lower fiber availability?

Yeah, so it's a fair question, Mark. I mean, I think there are commentators out there that are indicating there have to be at least one or two pulp mills that have to close in BC that's consistent with curtailments that many expect for the lumber business. For us right now, as you know, we've taken the downtime that we've announced, and that's really principally to make sure that we have sufficient fiber at competitive prices to run through the fall and winter. So we feel we're in a reasonably good position there, but clearly, no one's immune from the impacts and the risks associated with the lumber market curtailments and the landscape there.

Mark, if you look at the lumber side of it, I mean, clearly with what we're seeing in terms of reductions already and what we expect to go forward, which not only we have a view, but also there's been a lot of external views from different consultants in terms of the numbers, which seem to be increasing. Clearly, there's going to be ramifications for some of the you know, probably one or two higher cost pulp mills as well potentially down the road here. So that would be our view.

Okay. And then finally for me, I wondered if you can just update us on capital spending plans, you know, in light of the soft markets right now, whether you've pulled back at all and maybe include in that commentary kind of where we're at vis-a-vis that green field that you had talked about in the southern U.S.? ?

We're dealing with a green field first, and then I'll get Alan to give you a little more color around the capital this year and then what we're thinking about next year. I think I got the easier question. But in terms of Washington, Georgia, which I think you're referring to, right now we still have that on hold for the time being. And at this stage, it's not really on our radar screen at all right now. We've got some other priorities that we're working on. So down the road here. We'll probably look at that again, but it'll be certainly well into 2020 before we start to even look at that again for the time being.

Just in terms of spend, Marcus, as you probably picked up in my comments, we do see our spending lower in 2020, both for lumber and pulp. That, for the most part, is reflecting the completion of, in the case of pulp, a number of bigger projects. We still have one that's going to be done here in the spring. I think in terms of lumber, we're well advanced in terms of that organic growth initiative in the U.S. South, so we do see a natural opportunity to pare back. And to your point with the market conditions as they are, I think that total capital spend number is going to be a lot closer to $200 million, which is where it's at today. That's our current thinking anyway.

Okay, that's helpful. I'll turn it over.

All right. Thanks, Mark.

Thank you. Your next question is from Sean Stewart from TD. Please go ahead.

Thanks. Good morning, guys. A few questions. The lumber unit costs actually trended a little better than we expected when you back out the duties and inventory revaluation. You referenced in the MD&A some log cost relief in Western Canada, which I guess I was a little surprised by. Can you quantify that this quarter and give us a sense of how quickly the July stumpage hike We'll roll through your second half results, I guess, according to your logging schedule. Any sense you can give us there?

For sure, Sean. Maybe, Stephen, we've been doing a lot of work on that. You have been, so go ahead and give Sean an update on that one.

Sure. Excuse me. Good morning, Sean. So, just with respect to log costs and some of the relief that we're seeing, you know, Obviously, as Don talked about, all of the capacity downtime that we've seen. We have seen some moderation or softening in purchased wood markets. Slightly down depends on a region-by-region basis, but we're seeing a bit of softening in timber bid behavior. We're also benefiting from significant working capital and high log inventories as a result of some of the capacity outages. While we did see that significant stumpage increase effective July 1st, we haven't seen that hit really into our results yet. and we've got sufficient inventories going into the back half of this year. So we do expect continued upward pressure until we see the full effects of rationalization across BC. We've got fiber supply constraints that are still driving costs up, but we are seeing some moderation there, if that helps you.

Okay.

That does help. Thanks, Stephen. One follow-up on VIDA as well. I just want to make sure I'm looking at this and I appreciate the context you've given us and the results in the report. It looks to me like your average price realizations quarter over quarter dropped by about $70 Canadian per thousand board feet. And I guess some of that is the timing of the acquisition closing, maybe a few other items, but maybe you can help connect the dots there because it doesn't sound like markets were off that much in Europe. And the pressure you're expecting through the second half of the year, can you give us any context on percentage terms, how much you're anticipating there?

Maybe Alan, why don't you go ahead?

Yeah, so there was, yeah, we can maybe chat a little bit offline in terms of some specifics to your question there, Sean. But yeah, there was a modest reduction in sales realizations. It wasn't wasn't a very significant mindset because, as we mentioned, prices stayed relatively stable there. Overall, I think we didn't see an appreciable decline there. We maybe need to have a little chat just to figure out where you're seeing your numbers.

Okay. The magnitude of weakness you're expecting through the second half, any sense you can give us there?

Yeah, I mean, as I mentioned, I think maybe I didn't, but earlier on, the second half of this year, we believe we'll be off about 5% on pricing. But we do believe, though, there'll be some offset there on log prices, too, because unlike North America, or at least not as much, you don't see this as much in North America, in Europe, when revenue goes up, you tend to see log costs go up to some degree. And when revenue goes down, you tend to see log prices go down to your margin. you know, it's probably more protected than what it is in North America. At least that's what we've seen over a number of years.

Okay. That's all I have. Thanks very much, guys.

Thank you. Your next question is from Paul Quinn from RBC Capital Markets. Please go ahead.

Yeah, thanks very much, and good morning, guys. Good morning, Paul. Just following up on this fiber, I guess, fiber to the pulp mill availability question, can you remind us what CAMFOR is supplying to CAMFOR pulp in terms of fiber availability, and is this materially going to shift with your round of curtailment announcements?

Yeah, so Paul, typically CAMFOR supplies between 60% and 65% of CAMFOR pulp's requirements. So clearly there's some correlation with curtailments that we've been taking. Having said that, As we mentioned in a press release, we have pretty reasonably cost options in terms of whole log chips with our chip plant that's quite adjacent to our Northwood mill in particular. So there's a number of things that we've been doing clearly to mitigate the actions there.

Okay, and just on the curtailments themselves, it sounds like, you know, from my perspective, you guys have done just a a huge amount of the heavy lifting required to balance out this BC log availability versus log demand side. Is it surprising to you that we haven't seen, I guess, some of the smaller privates take out some capacity given where pricing is and where their mill economics are?

Yeah, I'm not, you know, I don't know if we're surprised or not. I think at the end of the day, we've tried to, you know, just really focus, you know, maybe unlike the past, but really focus on what's the best economic footprint in British Columbia for ourselves, really. And that's really what we've been focused on more than ever. And we really, and it's absolutely tried to not worry too much about what anybody else is doing, really. I mean, we've got lots of work to do ourselves. And so that's where we really spend our time, Paul. And I think, you know, what I do think as we go forward here, I mean, you know, that we would expect, though, particularly companies that don't have a lot of fiber security or self-sufficiency, that they'll be having to make some of the tough decisions that some of the other companies have already made. And we think that that will happen. Our expectation would be over the next probably 30 days, 60 days, that we'll start to see some of that perhaps.

Okay, that's fair. And then I guess, you know, we talk a lot about BC log costs, but you've got a mill in Alberta. Maybe you could just give us an idea of what you're seeing there in terms of relative log costs and then what you're seeing on the inflation side.

Steve, I want to hear it.

Yep, sure. Good morning, Paul. So I'm probably not going to give you as much as you'd like there, but maybe suggest that it's definitely lower log costs in Alberta. We're really pleased with our Alberta operation. I could use a couple more of them, but relative to British Columbia, certainly the costs are far more competitive, and we're pretty happy with our position in Alberta.

Are you seeing any kind of log price inflation there, or how sensitive is that Alberta log pricing model or stumpage model to lumber prices?

Yeah, as I think you probably know, Paul, it's far more responsive to the lumber markets and quicker reaction in terms of the current market conditions. So we're seeing better stumpage in Alberta than currently we're facing in British Columbia.

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

Thank you. Your next question is a follow-up from Mark Wild at BMO Capital Markets. Go ahead, please.

Yeah. I wondered, Don, if you and the crew could just give us a little more color on what you're seeing in China right now in terms of both demand and, you know, how you think the inventory situation is.

Yeah, for sure. We'll give you two views, one on lumber and one on pulp. So, Kevin, why don't you start with lumber and then, Brian, give a pulp update there.

Sure. So for sure, our shipments into China are down a little bit here, but largely reflecting lower volumes of low-grade that we're making. And so we do expect that trend's going to continue, and the offset to that will be just more focused on some of the higher-volume products into China, and in fact, even expanding into Southeast Asia. And for sure, some softness in the market there, but it's a reallocation and a focus on where we're channeling our energies on the market development to higher value products there.

Good morning, Mark. Yeah, on the pulp side, for sure, we're in a seasonally slow period in China. But on the positive side, the curtailments announced over the summer period by Elam and ourselves has definitely helped stabilize the market. And in fact, we've seen a modest uptick in softwood pricing in China this month.

That's good news. Is it possible to get some sense, Alan, of how we might see your realizations move kind of between the second quarter and third quarter? I think you mentioned that a lot of the decline will show up in the third quarter just because of timing on shipments.

Yeah, it's a fair question, Mark. I'm not sure I'm going to be able to help you a whole lot on the call, but I appreciate where you're coming from. But I think typically there's a little bit of a lag here, as you appreciate, between taking orders and when we actually ship the product. So if you factor in what happened in May and June and certainly take a percentage of that and roll that in for a good part of Q3, you're probably not going to be too far off as a starting point. but it is not easy to financially model. You've got a week order file in there. You've got spot prices moving around in contrast to a more stable contract business as well, but that would be the only guidance I could give you, Mark, just to at least start you off there.

Yeah. The final one I've got is just, you know, the lumber market, you know, seems particularly weak right now. I'm just curious that, Random links price on the SPF 2x4 is down at like $3.22 last night. A, can you generate cash at those kind of levels in B.C. right now? And then, you know, B, I just wondered if you had any thoughts on what was going on in the repair and remodel market because I've, you know, heard some commentary over the last couple months about big box retailers really trying to pull back on their inventories in the U.S., the Harvard Center for Housing Studies recently pulled down their both historical numbers on repair and remodeling spend and also put out a pretty cautious outlook if we look forward a year. So I wondered if I could get your perspective on the market from both of those angles.

Why don't you start with the market first, Kevin? I can't remember if you've done a lot of work around that.

Yeah. So, Mark, based on like what we're seeing in the market there on the R&R side, we've actually had some pretty good growth year over year. So it's actually it started in Q4 of 2018. And we've seen that trend continue all the way through the current state. And in fact, we see that trend continue for the balance in the year and into next year. So it's the one segment that we've actually seen some pretty good growth from a volume unit point of view.

Mark, just maybe one other on addition to that, because that's exactly right, Kevin. But I mean, because we've heard similar comments that you just raised there. But I mean, at the end of the day, the one thing about the retail businesses that we've been dealing with for a long time is through the VMIs. And it's a really good indicator of true demand, right? There's no speculation there, right? Absolute takeaways. And like Kevin mentioned, in all of the distribution areas, pretty much where we have product, We've seen those kind of increases overall. So, I mean, for us, we're definitely not seeing what some of these external consultants or whatever they're called have been talking about overall, which is actually encouraging. And it's quite significant growth, actually, that we're seeing, as Kevin mentioned, right? So, Stephen, in terms of the cash costs and so forth,

Yeah, I mean, and Mark, you know, I guess maybe the way I would, you know, the only guidance I can give you there is that I think it's well reported that the current market levels are unsustainable from a BC perspective, given our fiber costs and operating costs. Numbers in the low 300s on a two by four to a better basis are well below cash break, even for the BC sector as a generalization. And that's unsustainable. And I think you're seeing the impacts of that with all the capacity reductions you've seen across the industry.

Okay. That's really helpful, guys. Thanks very much. Thanks, Mark. Take care.

Thank you. There are no further questions. I will now turn it back over for closing comments.

All right. Thank you very much, operator. And thanks for everybody that joined the call and look forward to talking to you at the end of Q3.

Ladies and gentlemen, this concludes today's conference call. We thank you for participating and we ask that you please disconnect your lines.