Canfor Corporation

Good morning, ladies and gentlemen, and welcome to the Canfor and Canfor Pulp third 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. And I would like to turn the meeting over to Mr. Don Kane, Canfor and Canfor Pulps Chief Executive Officer. Please go ahead, Mr. Kane.

Thanks very much, Operator. Good morning, everyone, and thank you for joining the Canfor and Canfor Pulps Quarter 3 2019 Results Conference Call. I'll make a few comments before I turn things over to Alan Nicol, our 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 three. Joining Alan and I today are Kevin Pankratz, our Senior Vice President of Sales and Marketing, Stephen Mackey, our Senior Vice President of Canadian Operations, and Brian Nguyen, our Vice President of Pulp Sales and Marketing. As everybody is aware, in August, Great Pacific made a non-binding proposal to acquire all the outstanding common shares of Canfor. Canfor's board of directors has formed a special committee of independent directors to review the offer in consultation with its legal and financial advisors. The decision to proceed or not proceed with the proposal is in the hands of the special committee and ultimately the shareholders if recommended by the special committee. While that process is underway, we continue to focus on operating our business as usual and unfortunately do not have additional information in regard to timing or outcome at this time. As such, we cannot speculate on either the timing or the decision to proceed or not during this call, as I am sure you all will understand. Moving to our specific Q3 results, the quarter was challenging for both our pulp and lumber businesses. resulting in us having to make very difficult decisions that involve temporary and permanent curtailments in British Columbia. On the pulp side, we took phased summer curtailments at our Intercon Northwood and Prince George MBSK mills, as well as at our BCTMP mill in Taylor. While these curtailments are difficult, we believe they will support a quicker market recovery in addition to solidifying our chip inventory over the winter months. On the lumber side, we made the very difficult decision in July to indefinitely curtail our McKenzie sawmill. At the same time, we also announced the permanent elimination of one shift at our ILPR mill, and we announced temporary sawmill curtailments mostly in July and September. We have not taken any of these curtailments decisions lightly. However, they reflect the very challenging lumber market conditions in combination with high fiber costs in British Columbia. On behalf of myself and the entire executive team, I want our employees to know that we deeply regret the very real impacts these decisions have had on them, our contractors, and the local communities. With the exception of McKenzie, all of our sawmills and pulp mills are currently operating. Now we'll go into a bit more detail on each of our business lines. Beginning with our pulp business, we were challenged with weak global pulp market conditions, significant market-related downtime, and fiber supply issues in British Columbia. This was the third straight quarter of weak demand combined with excess inventory in the supply chain, most notably in China and Europe, which significantly impacted global pulp prices. On the positive side, energy revenues increased in Q3, largely driven by Northwood's new turbo generator condensing turbine and higher energy prices. Looking forward, it's expected that global pulp pricing will gradually improve in Q4 and into 2020 as global inventories will come back into balance. Moving to lumber, in June we announced the permanent closure of our Wavenby Mill and subsequent agreement with Interfor to sell them the associated tenure for $60 million. The tenure transfer is subject to approval by the Minister of Forests and we continue to work through that process. We anticipate the sale will close in Q4. SPF pricing continued to be challenging in Q3 with excessive inventory impacting overall price levels. While several industry curtailment announcements were made over the last six to nine months, we believe we are just now seeing the impact of these curtailments in the market. U.S. housing starts increased modestly over the quarter, and we anticipate that that trend will continue through the balance of the year. Lumber prices in Asia, particularly in Japan, are expected to return to more normalized levels in Q4. Our lumber operations in Alberta, the U.S. South, and Europe remain strong. Price of Southern Yellow Pine remained steady over the quarter, although our sales were slightly lower than last quarter. Our European lumber business saw tempered pricing in the quarter as a result of global market weakness, but was somewhat insulated from broader pricing declines due to the relatively higher value customized products that Vita produces. This pricing pressure is expected to continue through the balance of the year and should stabilize in early 20 as global inventory levels continue to come back into balance. We remain focused on continuing to reduce our debt levels and continue to strengthen our balance sheet. I will now turn it over to Alan to provide an overview of our financial results.

Well, thanks, Don, and good morning, everyone. As Don mentioned, the Canfor and Canfor Pulse 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 this morning, I'll expand a little on the number of Dawn's points and also speak specifically to several quarterly financial highlights. Our lumber segment reported an operating loss of $70 million for Q3 compared to a loss of $61 million reported for the previous quarter. Results included a net duty expense of $54 million, restructuring costs of $6 million, and a $5 million reversal of a previously recorded inventory write-down provision. After adjusting for these items, the lumber operating loss was $16 million. Lumber segment results continued to reflect the ongoing weakness in Western SPF lumber prices, high duties, and elevated log costs in British Columbia. As Don mentioned, Canfor took significant market-related curtailments and capacity reductions in Q3, and as a result, shipments were down by 16% compared to Q2, while overall sales revenue declined 12%. Average Western SPF sales realizations saw a modest increase from the prior quarter, largely reflecting a small increase in benchmark prices and our sales mix. For our U.S. South business, average sales realizations were slightly lower than the previous quarter as the modest improvement in the 2x4 number 2 price was more than offset by lower prices for wider width dimensions. European sales realizations saw a small decrease with the region's higher value sales mix partially offsetting a decline in European benchmark prices. Our pulp and paper business reported an operating loss of $44 million for the third quarter, down $62 million from the $18 million profit reported for the second quarter. The loss reflected the very weak global pulp market conditions that Don mentioned, as well as the significant fiber supply disruptions from industry-wide sawmill curtailments in the BC interior over the summer months. Average sales realizations were well down compared to the second quarter, reflecting this backdrop. Hope production was down 42% from the previous quarter, principally reflecting the impact of 135,000 tons of market-related downtime. Hope unit manufacturing costs were significantly higher in the current quarter, largely due to that curtailment, and to a lesser extent, the advancing of some planned maintenance work during the downtime. Fiber costs showed a small decrease quarter over quarter with the impact of lower market prices for sawmill residual chips tied to market pulp prices, helping to neutralize the effect of an increased percentage of higher cost whole lot chips. Capital spending for the third quarter totaled approximately $76 million and included approximately $50 million in the lumber business and $26 million in chemical pulp. For 2019, we are forecasting a total capital spend of $180 million and $80 million for Canfor and Canfor Pulp respectively. We currently anticipate much lower capital spending in 2020 following the completion of our U.S. $125 million organic growth program and several other major upgrades by early 2020 and our strong focus on debt reduction. During the third quarter, Canfor increased its operating line of credit from $450 million to $550 million, maturing in January 2024. In addition, Canfor Pulp extended its operating line of credit through April 2023 and added a new three-year $50 million term loan expiring September 2022. At the end of the third quarter, Canfor, excluding Canfor Pulp, had net debt of approximately $1 billion and a fillable liquidity of just over $300 million. Canfor Pulp ended the third quarter with net debt of approximately $30 million with a fillable liquidity of just under $100 million. And lastly, Canfor Pulse directors approve the continuance of a quarterly dividend of six and a quarter cents per share for the third quarter.

And with that, Don, I'll turn the call back over to you. Thanks, Alan. Operator, we're now ready to take calls from analysts. Thank you.

Thank you, sir. Ladies and gentlemen, we will now take questions from financial analysts. If you do have a question, please press star on your telephone keypad. Star one, my apologies. If you are using a speakerphone, we do ask that you please lift your receiver and then press star 1. If at any time you wish to cancel your question, please press star 2. Please go ahead and press star 1 now if you have a question. And your first question will be from Mark Wild at BMO. Please go ahead.

Good morning, Dawn. Good morning, Alan.

Good morning, Mark.

Don, I know you can't really say much about this Pattison bid. I'm just curious if it is possible to put any color around the selection of Greenhill as the advisor. I've been covering the sector for about 30 years. They have not ever been a real active player or a real knowledgeable player around this sector, so I'm just curious about how that decision might have been made.

Yeah, I guess, first of all, I can't say much at all, Mark, as you probably understand. As I mentioned earlier, I just know that they went through a process, the committee, and I wasn't involved in it, and so they chose Greenhill, and that's all I can really say.

Okay, all right, fair enough. I wasn't sure you really could say much more. Okay, all right, well, let's turn to the business end. First of all, I wondered if you could... Talk about just sort of lumber demand at the moment and how you guys see kind of lumber inventories in the channel.

Yeah, okay. I mean, I'll talk a bit about that at a high level and maybe turn it over to Kevin, who's a bit closer to it, a lot closer to it, actually, than I am. But I think, you know, like everybody else, we've been over the last few quarters here, you know, concerned as to where that was headed. But it does, you know, and because it's been several false starts over the last probably couple, three quarters, but we are seeing... And partly because inventory levels, we think, are starting to decline a bit more rapidly now. It's taken some time due to these announcements that were made six or nine months ago. It's taken a lot longer to see that in the supply chain that we would have anticipated. But we do think now we're starting to see the result of that. And so that combined with pretty decent housing starts and permits in North America is A bit of an improvement in China around inventory levels, and then Japan, just over there recently, seems to be pretty good. So between all of those things, demand-wise, it's not a big increase, but I think it's started to at least look a little bit more positive. And supply, we're starting to see the inventory starting to have an impact on that. So overall right now going forward, I think we would see things probably looking slightly better over the next couple of quarters. Kevin, you've been over there recently yourself in China particularly.

Yeah, so we're seeing some good inventory depletion at the major ports. And to your point there, Don, we're starting to see a little bit more tension in the market compared to what we have seen earlier in the year, which I think is boasting for a little bit more of a positive uptick for the balance of the year and into 2022. Okay.

And then, Don, I wonder if we could just talk for a minute about this European spruce beetle and the impact of that on the Vita business over in Europe and then also sort of any ripples into the southeast U.S. lumber operations and also potentially into your Chinese export markets.

Yeah, for sure. Well, give me a status at the start that the beetle issues that's being faced in Europe right now are probably more severe than most people probably had expected them to be. And so in Germany, Austria, and certainly all of Czech, it's pretty serious, right? And so as a result of that, there's a lot of log, you know, a lot of the fiber there has been and will be degraded quite significantly, which is resulting in more commodity products being produced. Some of that's going into North America, obviously some of that's going into China and so forth, and it's having some impact. If you look at the North America though, particularly compared to where it was 10, 15 years ago when we were importing in the past, we still don't see anywhere near the same amount of volume coming into North America. that we saw back then, and neither do we expect that to happen either. There's been a bit more in China too, but even there, it's not really having a significant impact on our business for sure. In terms of, good question, how is that going to impact us in Sweden? Actually, the one thing, and we went through exactly the same thing when we got into the Pine Beetle in British Columbia, what we just saw is pretty quickly an immediate reduction in the amount of prime percentage and premium products. That's exactly what's going to happen in Europe as well, who in the past has been pretty significant high-value product producers. In Europe, so in Sweden, because we don't have the beetle or 1% or less there, mostly probably less, we actually think with that reduction in high-value products coming out of Austria, Germany and Czech, it's actually going to benefit us up there in Sweden because they don't have to deal with that, and they do mostly make high-value products. So it actually, for us at least, will have, we think, a positive impact on our Swedish returns on a long-term basis.

Okay. Now, just one more for me. I wondered, Alan, you know, when we look at sort of the first three-quarters of the shootout here with Vita, you know, the numbers have been coming down steadily, right? I wondered if you guys can just address sort of, you know, whether this has changed your view of earning stability at Vita. And also, in the third quarter, if you can just help us understand how much of the decline was kind of price versus the summer outages.

Yeah, I hope I can help you a little bit there, Mark. In terms of your first point, I think clearly, as Don guided, there is somewhat downward pressure there. But I think we're comforted, I think, with how well those businesses are running. We are seeing log costs respond accordingly, and so that's clearly going to be a mitigating impact. But I think probably appropriate to caution for some conservatism in your numbers, but I think we're comforted by some of the mitigating factors there as well. In terms of the third quarter, as I think we disclosed in our press release, you know, the feeder did take a month. downtime and clearly that weighed on the shipments and the costs and so on. So one just has to take that into account. But as I mentioned earlier, our sales mix and some of what Don outlined is clearly helping us mitigate some of the impacts from more of the commodity pricing movements in Europe today.

Okay. I'll turn it over. Thanks. Thanks, Mark.

Thank you. Next question will be from Sean Stewart at TD Securities. Please go ahead.

Thanks. Good morning, everyone. A few questions. First, on the timber sale to Inter4, you guys indicated you still expect or you do expect a Q4 close. This is dragged on a little bit longer than initially thought. Can you give us a little bit more detail on the process with the government approval and what have been the hang-ups and what gives you confidence that this will close in the fourth quarter?

Yeah, I think, first of all, we're confident that it will close in the first quarter or fourth quarter. Sorry, I'll say that right away. You know, I think, you know, we expected this thing to maybe close, you know, maybe a month or two quicker than it has. But clearly, you know, us being the first ones to really go through this process, you know, as you go through it, there's some things that you learn and things that maybe take a bit longer than you thought, perhaps. But But we really, you know, at the end of the day, so far it's kind of gone as we expected. I don't think we've had any major surprises at all. Some areas we probably had to put a little more work into it and so forth. But for the most part, I think it's kind of, it's just other than taking a bit longer, we haven't had any real big material surprises whatsoever. And as I said at the start, we do expect it to close in Q4.

Okay. Thanks for that. And then question on the pulp operations. Post the heavy downtime you had in Q3, can you give us an idea of what percent of the fiber will be tied to whole log chipping on a normalized run rate going forward and an update on the cost differential between whole log chipping and residual chips right now?

Yeah, no, it's a good question. There, Sean. So I think clearly what I would say is that the actions, as tough as they were in the third quarter, have positioned us well here to run through the winter months, and we're in a much, much better position and clearly had to take the response that we did. In terms of your question around OLOG chipping, I would say that historically it's been a lot lower than it is today, but looking forward, I think you could use something like 30% or a third. That's what we're kind of anticipating, something like that.

and the cost differential between that and residual chips right now?

Well, yeah, so it really depends on many factors, and clearly we're motivated to apply a lot of cost discipline there as well, but it's a fair statement to say it comes at a healthy premium to some of the residuals today.

No details on that, Alan?

That's as much as you're prepared to say. Not many more that I can share with you, no, not on the comment.

Okay, that's all I have for now. Thanks, guys.

Thank you. Next question will be from Paul Quinn at RBC. Please go ahead.

Thanks very much. Good morning, guys. First question, maybe just on the log cost side, what you're seeing, whether you're seeing any inflation in the U.S. South. I suspect BIDA's costs are coming down slightly, and then Alberta versus B.C.,

Stephen, why don't you give an update across all the regions? Sure. Yeah, good morning, Paul. So I think, you know, if I start in BC, Paul, and maybe a contrast against Alberta, I mean, clearly there's a stumpage differential between BC and Alberta. So we enjoy that benefit in our Alberta operations. You're aware, obviously, that the July 1st stumpage increase was pretty significant in British Columbia. But we're pleased with some of the actions we've taken internally to mitigate those impacts. So relatively speaking, quarter over quarter, pretty flat log costs and Starting to see some relief in British Columbia on pressure on purchase wood prices and bid behavior out there in terms of BCTS sales, which we're seeing a little bit of benefit from. So we're expecting relatively flat log costs in BC. And similar situation in Alberta. Alberta will be pushed up a little bit as market improves, as Kevin and Don indicated earlier. The guys have touched on VIDA. We're seeing corresponding reduction in log costs to reflect market conditions and the downward pricing pressure that Don indicated. So in Europe, we're pretty pleased with the responsiveness of the market. And the U.S. South is really quite flat. There's an abundance of timber, high-quality fiber available there, so flat.

Okay, and just maybe just follow up on that. BC, you're expecting log costs to be flat going forward, but my understanding was you did quite a bit of logging in front of the July 1st stump increase. So isn't that going to be if, you know, that increase will be effective on all the stuff that you're logging, you know, through the balance of the year and in the first half of next year? Won't that increase your overall cost?

Yeah, we're expecting there is some upward pressure there for sure, Paul. And we're in pretty good shape with healthy inventories. Obviously, we've taken some pretty significant downtime and capacity reductions across our operations and taken lots of steps to reduce some of the high-cost fiber that we've got in front of our mills. So we're confident we can offset that to a large degree. So I think I would guide to relatively flat quarter-over-quarter log costs.

Okay, and then maybe just flipping over to the pulp side, pulp costs were up significantly quarter over quarter. A lot of it attributed to the downtime. Just wondering how much can we put on that market-related maintenance downtime in terms of the cost increase quarter over quarter?

No, totally fair question. Paul, I mean, I think honestly the lion's share of that delta was. I think the maintenance, the fencing of the planned maintenance work was a smaller percentage, just to put it in context, about $7 or $8 million. But I think the principal reason clearly was tied to the fertility illness.

Okay, then just while I got you, Alan. This sounds like you guys are more bullish than most other people I've seen out there on pulp turnaround here, expecting a gradual increase in pricing in Q4. What gives you that level of confidence?

Yeah, so I'll maybe pass it over to Brian to speak to that. But I think in our minds, we didn't think we were being extremely positive by talking about a modest recovery fall. But I'll maybe just ask Brian. Brian, to speak a little bit more to what we're seeing in the market and where we're expecting prices to trend here.

Sure, I can speak to that, Alan. Good morning, Paul. We're actually seeing a stabilization in the market for sure. With the price corrections over the summer, we've seen an uptick in Chinese demand. Paperboard tissue producers, these guys are all making solid profits given the lower fiber costs and the relatively stable paperboard tissue prices. We are, in fact, actually seeing some modest improvements going into the fourth quarter in Chinese pricing. What we are keeping a close eye on, however, are the hardwood inventories. For sure, this needs to get in balance before we see any significant improvement in all prices.

Okay, great. Thanks for the call. Good luck going forward. Thanks, guys.

Thank you. Next is a follow-up from Mark Wild at Bebon. Please go ahead.

I just want to go back to these log costs because on page three of the release, you talk about the increase in stumpage in B.C., and there's a line in here that says this will materially impact B.C. log costs in the upcoming quarters. So I just wondered if you can kind of square that with what we just heard about stable log costs.

For sure, Mark. I'll get Stephen to comment on that. Yeah, sure, Mark. I think that, you know, while we certainly do expect pressure, you know, on stumpage and, again, back to the July 1st stumpage update and increase, and we'll also see some further upward pressure as a result of improving market conditions and AMB updates that will push stumpage up. I guess it's a bit of a function of some of the actions that we're taking internally to mitigate those costs and really the great effort by our teams across the BC business to be responsive to the economic times that we're facing and a lot of good work. So I'm probably a little bit more optimistic on what we're able to achieve there to try to mitigate those cost increases.

Okay. Any examples of things you can do?

Not probably not a lot of stuff that I'm going to disclose here, Mark. But I think, you know, fair to say, obviously, the capacity reductions across B.C., our own and others, temporary and permanent, are having an impact on the purchase wood market. And we're seeing a change in bidding behavior that is helping offset some of those high cost fiber.

OK, that's helpful. Don, any thoughts on just sort of the potential potential? for some right-sizing and kind of Western Canadian pulp capacity, just given the fiber constraints?

Yeah, hard to say at this stage yet, but, I mean, just like we've seen happen on the lumber side, I mean, ultimately there's probably going to be some impact down the road yet, and we're certainly looking at that, aware of that, and watching that carefully ourselves. But, you know, as Alan mentioned, I believe in his comments, I mean, we think with the work that we've been doing on our – chip supply and our raw material supply for the pulp mills. You know, at least for now, we think we can certainly move forward with the production levels that we have today.

Yeah, okay, that's helpful. I think that's it for me.

Okay, well, thanks, Mark. Good to talk to you.

Thank you. Ladies and gentlemen, at this time, we have no further questions, so it does conclude your conference call for today. We would like to thank you for attending and ask that you please disconnect your lines. Enjoy the rest of your day.

All right. Thanks, Operator. I look forward to talking to you all soon.

Thank you, sir.