Canfor Corporation

Good morning, my name is Michelle and I will be your conference operator today. Welcome to the Canfor and Canfor Pulse third quarter analyst call. All lines have been placed on mute to prevent any background noise. During this call, Canfor and Canfor Pulse 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 Corporation's President and Chief Executive Officer. Please go ahead, Mr. Kane.

Thanks, Operator, and good morning, everyone. Thanks for joining the Canfor and Canfor Pulse Q3 2022 Results Conference Calls. I'll make a few comments before I turn things over to Kevin Hedson, CanForce Pulp's President and CEO, and Pat Elliott, Chief Financial Officer of CanFor Corporation and CanFor Pulp, and our Senior Vice President of Sustainability. In addition, we are joined by Kevin Pankratz, Senior Vice President of Sales and Marketing. The third quarter resulted in reduced margins in our lumber business as prices moved lower throughout the period. However, we continue to benefit from the diversification of our earnings stream as Europe and the U.S. South generated solid returns. Our strategic growth in regions that have strong and competitive fiber baskets, the U.S. South, Sweden, and Alberta, will allow us to generate more consistent earnings throughout the cycle. In British Columbia, the allowable annual cut continues to decrease due to the mountain pine beetle damage, government policy decisions, species at risk, and wildfires. We continue to assess our operating rates against the available fiber supply in the region and remain focused on producing higher value products and managing production to meet market demand in order to maximize the value of every consumed log. As a result, Canfor took operational downtime throughout the third quarter, with the majority of our BC sawmills continuing to operate today on a reduced basis. I want to acknowledge our employees for their ongoing hard work and dedication. Through the downtime, we have worked to support our employees and thank them for their flexibility. U.S. lumber demand in the repair and remodel sector remains solid throughout the quarter. However, with rising interest rates, ongoing inflationary pressures, and reduced housing affordability, slowing new home construction activity in the U.S. led to lower demand in that segment. In Europe, our largest lumber business generated solid financial results in the third quarter, despite the impact of seasonal downtime, principally in July. Rising interest rates, inflationary pressures and soaring energy costs in Europe have, however, contributed to a sharp decline in lumber consumption in recent months, particularly for the retail sector. Even though pricing is anticipated to remain relatively solid, we will continue to evaluate market activity levels and manage production as necessary through the fourth quarter to align with current demand. To date, the mills have taken minimal downtimes. Notwithstanding the current macroeconomic uncertainty, North American lumber prices continue to trade above pre-pandemic levels. Supported by lean inventories throughout the supply chain, steady underlying demand in the repair and remodel sector, and pent-up demand for new home construction in the United States. While inflationary pressures are anticipated to persist in the near term, we remain focused on growing our lumber business on a global basis, currently through three major capital projects in the U.S. South. I will now turn it over to Kevin to provide an overview of Canfor Pult.

Thank you, Don, and good morning, everyone. Canfor Pult had a strong third quarter. with solid financial results driven by sustained strength in global pulp pricing and an improved operational performance. This contributed to a 4% increase in pulp production despite planned maintenance downtime at Northwood and Intercon during the quarter. As previously discussed on these calls, the management team at Can4Pulp remains focused on improving asset reliability and running the mills more consistently. We have seen some positive momentum in this regard over the last few months and I expect continued progress over the coming quarters. Sourcing economic fiber remains a challenge in BC due to the decreasing residual chip supply and inflationary cost pressures on pulp blocks. As a result, we recently announced extended downtime at our intercom mill in order to better balance our chip supply for the winter. Transportation networks improved through the third quarter and in general, we're able to support our production volume. Our tailor mill continues to be faced with supply chain challenges, and at this time, we are not anticipating a restart before the spring of 2023. While we are encouraged by recent operational performance, we are prepared to adjust future operating plans to match available logistics and economically available fiber. We appreciate the resilience and dedication of our employees as we manage through these headwinds. I will now turn it over to Pat to provide an overview of our financial results. Thanks, Kevin, and good morning.

The Canfor and Canfor quarterly results were released yesterday afternoon and come together with our overview slide presentation in the investor relations section of the respective companies' websites. In my comments this morning, I'll speak to quarterly financial highlights, a summary of which is included in our overview slide presentation. Our lumber business generated operating income of $102 million in the third quarter, which included a net duty recovery of $98 million and a $90 million inventory write-down related to logs in British Columbia. Results reflected a steady decline in global lumber prices throughout the quarter, as well as the effect of significant operational downtime in Western Canada. As Don mentioned, we continue to realize the benefit of our diversification strategy with our European operations contributing $57 million in cash earnings in the third quarter, despite taking its traditional summer downtime. Looking ahead, we anticipate a more challenging fourth quarter reflecting current lumber market conditions, as well as the impact of downtime on unit manufacturing costs. While we expect B.C. stomach rates to fall in the fourth quarter, it would likely take much of the quarter before we realize those lower prices into our results. Our pulp business generated operating income of $19 million in the third quarter, an improvement of $27 million quarter over quarter. As Kevin mentioned, third quarter results benefited from significantly higher sales realizations and improved productivity, offset in part by increased fiber costs. Despite significant challenges in recent quarters, Canfor Pulp has maintained its strong balance sheet and remains focused on improving productivity, closely managing inflationary cost pressures, and optimizing the available transportation and economically available fiber. Capital expenditures were approximately $139 million in the third quarter, including approximately $29 million for Canfor Pulp. We project capital spend of approximately $450 million for our lumber business in 2022 and approximately $110 million for Canfor Pulp. Looking ahead to 2023, we are currently forecasting a capital spend of approximately $500 million for our lumber business, including the remaining spend on our Derrida Greenfield sawmill, which is currently on track for completion in the first quarter of 2023. We also anticipate being modestly active on Canfor's share buyback program in the fourth quarter. As Canfor continues their focus on asset reliability and productivity improvement, our expectation for capital spending in 2023 pending on market conditions.

And with that done, I'll turn the call back over to you. Thanks, Pat. So, operator, we're now ready to take calls from our questions, excuse me, 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. Our first question comes from Mark Wilde of Bank of Montreal. Please go ahead.

Thanks. Good morning, Don, Kevin, Pat. Good morning. Good morning. First question I have, Don, if you would just give us a little more color on the European lumber situation, because it sounds like you might be taking a little less downtime than you were pointing to a month or two ago.

Yeah, for sure, Mark, and that's correct, first of all. We anticipated initially that we would be taking a little more than we've had to, but we've been fortunate, despite the challenges in our key market in the UK, we've been able to do a real good job the guys here on the ground here have done a really good job along with our marketing group in Vancouver to move a lot of that volume quicker and more expeditiously than we would have thought to alternative markets so we've been a real real surprised and that's one of the reasons why we would have done that okay is it also is it possible Don to get some sense of how much price has moved in the European market I know it moves differently than it does here in North America but if we could just get some sense of

price movement?

Yeah, Kevin, you want to talk about that a little bit? Yeah, for sure, Mark. I would say that that 10%, 12% range down is quarter over quarter. There was a bit more pressure towards the end of Q3, but that's in that range is sort of what we experienced.

One thing, Mark, just to quickly add, in terms of our Europe saying this, but we'll say it again. One of the reasons why we focus heavily on Europe and we have for a while is the flexibility that it presents us that you often don't see that in other markets. So we really see that. So we're able to move around as we see fit to take advantage of market levels as we see fit. So it's really that part of our acquisition has really turned out at least as good or better than we ever expected.

Yeah, just one more on Europe. What's your expectations when you look into 2023 in terms of European volume into the North American market. I mean, demand is down in both markets, but the Euro is quite weak now, which you might think would push a little more volume over toward North America.

Yeah, and we let Kevin talk about that. I'm sure he can add on, Kevin. But I mean, yeah, that's clearly what we're seeing, and that's one of the alternatives that has really come about here over the last little while here. But yeah, certainly we see an increase in North America to a degree. I'd Kevin, you know way more than I do.

Yeah, well, just what I'm hearing there too, Mark, is that underlying demand is pretty good. The big issue that they're dealing with over in Europe is really about energy and really how it's going to play out over the next six to eight months. And then I think if energy prices come down to a certain degree, then you could see potentially a pickup in some European demand. But short term, for sure, I think you can expect to see increased volumes coming into North America. And actually other markets as well.

Okay. All right. And then, you know, the other question I have is just on capital allocation and the share repurchase. You know, if I go back to 2018, you bought a couple million shares up at 28. And today the stock is $20 a share. You've got over $10 a share in net cash and $7 a share in deposits. It looks like a far better value than it was in 18. So I'm just, I'm curious as to why we're not seeing a little more activity there. It didn't look like there was anything in the third quarter.

I want to talk to Mark a little bit about that, and we can maybe talk also about overall capital allocation and what we're thinking.

Yeah, sure, Mark. So, yeah, I'm not sure I can reconcile that. map to 2018 directly. What I would say is, you know, we've kind of been thinking that there's a fullback coming. I don't think that's a big surprise. We've, you know, made some significant capital investments, three big projects, as Don mentioned, in the U.S. South, the guts of the U.S. $500 million. And I just think, you know, we kind of took a little bit of pause and assess how things are going to play out. We do have a very strong balance sheet and we want to have a very strong balance sheet, but we also want to be able to build and diversify our business either through organic growth or M&A and you know, frankly, I think arriving into a weak market with a balance sheet like we have is going to be a strategic advantage. So, you know, we're always going to do this on a modest basis anyways, you know, some of the background on that and put it in our stock. So, as I said in my comments, I think we'll be active again, but it will remain a modest part of our overall capital allocation.

Yeah, so for sure, absolutely. And if you look at it overall, like we do, you know, and we've been feeling this way for a late half of the second quarter, the things are going to, demand is going to temper quite a bit due to affordability and probably carry on through the part of 2023. So we try to be extremely disciplined here and, and, you know, call it conservative, whatever you want our patience around the fact that we do believe we're going to get opportunities here over the next 12 to 18 months at a far better value than we've seen in the last 24 months.

Okay. And just, you know, one more Pat, you mentioned that those log costs in BC take a while to, work their way through your inventories. Can you give us just a little more color on that?

Yeah, I'll go for sure. We basically Q3, Q4, Q3 locked off for up to $35 a cubic meter, roughly that, and Q4. And that lags probably two to three months, something like that, into Q1. That would be our guess right now.

Okay. All right. That's helpful. We'll turn it over.

Thank you. The next question comes from Paul Quinn, RBC. Please go ahead.

Yeah, thanks very much. Bye, guys. Bye. Yeah, just trying to understand this European dynamic with lumber prices and log prices. So, you know, what I've seen in the past was, you know, if lumber prices come down, log prices are coming down as well. So that margin sort of seems a little bit more stable than what you'd typically expect to experience in North America. Is that the case right now?

Yeah, I think, you know, for the most part, I mean, we all try to compare it a little bit to the Western Canadian and Southern Yeltsin and that range. anywhere near like it is here in North America.

Okay. And then, you know, maybe over on the camphor pulp side, just, you know, this BC log supply continues to decline. Just wondering, when you look at, you know, future chip availability for the camphor pulp mills, does that equate to all the existing mills that you're offering right now, or is it more prudent to take one mill out of the out of the quiver as opposed to taking some rotating down time because of the locket shift.

Thank you for the question, Paul. I think we all can recognize the fact that there have been both indefinite and permanent curtailment within BC on the sawmilling side. There have been a number of fall passes that have likewise been either curtailed permanently or indefinitely. It would be my opinion that for the industry it is not yet done. As to where we fit will be a function of how well our assets run and what the fiber supply is in our region versus other regions within BC.

Okay, and then just maybe on a thing that's strategic here, there's a couple of pulp mills that are available in eastern Canada. Is that something that you guys would be interested in growing that pulp business on the Camphor Pulp Center?

Well, I think today our primary focus is ensuring that the assets we have are well capitalized and running well before we start looking at expansion. And so at this point, I don't think that that's really a key focus for us.

All righty. That's all I had. Best of luck. Thanks, Paul.

Thank you. There are no further questions. I will turn the call over to Don Kane for closing comments.

All right, thanks, operator, and thanks, everyone, for joining the call, and we look forward to talking to you as the year progresses here. Thanks.

This does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.