Canfor Corporation

good morning my name is Michelle and I will be your conference operator today welcome to can for and can for pulp second quarter analyst call all lines have been placed on mute to prevent any background noise during this call can for and can for 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 company's and 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.

Thank you, Michelle, and good morning, everyone. Thank you for joining the Canfor and Canfor PULP Q2 2023 Results Conference Call. I'm going to make a few comments before I turn things over to Kevin Edson, Canfor's pulp president and chief executive officer, and Pat Elliott, our chief financial officer of Canfor Corporation and Canfor Pulp, and our senior vice president of sustainability as well. In addition, we are joined by Kevin Pankratz, our senior vice president of sales and marketing. In the second quarter, we continued our strategy to align our operating footprint in British Columbia with the available timber supply as our treatment facility was permanently closed. In addition, our Houston facility was temporarily closed pending a potential reinvestment decision. We have worked in partnership with the USW to support our employees through this very difficult transition. These were very tough decisions and we recognize the impact on our employees, their families, our contractors, and the local communities. We are continuing to advance the Houston Brownfield project. We have completed our planning and technical work. We have also engaged in a series of discussions with the Ministry of Forests to understand the future fiber supply outlook for the region. We need to be sure that if we proceed and go forward with construction, we will have the required economic fiber to operate consistently and successfully. Our discussions with government are progressing well. We hope to complete these discussions in the coming weeks, and once satisfactorily concluded, we will be advancing this project to our board. Turning to the current wildfire situation in Western Canada, the 2023 fire season is the worst in Canadian history. Across Canada, over 12 million hectares has been burnt to date, making it the worst wildfire season on record. BC and Alberta have also set new records for the most hectares burned, with British Columbia at almost 1.5 million hectares and Alberta at over 1.7 million hectares. With respect to the wildfires, I'd like to acknowledge the two brave firefighters and pilot who have lost their lives this year battling wildfires in Canada. I want to acknowledge and thank our employees and contractors who are helping respond to the wildfires and are working to ensure continuity across our Canadian operations and protection of our assets. We also thank all of the firefighters, emergency responders, and military personnel who are working hard responding to wildfires across the country. While it is too early to determine the long-term fiber supply impacts, we have seen significant short-term disruptions to our operations, including a three-week curtailment of our facility in Fox Creek, Alberta, in the second quarter. Despite a challenging operating environment and depressed lumber markets in the second quarter, we continue to see positive results from our geographic diversification strategy, with our European and U.S. South operations performing well and generating improved results quarter over quarter. While high interest rates and affordability constraints are projected to persist through the third quarter, we have seen an improvement in lumber prices in the last few weeks, supported by better than anticipated demand and reduced supply. We are encouraged by the medium to long-term market fundamentals and remain focused on executing our diversification strategy and organic growth plans. Our new facility in Derrida, Louisiana continues to ramp up production and is performing well, with a second shift expected to be added late in Q3. Our other projects remain on schedule and on budget, including the rebuild of our sawmill in Urbana, Arkansas, our second greenfield sawmill in Alabama, and our organic growth in Sweden. In addition, we continue to review additional organic and external growth opportunities as we look to grow our lumber business on a global basis. I will now turn it over to Kevin, to provide an overview of Canfor Pulse.

Thank you, Don, and good morning, everyone. I want to start with an update regarding the impacts of the labour dispute at BC's ports. The 13-day strike, followed by an on-again, off-again job action, has severely impacted our supply chain. For reference, approximately 70% of our pulp shipped through these ports, both in Vancouver and Prince Rupert. As a result, we announced a curtailment at Northwood in July, which lasted a week and resulted in approximately 10,000 tons of reduced MBSK production. We anticipate the supply chain challenges to persist through much of the third quarter, and with our pulp mill inventory near capacity, we are closely following the union's ratification vote, which is expected to conclude today. Turning to our quarterly results, Kanfor pulp had a challenging second quarter with elevated global pulp inventories and tepid demand resulting in a significant decline in pulp pricing. We implemented the permanent closure of the pulp line at our Prince George pulp and paper mill on April 1st. I'd like to take a moment and thank our employees for their commitment to safety and dedication and resiliency as we navigate the current challenges facing our business. With our operational footprint now better aligned with the current available fiber supply, we anticipate an improvement in our cost structure going forward. In addition, we believe there is significant opportunity to improve our operational efficiency and reliability, which will support the sustainability of the company for the foreseeable future and allow us to capitalize on the strong global pulp market fundamentals we believe will remain over the medium to long term. To achieve this goal, we have identified a significant capital reinvestment plan with approximately $500 million of capital spend identified over the foreseeable future. This includes a major rebuild of the recovery boiler number one at Northwood, which will significantly extend the useful life of this critical asset. We currently anticipate the work on the boiler to commence in 2025, although this timeline may be accelerated or deferred depending on the condition of the boiler, which will be inspected during our planned maintenance outage in the third quarter. We currently anticipate spending of more than $120 million on RB1, subject to final engineering and labor costs at the time of installation. The balance of the recapitalization consists of smaller projects aimed at improving reliability and asset performance. While timing and magnitude of spend will take into account market conditions and available cash flow, we currently anticipate our annual capital spend to trend in the neighborhood of $100 million for each of the next several years. I will now turn it over to Pat to provide an overview of our financial results.

Thanks, Kevin, and good morning, everyone. The Canfor and Canfor Pulp second quarter results were released yesterday afternoon. In my comments this morning, I'll speak to quarterly financial highlights, a summary of which is included in our overview slide presentation, located, as always, in the investor relations section of Canfor's website. Our lumber business generated an operating loss of $16 million in the second quarter, which included a $64 million recovery of a previously recorded write-down of inventory in Western Canada and an incremental non-cash anti-dumping expense of $23 million. These results continue to reflect losses associated with our operations in British Columbia as a result of weak lumber pricing and a high-cost operating environment. Following the permanent and temporary closures of our Chetwynd and Houston facilities respectively, as well as the decline in market-based dumpage, we anticipate an improvement in our cost structure in BC through the back half of 2023. Notwithstanding the current headwinds facing our industry, we continue to benefit from our diversification strategy with our U.S. and European operations generating strong financial results in the quarter. Our U.S. operations benefited from an improved sales realization as well as a contribution from Derrida, where ramp-up is progressing well. Our European operations contributed approximately $54 million in cash earnings in the second quarter, supported by improved pricing. Canfor pulp generated an operating loss of $38 million in the second quarter, which included a $7 million inventory write-down. These results principally reflected the sharp decline in global pulp pricing, which more than offset a modest improvement in fiber and conversion costs in the quarter. Looking ahead, we anticipate a challenging third quarter as a result of current pulp market conditions, supply chain uncertainty, and planned maintenance downtime at North Swift. Notwithstanding the current challenges facing our pulp business, we believe the longer-term market fundamentals remain strong. At the end of the second quarter, Camphor Pulp had net debt of $46 million with approximately $180 million of available liquidity, including the commitment to receive up to $80 million of new-term debt as part of our capital reinvestment plan. In 2023, we currently anticipate capital spend of approximately $450 to $500 million in the lumber segment, and approximately $70 million for CAMFOR pulp, including capitalized maintenance. In addition, we anticipate CAMFOR will continue to allocate a modest amount of capital to repurchasing shares throughout the year. And with that done, I'll turn the call back to you.

All right. Thanks, Pat. So I'll turn it over to you, Michelle, and we're ready to take questions from analysts.

Thank you. We will now take questions from financial analysts. If you have a question, please press star one on your telephone keypad if you're using a speakerphone please lift your receiver and then press star one. If at any time you wish to cancel your question, please press star to. Please press star one now, if you have a question, there will be a brief pause will participants register for questions, thank you for your patience. Our first question comes from Hamir Patel of CIBC Capital Markets. Please go ahead.

Hi. Good morning. Donna, are you starting to see more acquisition opportunities emerge in Europe given the weaker demand backdrop?

No real change. We do see them occasionally for sure, but I wouldn't characterize that as any different than what we've seen over the last 12 to 24 months at all.

Fair enough. And, Pat, I want to talk about the Houston potential project there. If you did proceed, what's your latest estimate on the potential cost and capacity of the project?

Yeah, at this point, Hamir, it's probably in the neighborhood of $200 million Canadian, and the capacity would be sort of 3 to 350 million board feet. 50s.

And then timing of when that would come on, Pat?

That's still to be determined, you know, depending on available building slots, but it's going to be 2025 or later.

Okay, great. Thanks. That's helpful. And just the last question I had for Kevin Pankratz on the lumber side. With respect to European imports, do you have a sense as to what kind of SBF price Prince George we need to kind of see those imports, you know, kind of trend one way or the other?

I think that price level, Hamir, really, you know, it ranges, it moves a lot depending on currencies and what the value of residuals are. So it's really hard to pinpoint an exact one here, but... We did know that when prices were down at that $3.30, $3.40 level that you saw that there were other options for the Europeans to, you know, to send their wood, you know, via China or Middle East, North Africa markets. So I don't think there's always a constant number. I think it's going to fluctuate a little bit. But I do think an inflection point is that we maybe anticipate a little bit more pickup in European imports towards the end of Q3, as a lot of them are still obviously downturned. downturn in the markets. We see them picking up a little bit towards the end of Q3 as European markets might have a bit more of a cautionary tone towards the back half of the year.

Okay. Thanks, Kevin. That's all I had. I'll turn it over.

Thank you. The next question comes from Sean Stewart of TD Securities. Please go ahead.

Thank you. Good morning, everyone. I want to start with Pulp, Kevin and or Pat. I just want to understand this longer term capital program because half a billion dollars, even if it's over the long run, is a lot of money. Can you speak to your comfort with your current liquidity position at Canfor Pulp and borrowing capacity and any perceived needs to bolster that liquidity ahead of more aggressive CapEx and given the extent of how deep this commodity price drop is, do you see a need to bolster the balance sheet further to fund this CapEx program?

Sean, Kevin here, and I'll answer it quickly on the basis that the purpose of the refinancing was to put us in a good, solid place going forward. At this point, we're not going back to the market looking for money. What we're looking to do is between that financing and generation of cash within the organization to tackle our reinvestment plan as quickly as we can with the available money that we have.

Okay. Second question is on the European lumber business. There was reference to intermittent log availability, partly tied to Russian log imports or Russian log exports to Western Europe. Any visibility on how long you expect this to continue and how this could affect costs of the segment and result in margin pressure?

I'll maybe try to take that one, Sean. It's Don. Yeah, let's... If you separate Central Europe from Northern Europe, because they're entirely different in terms of several things, including log imports from Russia. But in terms of Central Europe, hard to say. I think that's probably going to exist there for a while, I would say, just based on the degree of reliability they place on Russian imports. But in terms of Northern Europe, particularly in Sweden, there's been some challenges here on just log imports. log availability period in certain locations, but it hasn't had any material impact on us at all. And of course, from a Russian import standpoint, it doesn't impact us at all there in Northern Europe whatsoever.

But as it stands now, Don, you wouldn't expect this to undermine your operating rates, you know, absent market pressure, price pressure in general, but you're your production is not constrained significantly by log availability. Is that a fair assessment?

Yeah, fair assessment. And like I think we mentioned in Q2, there's been one or two regions where we've had a minor impact in terms of log availability. But we, you know, I mean, I think that's always a bit of a challenge in certain areas and it may continue to some degree, but we're not concerned about it. Okay.

All right. That's all I have for now. Thanks, guys.

Okay. Thanks, Sean.

Thank you. The next question comes from Keitan Mentora of BMO Capital Markets. Please go ahead.

Thank you. Good morning. Thanks for taking my questions. Maybe first question, can you give us a sense of the demand trends you are seeing in repair and remodeling and new residential thus far as we've moved into July?

Sure. I can take that one for you. And on the R&R, you know, obviously year to date towards the end of Q2, very solid, strong demand. And while we're not at that same pace going into July, it's still at elevated levels when you look at the units compared to this time last year. So quite strong fundamentals. And we continue to see a very strong performing sector for the balance of the year, yet maybe just not quite at the pace that we saw for the first six months. And for new home construction, obviously we've seen some resurgence there on the total housing start numbers, which is encouraging better than we would have thought earlier this year. And what's encouraging is that we're seeing a recovery of single family home construction versus the multifamily, which I think is positive for our sector. And we're seeing certain geographies really performing well. And it's good to see markets like Texas back, which were quite quiet early in the year. And that's a very large consuming market for lumber and for single family construction. And so I think we've got a bit more positive trend on demand in both of those segments.

Got it. That's helpful. One follow up on that. on the R&R side, so is your volume up on a year-over-year basis in R&R? Is it kind of flattish, and has that sort of trend changed materially recently?

Yes, it's up double digits versus 2022.

And that's a year-to-date number?

Year-to-date, yes.

Got it, okay. That's helpful. And then Switching to Pulse and coming back to an earlier question, how should we think about the return expectation on this big reinvestment program? Clearly, at least in the short term, we understand that the market fundamentals are tougher, pricing is down. I'm just curious how you think about normalized you know, earning power in the bulk business and kind of what this reinvestment program, you know, what kind of a jump you expect post that?

I think the way I would respond to that is we remain confident in the long-term fundamentals for the bulk business. And therefore, what we're doing is working towards ensuring our facilities are in a condition that allows that sustainable operation long term. In terms of specifics around returns on various projects, I don't have anything there to share. And likewise, you know, looking at earning power into the future is far too dependent on what the markets are doing. What we expect to do is be able to return our mills to a level within the cost curve that we think is appropriate for the facilities.

Okay, I'll jump back in the queue. Thank you.

Thank you. Our last question comes from Paul Quinn of RBC Capital Markets. Please go ahead.

Yeah, thanks very much. And morning, guys. Maybe just start on the lumber side. Just current market conditions, I mean, in terms of overall inventories, would you say it's adequately, you know, or slightly oversupplied right now?

I think, Paul, like right now, I think it's adequate. I think it's got a fair amount of tension. I mean, there's been significant supply out of the system with fires in eastern Canada, reduced European imports, and, of course, reduced supply out of B.C. So I think it's relatively balanced right now, and I think our customers' inventories are probably still lower than they would normally be.

Okay. So pricing direction for the balance of the year, do you think we sort of sit in this band for a while, just given that – that overview?

Yeah, I think a lot is going to depend on, obviously, supply is going to be a big driver, but I think we're going to be in this band and it's going to be variable. And I don't see that exceeding for the balance of year, but I see us being within that band in that aspect there. And then I think the other aspect too is our offshore markets. I think those are going to be relatively stable from what we've seen for the balance of years, particularly Japan. And, you know, China's going to, I think, might be a better opportunity with China with all the investment that they're announcing there. We haven't seen it triggered into actual demand yet, but the outlook is that we may see some pickup in China towards the back end of the year.

Okay, thanks, Kevin. That's helpful. And then you guys referenced organic growth in Sweden. Is that like a 2% to 3% number? Is that a 5% growth year over year?

Yeah, Paul, I mean, with Pat, we're sort of seeing roughly 100 million feet a year over the next couple of years. So I think we talked about we think we can get up towards 1.8 there from 1.5. So just numbers slow and steady, a couple of numerous projects, I guess, that are slowly raising that total.

Okay, and then maybe just switching over to the post side for Kevin. Saw the cost for the paper side come up in the quarter. I guess that's a result of you know, some of the costs attributed to shutting down PG Pulp and Papers pulp supply line. How material would the cost drop be? I mean, is paper going to sort of generate that $20 to $25 million you need to, you know, going forward once it's on the new operating platform?

Yeah, we're comfortable that paper is a really steady part of our value-added program. The most sensitive they are is to pulp prices, and so I think you can track the contribution, and with pulp prices easing off, we'll see an improved contribution. A little bit on energy as a negative in the first quarter, but we don't see that being a significant issue going forward. The transition over to intercom supplying has largely been able to do that and keep our cost base of paper consistent.

Okay, and then just overall, I mean, I take a look at the enterprise value of Canfor Pulp right now, and I'm seeing it's around $200 million Canadian. You guys have just kind of announced a $500 million rebuild effort. What is the market missing on the valuation of your assets on Canfor Pulp's side?

I wish I understood, Paul. I've got a whole bunch of phone calls to make to find an answer to that.

All right. I'm a little mystified myself. That's all I had. Best of luck, guys. Thanks. Thanks, Paul. Thanks, Paul. See you.

Thank you. I'll turn the call over to Don Kane for closing remarks.

Please go ahead. Thanks, Michelle, and thanks to everyone that participated on the call this morning. We certainly appreciate your support of Canfor and wishing you all a good, safe rest of the summer. And we'll talk to you at the end of this quarter. Take care.

Ladies and gentlemen, this does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.