Stella-Jones Inc.

Good afternoon and thank you for standing by. Welcome to the Stella Jones first quarter 2023 earnings call. At this time, all participants are in listen-only mode. Following the presentation, we will hold a question and answer session. To queue up for the questions by phone, please press star 1. A moderator will contact you. If anyone has any difficulties hearing the conference, please press star 1 for operator assistance at any time. I would like to remind everyone that this conference call is being recorded on Wednesday, May 10th, 2023. Please note that comments made on today's call may contain forward-looking information, and this information by its nature is subject to risks and uncertainties. Actual results may differ materially from the views expressed today. For further information on these risks and uncertainties, please consult the company's relevant filings on CDAR. These documents are also available in the investor relations section of Stella Jones website at www.stella-jones.com. We have also prepared a corresponding presentation, which we encourage you to follow along with during this call. I now pass the call over to Eric Vachon, President and Chief Executive Officer of Stella Jones. Eric.

Good afternoon, everyone, and thank you for joining us today. I'm here with Silvana Travolini, our Senior Vice President and Chief Financial Officer of Stella Jones. Earlier this morning, we issued our press release reporting the results of our first quarter of 2023. Along with our MD&A, it can be found in the investor relations section of our website at www.stellajones-.com, as well as on CEDAR. As a reminder, all figures expressed on today's call are in Canadian dollars unless otherwise stated. The positive momentum we generated from our record year in 2022 has carried into 2023. Our first quarter results were excellent, featuring strong sales and increase in EBITDA, which has outpaced sales growth. Our great start to the year reflects our growth plan in action. During the quarter, we successfully secured fiber supply, enhanced production capacity at our plants, and invested in the network upgrades to further increase pole production. All of these initiatives speaks to our unwavering focus on continuity and quality of customer service, maintaining our North American leadership position in the markets we serve. Now let's turn to the performance of our product categories for the quarter. our utility pole's product category significantly outperformed during the quarter. Sales grew organically by 29% and also benefited from the contribution of our timely acquisition in 2022 of the treating assets of Texas Electric Cooperatives, or TEC. The strong growth in this product category is a testament to our pole procurement team, which once again continued to leverage their longstanding industry relationships to meet growing customer demand while establishing the foundation to access new procurement areas. Sales of railway ties were also up, increasing organically by 5%. We were encouraged to see signs of continued increased railway tie availability in the first quarter of this year. At the current rate of procurement, We expect untreated tie inventories to be replenished by mid-year, with optimal dry inventory levels being reached in the second half of 2023. This will reduce the number of boltonized charges and open opportunities to respond to customer demand, which is being driven by steady railroad maintenance and ongoing infrastructure spend. For industrial products, sales continue to benefit from higher demand. Our industrial product category perfectly complements our rail and utility offerings. Finally, sales for residential lumber pulled back in this quarter in line with our expectations. Before I turn the call over to Sylvana, I want to provide an update on ESG. As many of you know, health and safety is a priority at Stella Jones. We strive to create a safe and healthy workplace that promotes responsibility and mutual respect. We are in the final phase of rolling out the SHIELDS program across North America. SHIELDS stands for Safety Health Improvement Leading Our Decisions and is an integrated environmental health and safety management system. These systems allow us to more accurately track and assess progress of our health and safety metrics to maintain our company-wide commitment to the safety and well-being of our people. At the start of this year, we reinforced our commitment to health and safety with the launch of a new employee-focused educational and informative campaign called Safety Matters Because You Matter. We believe that our most valuable asset is the people that walk into our facilities and offices each day. We all must play a role in owning health and safety and ensuring everyone performs successfully in their work environment and returns home safely at the end of the day. With that, I will turn it over to Sylvana to provide a more detailed overview of our first quarter financial results. Sylvana?

Thank you, Eric. And good afternoon, everyone. As Eric mentioned, we began the quarter on a very positive note, which is reflected in our strong financial results. Net income in the first quarter was $60 million, up 30% compared to net income of $46 million last year. This translated into earnings per share of $1.03 compared to $0.73 in the same period in 2022. We generated total sales of $710 million compared to $651 million last year. The increase was driven by an 18% organic sales growth of our infrastructure-related businesses. Sales this quarter also benefited from the contribution of the pole treating assets acquired from TC late in 2022 and the positive effect of currency conversion. This growth in sales was partly offset by the anticipated pullback of residential lumber sales. Utility pole sales rose to $362 million, up from $254 million from the same period last year. Excluding the currency conversion effect and the contribution from the acquisition of TEC assets, utility pole sales increased by $73 million or 29%, almost entirely driven by higher pricing. Sales volume gains were limited this quarter by our current production capacity. Downtime related to the ongoing capital projects largely offset the increase in our treating capacity stemming from the installation of upside cylinders. Sales from our utility pole product category accounted for more than half of total sales for the first quarter. Sales of railway ties grew to $195 million versus $175 million in the corresponding period last year. Excluding the currency conversion effect, sales of railway ties increased by $9 million or 5%, all attributable to favorable sales price adjustments to cover higher costs. Volumes for non-class one customers were lower due to the reduced level of treated ties inventory following the limited fiber supply availability in 2022. However, The steady maintenance demand for railway ties enabled this product category to account for 27% of total sales for the quarter. Residential lumber sales were down compared to the same period last year, which as Eric mentioned, were in line with our expectations. The decrease was attributable to lower volumes and pricing compared to the stronger demand and the rise in the market price of lumber in the same quarter last year. Sales in residential lumber accounted for 13% of total sales during the quarter. Turning now to profitability. Led by the strong organic sales growth, particularly for utility poles, our EBITDA increased $120 million in the first quarter of 2023, up 36% compared to $88 million in the first quarter last year. We saw notable strength in our EBITDA margin, growing 340 basis points to 16.9% in the first quarter from 13.5% last year. The increase was largely due to the margin expansion of the company's infrastructure-related product categories, particularly stemming from favorable price adjustments realized for utility poles and railway ties, as well as the impact of a better product mix. The relative proportion of utility poles in the first quarter amounted to over 50%. During the quarter, we continued to actively invest in our inventory position. We invested $138 million inventories to build our position to support the continued strong demand for poles and to replenish our untreated ties inventory given the market availability. Inventories are a significant component of working capital and the turnover is relatively low. We consider this an investment in our ability to provide service to our customers and meet their demand. During the quarter, we also used our liquidity to maintain the quality of assets and expand our pole production capacity, including acquiring the pole peeling and drying assets of industry, as well as return capital to shareholders. Yesterday, our board of director announced a dividend of 23 cents per share. And during the quarter, we repurchased over 600,000 shares for a total of $30 million. Since the beginning of the current NCIB program in late 2022, we have repurchased over 1 million shares for $50 million. As a result of our buyback programs, we had almost 4.5 million fewer average shares outstanding this quarter compared to last year's Q1. We ended the year with a net debt to EBITDA ratio of 2.8 times, which is within our expectations due to our typical working capital requirements in the first quarter of each year. We hold a strong financial position and are able to finance our business plans, meet working capital requirements, and maintain our assets through our cash flow generation and available credit facilities. In summary, Our financial performance to begin the year has positioned us well to remain on track to achieve future growth and value for our shareholders. With that, I will now pass it on to Eric for his concluding remarks. Eric?

Thank you, Silvana. Our established track record of achieving robust results, delivering return to shareholders, and maintaining a solid financial position has continued into 2023. We attribute these achievements to our proven and resilient business model, as well as our ability to supply the growing demand for our products in the marketplace. We are well positioned to meet or exceed the targets laid out in our three-year plan. From a sales perspective, we continue to benefit from strong demand on the utility pole side. Building on the growth trend for 2023, Utility Poles 2024 sales are now projected to grow at a compound annual rate of 20% from 2022, and the company also expects the EBITDA margin to exceed its 15% target by 100 basis points. We also continue to enjoy steady growth in our railway tie product category, driven by stable partnerships and maintenance programs by our customers. The forecast for utility pole growth capex stood between $90 and $100 million since the beginning of 2022. We have committed to equipment purchases and spent $49 million. So far, we have successfully changed three treating cylinders and increased our Douglas fir network treating capacity by 15%. We will also benefit from the production of two new southern yellow pine bowl peeling and drying facilities starting mid-year. Finally, we have returned $273 million of capital to shareholders since 2022. We are on track to achieve the target we outlined in our three-year plan of between $500 and $600 million. We have started 2023 on the right foot. We will continue to build on our achievement to support future growth of our infrastructure-related product categories and continue to return capital to shareholders. Before I conclude this call, I would like to acknowledge all of our employees across North America. They are the reason behind the great brand and reputation we have built. Our customer can rely on us for quality products, customer care, and meeting deadlines. All of those traits are because of our dedicated employee base. Thank you for all of your efforts. I also want to extend a special thank you to those who attended our annual meeting of shareholders earlier today, both in person and virtually. We are grateful for your ongoing support and trust in our business and look forward to seeing you again next year. This concludes our prepared remarks. Thank you for your time today and I will now open up the lines for questions.

Thank you, Eric. The line is now open for questions. I would like to remind you that if you are on the phone and wish to ask a question, please press star one. Our first question is from Walter Sprocklin from RBC Capital Markets. Please go ahead, Mr. Sprocklin.

Good afternoon, everyone. Congratulations on a great quarter here. Eric, I guess starting with you on polls, It's a pretty high run rate, 20% now out to 2024 on a CAGR basis. I guess maybe you can give a little color. I apologize. I was only connected in later in the call, a little later in the call, but you know, the main drivers of that is this kind of, uh, a fast and furious situation or higher for longer? I don't think it's going to drop off from 20 down to 5 in 2025. Is this something that kind of stays at a heady clip for many years based on what you're seeing or do you see a lot of upfront here and then indeed falling off quicker after a few years?

Thank you, Walter. So, you know, if you recall, last year we had a great year in organic growth, 20 plus percent. In March, when we disclosed our Q4 results, we provided more, you know, insight for this year's, you know, stating that we would see in 2023 similar growth to the prior year. So obviously, us seeing a CAGR of 20 percent over, let's say, the whole year of 23 and 24, would suggest something that's a bit front-loaded, obviously, since we'll be in the 20-ish this year. We've seen great growth in the last two years on the pricing side and the volume side. I do see going beyond continued maintenance from our customers and continued maintenance, and that is Our beliefs to that are supported by our growth CapEx initiatives, as I mentioned a few minutes ago. We've got two new pole pilling yards that are coming online mid-year, which will offer us more fiber in our network, and we do plan on seizing more opportunities in the market. To your point, or to your question, will it be 20% every year for the next five years? I wouldn't think so. We'll provide more insight on our investor day on May 25th. But I could confidently say that the level that we're seeing now will be sustained through time for a number of years at the very least.

That's fantastic. The 100 basis point improvement in margin, would you say that's a function of pricing or kind of scale with higher volumes or would it be a bit of both? ascertain whether this is something that we can put in our models now longer term as the new is 16 the new 15 or is this something that you think maybe just a temporary benefit you're receiving you're receiving and maybe 15 is still the better number to use longer term so the short answer is our recommendation would be 16. um you know we we will see we have seen in the first quarter you know improved pricing and we'll continue to see that throughout the year

We believe that will be sustained over time. And there's also a product mix, if you want, in the sense that obviously our fast-growing product category is utility poles, so their weight in the mix of products is heavier, therefore enabling us to reach better EBITDA margins.

Okay. Last question for me is now that the CP deal is done, KCS is now part of the new CPKC and given CP's historical decision to outsource tie treatment versus KCS's focus on doing it in-house. Can you size that for us? Not whether you're going to get it or not, but from your understanding of what KCS does in-house, what percent of your overall tie volume would that be on just a rough basis to to get a sense of upside if you were to get that contract?

Well, so, Walter, you know, so we know the team at that treating facility in Louisiana well. As I stated before, you know, we do have interactions with them for bridge timbers and some very small volume of railway ties. You know, it would be a low percentage of our total business, you know, If I have to size those annual sales, you know, from outside, not having to be privileged to any information, I would say it's, you know, call it 30 to 35 million in annual sales if we were to be supplying them. And obviously, I'm sort of not an educated guest, but fairly, it's our appreciation of what that could be.

Yeah, that's great. That's great. Okay, that's all my questions. Really appreciate the time. And again, congratulations on a great quarter.

Thank you, Walter.

Thank you. Our following question is from Gabriel Nicholson from CIBC Capital Markets. Please go ahead, Mr. Nicholson.

Hi, hope you all are doing well. And yeah, once again, congrats on the quarter. You mentioned that you were capacity constrained in polls. And this is kind of building off of Walter's first question. How much additional volume growth do you think you could have realized if you had the capacity? And do you think that the two new poll additions would cover that unmet demand?

It's a great question, thank you. Our constraint right now is not on the treating capacity, it's on the procurement capability. And even then when I say procurement, it's really more on the drying capability on the Southern Yellow Pine. It's a wood species that you need to kiln dry and right now we're putting in new pole building yards and each of those yards have kiln capacity. So we're definitely going to leverage that up and everything we'll be able to produce out of those facilities will be sold, you know, will be sold going forward. We have no doubt of that. We have discussions with customers on their needs, and we're adjusting our offerings to them, and they're adjusting their maintenance schedules based on our long-term commitments to them. So I feel very optimistic about our ability to be able to start seeing volume growth in the coming quarters.

Okay, yeah, great. Thanks. And then also on polls, the high teens growth, your poll guidance is embedding for 2024. How much is price versus volume?

I would say it's heavily weighted towards the price, but, you know, call it 30, 70, let's say, 70 being the pricing. Okay, great. Thank you. I'll leave it there. Thank you very much.

Thank you. Our following question is from Michael Kyprios from Desjardins Securities. Please go ahead, Mr. Kyprios.

Thanks. Congratulations on the great quarter. Maybe just on the Canadian federal budget that was released since your last reported 4Q results that included a 15% investment tax credit for corporations like Hydro-Quebec and some positive comments on electrical grid expansion and demand in Canada. Is there anything that specifically caught your eye and could be a driver for utility pools moving forward?

Obviously, we're always happy when we hear different governments or Canada and the US put in place programs to help utilities or companies invest in their infrastructure. So obviously, yes, our utilities are well in tune, our customers are well in tune with those programs. Our forecast doesn't, when we talk about potential growth, does not scope in those infrastructure initiatives. It sometimes takes a while to start seeing them. You know, if I think about the U.S. infrastructure bill, I can't say we've seen much of that to date, maybe a bit on the rail tie side. So these programs take a while to get to market. So they're not scoped into our views in future sales and future demand for us. So obviously all of this would be just, you know, over and above and obviously great news for us.

Thanks, that's very helpful. Maybe just on the residential number. I know seasonality played a factor in the first quarter, but looking forward, do you still have confidence in 600 to 650 million in sales for the year? And maybe are there any changes or tone and commentary that you could share from your discussions with your retail partners on customer demand so far this spring? Thank you very much.

No, no change in views on that on our part. I think we were, Why isn't establishing this base of expectation in sales? I think it's something that, as a company, we can recreate year over year confidently. And if then there's favorable R&R trends, if there's different dynamics, lumber prices impacting this business, I think it would be just upside for us from that point on. But we remain confident with that 6 to 650.

Thank you.

My pleasure.

Thank you. Our following question is from Michael Topholm from TD Securities. Please go ahead, Mr. Topholm.

Thank you. Good afternoon. Hey, Mike. Hey, Eric. Just a question on the 16% margin. So I understand that that's the number we should be focused on for 2024 and beyond. Is that also what we should be thinking about for this year? I mean, I realize you had a strong start to the year, but is that the 2023 number as well?

16 would be our guidance going forward. Uh, you know, and if I could maybe clarify our Q1 result, the 16.9 is a very strong number. Uh, but obviously we don't have a full year mix of products, right? Uh, other products such as residential lumber have a stronger presence in our product mix in Q2 and Q3. So, uh, you know, I do expect to average down during the course of the year, but using 16 would be my, uh, my recommendation or our guidance presently for, for coming years.

Okay, that's helpful. Thank you. Yeah, and sorry, just to, I think this maybe overlaps a little bit with one of the last questions, but just in terms of the demand, the market demand you're seeing in the utility pools area now, I realize in Q1 it was primarily price or almost all price that drove the organic growth, but it does sound like from your comments there is strong market demand and it's just a function of being able to to meet that demand and hence the investments you're making in capacity and drying and whatnot. But is this really just heightened replacement activity and I guess the benefits of the fire wrap and there's really nothing contributing at this point at all in terms of any sort of EV related infrastructure initiatives or broadband initiatives and things of that nature?

Well, so There is some of that in the mix of the demand we're seeing. A good example is the Ontario broadband program. There's a $4 billion program over four years now. We're a bit into it right now, but obviously that spend will increase demand for products. That's a public example I could point to. There are other similar examples across different provinces and states in North America. um ev is a growing point of discussion with our customers i think utilities realize that there's going to be increased demand from the network so obviously as maintenance is being planned out all of these factors are now taken into account right because you're replacing a pole it has you know more hardware and more line loads than it had 50 years ago and there will probably be increased demand going forward you know with AC with electric vehicles. So our customers are discussing about it and are planning accordingly. So obviously all of that, it's hard to say how much dollars would go to one of these. It's now part of the new mix in demand. Our customers are designing line and designing their maintenance programs. And this general approach is driving the volume for a greater number of product from our part.

OK, I know that's helpful. It makes sense. I guess and not to belabor the point, but it just sounded like earlier on you were suggesting you haven't really built that into the into the sort of the 20% CAGR number you would you would put out there for the polls business. Is that is that correct? Notwithstanding the fact that there's things happening in that area, you're not that that's not really a driver to your 20% number.

So so all of that is in what's not in is. government infrastructure bills, for example. The previous question was about the federal budget that came out a few weeks ago and had special acknowledgments, reserves for particular info programs. I don't know what's going to come out of it, so we can't speculate, so that's not in there. But definitely everything that our utilities are talking about to increase their network, that is definitely scoped in our 20% CAGR.

Got it. Okay. Just shifting over to the ties business, 5% organic growth in the quarter. How do you see that trending over the balance of the year? Because if I'm not mistaken, originally you were thinking maybe a little lower than that. Just curious about how to think about the rest of the year here.

So I would see the pricing piece decline slightly throughout the quarters. We've been increasing sales prices to our customers every quarter of last year. So obviously, we're coming into the year in Q1 with four quarters of price increases. So as we're lapping ourselves, you would see that pricing effect reduce over time. With my comment on increasing dry inventory, I think we'd have the opportunity to sell a bit more volume in the back half of the year. So still think that low single digit, maybe a bit lower than the 5% somewhere in there is where we'll end up the year.

Okay. And raw tie availability, is that improved now?

It has. I mean, the last two quarters, sorry, the last two months of Q4, so November to December was great. The four, I can actually talk to April now, the first four quarters of this year, supply has been coming in at a very healthy rate. We will be at optimum inventory levels by mid-year. And obviously, the inventory we procured in December, January, February will be dry by, call it September, so somewhere in H2. will have more dry inventory therefore we'll be bolting less and have an opportunity to treat more ties and you know take advantage of some some bidding opportunities in the market okay perfect thank you and then just lastly and i also had some issues earlier with the call so i don't know if i missed this or not but um

the industry acquisition uh that's that's called out in the in the release is that is there any revenue associated with that or is that more just um in order to to enhance your production capacity no it's to there's no revenues it's to enhance enhance production uh and optimize you know optimize the cost profile of our product and optimize production Okay. And that's one of the things that you were pointing to in terms of seeing enhanced ability to meet market demand sort of overcoming quarters here. Correct. Okay. Okay. Thank you.

Thank you, Mike.

We have no further question in line. Thank you.

Well, thank you, operator. And thank you everyone for joining us today. We hope you can listen in to our investor day on May 25th in Toronto. Details for virtual attendance will be posted on our website as we get closer to date.

Ladies and gentlemen, this concludes the conference call for today. Thank you for participating. You may disconnect your lines.