Stella-Jones Inc.

Good morning and thank you for standing by. Welcome to the Stella Jones third 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 Tuesday, November 7, 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 SIDAR. These documents are also available in the Investor Relations section of Stella Jones' website at www.stella-jones.com. We have prepared a corresponding presentation, which we encourage you to follow along with during this call. I'll now pass the call over to Eric Vachon, President and Chief Executive Officer of Stella Jones. Eric.

Thank you, Shirley. Good morning, everyone, and thank you for joining us today. With me on today's call is Silvana Travolini, Senior Vice President and Chief Financial Officer of Stella Jones. Earlier this morning, we issued a press release reporting our results for the third quarter of 2023. Along with our MD&DNA, it can be found in the Investor Relations section of our website at www.stella-jones.com, as well as on CDAR. As a reminder, all figures expressed on today's call are in Canadian dollars unless otherwise stated. During the third quarter, we made notable progress in our growth trajectory, generating strong sales growth and a record increase in profitability. Our results speak to the continued positive momentum and performance of our infrastructure-related businesses, as well as our residential lumber business, which delivered results in line with our expectations. While our organic growth so far has been supported by favorable pricing dynamics, 2023 has also been a year where we focused on building additional capacity and inventory levels to take on more demand from our customers and meet their long-term needs for our infrastructure products. We're doing this with ongoing investments and acquisitions to support our growth while ensuring predictable and consistent customer service. Let's take a closer look at the performance of our key product categories during the quarter. Building on the momentum it has generated since the start of the year, our utility polls product category continued its strong performance during the quarter, driven by favorable pricing dynamics and a continued increase in production volumes. In Q3, we benefited from added bandwidth stemming from a number of capital projects, which I'd like to provide some color on. Since January, we concluded three utility pole-related acquisitions, adding pole-treating facilities and pole-pilling operations to our expansive North American network, as well as securing fiber supply. The latest of these acquisitions was Baldwin's two treating facilities in Baymanette, Alabama, and Wiggins, Mississippi. We've also made important inroads in bolstering our assets on the procurement front. with the addition of pole peeling facilities to optimize efficiencies and enable us to deliver on growing demand. Our own new peeling facility in Durant, Mississippi became operational in June and our Enfield, North Carolina facility is set to be commissioned earlier next year. Both focus on augmenting our Sun Yellow Pine offering. Additionally, we are targeting the commissioning of another peeling facility in Kamloops, British Columbia in 2024, which will serve to further support our western species operations. These facilities, along with our new treating operations acquired from Baldwin, are presented by the yellow dots on the map you see on the current slide. Significant investments has been also made to upsize treating equipment at a number of our whole treating facilities through 2023, further building out our production volume capacity. These projects and initiatives showcase our proactive and thoughtful planning and execution in building a robust procurement and manufacturing platform, which in turn will allow us to further reap the benefits of favorable conditions and enhance our leadership position. The added capacity provided by these capital projects in Q3 and throughout the year allowed us to grow our inventories to the levels needed to deliver on long-term sales commitments to our utility customers and secure agreements with new customers. We don't take it for granted that our teams can quickly ramp up existing capacity or commission facilities on time and on budget, because sometimes not everything goes as planned. To that end, a portion of our Silver Springs manufacturing operations in Nevada was damaged by fire during the quarter. Fortunately, there were no injuries following the incident, and work is already underway to repair the damaged equipment. We have been able to adjust production and to continue serving our customers with the help of our extensive network while repairs are ongoing, a testament to our agility in responding to unforeseen situations. Moving on to railway ties. This product category experienced a strong quarter with increased sales, which speaks to our continuing ability to pass along price increases to our customers. The limited supply of untreated tie inventories in 2022 has impacted sales volumes so far in 2023. Having replenished our untreated Thai inventory by June of this year, we now find ourselves standing at an optimal level of dry inventory, which sets us up to meet customer demand as we move into 2024. However, in 2023, volumes are expected to remain lower, which will result in a year-over-year low single-digit sales growth in line with our guidance versus the mid-single-digit growth realized so far this year. Sales volumes for residential lumber were higher this quarter compared to the same quarter last year, which is indicative of our proven ability to supply consistently to big-box retailers. Even considering the decrease in lumber pricing year-over-year, our residential lumber product category is performing within management's expectation and in line with our stated guidance. Let me now take a moment to discuss ESG at Stella Jones. During the quarter, we published our fifth annual Environmental, Social and Governance Report, which is now available for download on our website. For the first time in our company's history, we have formalized our ESG strategy, titled Connecting Our Sustainable Future. This strategy is a product of extensive listening and data collection across our organization and has measurable targets across six key strategic topics. These topics include climate change, greenhouse gas emissions, as well as health and safety. an area where we have made great strides so far in 2023, namely through initiatives such as our Safety Matters Because You Matter campaign. Before I turn it over to Sylvana to provide a more detailed overview of our third quarter financial results, let me provide a brief update on our efforts to phase out the wood preservative PENTA through our network. Pentachlorophenol, or Penta for short, is an oil borer preservative which is being discontinued across North America. In the United States, our phase-out of Penta is largely complete, which places us well ahead of the 2027 end date required by the United States Environmental Protection Agency. In Canada, operations were required to cease use of Penta by October 4th of this year. Our team has gone to great lengths leveraging our network and internal resources to adjust our Canadian offerings to ensure continuity of supply for our utility customers. We have been at the forefront of the industry with respect to this transition and are working collaboratively with utilities to tailor solutions to meet their requirements. I am very proud of our team for their tireless efforts towards addressing this phase-out, the culmination of many years of hard work. With that, I will now hand it over to Silvana.

Thank you, Eric, and good morning, everyone. Our strong start to 2023 has carried into June 3. which featured another quarter of solid organic sales growth, a record increase in EBITDA and EBITDA margin, and a notable contribution from acquisitions. Sales in the third quarter reached $949 million, up from $842 million last year. This increase was driven by organic sales growth of our infrastructure-related businesses of 17%. Sales also benefited from the acquisition of Texas Electric Cooperatives in November last year, the more recent Baldwin acquisition, as well as the positive effect of currency conversions. Pricing gains for utility poles, railway ties, and industrial products, as well as volume gains for residential lumber, largely explained the increase in sales, which was mitigated in part by a decrease in residential lumber pricing. Utility pole sales grew to $438 million in Q3 compared to $331 million for the same period in 2022. The increase was largely explained by organic sales growth of 21% and the contribution from the acquisition mentioned moments ago. The organic growth was driven by higher pricing as sales volumes remained relatively flat compared to last year. As Eric mentioned, in the quarter we focused on increasing capacity and building inventory to support long-term sales contracts, which currently represent over 70% of our utility pole business. Sales of railway ties increased by $31 million to $230 million, compared to $199 million last year. Organically, sales were up $26 million, or 13%, all attributable to favorable pricing. Volumes were relatively unchanged in Q3 compared to the same quarter last year. The lower non-Class I volumes stemming from the limited supply of untreated Thai inventories in 2022 were largely offset by higher Class I volumes, mainly attributable to the timing of shipments. Class I volumes in 2023 are expected to be unchanged versus 2022. Residential lumber sales of $202 million decreased $24 million compared to the same period as last year. While sales volumes were higher in the third quarter of this year compared to the same quarter last year, the volume gains were not enough to offset the lower pricing attributable to the decrease in the market price of lumber. The overall decrease in sales was, however, in line with expectations as we continued to project $600 to $650 million of annual sales for residential lumber. Turning now to profitability, EBITDA increased to $193 million in the third quarter, up from $119 million in the same period last year. This increase was largely explained by the margin expansion of our infrastructure-related businesses, particularly utility poles, as well as the EBITDA contribution of our acquisition. As a percentage of sales, EBITDA also benefited from the higher proportion of utility pole sales this quarter, representing 46% of total sales compared to 39% in Q3 last year. EBITDA margin expanded to 20.3%, a record improvement this quarter from 14.1% in Q3 last year. Year-to-date, our EBITDA margin stood at 18.5%. We now expect the EBITDA margin for 2023 to be closer to the 18% mark. Looking forward into 2024, the uncertain effects of external factors, such as the higher cost of capital and increased supply from the utility pole industry, may impact our current level of EBITDA margins. With this considered, we remain confident in achieving the 16% margin objective stated in our guidance. Net income in the third quarter was $110 million. up 69% compared to last year, while earnings per share was up 79% to $1.91 per share. Earnings per share also benefited from the ongoing share repurchase program. During the quarter, we used the cash generated from operations of $130 million to maintain and upgrade our assets, expand and secure production capacity, which included acquiring the utility pole manufacturing business of Baldwin, as well as return capital to shareholders. During the nine months ended September 30th, we returned $145 million to shareholders through dividends of $40 million and share repurchases of $105 million. Since the beginning of the current normal course issuer bid program, the company has repurchased 2.2 million shares at an average price of $57 per share. Yesterday, the TSX accepted our notice of intention to proceed with the new NCIB program, which we announced in a dedicated press release earlier today. Pursuant to this NCIB, Stella Jones is authorized to repurchase up to 2.5 million common shares representing approximately 5% of the public flow. These repurchases will take place over a 12-month period ending in November of next year. At quarter end, we had $271 million available under our credit facilities and maintained a solid financial position with a net debt to EBITDA ratio of 2.4 times. Our strong balance sheet and ability to finance our business plans, meet working capital requirements, and maintain and upgrade our assets to consistent cash flow generation and available credit facilities reflect our disciplined financial strategy. Yesterday, our Board of Directors announced a dividend of 23 cents per common share payable on December 21st, 2023 to shareholders of record at the close of business on December 4th. In summary, our strong operating and financial performance positioned us well to achieve our long-term growth plans while returning near-term value to our shareholders. I will now turn the call back to Eric for his closing remarks.

Thank you, Silvana. Much of our efforts this year has been focused on meeting demand as well as preparing for long-term growth. It's been thus far a year of building and setting up the business for the future. And we've done that through a combination of capital investments, acquisition, and ongoing organic growth. 24 months ago, we had the foresight to target acquisitions that provided us with opportunities for enhanced poll procurement, drying, and treating, while investing in capital projects to build upon an already strong foundation, which has proven to our customers our will and capacity to meet their requirements. We believe these strategic decisions helped enable us to capitalize on additional opportunities going forward. As we approach the end of the year, we are confident in the sustained growth of the company and are staying focused on our three-year financial objectives. Stella Jones has built its reputation on servicing its customers. They recognize the quality of our work and our ability to adjust to their needs, which is anchored by our strong procurement, manufacturing, and distribution network. We take pride in knowing that our customers can rely on us for quality of products, certainty of supply, and timely service, and that we play a key role in the development and maintenance of a robust North American infrastructure landscape. With nine months of operations behind us in 2023, I'm very pleased with our performance, both as a business and collectively as a team. I often say that our people are our most valuable resources, and so I wish to thank our more than 2,800 employees across North America who consistently bring their very best for Stella Jones and its customers. Through our products, we are building a strong, resilient future together, and I look forward to us maintaining our position as a leader in our space. With that, I will 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 1. Our first question is from James McGarigal, RBC Capital Markets. Please go ahead.

Hey, good morning, and congrats on the very strong results. Thank you, James. I have a question on margins, and I know you guided to the 18% this year. You pointed to some uncertainty looking ahead due to potential cost inflation. But anything to call out specifically in the quarter? I mean, you know, looking ahead, it seems like mix should continue to shift toward pulls. That pricing will remain solid. You know, so that said, I'm just trying to understand the puts and takes and to what extent these margin levels could potentially be sustainable.

Right. So for the quarter, obviously, as Sylvana pointed out, we did have a very strong mix towards utility polls, which helped, you know, the average of the margin profile. Going forward, you know, in our prepared remarks, you know, we did speak about certain uncertainties in the future. One is the cost of capital increasing for our customers, which, you know, might change their behaviors or slow down the growth rate at which they're doing their maintenance. But also as an industry, in my different travels, I've seen more availability of products from suppliers and the competition, so capacity has been brought online, which would in turn potentially bring some pricing pressures for the spot market business. Now, we do highlight that 70% of our business is under long-term contracts for utility poles, which sort of shields us to some extent. But it doesn't shield us on the 30% piece where we could see some pricing pressures into the future. So still very comfortable with us achieving that 16%. Very, very confident with that going forward. But I also want to sort of, you know, provide some insight as we see it today. And we will be obviously providing updates on that in future calls as we see, you know, the next quarters be fulfilled.

Hey, thank you. And just one more for me. So on the railway tie business, your competitor last week, they were talking about some significant issues in their tie business due to cost inflation. And, you know, your results today makes it seem like you're dealing with these cost inflation issues much more effectively. But with your guidance for sales up low single, does that include any of the pass-through of cost inflation going forward? And, you know, what type of upside could that represent if you're able to more effectively pass on some of that railway tie cost inflation going forward?

As we see year-to-date after nine months, our growth is 8%, which is driven by pricing. Cost of untreated ties in the last 18 months have increased, you know, at the sawmill level. So we've been successfully passing through those cost increases throughout the year. But, you know, our guidance to the low single digits is more volume related. Our class one programs for this year, you know, remain consistent with, you know, year over year. But we've seen most of our Class 1 customers complete their maintenance at the end of September. So our Q4 volumes for railway ties would be lower, I guess, than what we've seen previously or updated after nine months, thus bringing us to the single-digit growth, the lower single-digit growth, I mean.

I appreciate it, and I'll turn the line over. Thank you. Thank you, James.

Thank you. Our following question is from Benoit Poirier, Desjardins Securities. Please go ahead.

Yeah, thank you. Good morning, Sylvana. Good morning, Eric, and congrats for the strong achievements. Just to come back on the railway ties, could you provide some color on 2024 following the RTA conference, but also related to the 1 million additional ties that will go out for sale to non-Class 1 customers? I'm just wondering whether we could expect double-digit growth for railway ties in 2024 on the back of this additional capacity.

Thank you for the question, Benoit. Obviously, our inventory position today positions us favorably to address the spot market. So we've been very focused this year on servicing our long-term agreements with our Class 1 customers. But you're completely right that we – The gains that we've seen in sales are driven by pricing offset by volume that we know we didn't have sufficient dry inventory. So going forward into next year, you know, we're definitely well positioned and we're addressing that market and, you know, We're working diligently at that, so I would expect next year, if I look at our crystal ball, could our pricing be relatively stable for the year? Assuming that tie prices don't change too much, I think that would be a fair assumption. But I do expect our volumes to increase next year with regards to the non-class one business.

Okay, perfect. And just for the utility pole, it looks like the demand environment still remains pretty strong with Hydro-Québec that wants to double electricity production and add basically 5,000 kilometers of transmission line by 2035. Do you have a sense of the wood pole requirement for this particular opportunity?

So... We are a supplier to Hydro-Québec. They have not quantified that for us as of today, but you're right that in their announcement last week, which was $150 to $180 billion of investment, If I recall, about $45 to $50 billion is dedicated to the reliability of the network. So I do think that there will be significant investment, as we see with many other utilities in North America, but if we're speaking in this particular case about Hydro-Quebec, I do think we're well positioned to benefit from any increased demand for maintenance or expansion of the grid network.

Okay, and last one for me. Could you provide an update on where you are related to the 115 million growth capex and whether additional capex is needed to grow above the mid-single-digit growth that you're implying in 2025, especially in light of the strong market environment for utility pool?

I'll ask Sylvana to comment on that part, Benoit. Thank you.

So far, on the $115 million, as of the end of September, we have approximately $80 million of that done. As we had noted when we had presented our three-year guidance, we said most of the $115 million would be front-loaded. So, you know, there is about $30 million left between Q4 and next year to complete that program. So, pretty much in line with that. And, yes, as we had noted, that this CAPEX program is really to meet the demand that we have currently in our radar. So, any additional infrastructure-related demand would go above that. So, we would need additional, you know, capacity in order to be able to service, you know, significantly additional demand from infrastructure money.

Okay. Thank you very much for the time. Thank you, Benoit.

Thank you. Our following question is from Hamir Patel, CIBC Capital Markets. Please go ahead.

We start on the poll side. Could you scale how much additional poll volumes you'll have available next year just based on the capacity initiatives that you have underway?

Yeah, so... I'm trying to figure out because we typically measure everything in cubes, right? So which does it necessarily?

I guess I meant just like a volume percentage increase.

Yeah. So call it 10% to 15% additional capacity would be available for next year.

OK. And Eric, on the res lumber side, your volumes were actually up in the quarter. I think some of your peers were down. Do you think you can continue driving volume growth in lumber in 24? I'm just wondering what you're hearing from your retailer partners.

Right, so your question is spot on. We debriefed earlier this week with several of our customers on the year and their expectation for next year. There is a positive momentum from our customers at the very least to be able to hold these volume gains into next year with potentially slight upside. Obviously, that's their views on it, but I'd be very pleased if we'd be able to hold the current volumes into next year, and I think that's quite feasible, and that would still bring us within our guidance in our three-year objectives.

Great. Thanks. That's all I had. I'll turn it over. Thank you. I'm here.

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

Thank you. Good morning. Good morning, Michael. Good morning, Eric. Can you talk about when you will start to lap the pricing increases that have been benefiting your results and continue to do so this quarter in both utility pools and railway ties? So when you'll be facing essentially tougher year-over-year comps and fully lap the benefits you were seeing this quarter?

So I would say at the end of this quarter, we will have lapped this quarter. I guess 20-some percent organic growth, which is driven by pricing. And, you know, going into next year, then we would be looking at, you know, what would be more normal increases compared to the historical trends. But, yeah, I think this year – and the end of quarter is where we would be lapping it, but still foresee some pricing uptake, although smaller, going into the future.

Sorry, and just to be clear, when you say end of the quarter, are you talking about the end of Q3? It's now fully lapped, and we can see it come down in Q4, or you still have those benefits in Q4?

I'm sorry, Q4. Q4, so at the end of the year, December 31st, we'd be pretty much lapped on this 20% organic growth piece.

Okay, and that's on the poll side. What about on the railway ties side, where, again, in the quarter, I think you were up 13% on organic basis, all pricing?

Yeah, all pricing. I think we're pretty much there at this point. At the end of Q3, at the end of September, I think we've done all the catch-up that is related to the increased cost of railway ties. We've been seeing railway tie prices increase.

being relatively stable now for the the last uh five six months i would say so we pretty we're pretty much done with with those increases okay and then just going back to utility polls i guess if i think about your your comment about having you know largely lapped those pricing gains by or pricing increases by the end of the year maybe still some some additional ones next year but doesn't sound like to the same extent but then your your production capacity is up which should allow some volume growth Thinking back to your multi-year guidance or objectives, you've talked about, I think, 20% CAGR in utility pools over the first couple of years of your three-year plan. So I guess we should see a significant improvement or step up in your volume gains next year in pools and then just a lower level of pricing gains.

Yeah, I agree with that statement. We will see volume gains into next year. And I guess back to my capital cost comment earlier, can that growth slip into early 25? We'll have to see. So I guess that's part of the reason why we added a bit of that color. Obviously, our customers are living interest rate increases like everybody else on the planet, I guess. But I'll just say there's still strong momentum for maintenance to be done and quite a positive sentiment with our customers that there's a lot of work to get done.

Do you have a sense for – again, a lot of the gains recently in utility pools have been coming on the pricing side, and you'll have the increased production capacity to better capitalize on volume gains. gains next year, give a sense for what the growth rate in terms of volumes is within the broader utility pool market given the replacement cycle, given some of the other drivers related to energy transition and things of that nature. Again, what overall volume growth is looking like in the industry at the moment?

Very hard to answer the question, Mike. You know, there's no industry association that sort of collects all the data to give us some insight. I guess we really see what our customers are sharing with us. Obviously, there's some indications through different announcements. I believe, you know, last week the U.S. federal government announced three major transmission projects. Those are all signs of infrastructure money getting spent. Obviously, it'll take time to plan out and execute on it, but it's really hard to say where that growth percentage is for the total industry.

Okay, fair enough. Next question related to your comments around the strong margins this year, but still comfortable with 16% as we get into next year in 2025. on the basis of some of these uncertainties you called out. I think you specifically mentioned, besides a higher rate environment, which could impact capital spending decisions, you talked about the possibility of spot market pricing pressures on the 30% of your business that's not under a long-term contract. Have you seen any evidence to suggest there is pressure already in spot market pricing in utility pools, or is this more... just a potential risk as we look forward?

So no evidence as of today of the pressures. So it is a bit, I guess, an assumption or a sort of looking into the future. But, you know, talking with suppliers and, you know, understanding what our competition is doing, the industry is investing. There's obviously strong demand throughout the industry. And as we have been doing for the last 24 months, investing and acquiring, wanting to see those opportunities for the long-term business, you know, we're seeing fiber being made available on the market. So I guess my suspicion is that at one point, Our competition or treaters in the industry will want to move their inventory and we might see some pricing pressures. But for now, no evidence of that.

Okay. And then there was an announcement yesterday by President Biden about $16.4 billion of new funding for 25 passenger rail projects on Amtrak's Northeast Corridor. I know a lot of your business has historically been, obviously, on the Relatized side, dominated by Class 1 activity, but can you comment on the extent to which you see that as a potential opportunity for Stella Jones, and if that could result in incremental sales volumes within your Ties business relative to what you might have been able to do absent that announcement?

Our exposure to Amtrak is very small. It's less than 1% of our sales. They buy a variety of products, so I don't see that. The Amtrak piece, I don't see that as being a big impact for us. Okay, that's helpful.

All right, thank you.

Thank you, Michael.

We have no further questions in the queue. Thank you.

Well, thank you, Shirley, and thank you, everyone, for joining us today. We look forward to updating you on our fourth quarter and year-end results in the new year.

Ladies and gentlemen, this concludes today's call. Thank you for participating. You may now disconnect your lines.