West Fraser Timber - Q3 2024

Transcript

Operator (participant)

This call is being recorded on Thursday, October. During this conference call, West Fraser's representatives will be making certain statements about West Fraser's future financial and operational performance. Business outlook statements may constitute forward-looking information or forward-looking statements within the meaning of Canadian and United States securities laws. Such statements involve certain assumptions, which may cause West Fraser's actual or future results and performance to be materially different from those expressed or implied in these statements. Additional factors and assumptions is included both in the accompanying webcast presentation and in our 2023 annual MD&A and Annual Information Form, through website or through SEDAR+ for Canadian investors and EDGAR for United States investors. I would now like to turn the conference over to Sean McLaren.

Sean McLaren (CEO)

Thank you, Emily. Good morning, everyone, and thank you for joining our third quarter 2024 earnings call. My name is Sean McLaren, President and CEO of West Fraser, and joining me today are Chris Virostek, Senior Vice President and CFO, Matt Tobin, Senior Vice President of Sales and Marketing. On the earnings call this morning, I will begin with a brief overview of West Fraser's Q3 2024 financial results, and then pass it before I share some thoughts on our outlook and offer concluding remarks. West Fraser generated $62 million of Adjusted EBITDA, representing a 4% margin. Note that this quarter was impacted by a $32 million lumber export duty expense. Results were varied across our business again in Q3, with relative strength in our North American Engineered Wood Products segment and stronger than expected demand, set by continued softness in SYP lumber demand.

In the third quarter, levels of new home construction in the U.S. showed further signs of stabilization. The Fed began to trim its benchmark interest rates, which we believe is supportive of demand for OSB and to some extent, SPF lumber. That said, elevated rates still appeared to be constraining existing home sales activity and the repair and remodeling segment, which we expect that the R&R has soft lumber demand. On a trailing four-quarter basis, adjusted EBITDA was $630 million, which is an improvement from the $561 million reported at year-end 2023. We've now been able to maintain a trailing four-quarter EBITDA above $500 million in this down cycle that started back in late 2022, aided by actions we have taken, including acquisitions, strategic initiatives to optimize opportunities.

Finally, in terms of our balance sheet, we have more than $2 billion of total liquidity at quarter end, which offers us the ability to support a consistent capital allocation strategy through the cycle. With that overview, I'll now turn the call to Chris for additional detail and comments.

Chris Virostek (CFO)

Thank you, Sean, and a reminder that we report in US dollars and all my references are to US dollar amounts unless otherwise indicated. So $62 million in the third quarter, compared to a $51 million adjusted EBITDA loss in the second quarter. Note that the third quarter of 2024 included a prior period duty expense that relates to the 2022 calendar year period. Excluding the impact of this prior period adjustment, lumber adjusted EBITDA would have been a loss of $30 million, a nearly $20 million improvement from the prior quarter. Our North America EWP segment of adjusted EBITDA in the third quarter versus $308 million in the second quarter. The Pulp and Paper segment generated $2 million of adjusted EBITDA in the third quarter, second quarter.

Finally, in our European business, Adjusted EBITDA was $1 million in the third quarter versus $6 million in the second quarter. Lower prices in the engineered wood products and lumber businesses, which was only partially offset by higher North American OSB shipments. As noted last quarter, our lumber business continued to benefit from the actions we took earlier in the year to curtail production at three of our higher cost mills, essentially replacing that higher cost volume with lower cost mill volume, which is positive for our overall cost structure. In the U.S. South, on a year-to-date basis, our SYP shipments are now down more than 2%, down nearly 12% versus the prior year. With regard to softwood lumber duties, as noted, we recorded a $32 million duty expense in Q3 related to the finalization of the AR5 rates.

West Fraser's AR5 final combined rate, which now forms the cash deposit 0.9%. This is the cash deposit rate that will be in effect until the US Department of Commerce finalizes AR6, which covers up to December 31, 2023. If our AR6 finalized CVD rate were to remain unchanged from the AR5 and the AR6 finalized AD rate is the same as West Fraser's estimated rate for that period of 8.84%, 13.7%, and would take effect next August and be in effect through August of 2026. Cash flow[audio distortion] million in the third quarter, with our cash balance net of debt and lease obligations at a healthy $463 million, similar to the $469 million reported last quarter.

The nominal change in our net cash balance reflects some further release of working capital this quarter, offset by $107 million of capital expenditures, $65 million of cash deployed towards our buybacks and dividends.

With that brief financial overview, I will pass the call back to Sean.

Sean McLaren (CEO)

We remain steadfast in our strategy and proud of the company we have built, with its geographic and product diversification that has allowed us to weather the period experience for more than a year now. As seen in the right side figure on slide seven, our North American EWP segment hit $760 million of adjusted EBITDA over the last four quarters, a period of challenging cyclical conditions for our other segments. It is this diversity in our wood building product offering that has allowed us to generate $630 million of adjusted EBITDA on a consolidated basis, which is more than two and a half times the level of pro forma EBITDA experienced in the down cycle of 2019. I'll now offer concluding remarks.

We remain encouraged that the Fed's rate hiking cycle is seemingly in the rearview mirror, and that rate cuts are now over the near term, which should be supportive of demand for wood building products in the housing and repair and remodeling markets we serve. Overall, inflation risks are relatively benign, with costs having stabilized across much of our supply chain. As such, and based on what we can see today, we are confident that we are unlikely to experience meaningful upward cost pressures over the near term. For our lumber operations, to make progress refining and optimizing our operations by removing costs and looking for additional margin opportunities. Although market conditions today, the industry supply-demand balance appears to be stabilizing, which is supportive for the industry over the medium term.

As shift reductions, mill closures, and indefinite curtailments, we have reduced available capacity by more than 800 million board feet since, including the latest announcement to indefinitely curtail 110 million board feet at our lumber mill in Lake Butler, Florida. We have also reduced the number of shifts or hours of operations at various lumber mills across our platform. In conjunction with these capacity adjustments, and to manage costs, more productive mills, where we have been spending our modernization capital.

SPF products realized better demand than we originally expected in Q3, as new housing markets appear to have demonstrated more resilience than repair and remodeling markets, in which we tend to see a greater demand pull for our products. In our North American EWP business, we continue to ramp production at our Allendale OSB mill, where we are pleased with the cost production progress. Expect the mill to be among our lowest cost OSB facilities when it achieves its full operating rate.

Given this backdrop, we now expect SPF shipments to slightly exceed the top end of our previous 2024 guidance range of 2.6-2.8 billion board feet. Reiterate our previously reduced 2024 guidance for SYP shipments in the range of 2.5-2.7 billion board feet. For North American OSB shipments to be closer to the top end of the guidance range of 6.3-6.8 billion square feet. Lastly, as we near year-end, we are narrowing the guidance range for our 2024 capital expenditures to $475 million, versus our previous guidance range of $450-$550 million. Before I shift to my concluding remarks, I wanted to briefly reflect upon the attractive returns generated for our shareholders.

As you can see in the figure at the bottom of slide nine, our shareholders have, as we have executed our plans to grow the business, both organically and inorganically. We have optimized our portfolio through dispositions of variable or underperforming assets such as pulp, as the pulp mill divestments we recently completed, and we have returned surplus capital through dividends and buybacks. Expect for us to look to do more of the same on our journey towards creating value for our shareholders. In conclusion, The favorable outlook over the near term, which should be supportive for industry demand. We are taking actions that we expect will make us even stronger when the industry begins.

We will continue to focus on costs and margins in order to build a more resilient business through the cycle, while maintaining the type of financial strength to be able to take advantage of opportunities if and as they arise. We remain optimistic about the longer-term demand prospects for West Fraser, one of the world's leading wood building products companies. With that, we'll turn the call back to the operator for questions.

Operator (participant)

In the question and answer session. Should you have a question, please press the star followed by the one on your touchtone phone. You will hear a prompt that your hand has been raised. Please press star followed by the two. If you are using a speakerphone, please lift the handset before pressing any keys. One moment, please, for your first question. Ketan Mamtora from BMO Capital Markets, please go ahead.

Ketan Mamtora (Analyst)

Good morning, and thank you for taking my question. Sean, perhaps to start with, can you give some additional color on how the R&R demand is trending as we think about lumber? First, or is it more the same and looking for interest rates to drop before things actually, you know, start to stabilize?

Sean McLaren (CEO)

Yeah, good morning, Ketan. I'll make a couple of comments here and then maybe ask Matt to fill in what I miss. I would say, from our perspective, you know, we have seen a little better demand on the southern yellow pine side. Saying that, I think largely the recent price improvement we and others have taken, our treated businesses, our treated customers are our best proxy for that. But with that, maybe I'd ask Matt to,

Matt Tobin (SVP of Sales and Marketing)

Yeah, no, I think agree on, on, you know, the supply adjustments that have created positive pricing environments for us. And, you know, we believe that influence that pricing in our demand is one of them, and our long-term view of R&R is unchanged. Historically, it's a GDP-like grower, and we expect that to be the case over.

Ketan Mamtora (Analyst)

Understood. Just maybe one more on this. You know, you talked about supply in SYP, you know, supply-demand in a better shape, yet, you know, SPF, you've taken up your volume target. Any just sort of high-level thoughts on why these, the bigger price response in SPF, given that new residential is holding up, is holding up better relative to R&R?

Sean McLaren (CEO)

Yeah, and it's what customers do and the products they choose to buy or not to buy. I would say to look beyond, you know, the benchmark pricing early on in the quarter between SPF and SYP. You know, that's corrected, but if you go to the wider widths, two by six, two by eight, those spreads continue for SPF. You know, so I think, you know, combined with more curtailments on the SPF side, you know, the supply-demand balance is. That's why there's more volume coming from us than SPF.

Ketan Mamtora (Analyst)

Got it. And just one last question from me. Chris, as you think about CapEx, for next year, without getting into specific projects, how would you have us think about it at this point? Would it be similar to 2024, lower, higher? Just a.

Chris Virostek (CFO)

Yeah, and we'll have some guidance out kind of at when we release year end around kind of where we think the CapEx range is going to be next year. I'd say a few things. You know, we've had quite a bit of projects underway, and we're quite happy to be bringing those projects to completion here, just as we're maybe reaching an inflection point, and feel that'll really prepare us well for the backside of this cycle when it improves. I'd say, you know, a few things. Henderson will be wrapping up. That's been here over the last couple years. I don't think we're quite ready to start something as big as Henderson again, you know, in the near term. Here, we do have more opportunity things.

You know, I think where we've been the last couple years is a good place to start. But bias is probably a little bit to the forward, just because we're bringing so much stuff to completion here over the next couple quarters, which we're actually really excited about wrapping up some of these projects that we think will serve us.

Ketan Mamtora (Analyst)

That's very helpful. I appreciate it. Good luck. Thank you.

Chris Virostek (CFO)

Thanks.

Sean McLaren (CEO)

Thank you.

Operator (participant)

And your next question comes from [audio distortion] . Go ahead.

Thanks. Good morning, everyone. A couple questions. I want to first touch on capacity closures in the South, and you attributed some of the recent price momentum for Southern Yellow Pine lumber to the capacity shut announcements. A lot of that won't actually start to hit the market until towards the end of this year and into early 2025. So wondering if you can give some context on, you know, how this actual market's getting tighter or speculative buying ahead of these supply reductions actually hitting the market?

Sean McLaren (CEO)

Morning. You know, I guess it's hard for me to speak for across the whole industry, but I will speak for us. You know, we took action, and as things really kind of deteriorated even further through Q2, we took further action. And I would say that the impact, the inventories are relatively small in a southern mill compared to what you'd see in a northern mill or areas where bigger log and process inventories. So I'm speaking for West Fraser, you know, probably are a little better, but not materially different. But so the improvement we've seen in our, in our, you know, to the actions we've taken on the supply side.

Chris Virostek (CFO)

I think, Sean, when you're unwinding all the inventory at a mill in the north and the supply chain, the length of it, it's probably a matter of months to see the impact as you unwind everything. In the south, when we think about our recent experience around the facilities that we've closed, in the weeks until the inventory is exhausted.

Got it. So basically, we've sold all the inventory off at this point?

Correct. Yeah, very quickly.

Thank you for that. Second question's on softwood lumber trade file. We've seen a competitor borrow against receivables. You guys don't need the money, but wondering if you can comment on those types of opportunities and any updated thoughts on whether to wait for elections to play out before we get any potential momentum towards this. Any updated thoughts on the trade file?

Maybe I'll take the liquidity side of it, and Sean can deal with kind of path forward on it. Sean, I would say, you know, when we think about where we are from a liquidity standpoint, you know, I would agree, we don't with some sort of duty transaction, you know, we repaid our notes a couple weeks ago. So, you know, our gross debt is down to $200 million from Moody's, upgraded another notch. So, you know, feel very good about the investment grade rating that we have and our ability to access capital markets, if there was something else, you know, for us, you know, our primary sources of financing would be the traditional sources of financing that we would tap into.

So, you know, on liquidity front, I think we're very well covered off, from that standpoint. And Sean, maybe you want to comment on path forward here.

Sean McLaren (CEO)

Yeah, sure, sure. Maybe a couple comments on path forward perspective. Our perspective, really not a lot new to report. You know, as everybody on this call knows, West Fraser has always been a supportive of a, of some type of management, of moving parts in the political arena, and this is a deal between two governments. So really tough to see how something happens in the short term, but I guess you never know. I would say in what, on controlling what we can, which is our costs and how that plays into any rate, duty rates that we're gonna be exposed to, and continuing to litigate to get a refund of money that is owed to us.

Understood. Thanks for that detail. That's all I have for now. Thanks, guys.

Sure.

Operator (participant)

And the next question comes from Ben Isaacson from Scotiabank. Please go ahead.

Ben Isaacson (Managing Director of Equity Research)

Thank you very much. First question, Sean, can you talk about your order book for SYP, SPF, and OSB? What, what should it be at this time of the year? It's been over the summer.

Sean McLaren (CEO)

Good morning, Ben. I'll just make a quick comment, then maybe Matt can add, but our, you know, in lumber, you know, our order book and it typically doesn't materially change seasonally. You know, it generally is not that long, and it's a cash market and it, but not a great extent and nothing unusual that I would say today. Matt, anything to add to that?

Matt Tobin (SVP of Sales and Marketing)

Nope, no, I think covered it.

Ben Isaacson (Managing Director of Equity Research)

Okay, thank you for that, to the supply curtailments that we've seen in the industry. So I understand we've seen about roughly 5 billion board feet, and most of that looks like it's gonna be structural. Do you think that the supply side has now done enough, and we really are just waiting for demand to normalize? Or do you think that there's still of demand?

Sean McLaren (CEO)

You know, again, a really tough to have, you know, because it really depends on what future demand is gonna be. I can only speak to the actions we've taken. And just as, you know, I know I said it in my comments, but eight hundred million board feet since 2022 that we have taken action on, frankly, has brought us to a point where we're essentially in balance with what our customers are currently buying and their demand. If that changes, so that would be the way I would, I would. But I think we feel like the moves we've made were well positioned to build from here as demand gets better.

Ben Isaacson (Managing Director of Equity Research)

For me, on the OSB side, you mentioned in the press release that curtailments at the mills have created chip shortages for pulp producers, and that's impacting OSB margins. Can you talk about where we are on that kind of path? Are pulp logs still gonna go higher in your view, starting to stabilize? And when OSB prices kind of get back to their normal run rate, we should get back to normal margins.

Sean McLaren (CEO)

Yeah, it's depending on the drain, depending on where the pulp mill is located. Very short term, our view would be that longer term, you know, our position, you know, there will be more production over the long term, shifting to Southern Yellow Pine, which will create more chips, which will ultimately offset closures that have happened in the U.S. South this year. We believe will mean there'll be, you know, a favorable trend to wood cost long term versus any short term.

Ben Isaacson (Managing Director of Equity Research)

Got it. Thank you very much.

Operator (participant)

And your next question comes from Hamir Patel from CIBC. Please go ahead.

Hamir Patel (Managing Director and Senior Equity Analyst)

Sean, when you think of the closures announced in the South over the past twelve months, it looks like they totaled maybe over one and a half billion board feet. How much of that being in a cold idle state that perhaps would come back in a stronger market?

Sean McLaren (CEO)

Good morning, Hamir. You know, again, hard for me to comment. You know, I'll just comment on West Fraser. So we've had four southern mills. Two have been permanent. Two have been, in my view, you know, I mean the difference in West Fraser is we don't immediately begin taking down the mill. You know, back to 2008, we announced Folkston, Citronelle, McDavid. Folkston and Citronelle were dismantled after about a year or so. They were permanent closures. McDavid, but that mill restarted. These are not short-term, month-to-month, quarter-to-quarter decisions. There needs to be, you know, adequate wood supply, adequate plan that makes that mill competitive at the bottom of the market. There's a reason the mill shuts down, because it's not competitive.

We would not restart a mill till we had a plan to make it competitive, and that is an uncertain time. There's a lot of factors that go into that before we make that decision. In terms of what others are doing, hard for me to comment on that.

Hamir Patel (Managing Director and Senior Equity Analyst)

Yeah, fair enough. I'll ask on the European panels business. Looks like it's kind of basically gone to zero over the past year. I know historically, that used to be kind of the steadiest part of the old take to restore profitability in Europe.

Sean McLaren (CEO)

You know, it continues to be slow over there. I would say, you know, a major kind of shutdown at actually our MDF facility in Scotland that was planned for some time. OSB side, I would say we really, we've seen a little bit of price improvement, but we've seen more volume improvement. So, I think it's gonna take just general economic Europe for things to get back to maybe normal or where they were previously. We feel quite good about our position. You know, our investments, you know, as we've got to know the European business more board made, and we continued on, really have put those plants in a good place, in a tough market.

Hamir Patel (Managing Director and Senior Equity Analyst)

Great. Turnover.

Operator (participant)

Once again, if you have any questions, please press star followed by the one, and your next question comes from Matthew McKellar. Go ahead.

Hi, good morning. Thanks for taking my questions. I'd like to start by asking about your conversations with customers in the lumber business and specific to secure larger volumes of lumber in the contract for 2025.

Matt Tobin (SVP of Sales and Marketing)

You know, I think that demand or customer demand relative to, you know, what we're looking for, or we're going through, what I would say is season right now is 2025 planning, but those volumes can adjust and shift over time, so you know, I think from a customer standpoint, you know, they see the shortage of homes long term, but still uncertainty around affordability, but certainly doing that planning with our customers to ensure they're supplied over 2025.

Okay, thank you. Maybe next, on lumber operations in the US South, you mentioned looking for some additional cost savings and margin opportunities. Can you maybe just provide a bit you're pursuing in the South right now?

Sean McLaren (CEO)

Yeah. Good morning, Matthew. You know, I think really a lot of the stuff will be a continuation of a lot of high cost volume with the four mills we've curtailed. As we brought on volume, it's going to modernize plants. That coming on mid-next year. Other projects that we've completed that are all related to, you know, a margin of better grade, better productivity, better working conditions that improve our turnover, a number of things that we've done, and those, we've got a whole series of smaller, and for some time, we've been at this for a while, and it'll be a continuation of that, which we expect will continue to make our southern business more competitive.

Great. Thanks very much. And then last one for me, just a quick cleanup on Cariboo. It looks like you're expected to be down for four weeks in the quarter versus maybe two weeks previously. Can you talk about?

Yeah, absolutely, Matthew. Yeah, you know, so Cariboo, we, you know, it's been eighteen months, I think, since our last major. So we had a lot of work lined up for our major shutdown. We expected it to be a full two weeks. We had an additional two projects that we wanted to complete, as well as, you know, for our sawmill fiber allotments here in British Columbia. You know, we need to be able to make sure we've got adequate fiber supply to get through the coldest months. So that additional two weeks, as well as it gets the mill through the coldest part of the season, and we feel good about next year's fiber supply. We wanted to make sure we didn't have any problem.

Great. Thanks for that. That's all for me. I'll turn it back.

Thank you.

Operator (participant)

At this time, we have no other questions. Please proceed.

Sean McLaren (CEO)

Thanks, Emily. As always, Chris and I are available to respond to further questions, as is Robert Winslow, our Director of Investor Relations. Stay well, and we look forward to reporting on our progress next quarter.

Operator (participant)

Ladies and gentlemen, this concludes the conference. You may now disconnect your lines.