Interfor Q1 2024 Earnings Call Transcript

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May 10, 2024

There are 9 speakers on the call.

Operator

Good morning. My name is Julie, and I will be your conference operator today. At this time, I would like to welcome everyone to the Enter 4 Analyst Conference Call. Thank you. Ian Fillinger, you may begin your conference.

Speaker 1

Thank you, operator, and thank you everyone for joining us this morning. With me on the call, I have Rick Posbon, our Executive Vice President and Chief Financial Officer and Bart Bender, our Senior Vice President of Sales and Marketing. I'll start off by providing a brief recap of our quarter, provide some comments on the market outlook and several key initiatives before passing the call on to Rick and Bart. Turning to our Q1 results. Our adjusted EBITDA was a loss of $22,000,000 during another challenging quarter that was impacted by continued weak pricing.

Speaker 1

To be clear, current pricing is generally below industry breakeven levels, which is simply not sustainable for an extended period of time. We've been proactive in addressing the controllables during these market conditions. Last quarter, we made the decision to indefinitely curtail our Philomath operation in Oregon. We've also done a good job reducing working capital and recently we announced the removal of 175,000,000 feet of production across all North American regions to address the oversupply and weak pricing that exists today. We've always been fact based and disciplined and consistently have been an industry leader when it comes to dealing with adjusting capacity or making tough decisions to strengthen our portfolio of operations.

Speaker 1

We have a more positive outlook as we head into the back half of twenty twenty four and into 2025. However, we intend to continue to manage the business and our balance sheet conservatively.

Speaker 2

I'll now turn the call over to Rick and he'll walk you through the financials. Thank you, Ian, and good morning all. Please refer to cautionary language regarding forward looking information in our Q1 MD and A. At a high level, Inner Forest Q1 results were a slight improvement over the preceding quarter, but lumber markets continued to be challenging. Lumber prices remained unsustainably weak relative to average costs across the industry, resulting in cash margins hovering around breakeven levels across North America.

Speaker 2

As Ian mentioned, our focus continues to be on the controllables within our business. We're using this down market as an opportunity to strengthen the core of our business and set up for success over the long term. Turning to Q1 earnings, Interfor generated an adjusted EBITDA loss of $22,000,000 on total revenue of $813,000,000 Compared to the previous quarter, revenue benefited from a 5% increase in lumber shipments and a 2% uplift in the average realized lumber price. On the cost side, reported production costs on a per unit of lumber basis were 5% lower quarter over quarter, benefiting from a $14,000,000 decrease in the provision against inventories. A net loss of $73,000,000 was realized in the quarter, which included $31,000,000 of gains from the ongoing sale of coastal BC forest tenures.

Speaker 2

In terms of cash flows, there was a $17,000,000 outflow from operating activities in the quarter as negative operating earnings were partially mitigated by the management of inventories to reduce levels. Capital expenditures were as expected at $26,000,000 in the quarter, while the sale of forest tenures contributed $29,000,000 of cash. Ultimately, our net debt to invested capital leverage ratio ended the quarter at 34.7%. Looking out over the remainder of 2024, we continue to expect collection of $64,000,000 in tax refunds and further cash proceeds from the sale of coastal BC forest tenures. Regarding capital allocation, we will continue to take a conservative approach as we manage through this sustained market weakness.

Speaker 2

The primary focus is on reducing financial leverage into our target range below 25% net debt to invested capital. Capital expenditures will continue to be restrained in line with previous guidance. To wrap up, Interfor's Q1 results reflect significant ongoing market weakness, which we view as unsustainable for the industry as a whole. Fortunately, Innofor is well positioned to successfully navigate through this period as supply rebalances with demand. That concludes my remarks.

Speaker 2

I'll now turn it over to Bart.

Speaker 3

Okay. Thanks, Rick. Good morning, everyone. Lumber markets have been difficult to forecast for some time now. The near term market indicators remain mixed.

Speaker 3

Longer term fundamentals remain positive. Our expectation was to see an improvement in lumber demand through the spring building season. However, this time remains elusive and less likely as time goes on. We are encouraged with the single family housing starts with new homes continuing to take an increased share of home sales. We expect this to continue as we finish out the year.

Speaker 3

Multifamily construction is less certain as affordability takes a greater toll on this segment. When interest rates start to decline, multifamily is positioned to benefit. With that, builder sentiment has been mostly positive, although most recently it started to decrease. We expect this to stabilize in the coming months. Repair and remodel end use segments have been mixed have seen mixed results recently.

Speaker 3

The programs we have with box stores continue to meet expectations at this time of year. However, with U. S. Household savings largely exhausted, we are expecting borrowing rates to factor into future spending. Lumber markets are highly sensitive to demand and supply levels and we know that there is a fine line here.

Speaker 3

We've recently announced curtailments and expect to continue to manage our production to meet our customers' demands. We're seeing a similar response across our industry as it becomes more evident that lumber demand is likely to remain at current levels for longer. As we move back into the back half of twenty twenty four, we expect a better balance between supply and demand. I'll stop there Ian, back to you.

Speaker 1

Okay. Thanks, Bart. Thanks, Rick. Operator, we're ready to take any questions.

Operator

Thank Your first question comes from Sean Steuart from TD Cowen. Please go ahead.

Speaker 4

Thanks. Good morning, everyone. Ian, a question on the downtime plans from May through September. The implication, I guess, is you're taking it across the platform. Wondering if you can give a sense of relative weight region to region.

Speaker 4

And I guess what I'm trying to get at is presumably the U. S. South is quite compromised of these prices in terms of margins. Any more granularity you can give on the relative weighting of where this downtime is going to be taken?

Speaker 1

Sean, I don't have the like specifics yet because we kind of look at when we look at the downtime, we look at the operations that are in performing, I would say, better. So BC is doing okay right now in the Northwest. And when we look at Eastern Canada and the South, we look at it on an individual mill basis more than a regional basis. So where a mill is in a situation where it's more positive than a mill that may be in a tougher situation. We're taking the tougher situation in the downtime and continuing to obviously operate the mills that are in a more positive situation.

Speaker 1

So it really is not more regional, it's more mill specific. And so we're being smart about obviously our portfolio of mills and running the ones that we feel are maybe a little advantaged over other ones at this point in the market. And so that's how we're managing that. And it really is spread across North America. Each region has different unique situations.

Speaker 4

Okay. Thanks for that. Second question for Rick on leverage. I guess in the hopefully unlikely event that this price trough extends substantially longer, at what point do you start to think about getting ahead of the covenant on debt to cap and presumably this isn't a concern in the next few quarters, but you likely don't want that ratio to get to 50% before you worry about it. How do you think about available liquidity and covenants at this point?

Speaker 2

Good morning, Sean. Yes, we our leverage ratio is at 34.7 percent at quarter end and we've got plenty of headroom up to our leverage covenants. We also have ample liquidity today of around $300,000,000 So in here and now, we're not concerned. And when we look at, we've got plenty of levers to pull to manage our leverage ratio. 1st and foremost, it's operational excellence, making sure we're doing the right things at the right time within the business, focusing on maximizing cash flows from operation as Ian alluded to, we're targeting our underperforming operations when it comes to downtime and those sorts of things.

Speaker 2

So that's the first level we're focused on to sustain ourselves through this market weakness. And then as I mentioned in my comments, we've got significant non operational cash flows coming ahead, which bolster we look out to 2025, we're generating losses this year, which will result in cash refunds next year as well on a tax basis. So, there's lots of look ahead to as well in 2025. And then when we think about our BC coastal tenures, we've got significant progress made already, but looking ahead, there's substantial cash flow as we expect this year and into 2025. You can think about that in the range of $65,000,000 to $70,000,000 in total net cash flows to Interfor to come over the next 12 months to 18 months.

Speaker 2

You can think about half of that happening in the next 9 months of 2024 and then the remainder into 2025. So when you factor all those things in, we feel we've got plenty of headwinds, but certainly as the market stays down and we progress through this, we're going to be proactive if we need to be, but we're not at that stage

Speaker 4

yet. That's great detail. Thanks very much. That's all I have for now. I will follow-up if I need anything else.

Speaker 1

Okay. Thanks, Sean.

Operator

Your next question comes from Matthew McEller from RBC Capital Markets. Please go ahead.

Speaker 5

Hi, good morning. Thanks for taking my questions. Maybe first, I think you mentioned seeing a supplier response in lumber across the industry. Do You think the impact of that response is reflected in the market and current cash pricing today? Or should we expect that impact to be increasingly felt more as the quarter progresses?

Speaker 1

Yes. Hey, Matt. Ian here. I'll jump in and Bart, you can do the same. But I would say, Matt, we've been underwhelmed by the response from the industry to really kind of rebalance the situation here.

Speaker 1

Having said that, we are getting intel both from announced curtailments and quiet curtailments that are happening. So we're positive that on that that people are starting to do that. I would say, Matt, that we're probably not going to feel that capacity coming out for 60 or so days, just given that as you well know, when you do take a sawmill down, you generally continue to run the planer mill and continue to move your inventory and that takes weeks to work through. So I think there's a lag there before there'll be really any feeling in the supply side in the market. I don't know Bart is that fair or what's your

Speaker 3

Yes, totally.

Speaker 5

And the only thing

Speaker 3

I would add to that is that the distribution channels over the years have kind of introduced a discipline where they're not reacting to announcements, but rather they're reacting to whether they're able to resupply or what the lead times look like or what the demand side of the equation looks like. And so, they won't react, I don't think until they actually see it. So less so on the announcement, more so on an actual constraint in the marketplace. And to Ian's point, that's going to take 60 to 90 days in my opinion.

Speaker 1

Yes, Matt, maybe just to close on this question. I mean, we have seen a sizable decrease in our own inventories through some of the levers that we pulled and quite a bit on the lumber side. So it is our check or our opinion is it's pretty lean out there. And so as this works through, it'll be interesting to see how things unfold. But I would use the word sizable decrease for our situation in lumber and log inventories.

Speaker 5

Thanks. I appreciate all the color. And the last one for me, I think you noted in February that unseasoned will be warm weather impact log deliveries in BC. Can you provide an update on how things have trended over the past couple of months and how the log decks in your mills in the province are looking at this point?

Speaker 1

Yes. I think in BC, as you know, we've got pretty competitive operations and we have water storage at a couple of our mills. So I would say that we're comfortable generally in British Columbia. I would say though that in Eastern Canada, there's been challenges in particularly in Quebec when it comes to log inventories with the warm weather and what have you. So yes, I think it's tight.

Speaker 1

Our log inventories generally are in Canada are down more than double digit percentages. If you kind of look from New Brunswick all the way to British Columbia and every region that we operate and kind of use that as an average, we're again double digit percentages down in Canada. I wouldn't be surprised, come summertime, the industry, some industry mills may be taking downtime for log shortages, especially if there's an upset condition like a fire season or something like that, that would restrict logging during any kind of summer hours.

Speaker 5

Thanks for all the help. That's all for me.

Speaker 3

I'll turn it back.

Speaker 6

Thanks, Matt.

Operator

Your next question comes from Ben Isaacson from Scotiabank. Please go ahead.

Speaker 6

Good morning. This is Victor jumping on for Ben. I just wanted to ask about the timing of recent curtailment. Supply seems to be acting rationally and with lumber prices up somewhat sequentially and we are at what is usually the peak construction season. So how do you see the demand side of the supply and demand balance develop for the rest of the year and throughout the summer and into winter?

Speaker 3

Okay. You've got a lot to unpack in there, Victor. I would have to say that the demand side as we're coming into the spring building season, we're expecting we were expecting to see an increase in activity and frankly that hasn't taken place. And so it seems like this year we're going to miss that part of it. And when we're looking at that, we think it comes down to 2 factors, a decline on the repair and remodel side of it, especially when you talk about treating.

Speaker 3

That's an area that we've seen some slowdown. And the other is multifamily, especially in the South multifamily has decreased. And so the demand side of the equation has seen a slowdown and I would say that the supply side has not from an industry perspective has not responded yet. So we're still in a position where we think the markets are oversupplied and quite frankly the pricing that's in place is reflecting that. So overall we think demand is going to be quite similar year to date for the balance of the year.

Speaker 1

Victor, Ian here. I'll just add to Bart's. We see that the spring buying season has essentially failed to take off this year. And so when we look at that and we look at where the U. S.

Speaker 1

South pricing is, in the U. S. South typically isn't impacted by downtime decisions, given the low cost fiber base there. But prices in the U. S.

Speaker 1

South are near 50 year lows on an inflation adjusted basis. As you start to see these impacts of permanent and temporary curtailments coming into effect, with the lean inventories that we talked about throughout the supply chain, I mean, any uptick in demand could provide meaningful tension into pricing. But if they don't recover, obviously we expect given particular in the U. S. South at the 50 year lows continued supply responses.

Speaker 6

Thanks for the color guys.

Operator

Your next question comes from Ketan Mamtora from BMO Capital Markets. Please go ahead.

Speaker 7

Thank you and thanks for taking my question. But I mean, I think this weaker than expected pickup in R and R demand is echoed by some of the other peers as well. Can you talk about what you guys are seeing in terms of your volumes in R and R on a percentage year over year basis? Any color around that?

Speaker 3

Yes, I won't get into the detail particularly, but I will the commentary is we have our box store programs that are out there. So we have a pretty good view of the consumption that's taking place there. And I would say it's matched with what we had budgeted so far year to date. Generally, Q1 is a bit slower, Q2 starts to pick up and that's what we're seeing quite frankly. It's the treating side of the business that I think has really seen the slowdown.

Speaker 3

And we see that through the programs that we have in place for that as well. And so really almost need to look at it in 2 ways. So the DIY out of the box store fairly stable, but there does seem to be a slowdown with any of the treated products. Obviously, that's your exterior type projects in the backyard and those types of things. Those have definitely slowed.

Speaker 3

And I would say if I was going to give you a percentage on the treated side, you're looking at in the 20% range decline on that side, so fairly significant.

Speaker 7

I see. Okay. No, that's helpful. And then, Rick, on 2024 CapEx is $90,000,000 still the plan? Do you have any flexibility there?

Speaker 2

Hi, Ketan. Yes, dollars 90,000,000 still is the plan and we're on track for that. There's certainly a little bit of flexibility there as we take some downtime and maybe that requires less maintenance CapEx. But as it stands right now, we're still on plan for the $90,000,000

Speaker 7

Got it. And then just coming back to financial leverage. So you called out a couple of items, the tax proceeds, BC tenures. Anything outside of that you can do that could help accelerate bringing down the financial leverage? Revenue Advanced Materials recently sold their number duty rights.

Speaker 7

Is that something that you guys are considering at all?

Speaker 2

For sure. We did see those transactions announced without knowing all the terms though, it's hard for us to comment on the economics. It is nice to see though that some value is being ascribed to the duty deposits out in the open market. We certainly believe our US560 $1,000,000 in deposits represent significant value to our shareholders. And in dollar terms on a per share basis, our duty deposits represents about CAD11 on an after tax basis.

Speaker 2

So there's significant value there in our minds. In terms of the leverage piece, as we look out, I mentioned it's the operational excellence piece, making sure we're getting the most out of our operations out of each individual operation. So we look closely each and every week of each operation and make decisions based on the outlook for those and with the mindset of maximizing operational cash flows and minimizing the impacts on our leverage as we work through the down market.

Speaker 1

Maybe Rick, I mean, KTAM, when we look at those transactions that happened, I mean, they're not attractive to us to consider, I guess.

Speaker 2

I agree.

Speaker 7

Got it. That's helpful color.

Speaker 1

Yes. Ketan, one thing that when you talked about R and R and what have you, just to come back to that for second. I mean, Southern Yellow Pine supplies a lot of that. And I just kind of want to remind folks that we're not as heavily Southern Yellow Pine as maybe some people think. We do with Eastern Canada, about a third of our production is in SPF.

Speaker 1

And important is that SPF and Southern Yellow Pine are entirely exchangeable or substitutable. So we are benefiting on the SPF side of the business when it comes to pricing on when you look at the Southern Yellow Pine. So our diverse geography and the move to Eastern Canada to capture some of the SPF that was available through those acquisitions is we're seeing positive pricing and when we look at those gaps.

Speaker 7

Thanks Ian. I appreciate the color. I'll jump back in the queue. Thanks, Geeta.

Operator

Your next question comes from Amir Patel from CIBC Capital Markets. Please go ahead.

Speaker 8

Hi, good morning. Bart, I wanted to follow-up on the earlier question about the multifamily weakness. I was just wondering if you had a sense as to perhaps how much more wood intensive the multi starts are in the South versus the rest of the U. S. And is maybe Southern Pine just that much more prevalent in multifamily usage in the South?

Speaker 8

Because when you look at the actual starts, they're down more in the South, but not necessarily that much more than the whole U. S.

Speaker 3

Yes. I would take a look at the permits side of that equation as well. But I think if you look at the big the states that are big consumers and builders of multifamily, so that's your Florida, your Georgia and your Texas. Has decreased fairly significantly on the multifamily side. And in particular, if you look at the permits, I think you'll see a trend there.

Speaker 3

And obviously, those markets are right in the backyard of Southern yellow pine producers and are largely supplied by Southern yellow pine. So the act I think the impact of that is a little bit more heightened than itself and that really I'm looking at that as one of the main reasons that we're seeing the market that we have in the South.

Speaker 8

Okay. No, fair enough. That's helpful. And just last question I had, Ian, as part of the balance sheet management, would you look at potentially divesting any of your sawmills?

Speaker 1

Well, Hamir, that's a good question. I mean, our portfolio of 30 or so operations now, obviously, you've got different stages of each ones and you've got ones that are in the top and ones that are in the middle and ones that need some work. So we're always looking at those. Philomath is an example last quarter. You'll recall, we sold Acorn a year or so ago.

Speaker 1

We shut down our ham and cedar bill and then converted that into a real estate play. So at the end of the day, I mean, we're always looking at how do we improve the ones that need it, what's the capital investment, what's the timeline, how's the fiber supply and fiber security. So I would say just Hamir, I mean, generally, I mean, that's one of the most important things that we're doing all the time and always trying to improve or find a path to improvement for the shareholder and for the company. So it would be yes, we're always looking at our portfolio on how to improve it.

Speaker 8

Fair enough. Thanks, Ian. That's all I have.

Speaker 1

Great. Thanks, Sameer.

Operator

And there are no further questions at this time. I will turn the call back over to Ian for closing remarks.

Speaker 1

Okay. Thank you, operator, and thanks everybody for your interest in our company. And feel free to reach out to myself, Rick or Bart anytime and this concludes our call. Have a great day.

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