Good afternoon, ladies and gentlemen. Welcome to the Conifex Timber Inc. Q2 2022 Results Conference Call. I would now like to turn the meeting over to Mr. Kenneth Shields. Please go ahead.
Well, thank you, Oscar, and good afternoon, everyone, and welcome to this call covering our second quarter 2022 results. Our CFO, Winny Tang, is here with me today and available to respond to questions that any of you may have following my prepared remarks.
Quickly dealing with a housekeeping item, we will be making forward-looking statements and references to non-IFRS measures and therefore call your attention to the complete warning statements set out on pages one and two of our MD&A dated August 9th that we released earlier today. Our second quarter results were consistent with the guidance we provided on our last call when we indicated that the 30% sequential quarterly increase in lumber shipments we were targeting would offset the effect of lower price realization.
We didn't expect Canadian dollar benchmark prices to decline by as much as 35%, but it did, and we are therefore pleased that our Q2 net earnings did come in at CAD 12.3 million, equivalent to CAD 0.31 per share, which of course is CAD 0.03 per share higher than the CAD 0.28 we reported in Q1. On 20% higher revenue of CAD 85 million, we matched our Q1 EBITDA of CAD 20.1 million.
The first half 2022 operating income of CAD 34.7 million that we reported is after expensing CAD 12.2 million in duty deposits, which is equivalent to CAD 125 per thousand board feet of lumber we produced and shipped in the six-month period.
These duties caused our operating income per thousand board feet of lumber produced and shipped to come in below the levels reported by the two largest lumber producers in Canada, even though our operating income before duties was in line with the per unit operating income the two industry leaders reported for the opening six months of 2022.
Putting this another way, duty deposits represented 35% of our operating income in the first half of 2022, compared to somewhere between 2% and 6% for Canada's two largest public lumber producers. Naturally, we're pleased that the duty deposit rate was just reduced from 17.9%- 8.6%, and we expect a further reduction one year from now.
Since our operating income has been held back by duty imposition more than has been the case for any other public company, it follows that our operating income would be expected to recover by more when duty rates are further reduced or eventually eliminated. These lower duty rates will help us report operating income per thousand board feet of lumber produced and shipped more in line with the leading public lumber producers.
On June 30, our potentially refundable duties on deposit amounted to $29.1 million, or around CAD 92 cents per share, before allowing for any holdbacks and income taxes. While we appreciate that the likelihood and timing of a full or partial refund is highly uncertain, clearly our finances will be materially strengthened when the trade dispute is eventually settled and the cash refunds we expect show up in our bank account.
We are not aware of any other publicly traded lumber producer where potential duty refunds represent an equally high portion of their equity market capitalization, as is true for our company. Looking ahead to our Q3 results, they will be largely shaped by lower lumber prices, the delayed restart of our power plant, and by some minor sawmill downtime necessitated as a result of our successful installation of new log scanning and positioning technology to improve lumber recovery at our Mackenzie site.
Through the first five weeks of the third quarter, our average lumber sales mill net price realization are roughly 35%-40% lower than our second quarter average. Our MD&A discloses that we have approximately CAD 100 million invested in our power plant, and this represents 2/3 of our total investment in long-term assets. With the power plant temporarily idled, the resultant EBITDA drag is expected to offset much of the EBITDA we expect to earn from our lumber operations.
When we report our Q3 results in early November, it is likely that we will not be sufficiently advanced on our insurance claim to record any business interruption insurance proceeds. However, we expect to book some insurance proceeds during the closing quarter of 2022. Without insurance recovery, we expect our consolidated Q3 EBITDA will be materially lower than Q2, but we still expect it to remain positive.
I'd like to spend the next 10 minutes or so describing our journey to develop what we hope proves to be the most economically viable and environmentally sustainable integrated softwood lumber processing site in the interior region of BC. We should start with the updated information we received about future sawlog availability and quality in our supply region and why we expect improved operating performance and cash flow generation in 2023 and beyond.
On July 15th, the Ministry of Forests released its long-awaited public discussion paper, setting out its estimates of the maximum volume of timber available for harvesting in the Mackenzie Timber Supply Area, which they express as cubic meters of wood on an annual basis. Key information on this topic can be found on page two of our Q2 MD&A and on slides seven, eight, and nine in the deck we distributed a short while ago.
At present, our Mackenzie sawmill complex is the only sawlog processing facility operating in the Mackenzie Timber Supply Area. Our facility has an annual two-shift capacity of approximately 240 million board feet. A general rule of thumb that I use is that about 3.5 cubic meters of sawlogs are required to produce 1,000 board feet of lumber. On this basis, it follows that we require an annual harvest of approximately 860,000 cubic meters of sawlogs to support full capacity at our sawmill.
This is represented by the red line covering the 2022-2035 timeframe set out on slide nine. The ministry disclosed it has established a base case indicating that the Mackenzie TSA can sustain a sawlog harvest of over 2.5 million cubic meters annually for 10 years before stepping down by 10%-15% or so. The ministry's base case sawlog availability projections are represented by the green bars on slide nine.
The key point here is that the ministry's calculations indicate that the sustainable harvest in our fiber catchment area can support roughly three times our annual sawlog requirements. Most timber supply areas in the interior region of BC have too little supply relative to the installed lumber capacity, which exposes those operators to the risks associated with a heavy reliance on open market log purchases.
We believe we can operate our sawmill at full capacity when other mills in the interior region of BC will likely be forced to eliminate shifts due to fiber supply shortage. Since we've discussed fiber availability, let's quickly review fiber quality. On our previous calls with you, we discussed how over the past several years, we were forced to direct most of our annual harvest to beetle-killed trees and reserve the green timber for harvesting once the beetle salvage phase ended.
Since the economic value of beetle-damaged timber deteriorates each and every year after attack, our operating performance and financial results over the past few years have been adversely affected. The harvest level projections the ministry released last month indicate that beetle-killed timber is forecast to account for between 0% and an outside chance a maximum of 10% of the harvest established for the Mackenzie TSA.
We expect the chief forester to release his decision on the new AAC for the Mackenzie TSA prior to the end of 2022. Our first half 2022 results reflect the benefits of a minor shift over to green stands, and we expect materially greater benefits when we fully transition to a green log diet in 2023.
A green log diet reduces harvesting costs, sawmill conversion costs, it improves lumber recovery, it provides us richer lumber grade outcomes, and it also boosts average lumber selling price realizations and EBITDA per thousand board feet of lumber produced and sold. All these benefits are expected to combine and move us to a lower and much more enviable ranking on the lumber industry cost curve.
I'd now like to review another component of the opportunity we perceive to be available to us to develop and operate the most economically viable and environmentally sustainable softwood lumber processing site in the interior BC. Over the past decade. At Conifex, we've gained considerable knowledge and expertise from successfully developing and building our power generation cash flow stream, operating our plant 24 hours a day for up to 365 days each year, and producing something like CAD 1 million on average in monthly EBITDA.
This power sector knowledge and expertise provides us a launch pad to develop additional complementary cash flow. The potential opportunity we are exploring is described on page three of our MD&A. We're examining the feasibility of developing data center hosting activities in northern BC to consume surplus power that BC Hydro expects to have available in our region through 2030 and beyond. We're pursuing this opportunity in partnership with the Tsay Keh Dene First Nation.
Our partnership commenced hosting an initial 1.5 MW of capacity last December on a trial basis, and a second trial of 1.5 MW began in March of this year. The results from the 3 MW trial have been encouraging, and we gained valuable experience about the core competencies necessary to successfully host high-performance computing operations under a variety of climatic and operating conditions.
Besides generating positive net income and validating our belief that our power and corporate services teams have the expertise to successfully service HPC customers, the trial provided the input we required in order to assess the merits of scaling up our hosting services over the next few years. The partnership is now investigating the feasibility of building out a hosting business at other potential sites in northern BC.
The intention is for the partnership to expand its hosting business in phases, utilizing cash flow generated from the initial phases to fund the development of subsequent phases. We look forward to providing further details about our progress on this potential initiative in the third quarter of 2022 earnings release. However, at this time, there's no assurance that the partnership will definitively establish a data center hosting business.
Turning to our balance sheet, overall debt was CAD 57.5 million at the end of Q2, mainly represented by our long-term power loan. No amounts were drawn against our secured revolving credit facility. After deducting cash balances, we ended Q2 with net debt of approximately CAD 10 million and a modest net debt to capitalization ratio of roughly 6%. This solid financial position enables us to endure a lengthy period of low lumber prices in the event this should occur.
At our meeting earlier today, our board of directors instructed management and legal counsel to work to obtain regulatory approval to reinstate a normal course issuer bid, entitling us to repurchase and cancel approximately 10% of our public float over a 12-month period, likely commencing around September 1 of this year. We note that our shares trade at a much steeper 50% discount to net book value per share compared to the other public lumber companies.
We understand that if investors expect a company, will likely generate low returns on shareholder investment, we understand the shares will trade at a lower multiple of book value per share. We believe our return on shareholder investment will increase to levels common in our industry as we move to a greener log diet and as export duties are reduced or eliminated. Our intention to reinstate a normal course issuer bid is underpinned by our belief that the trading price of our shares reflects absolutely zero value for our Mackenzie sawmill complex.
As of June 30, after giving effect to the payment of the special dividend, we had about CAD 0.80 per share of unrestricted cash. Our non-cash working capital, namely inventories and receivables less payables, amounted to CAD 0.85 per share. On top of this cash and near-cash subtotal of CAD 1.65 per share, we believe that the equity in our power plant is worth at least CAD 1 per share. It follows that since these add up to well more than our recent trading price, no value is presently accorded our Mackenzie sawmill complex.
Before signing off on this call, our board of directors and leadership team asked me to reemphasize that our number one priority continues to be protecting the health and safety of employees and their families. The men and women at our harvesting sites, sawmill complex and power plant deserve the credit for ensuring a safe work environment while we successfully work through the numerous challenges we face.
In closing, we believe Conifex is well positioned with an excellent safety culture, a high degree of timber self-sufficiency, near-term opportunity to improve fiber quality and product mix. We also have industry-leading power generation assets and a strong balance sheet. We thank you for taking the time today to learn more about our company. We would be pleased to respond to any questions analysts or shareholders may have, and I'll now turn the meeting back to the operator.
Thank you. We will now take questions from the telephone lines. If you have a question and you are using a speakerphone, please mute your handset before making your selection. If you have a question, please press star one on your device's keypad. When prompted by the system, please clearly state your name to register your question. Please press star one on your device's keypad if you have any questions. The first question is from-
Hamir Patel.
Please go ahead.
Hi, Ken. First, I wanna ask you about just in terms of market conditions. I was curious, what are you seeing in offshore markets? You know, we're hearing more reports of excess inventories in both China and Japan. How do you see your geographic mix of business evolving in H2?
Okay. Well, first of all, we sell very nominal amounts to China, virtually zero, although we suspect some of the deliveries that we make to Canadian customers is re-exported to China. Our Japan business, we've got a couple of really key customers there, and it's been a pretty steady and financially rewarding business for us.
You know, Hamir, the real impact of less lumber going to the Pacific Rim markets is that when a rail car in the old days was loaded up in Prince George, say, and shipped to Vancouver and unloaded to be shipped over to Asia, that rail car returned to Prince George, say, five or six days later after shipment. With the drying up of those Asian markets, the rail cars are going a lot further into the U.S., and they're taking a lot longer to get back to Canada.
What we have experienced is that this shift in market destinations has resulted in longer cycle times for rail cars, and it's creating the low shipment-to-production ratio that has taken place in BC for some months now. It, of course, has triggered some of the shift curtailments that certain of our competitors have elected to take in Bella Coola.
Yeah. Thanks, thanks for that, Ken. You know, I know Conifex in the past has made use of lumber futures. I'm just curious, given the changes that are, I guess, recently implemented on lumber futures, do you expect to increase your use of futures going forward?
Well, you know, Hamir, we had a very interesting discussion about that at our board dinner last night. I'd summarize it by saying that the new futures contract probably on balance will be a deeper, more active market. In terms of our position as a commodity lumber producer, we're not sure that it will have any impact on our decision to use futures to hedge lumber prices. We haven't been in the futures markets for several months and have no present intention of reentering them.
Fair enough. Thanks, Ken. That's all I had. I'll get back in the queue.
Thank you. Once again, if you have any questions, please press star one on your device's keypad. The next question is from.
Paul Quinn, RBC.
Please go ahead.
Hey, Ken. Hey, Winny. Just maybe start on softwood lumber 'cause you brought it up, Ken. Any movement that you're seeing on that file at all? I mean, it doesn't sound like it from talking to the rest of the guys, but you know, you might have different contacts on the US side.
No. We have no individual information that is more encouraging than you're hearing from everyone else.
Okay. You know, it looked like, you know, obviously lumber prices started correcting in March and came down to a pretty low level and bounced up, you know, as stumpage came up in BC, and it seems to be sort of tracking that. What's your expectation in October for stumpage? Do you expect lumber prices to fall off, you know, going through 2023 as well?
Well, you know, Paul, we are in a pretty unique geographic area, so we know a lot about stumpage in the Mackenzie area. I've heard that the Q3 stumpage rates are gonna be high in most Interior BC TSAs and lower in Q4. You know, our view is that all the study and analysis we do indicates that sawlog availability is very constrained here in BC. We don't believe this industry has the sawlog availability to get anywhere near historical deliveries and production.
We think the supply-demand balance is such that lumber markets are unlikely to be heavily oversupplied in the face of falling demand. I guess the real question, Paul, is what are the incremental cash costs of producing lumber in BC? Our assessment is that we can't quarrel with some of the statements that people such as yourself and others on the line who have made, that it's around $600 or maybe as much as $650 .
Clearly, we think lumber prices will be probably slightly below that range in Q3, and we expect to have positive lumber EBITDA. Our best guess is that our anticipated cash costs would enable us to generate positive EBITDA, even if prices are below $600 .
Okay. That's helpful. Any update on what the process is on Canfor selling their sawmill site and the plans on the new company buying?
No. The understanding we have is that the Canfor tenures are being sold to three First Nations entities. We also are not sure whether the Bill 22 approval process will be launched immediately. I know that Canfor and the purchasers has filed certain material, but I'm not aware of any ministry actions to solicit stakeholder feedback on the transaction. I'm not sure when that could close.
You know, we have three potentially needle moving announcements coming from the Mackenzie TSA. One is the harvest level determination, which I said earlier we expect before the end of the year. We think that the Bill 22 approvals will happen shortly thereafter.
Once that happens, it'll be quite a while before the apportionment decision's made, and that apportionment refers to how the ministry allocates the harvest areas to various licensees with the objective of ensuring that every licensee has comparable log quality and operating conditions and year-round accessibility to fiber. That third process is gonna take quite a while, and it'll be well into 2023, in my opinion, before we're able to resolve those topics.
All right. That's great. Thanks very much. Best of luck going forward.
Thank you.
Thank you. Once again, please press star one on your device's keypad if you have any questions. We have no further questions as of this time. I would now like to turn the meeting back to Mr. Ken Shields. Please go ahead.
Okay. Well, thank you all for listening in on our call today. As you can probably tell, we think that fiber availability is taking a turn for the better for us, and we are very pleased with our ability to move the Conifex sawmill complex to a much lower ranking on the lumber industry cost curve. We'll keep you posted as to how well we do. Thank you, and enjoy the rest of your day.
Thank you. The conference has now ended. Please disconnect your lines at this time, and thank you all for your participation.