Earnings Call: Q1 2021

May 11, 2021

Good afternoon, ladies and gentlemen. Welcome to the Conifex Timber Incorporated 2021 Q1 Results Conference Call. I would now like to turn the meeting over to Mr. Ken Shields. Please go ahead. Well, thank you, and good afternoon, everyone, and welcome to this call covering our Q1 2021 results. With me today, we have Chief Financial Officer, Winnie Tang and Operations VP, Andrew McClellan. So I'm going to make some opening remarks, and then I'll hand the call over to the 2 of them, and then I'll have some closing comments, at which This time, all 3 of us will be pleased to respond to your questions. Before moving ahead, first, we wish to reemphasize that our number one priority He continues to be protecting the health and safety of our employees and their families. And the men and women at our harvesting locations, our sawmill site, Our power plant, they all deserve the credit for ensuring a safe work environment during this unprecedented global pandemic. 2nd, let's quickly deal with a housekeeping item. We will be making forward looking statements And references to non IFRS measures and therefore call your attention to the warning statements set out on Pages 12 of the MD and A documents that we released earlier today. Turning to our Q1, Net earnings were $4,500,000 or $0.10 per share and EBITDA was 9,700,000 And I know many of you still the knowledgeable Forest Products analysts on this call were expecting stronger results From us in the Q1. One reason our Q1 results came in below consensus We expensed 13 weeks of power plant costs that produced electricity for only 6 weeks. On our last call, we alerted you that the proceeds from our business interruption insurance claim will likely be booked in Q2 or Q3 of this year. Had we booked what we estimate the insurance proceeds to be, Q1 EBITDA would have been right in line with consensus. The other reason that our Q1 results Came in below consensus was that we only shipped 10 weeks of the lumber we produced in the 13 week reporting period. Although Q1 lumber production climbed to 51,000,000 in board feet, shipments of 37,800,000 board feet were much lower. Our ratio of SPF shipments to production was 74%, far below The 90% shipment to production ratio, BC's 2 largest SPF producers averaged in Q1 of 2021. Clearly, CN Rail Car Delivery Shortfalls were more pronounced in the Mackenzie region than in other parts of the province. To mitigate the buildup in finished lumber inventories, our sales and logistics team stepped up truck deliveries. And by doing so, we incurred extra delivery costs in the quarter. Subsequent to the quarter end, we've shipped The lumber that was built up. The mill net selling prices we realized on these shipments We're $200 per 1,000 board feet higher than we achieved on our Q1 shipments. The key point here is that besides lowering revenues, railcar shortages added to our costs I've lowered the mill net selling price realizations we recorded in Q1. Had we achieved a ratio of shipments to production in line with the 2 majors, We would have exceeded consensus Q1 EBITDA forecast. We are encouraged that to date in the current quarter, Railcar deliveries have improved and weekly shipments have consistently exceeded production. Should this continue for the next few weeks, Our lumber production and shipments are expected to be in balance by the time we report results for Q2 Good morning, Mr. Ken. I now have the pleasure of turning the meeting over to Andrew McClan, our Vice President and General Manager, Northern DC operations for Compex. Thank you very much, Ken, and good afternoon, everyone. Let's start with lumber. Our Q1 lumber production was 5% higher than Q4 of 2020. However, our shipments were approximately 23% lower. On my last call with you, I explained how we and certain other sawmillers in the Northern Interior region of BC experienced challenging weather conditions last winter, which led to log harvest and delivery shortfalls and retarded lumber production in the first half of twenty twenty one. We plan to boost lumber production as As soon as we have the benefit of summer log deliveries starting next month, and we continue to anticipate our full operating We will exceed 90 percent of our 2 shift rated capacity of 240,000,000 total feet in 2021. Any number of pandemic related or unanticipated production and or shipment disruptions could hold us back and prevent us from achieving the production target. However, on a full year basis, 2021 lumber production is anticipated to be 70% higher than our 2020 results. The BC Ministry of Forests has a timber supply review underway for the Mackenzie Timber Supply Area, and Chief Forester We have 2 major studies underway at present that are related to this Coming announcement, one focusing on the characteristics of the sawlog supply we expect to process over the next decade and beyond at our sawmill facility In a second study focusing on the potential to boost our lumber production capacity at Mackenzie by approximately 25%, Lower our cash conversion costs as well as improve our lumber recovery and grade out turns at our Mackenzie facility. We expect to settle our plans for And modernizing our Mackenzie Sawmill site shortly after the release of the new harvest level determination. I'll turn now to the power generation business. Our power plant continues to achieve its daily power production targets Since the plant restarted in late February. And at this time, I'll turn the discussion over to my colleague, CFO, Wendy Peng. Thank you. Thank you, Andrew, and good afternoon, everyone. And just so we're turning to finance. Overall debt at our quarter end totaled approximately $62,000,000 This is mainly represented by a long term power loan with limited recourse to our lumber operations, A fixed interest rate and a late fee amortization period. After deducting cash balances, we ended quarter 4 with Net debt of $49,900,000 a net debt to capitalization realized ratio of 29% And available liquidity of $16,400,000 The $10,000,000 revolving credit facility we had arranged late last year remains undrawn. In December 2020, we had commenced our normal course issuer bid, which allowed us to repurchase and cancel up To date, we have repurchased and canceled 922,800 shares At an average price of around $1.60 per share. We view share buybacks as an appropriate use of the excess cash we anticipate generating in Q2 through due to the balance of the year. We continue to believe our share price trades well below our estimate of fundamental value. I will now turn the meeting back to Ken. Well, thanks, Winnie and Andrew. Just as a reminder, we differ from the major public SBM producers in the sense that We pay duty deposits on nearly all our lumber shipments. The other public SPF producers do not. Accordingly, duty deposit expenses impact our pretax earnings to a much greater expense than the other public companies. For example, we achieved pretax income of $6,300,000 in Q1 of this year after expensing 2.5 $1,000,000 in duty deposits. For us, duty deposit expenses represented just under 40% of our pre tax income, While it ranged between 3.5% to 5.2% of pretax income for the larger, more diversified FPS producers, It follows that if there is a resolution of the trade dispute and furthermore duties are eliminated, It's clear that the impact on cash flow generation in our company will be considerably greater than for the other public companies. As a corollary to this point, we are building an off balance sheet asset in the form of potential duty refunds. And these duty refunds will likely represent a greater A portion of our equity market capitalization that is true for the larger, more diversified companies. We now have $12,300,000 on deposit that is potentially refundable to us. Given our expectations for lumber prices and shipments for the balance of 2021, this number will likely exceed $20,000,000 by the end of the year. This will represent a materially higher percentage of our present equity market capitalization than is True for the other company. While we appreciate that the timing of the settlement and the likelihood Our full or partial refunded duties is highly uncertain. History suggests it's highly likely that our balance sheet will be further strengthened at some future date. Before turning the meeting over to your questions, we are pleased that we have the ability to release our inaugural ESG report this afternoon. All of us at Conifex are very proud of the track record we've compiled In terms of each of the metrics covered in the report. In closing, lumber markets are strong and we Expect to report record Q2 and full year earnings for the leasing set out on Slide 11 of the presentation we released an hour ago. So thank you for taking the time today to learn more about Conifex. We're pleased to answer any questions You may have, so we'll turn the meeting back over to Russ Sands, our When prompted by the system, please clearly state your name to register your question. There will be a brief pause while participants register for questions. Thank you for your patience. We will take the first question. Hamir Patel. Thanks. Hi, Ken, you brought up a point about your duty burden being higher than some of your peers. I guess I'm just curious, in this very strong Mark, what is even compelling you to sell into the U. S? I'm assuming there's no Canadian discount. So why can't Why wouldn't you tri place all the products domestically? Well, first of all, When we reviewed that this morning at our Board meeting, we found that the MillNet sales price realizations, Depending on the product, we're pretty similar between the two markets. And We're selling roughly 80% in the U. S. The customers that we have in the U. S. Have been loyal to us for a long period of time, effectively lumbers on allocation and the people that have been Supporting us through good and bad lumber markets are being serviced now. We have about 8% of our lumber going to Japan. There's a definite Lower realization on Japanese lumber prices because those prices are set up in advance. And as you well know, cash lumber prices have increased $500 per 1,000 board feet in the last 5 weeks and will be up So Japan has low realizations, but it typically has Fully competitive realization. So that's how we're looking at the business in Europe. Okay. Thanks, Ken. That's helpful. And Andrew, I was I wanted to follow-up on the capital projects that you mentioned, A potential capital project at Mackenzie, which could potentially drive a 25% capacity increase. What would If you were to go down that road, what would be the CapEx and timing of How quickly that production growth would come on? So at this point, Hinder, we're Engage with an engineering firm and preliminary design and general arrangements are available, and we're Currently working on identifying lead time for equipment. So it will be a bit early for me to give an indication in terms of timing of our capital at this point, But we have committed the funding to do the front end engineering work and come up with those answers likely in Q2 or Q3. Great. And just last one for me. Ken, the Premier has made some A lot of comments about how he wants things to evolve in D. C. With forestry policy and tenure. And Just curious to get your thoughts as to how that potential changes could impact ConFX and your Fibroblasto specifically. Okay. Well, that's a very meaty question that you've posed, Javier. Here's our take on the situation. There are 2 important Announcements expected later this month. One is the release of the intentions paper, which I think will provide more detail On some of the comments that the Premier made at the COVID convention in early April. And the second is the allotment of the In the Prince George Trimmer Supply area, which is the largest TSA in the interior region of the DC. And about 3.5 years ago, the Chief Forester concluded that the harvest level Meeting to be established at a considerably lower level than it was previously, but there was still some Pine Beetle salvage harvest activity underway. But the ministry has never I'll disclose how they intend to divide up the harvest between BC Timber Sales, The 3 First Nations and what portion would be remaining for licensees. So It seems clear to me that certainly, Confection's expectation is that In order to remain at your present level of fiber self sufficiency, You're going to have to have some log purchase agreements or arrangements with First Nations. So The effect on BC in BC, one thing to know for sure is that the harvest levels are going down over the next Few years because the salvage programs are close to being exhausted. And the second Our conclusion is that for many companies, their degree of fiber self sufficiency is measured by The tenure is under their control and direction. As a percentage of the total log requirement, that degree Our self sufficiency is growing lower, and there will be a heavier Reliance on purchases from other carrier holders, namely the key timber sales and First Nations. So that's what we see happening on the air. And that's why we have, Yes, Andrew, it's explaining. We're commissioning these reports So we can come up with an ideal optimization plan for McKinsey site, but it's important to us that we know More about the volume and characteristics of the fiber available to us at Mackenzie before we then Finish up on engineering work. So that's why it will be late this year, likely following the release of the PSR review Before we can precisely set the specifications for our modernization and upgrade And before we can estimate what the costs are, but we see no reason why we would be out of line with the Industry in terms of modernization and upgrades typically have a 3 to 5 year payback Great. Thanks, Ken. That's all I had. I'll turn it over. Thank Shields. We will take the next question. Please go ahead. Marcus Campo at RBC Capital Markets. Hey, good afternoon. Thanks for taking my questions. Just with the mid year stumpage revision coming up, Do you expect that to impact your production costs at all? And if so, is there anything that you can do to help offset that? We were, again, scrubbing those numbers this morning. We have estimated that our deliberate log costs in The calendar year 2021 will be about just Somewhere between 20% 25% higher than I mean the previous year And 2% or 3% of the increase It is due to a greener, better loss mix. So we've got a slightly better quality loss coming Into the middle this year, and a bit of the increase is due to some general inflation In costs, but something in the high teens to the Perhaps as much as 20% is due to escalating stumpage costs. That's how the numbers play out for the past, and it's consistent with the Possibility of a $30 per cubic meter increase in province Great. That's helpful. And then just on Lumber Futures, they took a bit of a dip today and caused some concern. What are you seeing in the market today? And do you think we've hit a turning point yet? We had a discussion about that. It's what happened in our board meeting today. And What we found is that at various points in time, the futures market both Hold on cash prices are close and down. And our sales desk Reports that the cash market is stronger On Tuesday of this week than it was on Thursday of last week, where Random Lengths reported the last cash crisis Even though the future has sold off the last 2 days, so there's a bit of a divergence We don't know exactly how everything is going to shake out through the balance of the year. But what we've experienced, of course, has been incredibly beneficial to Convex. On January 1 this year, we had an equity market capitalization of $66,000,000 And an enterprise value of about $115,000,000 And looking at where prices are at, I suspect that our EBITDA this year will be greater than 66. And I don't know if we'll make it into triple digits or not, but it's a whopping number relative to The value that our equity base was recorded at the beginning of the year. So we're feeling very good about How things are shaping up, but what's the chance? The increase in tangible network will be in our company, and that's the reason why we'll be Okay. Sounds good. And then just on that share repurchase program, could you just remind us how you think about it? Do you have a target valuation that you're looking at or Just taking the current market prices as fair value. Well, One number that is often discussed is looking at books that is because We find that a lot of the forecasts have these companies, including us, Probably coming in at 3x earnings, perhaps even lower and not a terribly different Enterprise value relative to 20 21 EBITDA. So we look at book value, and our book value is It's going to be certainly by the end of the year, it's going to be above the current market trading price. The other lumber producers are at 60% to 80% premiums over book value. And so We don't have any trouble tracking or having a repurchase program that tracks Our book value can increase over time. Okay. Thanks. I appreciate the details. Good luck for the current quarter. Thank you. Thank you. We will take the next question. Please go ahead. Brian Podiker. Hi, Ken. Congratulations on a great quarter. So I'm curious if and if you answered this previously, I got on the call late, but curious as to whether with these high lumber prices, You're hedging in any of those prices. And if so, could you give us a description of your hedging program? Okay. Well, it's a matter of public record that I think we're sort of in the middle of In terms of hedging, we lost approximately $900,000 on our futures position Yes. In Q1 of this year, and we disclosed that. I'm aware of one other company Lost a little over $1,000,000 per sawmill on hedging and another company that did far worse than that. I'm also aware of some companies that don't hedge. We think that we will We currently are hedged on a portion of our production. It's way less than 10% of our production, but I think that we are going to use hedges To achieve a better balance between log costs and lumber prices. So earlier, you heard that launch that subject rates in BC were going up by material amount per 2 decretive logs effective July 1. So we don't want to find ourselves paying stumpage rates Based on, say, dollars 1300 lumber and only be getting $700 or $800 for that lumber. So we think there is a business argument to be made to work to try and achieve A balance between your anticipated stumpage costs and the prices That are available in the market to be sure you can cover those higher log costs. Great. Thank you. Thank you. There are no further questions registered at this time. I'd like to turn the meeting over back to Mr. Shields. Okay. Well, thank you, Roxanne, for your service today. And Winnie, Andrew and I all thank you for your interest in Conifex and Look forward to speaking to you when we release our Q2 results. Enjoy the rest of your day. Bye now.