Good morning, ladies and gentlemen, and welcome to the Interfor quarterly analyst conference call. At this time, all lines are in listen-only mode. Following the presentation, we will conduct a question-and-answer session. If at any time during this call you require immediate assistance, please press star zero for the operator. This call is being recorded on Friday, August 5th, 2022 . I would now like to turn the conference over to Ian Fillinger. Please go ahead.
Thank you operator, good morning and welcome to everybody listening in on our call, and welcome to our Q2 2022 analyst call. Before we get into the report out, I would like to welcome Tom Temple to our board of directors. Tom is a seasoned industry executive, and we look forward to working with Tom over the years ahead. Today, with me you have Rick Pozzebon, our Senior Vice President and Chief Financial Officer, and Bart Bender, our Senior Vice President of Sales and Marketing. Our agenda today will start off with myself providing a recap of our financial results, our strategic focus, and our improvement efforts. I'll then pass the call to Rick, who will cover our financial matters, and then Rick will pass the call to Bart to cover off the markets.
Turning to our financial results, our Q2 adjusted EBITDA was CAD 429 million. We are continuing to execute on our strategic plan, and we are generating industry-leading lumber margins and returns on capital. I encourage you to look through the investor deck on our website and look at these metrics. Our improvement efforts, again, were balanced across the company as we made progress in all regions. For the fifth consecutive quarter, our production volumes were again at an all-time high, largely due to the production quarter of our Eastern Canadian platform and the ramp-ups of our mills in DeQuincy, Louisiana, and our mill in Eatonton, Georgia. We are proactively reducing inventory levels throughout the quarter by managing lumber production, and we achieved improvements in logistics and capacity availability. This, combined with seasonal impacts, resulted in a significant reduction in working capital in the quarter.
Our SG&A expense decreased quarter-over-quarter as economies of scale are being realized from our growth through acquisitions and our capital investments despite persistent inflationary pressures. We continued with our CapEx improvement plans in every region, spending CAD 65 million in the quarter, up from the previous quarter. Turning to our financial capacity, we continue to have significant financial flexibility to consider several further capital deployment options, which Rick will cover off shortly, including our CAD 100 million SIB buyback that we announced last week. I'd also like to provide an update on how the integration is progressing with our Canadian Eastern platform. Since the acquisition date in February this year, the East region has contributed a robust CAD 206 million of EBITDA in the first 4.5 months, or approximately 42% of the CAD 490 million purchase price.
Our key focus areas in this region are to enhance our historical operating performance, identify further opportunities for operational improvements and synergy realization, and assess potential long-term strategic investments. Turning to our strategic focus, we continue to achieve greater returns on capital through our unrelenting focus on operational excellence and our balanced and situational specific approach to capital allocation. As such, I wanna outline a few key initiatives. We continue to optimize our portfolio, which included the sale of our Acorn mill on the coast of British Columbia. Our DeQuincy mill in Louisiana continues to progress well, and we have now fully moved to a two-shift operation several months ahead of schedule. In Georgia, our largest capital project at our Eatonton mill is now complete with very solid production, great outturn, and cost performances thus far. In summary, our balance sheet is in great shape.
Our returns on capital, ROCE, are again exceptionally strong in Q2 at 53% and year to date at 69%. We continue to work hard on our capital allocation discipline to ensure the best returns for our shareholders, and we're continuing to see strong performances from our internal projects and our recent acquisitions. That concludes my opening remarks, and I'll now hand the call over to Rick.
Thank you, Ian, and good morning. First off, I'll refer you to cautionary language regarding forward-looking information in our Q2 MD&A. Interfor's second quarter was successful in many respects. Most notably, we continued to capitalize on our significantly increased scale and capabilities to produce and ship the most lumber in our history. We further enhanced the competitive positioning of our sawmill portfolio, including ramping up our DeQuincy sawmill to two shifts and completing the full rebuild of our Eatonton sawmill. We also extended our track record of generating the best returns on capital in our industry through our continued focus on operational excellence and disciplined capital allocation. Our capital allocation in the quarter was balanced and driven by our focus on maximizing shareholder value over the long term.
We continued to invest in significant capital upgrades to our sawmill portfolio in line with our multi-year plans and repurchased over 1 million Interfor shares at an attractive valuation to complete our Normal Course Issuer Bid. We continue to see significant value in Interfor shares and last week announced our intention to commence a Substantial Issuer Bid to purchase up to $100 million of Interfor shares within a tender price range of $29-$34 per share. Assuming successful completion of this bid at $29 per share, Interfor would have then bought back and canceled over 24% of its shares within the past two years. Over the same span, we've grown our lumber production capacity by over 60% and added significant diversification with our growth into Eastern Canada. In terms of financial results, Interfor generated adjusted EBITDA of $429 million in the second quarter.
These exceptional earnings include CAD 116 million from our recently acquired Eastern Canadian operations, which is net of CAD 17 million of non-recurring purchase accounting expense. Excluding this, total adjusted EBITDA would have been CAD 446 million in the quarter. Earnings benefited from selling a record 1.1 billion board feet of lumber at historically strong lumber prices, while general cost inflation continued to be a headwind. Cash flow from operations was CAD 218 million, with another CAD 176 million generated from working capital reductions for a total of over CAD 7 per share. The working capital reduction was driven by the collection of trade receivables, improved lumber shipment rates, and seasonal reductions in log inventories. Our current lumber inventory level is now within our target range, and we will continue to adapt our production rates to match demand if necessary going forward.
Regarding capital allocation in the quarter, we invested $65 million into capital projects and returned $33 million to shareholders through buybacks. We ended the quarter with our balance sheet in a net debt to invested capital position of 5%, which is at the lower bound of our target leverage range. This leaves us with ample liquidity to continue pursuing our strategic plans, which include spending in the range of $275 million-$300 million on capital improvements for the full year 2022, which is up about $25 million over prior guidance. We'll also continue to be disciplined in looking for accretive lumber acquisition opportunities. To wrap up, I'll highlight two points. First, our business is well-positioned operationally and financially to succeed through ongoing market volatility.
Second, our record-setting financial results in Q2 have demonstrated the benefits of our strategic growth and portfolio optimization, including generating the best returns on capital in our sector. That concludes my remarks. I'll now turn the call over to Bart.
Okay. Thank you, Rick, and good morning, everyone. I'll provide an outlook on lumber markets through Q3 and into Q4. First, I'll start off with logistics. Our ability to service our customers has been challenging as equipment availability and labor continues to impact logistics capacity. Overall, I'm pleased with how our team mitigated this situation and with the progress we made through Q2 into Q3. Our inventories have essentially normalized, and the service levels from our carrier partners has improved. It's not perfect yet, but it's better in all of our operating regions. With respect to end market inventories, our understanding is that levels are holding at below historical lows and should be considered minimal. In terms of the markets, much like we discussed last quarter, there continue to be some uncertainties that is pushing our customer base to be cautious in their procurement strategy.
Current demand levels remain quite good. The uncertainty just lies with what might be coming. Certainly, the overall fundamentals in the market continue to support medium-term solid demand for lumber. However, the impacts of affordability weigh on expectations. In particular, new home construction is facing affordability issues given house prices and interest rates that is impacting their ability to sell homes. The demand for homes remains, so we expect this situation to be resolved over time. Accordingly, housing starts are starting to show the impacts of this. However, given the fact that completion rates are so much lower than starts, the impact on lumber demand is, in our view, more tied to completions. Repair and remodel is showing signs of strength. There was a period in Q2 where high lumber prices seemed to slow demand.
However, today, I can tell you our sales through this segment of the market are encouraging. In the industrial and non-residential markets, they're essentially holding and continue to be steady. Q2 marks our first full quarter with I-Joist as a part of our product offering. Our distributors continue to support our production levels, and I'm encouraged by the resilience of this product in the market, which is supported by high-quality standards and excellent customer service. Overall, our outlook for the balance of the year is for less volatility in lumber prices at higher than historical levels. With that, I'll stop there and pass it back over to you, Ian.
Okay. Thanks, Bart and Rick. Operator, we're open to take questions from our analysts now.
Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. Should you have a question, please press star followed by one on your touch-tone phone. You will hear a three-tone prompt acknowledging your request, and your questions will be polled in the order they are received. Should you wish to decline from the polling process, please press star followed by two. If you are using a speakerphone, please lift the handset before pressing any keys. Your first question comes from Sean Steuart, TD Securities. Sean, please go ahead. Sean, your line is open.
Sorry, guys. A couple of questions. Bart, I'll start with markets. You noted that your inventories have been at a level of normalized. You highlighted a sense that inventories at the buyer level are low. I'm just hoping you can square that with the pressure we're seeing on prices right now. It feels like we're below cash costs for higher cost producers in BC at this point. You know, how are you squaring good takeaway from repair and remodeling and what seems like tight inventories from your perspective with ongoing pressure on prices? Is this just a seasonal thing, or is there more to it than that?
I think there's probably a bit more to it than that, Sean. You know, when you think about the uncertainties that are ahead, you know, people look at their inventories, and they base what they feel is acceptable based on their consumption rates. If they're expecting those consumption rates to fall, they'll adjust accordingly. I really feel that that's part of this. People are prepared to take their average inventory levels lower in anticipation of a future decline. You know, I think that a lot of the interest that we're getting from our customers is, you know, they're particular on specification, and they're very particular on shipment. Shipment is a big part of it, and that tells us that they don't have the inventories.
They need the wood fairly quickly to meet the demand that they're continuing to see in the marketplace. I think until those uncertainties are more known, we're just gonna see a very cautious tone from our customer base.
Okay, thanks for that detail. A question for Ian and/or Rick. I wanna sort of wrap my head around the next leg of discretionary CapEx. This is obviously the busiest spending year, and I think the indication in your slide deck is that CapEx should moderate in 2023. Can you give us a better idea of what the next round of CapEx looks like for the company? Is it gonna stay as focused in the U.S., so there is a more spread out? How should we think about that?
Yeah, Sean, Ian here. Thanks for the question. We're, you know, have a great view of obviously our South, Pacific Northwest in Washington and Oregon and BC mills. What we're working on pretty hard is the Eastern Canadian platform, looking at, you know, what strategic projects and discretionary, you know, projects could look like, you know, over the coming years. I think, you know, to be able to answer that with a bit more clarity is probably a few months away as we go through our, you know, our normal course, you know, planning exercises on fiber and, you know, synergies, et cetera, like that. We're, you know, we're kinda, you know, November, January-ish, probably be able to provide better context on that.
I can tell you that there are several operations that are on our radar that we're working on currently with different levels of business cases and engineering and those type of things, but it's just a little early for us. The guidance that's in the South that we've you know provided over the last year or so is still accurate and solid. It's just the new platform that we've got in Eastern Canada that we're spending some time on now.
The bump to CapEx this year, that's strictly capital cost inflation for these types of projects, or is there any pull forward of projects that are envisioned for 2023?
No, it's actually the first point you brought up is accurate. The second would be that you know, after acquiring the Eastern Canadian platform, there was some you know, capital spending that we did pretty immediately. Some of it's been implemented, and some of it will be implemented by the end of the year. I would say the majority of that is inflation and new projects that were identified over the last few months.
Okay. Thanks very much, Ian. That's all I have for now. Thanks, guys.
Okay. Thanks, Sean.
Thank you. Your next question comes from Mark Wilde, BMO. Mark, please go ahead.
Thanks. Good morning, Ian, Rick, Mark. Ian and all the team, I really wanna acknowledge, I think, an excellent job of capital allocation over the last couple of years. We've really been in a very unusual environment, and I think you've actually, from a capital allocation standpoint, managed it very well. With that said, I wonder just if you could give us some sense of where you think cash cost is sitting right now, in BC, and how that will change over the next couple of quarters as we see stumpage costs going down?
Yeah. You know, I don't know if we could share the exact number that we have in mind, but I think that, you know, several, you know, you know, points of view are out there. I don't know, Rick, if you have anything else to add. It definitely is, as you've clearly identified, Mark, it is the benchmark now. BC is the highest cost, and in these situations, that's where we think the downtime will come. Not necessarily with us, as you well know, our three operations in British Columbia are not i n the same fiber basket as some of our competitors. We enjoy the ability to cut, you know, different species and stay off the random length, you know, price deck, a fair amount with Adams Lake, Castlegar and Grand Forks. Rick, anything else to add on?
I'd say maybe it's important to look at where SPF pricings have bottomed out recently in terms of what cash costs might do over the next couple quarters. If you look at stumpage rates in the BC interior, they were about CAD 60 per cubic meter in Q2. They're going up to about CAD 90 in the current quarter, and then in Q4, down to about CAD 50 per cubic meter. That'll drive some reduction in cost throughout the rest of this year.
Okay. All right. That's helpful, Rick. Then, can you also just help us with kind of what's going on with log costs for you in the Northwest and in the U.S. South? It does seem like in the South that we have finally hit an inflection point over the last probably six or seven quarters. I'd just be curious about what you're seeing in terms of log pressure there and again down in the Northwest?
Yeah, I mean, different dynamics starting with the South, Mark. There, you know, in our platform there, you know, one thing we do enjoy in some of our areas is, you know, some proximity advantages between operations. So, you know, when log costs tend to go up in the South, so our opinion is largely it's through some upset conditions, whether it's weather events, you know, and that causes, you know, shortages, you know, at pulp mills or competing mills. Then, you know, there's a short-term, you know, bid, if you will, or bidding war that goes up for, you know, a few weeks. Where we have a cluster of mills, we're able to mitigate that.
In some areas in the South, it's been pretty flat, and in some cases, a little bit down. In other cases, you know, it's gone up. You know, when it does go up, we sense that it's not a fundamental shift, it's more of a situational or an upset condition that, you know, after a few weeks, you know, works itself out. I think we're in pretty good balance, and we just have puts and takes, but there's nothing material, that's on our radar in the South. Pacific Northwest is actually, you know, I would say balanced also. You know, we actually saw a log cost decrease, this past quarter in the Pacific Northwest, which was great to see.
We don't see any major swings up or down coming at us. I think the log cost decrease was around 3% or something, if I've got that right, in the Pacific Northwest. Fairly in balance. I think the growth that we've done is both in the Pacific Northwest with Philomath. If you look down the coast of Washington and Oregon, our mills and the log circles and competition circles are, you know, very strategically lined up in the Northwest, and that's helping us from Port Angeles all the way down to Philomath.
Okay. Turning to the prospective sale of the harvest rights, you know, just I'm sitting out here in suburban New Jersey. Is there any way you could help me to kind of frame prospective values when you sell harvest rights on the BC coast?
Yeah. I'll take a shot at this and then if you know, Rick or Bart have anything else to add. You know, I'm glad you actually asked this question, Mark. I you know, you obviously picked that up, and that's great. Just the backstory is, you know, Acorn was our last coastal manufacturing operation. You know, with that now off or out of our company, we're assessing a number of strategic alternatives for the coastal business, including potential asset and tenure sales. You know, I would add that, you know, any dispositions are subject to you know, working with First Nations and consent from the BC government. We've been advancing and have advanced talks with both of those stakeholders, and it's going very positively.
From a timing perspective, you know, we would think between 12 and 18 months for the process to unfold. From a value, I think to your question, it's a little bit hard for us to provide reliable, you know, guidance on this, but the disposition of, you know, the entire Coast tenures is about 1.6 million cubic meters, and we would expect, you know, that to be, you know, significant and material. For context, our coastal assets, if I've got this right, as a book value, are at the end of Q2, around CAD 94 million. So we'll continue to work on this. We think there's great value for our shareholders, and we'll obviously announce anything significant at the right time.
Okay. Last question for me. I mean, it's very impressive results coming out of Eastern Canada. I'm just curious if you could help us think about the contribution from that I-Joist business. I mean, I-Joist prices the last six quarters have you know moved like I've never seen them move in my entire career. I'm just you know curious about sort of what type of benefit you're garnering from that tightening in the I-Joist market?
Pretty strong, Mark. I'll maybe leave it at that, but we're very pleased with the contribution from our I-Joist plant. You know, we control a lot of the input stock through MSR. You know, great outturns from our internal operations in Ontario and Quebec, and you know, we have an advantage, I believe, on that side of it. But we're very, very pleased with Sault Ste. Marie's contribution.
Any way to quantify just overall, like, is it 10%, is it 20%, is it 30% of kind of the earnings stream right now, Ian? I'm just looking for kind of a rough order of magnitude.
Yeah. I'd be a little hesitant to share that in this forum, Mark, but.
Okay
I can say that we're very pleased with its contribution.
Okay. All right. We'll leave it at that. Thanks very much. I'll turn it over.
Okay. Thank you, Mark.
Thank you. Your next question comes from Hamir Patel, CIBC Capital Markets. Hamir, please go ahead.
Hi, good morning.
Hi.
Ian, there may be some pulp mills that come up for sale in Ontario. Just given some of the codependency you have in Eastern Canada, is Interfor starting to move beyond the lead with lumber approach to also potentially include pulp assets into the mix of potential targets?
No, that's not our priority. You know, the lead with lumber is still core to our company. You know, when we do say that, you know, businesses like, say, the I-Joist that come with significant lumber volume, we're very interested in. But we really are focused in on, you know, growth in lumber. Having said that, you know, I can say, never say never, but, you know, we'd like to look at assets that come with significant lumber capacity. If there's a side non-core business, you know, we'll look at it, and we'll have a plan for it one way or the other. Yeah, I would say, Hamir, that, you know, we're core to lumber.
Okay. Fair enough. Thanks, Ian. That's helpful. Rick, I just follow up on the BC coastal logging operations. Are you able to say how much EBITDA is associated with that business?
No, I think similar to the I-Joist, we don't disclose that level of information in here. It's a pretty steady business, I'll say.
Okay. Fair enough. That's all I had. I'll turn it over.
Thank you. Ladies and gentlemen, as a reminder, should you have a question, please press star one on your touch-tone phone. Your next question comes from Paul Quinn, RBC Capital Markets. Paul, please go ahead.
Yeah, thanks. Morning, guys. Just questioning the operating rates going forward. Whether you expect any change or, you know, should we expect the U.S. South, it's kind of around, I guess, my number is 81% in Q2. Should that increase to, you know, kind of 90% over the next three to four quarters?
Yeah, I would think so. Paul, Ian here. You know, as we continue to ramp up, you know, on DeQuincy and Eatonton, and there's several other projects, you know, Paul, that, you know, across the company that have had, you know, some, you know, minimal amounts of downtime for, you know, implementing capital and, you know, and a Friday here and a Monday here and what have you. A lot of those are, you know, coming to an end here in the next, you know, couple of quarters. Having said that, you know, we're also planning, you know, future strategic capital for, you know, 2023 right up to 2027. I see the South as, you know, continuing to improve on the run rate there.
Okay. I guess BC, you're running kind of the interior assets at around 80%. We can expect that level to hold for a while?
Yeah, well, I would think, you know, that we had a bit of downtime at Castlegar for the planer rebuild that we're doing, but that's, you know, coming to an end here in the next month or so. The other, you know, impacts have really been around managing our inventory levels, you know, in a falling market. We'll continue to monitor that. There may be some, but we don't see any material events happening in the interior of British Columbia for us.
Okay. When I do the math on Eastern Canada, that's sort of the CAD 116 in EBITDA, it kind of, you know, nets out to a CAD 550 contribution per thousand. You know, which is if I look at the rest of your operations, less Eastern Canada, it's quite a bit higher. What's so special about Eastern Canada this quarter? Is it something that's sustainable going forward?
I mean, you know, as we went through the process, these are, you know, what we're expecting. I would say that we see improvements in Eastern Canada, that we're working on, you know, minor CapEx or non-CapEx improvements, whether that's in grade outturns or production. We do see actually improved performance coming from the operations in Eastern Canada. We had downtime at Ear Falls, as an example, for several weeks from a road that washed out a main highway. That's now behind us and there's been a few other, you know, weather-related upset conditions. The teams have done a great job. They did have an outstanding quarter for Interfor. As expected when we did our due diligence, they're performing exactly how we expected them to.
Paul, I'll just add the $160 million will include the I-Joist results.
Right.
I'm not sure if you've factored something for that into your numbers.
Yeah. It's still
Even if I back out something for that, I mean, it still seems like it's above the average of the rest.
It's Bart here. Another thing to consider for the East is the proximity of those assets to the markets. You know, very strategic locations to the GTA, and also to the Great Lakes markets. So I think that also helps the top line of that equation.
All right. Great. Thanks. That's all I had.
Thank you. Your next question comes from Mark Wilde, BMO. Mark, please go ahead.
Yeah, I just wanted to kind of follow up a little bit, get, you know, some thoughts on capital allocation, particularly around the SIB.
Sorry, Mark, you cut out there.
Yeah. Ian, I just wondered if you'd like to, you know, share any more thoughts about capital allocation and the SIB?
For sure, Mark. The SIB is a continuation of the balanced approach we've been taking over the last couple of years. As I mentioned in my remarks, we see continued value in our share price. When we look at our balance sheet, our leverage range is, like I said, at the lower end of our target range, and we saw an opportunity to buy back shares at an attractive price and still remain with a very strong balance sheet at the end of it. That's really the summary of the thinking there.
Ian, I wonder just finally any thoughts, incremental thoughts, since you picked up the Eastern Canadian assets, including the shares in GreenFirst, just about sort of opportunities across the Eastern Canada? I mean, Eastern Canadian lumber business in my career has always been sort of the poor stepchild to you know much of the rest of the North American lumber industry.
We actually don't see it that way at all. You know, I think that you know, when you look at what's happening in British Columbia and in the other timber producing region in the South with you know, heavy competition and you know, greenfields being announced, et cetera, you know, our strategy was you know, to diversify and reduce risk. You know, we're very pleased with the governments of Quebec and Ontario, their approach to business, their support for our industry and their support for Interfor has been top shelf. We see that as you know, a very you know, key component to Interfor, you know, obviously today and going forward.
We will continue to, you know, be as strong and competitive as we can in that region and spend the appropriate time and money to make sure that we're doing that.
Ian, I'm just curious, going forward, do you think that we should anticipate a different relationship between pricing on these regional lumber grades? Because it is striking that, you know, the curve has moved a lot over the last, you know, 10 or 15 years. BC's gone from being kind of low cost to high cost. You know, does this change the relative price of, let's say, SPF lumber relative to kind of Southern lumber over time, just you know, the fact that it's a more scarce resource and I think it's still preferred by many builders?
Mark, I mean, I think that I think you're onto something there. I mean, we've talked about that exact question. When we look at, you know, the forecast for BC for the next, you know, 12 months to 10 years, in areas where our mills are not located in BC, we think it could get a little rough. That SPF premium that, you know, that has been enjoyed traditionally, I think is just gonna continue to, you know, be there. One of the key, you know, reasons for going to the East for us was to, you know, secure quite a bit more of that SPF preferred species for the foreseeable future. We do see, you know, benefits of having SPF volume outside of British Columbia.
Okay. Sounds good. I will turn it over. Good luck in the second half of the year.
Thanks, Mark.
Thank you.
Thank you.
Thank you. There are no further questions at this time. I will now turn it back for closing remarks.
Okay. Thank you, operator. Just in closing, we are focused on maintaining the health and safety and well-being of our employees. I hope you heard that we continue to drive cost reductions across our company. We are matching production rates and order files and continuing with our balanced approach to capital allocation. Like to thank everybody for dialing in and participating in our call this morning and your interest in our company. If you have any further questions at all, please feel free to reach out to Rick, Bart, or myself at any time. Thanks, everyone. Have a great day.
Thank you. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.