Earnings Call: Q4 2019

Mar 11, 2020

Earnings release

Morning, ladies and gentlemen. Thank you for standing by. Welcome to Stella Jones Q4 2019 Earnings Conference Call. At this time, all participants are in a listen only mode. Following the presentation, we will conduct a question and answer session. Instructions will be provided at that time for you to queue up for questions. Before turning the meeting over to management, please be advised that this conference call will contain forward looking statements that are subject to a number of risks and uncertainties that could cause actual results to differ materially from those anticipated. I would now like to remind everyone that this conference call is being recorded on Wednesday, March 11, 2020. I will now turn the conference over to Eric Marchand, President and CEO. Please go ahead. Good morning, ladies and gentlemen. I'm here with Silvana Travalini, Chief Financial Officer of Stella Jones. Thank you for joining us for this discussion of the financial and operating results for Stella Jones' full year and Q4 ended December 31, 2019. Our press release reporting full year and Q4 results was published earlier this morning. It, along with our MD and A, can also be found on our website at www.stellajones.com and will be posted on SEDAR today as well. Let me remind you that all figures expressed on today's call are in Canadian dollars unless otherwise stated. Before we begin, I would like to also remind you that on January 1, 2019, the company retrospectively adopted IFRS 16 leases, but has not restated as permitted comparative figures for the 2018 reporting period. Please refer to our MD and A for further details. I will begin with a brief overview of our full year results. We delivered solid financial and operating results in 2019, concluding the year with sales and EBITDA growth. For the 19th consecutive year, we increased sales reaching $2,200,000,000 despite challenges of a tight untreated railway tie supply market. Higher sales were supported by solid performances in our utility poles, railway ties and industrial product categories, which more than compensated for the over $40,000,000 decline in sales in the logs and lumber product category, unfavorably impacted this year by lower lumber prices. Led by sales growth and consistent with our guidance target range, EBITDA rose 28 percent to $312,900,000 in 20.19 and net income amounted to $163,100,000 or $2.37 per share, up 16% 20%, respectively. After adjusting for the impact of IFRS 16, our EBITDA margins increased to 12.9%, up from 11.5% in 2018. For the year, we generated good operating cash flows, considering the significant increase in untreated wood inventory required to meet anticipated 2020 sales. Our strong balance sheet allowed us to return over $100,000,000 to our shareholders, while continuing to pursue our growth strategy by acquiring a key residential lumber production facility and investing strategically in our network, in line with our capital allocation approach, which is focused on balancing growth and returns, today, we announced a 7.1% increase in our quarterly dividend, reflecting our commitment to deliver continued value to shareholders. Turning to our 4th quarter results. Total sales in the 4th quarter increased to $439,900,000 up 1.6% compared to last year. Excluding the currency conversion effect, sales grew $4,400,000 or 1%. Utility pole sales amounted to $190,900,000 down slightly from $192,000,000 generated in the Q4 of 2018. Excluding the currency conversion effect, sales decreased by 1.5%. Despite higher selling prices and healthy replacement demand for distribution poles in the U. S, sales were unfavorably impacted by the lower level of transmission pole projects in the Q4 compared to Q4 last year. Railway pipe sales increased to CAD 131,300,000. Excluding the currency conversion effect, sales rose 3.1%. The increase in sales stemming from improved pricing from Class 1 and non Class 1 customers and ongoing strong demand was mitigated by the limited availability of untreated tie earlier this year. During the Q4, given the improvement in the availability of supply, we replenished our untreated tie inventory to levels required to meet anticipated 2020 sales. Residential lumber sales totaled $61,100,000 relatively unchanged compared to the Q4 last year. Excluding the currency conversion effect, sales increased by 1.2%. The reduction in the market price of lumber, which flows through to our selling prices, was more than offset by the continued organic growth in sales volumes and more winter booking sales compared to Q4 2018. Industrial product sales amounted to $26,300,000 up from $23,100,000 recorded in the previous year's quarter. Excluding the currency conversion effect, sales increased by 13% as a result of stronger volumes, mainly for preplating and crossing products. Logs and lumber sales, which are closely tied to the market price of lumber, were relatively unchanged at $30,300,000 in Q4 2019. Sylvana will now provide further details regarding our results and financial position before I conclude with our outlook for 2020. Sylvana? Thank you, Eric, and good morning, everyone. Turning to profitability. Operating income rose to $41,400,000 or 9.4 percent of sales in the 4th quarter compared to $31,800,000 or 7.4 percent of sales in the same period last year. The improvement was primarily attributable to higher selling prices for utility poles and railway ties, which more than compensated the decrease in volumes for transmission poles and higher production costs for railway ties due to longer treating cycles. The decrease in the mark to market losses related to diesel and petroleum derivative commodity contracts also improved operating income in the 4th quarter by $9,600,000 while the adoption of IFRS 16 did not have a significant impact. 4th quarter EBITDA improved to $58,800,000 yielding a margin of 13.4% compared to $41,800,000 or a margin of 9.7% in Q4 of 2018. The increase was mainly driven by stronger pricing and the favorable mark to market variation related to derivative commodity contracts, partially offset by higher costs for railway ties. EBITDA in the 4th quarter also benefited by approximately $8,000,000 from the favorable impact of the new lease standard, as operating lease expenses are now recorded as depreciation and interest expense rather than operating costs. Driven by the growth in operating income, net income for the 4th quarter increased 34% to $27,700,000 or $0.41 per share. Turning to liquidity and capital resources. With our resilient business model, we were able to deliver a solid performance in 2019, including generating $305,000,000 of cash flow from operating activities before the effect of working capital changes and interest and income taxes paid. The improved availability of untreated ties and the anticipated 2020 sales goals for utility poles resulted in an over $160,000,000 increase in inventories this year. This largely explains the reduction in cash from operations to $89,900,000 for the year. Together with additional borrowings under our syndicated credit facilities of $126,000,000 we returned for the full year $109,100,000 to our shareholders, consisting of $70,600,000 of share buybacks and $38,500,000 of dividends. As part of the company's normal course issuer bid, we repurchased in 2019 1,800,000 shares at an average price of $38.47 We also invested $65,800,000 in capital expenditures. This included spending to finalize our plant expansion in Cameron, Wisconsin and the acquisition and upgrade of the Shelbourne, Ontario assets, which expanded our network of residential lumber treating facilities. As of December 31, 2019, our long term debt stood at $604,900,000 and our leverage ratio remained low at 1.9x. We concluded 2019 in a very healthy financial position. Yesterday, the Board of Directors of Stella Jones declared a quarterly dividend of $0.15 per common share, representing an increase of 7.1 percent over the previous quarterly dividend, payable on April 24 to shareholders of record at the close of business on April 3. This represents the 16th consecutive year of dividend increase. I will now turn the call back to Erik for the outlook. Erik? Thank you, Saldana. Based on the assumption that current market and economic conditions stabilize and foreign exchange rates and raw material prices remain comparable to those of the prior year, we expect higher year over year overall sales, mainly driven by increased market reach in the utility pole, railway tie and residential lumber product categories. More specifically, in the utility pole product category, sales and margins for 2020 are expected to improve due to better pricing, healthy demand for replacement programs and greater market reach. In the railway tie product category, both sales and margins are forecasted to increase. Improved untreated railway type inventory availability should lead to opportunistic sales to Class 1 and non Class 1 customers. We also expect a stronger mix of Non Class 1 sales, which will support improved margins. In the residential lumber product category, we are forecasting higher sales, mainly driven by volume increases and market reach. Management closely monitors changes in the North American lumber markets and adjusts pricing accordingly in order to maintain dollar margins on similar volumes. While absolute dollar margins are expected to increase as a result of higher volumes, margin as a percentage of sales should remain at levels similar to those of 2019. In the industrial product category, sales are expected to be slightly lower in 2020 as rail related maintenance should require less bridge and crossing components. For logs and lumber product category, sales in 2020 are forecasted to increase mainly due to higher lumber volumes. It's important to highlight that this product category is used to optimize procurement and does not generate margin. Sales growth in our 3 core product categories is expected to support an improvement in operating margins. As a result, notwithstanding additional acquisitions, EBITDA for 2020 is forecasted to be in the range of $320,000,000 to $345,000,000 compared to $312,900,000 in 2019. In terms of capital expenditures, we plan on spending between $45,000,000 $55,000,000 in 2020. This includes an investment for stormwater control and the construction of a new distribution center to improve operating performance at the newly acquired Shelburne facility as well as expenditures to implement a new ERP system. As a follow-up to our press release from last December regarding pentachlorophenol supply, we have ceased taking steps to produce this preservative. We are currently working with our customers to offer a variety of solutions for the treatment of utility poles. Our robust network is well positioned to offer a wide range of preservatives that are suitable and approved for wood utility poles throughout North America. We believe that the fundamentals of each product category will remain strong. As a result, we will continue to focus on optimizing operating capacity while seeking acquisitions to further expand our presence in our core product categories. With our solid financial position, we have the flexibility to continue to carry out our growth strategy and deliver sustainable long term value to shareholders. This concludes our prepared remarks. We will now be pleased to answer any questions you may have. Your first question comes from Walter Spracklin from RBC Capital Markets. Your line is open. Thanks very much. Good morning, everyone. Good morning, Walter. So just starting on the margin expectation for margin expansion, you mentioned 2 items. So first of all, you had indicated that there were an increase in untreated wood inventory and that you expect that to improve. And you also mentioned a stronger mix of non Class 1 sales, which would lead to increase in margin. Is this something you're seeing your visibility on that you're seeing evolve and you're comfortable putting out there for 2020? Or is this something that you're predicating it on, but have not seen examples or demonstrated indications of either of those at this point. Okay. Thank you, Walter. So the comment on inventory is, as you know, last year, we had tight supply in the market and then we had opportunities in the Q4 actually, great opportunities to increase our inventory levels of untreated ties, which positions us very well to be able to answer to the non Class I demand. I'll start with that one. So we do see very active quoting activities in this commercial contractor business for railway times. And therefore, since we also have availability, we do believe we'll have a chance to see certain demand from Class Is. So based on that, you feel fairly comfortable that based on those indications and the actions you've taken, you should see margin enhancement as early as the first quarter? That is correct. Okay, perfect. And then interestingly on your shareholder return strategy, I noticed your buyback, you ramped it up in the Q4 here for $70,000,000 total for the year. The dividend increase is net $4,000,000 additional. So it seems that you're directing a higher focus here on your buyback. Can you talk a bit about your strategy there? Is that just based on the share where you see the shares today? Or would you consider increased dividends on a more regular basis to appeal to more income oriented investors? So the approach we want to be we want a balanced approach and we want to be mindful of leverage. I understand your question with regard to the dividend. It was important for the Board to show a year over year increase as we want to demonstrate that we continue believing in our capacity to generate strong cash flows. Although we want to be prudent with the leverage going forward, in particular, as we mentioned in the outlook that we maintain our position to be able to grow our network through potential M and A in the coming months, coming year. And on the M and A side, there's obviously some disruption emerging here. We have not seen you overly active on that front. Can you talk about is this due to willingness on the seller here, just not at this point willing to step up? Is it a disconnect in the multiple of the price offered? Is there an opportunity here in 2020 for you to really ramp up your acquisitions given everything, given the climate? So we've been constantly active with a few sellers over the last year and are continuing discussions with sellers. So I'm being prudent obviously because as you know, these processes take their own time and have their own approach. I'm confident that we can conclude a potential acquisition at historical multiples. I don't think the multiple is necessarily the roadblock. It's more the process to get there. But we management still remains quite confident in our ability to bring some M and A to the finish line. Okay. Final question here is sensitivities to economic activity given COVID-nineteen if it turns out to have a wider spread demand impact, you accurately pointed out, I believe, that you consider ties to be fairly low on the sensitivity range with regards to economic activity polls. Would you characterize as perhaps same directionally, but perhaps a little less than ties? And then as you go into things like residential lumber and so on, then we get into more sensitive. Is that the right way to characterize the aspects of your business? Well, yes, I agree with what you're saying are we haven't seen any disruption in our supply network. We are in a very healthy position on the inventory side. I would think if there were, there would be some short term disruptions, we could definitely be able to navigate through it and continue a consistent supply to our customers. So I think your view on that is accurate. Perfect. Okay. That's all my questions. Appreciate the time. Thank you, Walter. Your next question comes from Mona Nazir from Laurentian Bank. Your line is open. Good morning and thank you for taking my questions. Good morning, Mona. Good morning. So, in your commentary, you just touched on the 2020 outlook and that's revenue, particularly in the Pols segment and also related margin improvement. The guidance range is helpful, but I'm just wondering if you could quantify if we're thinking about the consolidated revenue growth range is kind of low single digits, are you comfortable with that? Or could it be higher? And just on the margin range, how much expansion could we expect year over year? So either one of those. So total growth on so as you know our business very well, Nona, and welcome back by the way. Thank you. So as you know, our 3 different categories have different dynamics. We've always guided our utility pole product category to be a mid single digit and that we will I sustain that assumption going forward into for our outlook for 2020. Our railway tie product category, which we've historically tied to inflationary growth, could be slightly higher simply because we this year have sufficient inventory to be able to answer to all inquiries from potential customers. And then we talked about growth in our residential lumber product category as we're seeing some great opportunities in 2020 to service some stores that we will qualify into dealer network or the non big box if you want. So I don't know if that's helpful. No, that's very helpful. Okay, perfect. And then if we're just looking at the leverage, just touching kind of on Walter's question, and you speak about your desire to do M and A, is there any change in the appetite from the management or Board? I mean historically you've done 1 to 2 acquisitions a year that has equated to $70,000,000 plus in revenue contribution. Is that still the case? Or can we expect it to tick down from that acquisition growth? That's a good question, Moana. There's no change in views and there's definitely appetite within management and myself included and the Board to pursue M and A and to grow our footprint. We are very disciplined in the multiple we want to play and we want to pay, sorry. We're also willing to work with sellers that have quality assets to sell. It would be easy for us to do an acquisition in the short term with a high multiple and assets that would require a lot of CapEx going forward, but that's not how we've been doing things over time. I understand your question in the sense that we did not have a well, we had a small acquisition last year in the residential lumber business, which will actually be of great use and it'd be a good contributor in our 2020 performance. But to answer your question, there's no change in appetite. And we're actively seeking some targets. We're actually in discussions with them as well. Okay. And that's a perfect segue. So the targets that you were speaking about or have started talking to in the last 12 to 18 months, are those targets still are discussions still occurring with some of them or is it new targets that you're looking at? We are currently in discussion with targets. Okay. Thank you. I'll step back. Thank you. Your next question comes from Hamir Patel from CIBC Capital Markets. Your line is open. Hi, good morning. Good morning. Eric, is your outlook factoring in any benefit from the 45 gs short line tax credit extension? And how meaningful could that be? Because from what I understand, that's sort of retroactive sort of for 2 years and renewed for 5 years? Well, it's a very good question. So that tax credit is what is prompting all the deposit inquiries in that non Class I business. So it's very insightful for you to bring that up. It is a credit that every year the short lines are expecting to see if it's going to be renewed. It's always a bit of a if the credit is not going to happen, we might be less active in maintenance. If the credit is available, the short lines are more active. So in this case, that is it is factored in behind our expectation for strong demand from another Class 1 business. Okay, great. And then Eric, can you speak to in Q1 the rail blockades in Canada, how did that how's that affected the business for the various segments? So for the easy answer is utility poles and residential number have had suffered no impact. We move a lot of inventory by truck. We also have a lot of distribution centers across North America to supply customers. We didn't see any impact. Obviously, having the Canadian rail network being offline for over 25 days slowed down shipments to the Canadian Pacific and the CN. Happy to see that car flow. I started up again late last week and over last weekend actually. So I expect our railway tie sales for the Q1 to be impacted, but the sales will be at least equivalent to last year's sales results for the Q1. Okay, great. Thanks. That's helpful. And could you elaborate more on the preservative options you're exploring to replace Penta when that supply comes to an end in 2 years? Thank you. So Penta supply will be available for the next, call it, 20 some 22 months. So we have plenty of time to actively work and we are actually actively working with our customers to seek what their preferences are going to be going forward. The company has access to a very wide range of preservatives. We mastered a process. We have supply agreements in place. So it's right now, it's more a question of working on a thoughtful transition with our customers. Great. That's all I had. I'll turn it over. Thanks, Eric. Thank you, Amir. Your next question comes from Benoit Poirier from Desjardins Capital Markets. Your line is open. Yes. Good morning, everyone. Good morning, Benoit. Yes. Just looking at the inventory replenishment, could you talk a little bit about what kind of working capital we might see in 2020 given you there was almost 146,000,000 usage in 2019. And does it mean that boltanization will be much very much reduced in 2020 and maybe kind of impact on margin given your ability to replenish the untreated railway ties? Thank you. Thank you, Benoit. So last we spoke back in November, December last year, we thought that our ability to replenish would be much longer in time. So we actually accelerated our ability to replenish untreated ties. So therefore, I don't expect a significant investment in untreated ties for at least, call it, 7, 8 months ahead of us in 2020, simply because we've got sufficient to be able to answer our customer requirements. To your other part of your questions, we do expect very little boltanizing. There's always some going on, but we never necessarily refer to it because it doesn't have any impact on the business. So boltanizing is something that should be behind us. As we're heading into the back half of the year and we get better visibility on our 2021 expected sales, we might have to ramp up and hopefully we will have to ramp up a bit of working capital to be able to answer future sales into 2021. So that's how I'm viewing working cap investment for rail and it's also true for utility poles. Okay. So probably some working capital investments still in 2020, but much less versus the $146,000,000 made in 2019, right? Yes, yes. Definitely much less and most likely closer to the back half when we back half of the year when we have proper visibility on our 2021 sales. Okay. That's great. And with respect to the lumber, could you maybe elaborate a little bit with respect to the dynamics with China here? How they impact demand and supply and which segment are impacted with the dynamics with China? Thanks. I mean, there's no significant dynamic, especially not with our residential lumber nor with poles because I mean residential lumber is sourced out of Canada, utility poles and ties as well. The only impact that we actually saw is there and this is a very getting really deep in the weeds and the explanation, but what we saw in last year is that the very low prices of grade lumber in hardwoods in North America, driven in part by the inability to export it to China, pushed our hardwood sawmills to cut more railway ties. That's actually where the supply came from is we saw the vast majority of hardwood mills in the Q4 cut railway ties instead of cutting grade lumber. So if anything, we've had a bit of a positive effect there to help us replenish on inventory. Other than that, we're not seeing much effect in our business. Okay. That's great color. And with respect to the ERP system implementation, could you maybe mention the overall capital envelope and maybe also the timing for the implementation, Edith? So implementation will span over we need we're initiating the projects, so there's a development phase and implementation phase. We're looking at a 24 to 30 month rollout if you want. CapEx will be in the range of $20,000,000 to $25,000,000 If I could quote these numbers generally, we're still working with our consultants to finalize pricing on it, but that would be arranged, but that's over that 30 month period if you want. Okay, perfect. And last one for me, when we look at the organic growth from utility pole down 1.5% in the quarter, although it seems that it was driven by transmission pole. So is it the fact that there was a tough comparison versus the Q4 last year? And how does it look like for transmission pole? Thanks. So you answered the question. We had a tougher comp in Q4. This year, we had very strong sales, which were project driven in Q4 2018. Going forward into 2020, if my basis is 2019, we're seeing sales growth for transmission poles in 2020. Okay. Thank you very much for the time. My pleasure, Bruno. Your next question comes from Michael Tupholme from TD Securities. Your line is open. Thank you. Good morning. Morning, Mike. Eric, maybe just a follow-up on Benoit's last question there about utility poles. If can you just comment on what the distribution pulls organic growth would have looked like in the 4th quarter as we sort of put the transmission pools tough comp issue aside? That's a tough question, Michael, simply because we don't provide that detail and color. The best guidance I can give you is to stick to that mid single digits for next year based on the 2019 results. Okay. And then just a question about the sort of the commentary you made in the outlook regarding sales growth. When I look at the commentary this quarter versus last quarter, it reads fairly Although last quarter when you talked about 2020, you were including some discussion around calling for price increases. I know it does sound like you're calling for some price gains on the utility pool side. But on an overall revenue basis, is pricing expected to be a driver to some growth? Or is that utility poles pricing increases getting netted out somewhere else? I guess the best way to look at it Benoit is to think more on the product mix side since we'll have more non Class 1. There will be there's a bit of better margin there for a bit of better pricing on the non Class 1 business. But I think you're right that volume will definitely be a driver for Rail Refines for us next year or 2020 ish, say, this year. Okay. And then, Eric, again, just on the outlook, you are indicating that the outlook predicated on the assumption that current market and economic conditions stabilize. And I understand it's sort of hard to look forward given some of the volatility recently and to really make sense of that. But to what extent have you tried to incorporate any conservatism in this guidance, in this outlook in view of what appears to be some concerns around the economic outlook? So to answer your question, Mike, right now, as I stated before, we are not seeing any disruptions on the supply and we're not seeing any pullback from customer demand. To your point, there's lots of volatility in markets right now. It's very difficult to understand where the price of the barrels of oil is going to go. And obviously, the coronavirus could have some sort of impact from low to significant in North America. All of these items are very difficult to decipher at this point. It's very early in the year. We're trying well. Right now, we're reaching out to customers and suppliers. We're being thoughtful about where the impacts could come. We're working on contingency plans internally. But I guess, I'd be I most likely will be able to provide a bit more color on that when we talk at our Q1 conference call. Okay. But at this point in your conversations with customers, has there been any change in tone or anything that would suggest that what they've been telling you previously is potentially in the process of altering? No, no. We haven't had and we consistently talk obviously with our utility pool customers, the thought is that we're talking a lot these days discussing about changing preservatives and we also talk regularly with all the Class 1 customers. No one has indicated a shift in their expectations for this year and I'll say so far. Okay. All right. That's all for me. Thank you. Thanks. Your next question comes from Maxim Sytchev from National Bank Financial. Your line is open. Hi, good morning. Good morning, Maxim. I had a quick question in terms of the commentary that Koppers was making on their conference call talking about growing market share in the RUPES division, which overlaps with your utilities and ties, obviously. Just wondering as I think you are telegraphing also sort of increasing market reach and your main competitor is looking for market share gains. Just in terms of how do you think that pricing dynamic might play out in this type of situation? I mean, Coppers has always been active in our industry. As you know, we can compete against each other in utility poles and railway ties. So I wouldn't expect any less from them to say that they're going to try to leverage opportunities in a market where the non Class 1 business is quoting and utilities are looking to do more increasing the replacement cycle. We are in very we are in very different markets in the utility pole business. So I don't see that necessarily being a concern. On the railway type business, we have our annual contracts with our customers that sort of guide the pricing and guide our how we service or the volumes. I want to measure my words here, but how we the volumes that we service our customers. So then we're left with the non Class I business to which we as a company, Stella Jones, have very strong ties. This is how we grew up in the U. S. Market through all the acquisitions we did starting in 2008 where we acquired a lot of businesses with some Class 1 business, but we always have been heavily weighted to the non Class 1 business and have serviced it very well. So I'm quite confident that we'll be able to leverage healthy pricing, which leads into the better mix and the increasing margin for that product category. Okay. That's very helpful. And actually, do you mind I'm not sure if you historically have disclosed this, but percentage of revenue that comes from non class 1 for ties, just like a ballpark, is it 20%, 40%, anything you can provide there? We've quoted in many occasions in the past, just I'll reiterate it, roughly we're 65% revenue is Class 1 and 35% is non Class I. Okay, very helpful. And then last question on ERP. Do you mind maybe just sharing a little bit in terms of which processes will the ERP will try to optimize? Is it procurement, sourcing, everything, just if you don't mind providing some incremental color? Yes. So we're looking for a full suite of the ERP system. So it covers the procurement, the sale, the finance and the logistics. Okay. And when was the last time you implemented an ERP system? That's a good question. We've been working with our in house system for the last 26 years. So this would be we've done many projects of implementing different modules and different tools within the company. This would be, I guess, our first attempt revisiting our entire ERP system. Rest assured that we are working with a few third party consultants that have deep knowledge in being able to execute these projects and we staffed accordingly to be able to support it. Okay. So you will have, as you said, a 3rd party helping you and actually implementing the actual ERP, right? Alongside with dedicated internal resources, yes. Okay. Okay, that's very helpful. Thank you very much. My pleasure. We have no further questions. I turn the call back over to the presenters for closing remarks. Thank you for joining us on this call. We look forward to speaking with you again at our next quarterly call. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.