Earnings Call: Q3 2019

Nov 7, 2019

Earnings release

Ladies and gentlemen, thank you for standing by. Welcome to Stella Jones Q3 2019 Earnings Conference Call. At this time, all participants are in a listen only mode. Before turning the meeting over to management, please be advised that this conference call will contain statements that are forward looking and subject to a number of risks and uncertainties that could cause actual results to differ materially from those anticipated. I would like to remind everyone that this conference call is being recorded on Thursday, November 7, 2019. I will now turn the conference over to Eric Vachon, President and CEO. Please go ahead, sir. Good morning, ladies and gentlemen. Thank you for joining us for this discussion on the financial and operating results for Stella Jones' Q3 ended September 30, 2019. Our press release reporting Q3 results was published earlier this morning. It along with our MD and A can also be found on our website at www.sellajones.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 comparatives for 2018 reporting period. Please refer to our MD and A for further details. Let me now begin with a brief overview of the quarter. We are pleased with our 3rd quarter results, which saw EBITDA up 22% to $96,100,000 and increase in net income and diluted EPS to $53,700,000 and $0.78 per share respectively. We saw solid performances in our utility pole, railway tie and industrial product categories, all of which generated increased sales stemming from a combination of higher pricing and volume. While sales in the 3rd quarter reached 626 $600,000 decreasing slightly by $3,400,000 from 2018, profitability increased. We generated solid margins even when adjusting for the impact of IFRS 16 and maintained a strong cash flow, which we use primarily to reduce debt and repurchase shares. The decrease in overall sales for the quarter was due to lower sales in the logs and lumber category, which was unfavorably impacted by lower lumber market costs, resulting in a sales decline of over $20,000,000 for the category. Excluding this impact, overall sales for the quarter would have increased 2.5%. Sales in the residential lumber product category also declined because of lower lumber costs, but the impact was less pronounced as it was largely offset by higher sales volume. Looking at the Q3 results by product category. Utility pole sales reached 211 $500,000 up 5.4 percent from sales of $200,600,000 last year. Excluding the currency conversion effect, utility pole sales increased $9,600,000 or 4.8%, primarily driven by increased sales prices coupled with healthy replacement demand. Railway time sales amounted to $190,700,000 up 1.6% from sales of $187,700,000 last year. Excluding the currency conversion effect, railway tie sales increased $2,300,000 or 1.2%. While we expected this delta to be more significant in the quarter due to ongoing strong demand and high selling prices, growth was partially offset as a result of the tight supply market for untreated railway ties, which has required us to treat railway ties that are not air season, resulting in longer treating cycle times. In addition, during the quarter, we manufactured finished product for a customer who later informed us they would only be taking delivery in the next few months. As a result, some third quarter sales have been pushed out to the next quarters. Consequently, railway tire sales for 2019 will be flat year over year and in turn profitability will be impacted. Sales in the residential lumber category totaled $158,200,000 down 1.4% from sales of $160,500,000 last year. Excluding the currency conversion effect, residential lumber sales decreased $2,800,000 or 0.5%. This variance is primarily explained by lower lumber prices, partially offset by higher sales volumes. Industrial product sales reached $37,600,000 compared with $32,400,000 last year. Excluding the currency conversion effect, sales increased $4,900,000 or 15.1 percent, largely as a result of stronger rail related and piling product sales. Sales in the logs and lumber category totaled $28,600,000 compared with $48,800,000 last year. Excluding the currency conversion effect, sales decreased just over $20,000,000 As discussed earlier, this variance is a result of reduced selling prices, which has passed through to customers driven by lower lumber market costs, a decrease in lumber transaction volumes as well as lower log sales due to the timing of harvesting activities. Turning now to profitability. Gross profit amounted to $110,200,000 or 17.6 percent of sales in the Q3 of 2019 compared with $97,400,000 or 15.5 percent of sales last year. The increase is explained by higher selling prices, lower lumber costs when compared to last year and improved operational efficiencies. These factors were partially offset by higher volume for utility poles, higher production costs for railway ties given the longer treating cycles and the effect of currency translation. EBITDA stood at 96.1 percent pardon me, EBITDA stood at $96,100,000 or a margin of 15.3 percent versus $78,500,000 or a margin of 12.5% last year. The increase in EBITDA is explained by increased gross margins and the adoption of IFRS 16, which effectively subtracted $8,400,000 in right of use asset depreciation and $1,100,000 in financing expenses from cost of sales. With the adoption of IFRS 16, it becomes difficult to compare our EBITDA to last year. As a general rule of thumb, you can subtract the reclass from cost of sales or in this case $9,500,000 from our Q3 2019 EBITDA to make it more comparable. By doing this, you can see that our EBITDA increased over 10% year over year, a very healthy growth rate on a true comparable basis. Operating income stood at $78,600,000 or 12.5 percent of sales in the 3rd quarter, compared to $67,900,000 or 10.8 percent of sales last year. Net income for the Q3 of 2019 was $53,700,000 or $0.78 per diluted share, up from $45,800,000 or $0.66 per diluted share last year. Turning now to liquidity and capital resources. Cash flow from operating activities before changes in non cash working capital components and interest and income taxes paid reached $97,400,000 in the 3rd quarter, up from $81,300,000 when compared with the same period last year. The increase primarily reflects higher net income and the impact of IFRS 16. Combined with favorable changes in working capital items, we generated strong cash flow from operating activities of 123 $700,000 versus $91,300,000 last year. As always, we continue to be mindful of our capital allocation, maintaining a prudent use of leverage, ensuring sufficient maintenance CapEx, making acquisition at reasonable multiples, buying back shares and paying dividends are all key priorities. We intend to maintain an optimal balance amongst all these facets. In the Q3, we used our cash flow to reduce debt by $64,000,000 and in the absence of M and A, we used our normal course issuer bid program opportunistically to repurchase shares for $30,000,000 We also supported purchase of property plant and equipment for $40,000,000 and paid dividends of $10,000,000 We concluded the Q3 in a very healthy financial position. As at September 30, 2019, our long term debt, including the current portion was $562,800,000 versus $513,500,000 as at December 31, 2018. The increase mainly reflects higher working capital requirements, higher capital expenditures and financing required for the acquisition of a residential lumber facility in Shelbourne, Ontario, partially offset by the effect of local currency translation on U. S. Dollar denominated long term debt. On the dividend front, the Board of Director of Stella Jones yesterday declared a quarterly dividend of $0.14 per common share payable on December 19, 2019 to shareholders of record at the close of business on December 2, 2019. Turning now to our outlook. For 2019, excluding sales from the logged in number product category, we expect higher year over year overall sales based on current market conditions, the current level of lumber prices and stable currencies. This increase is driven by stronger pricing for railway ties and utility poles as well as an increase in market reach for the utility pole product category. More specifically, in the utility pole product category, sales and margins for 2019 are expected to increase year over year, driven by both pricing and healthy demand for replacement programs. In the railway tie product category, sales for 2019 are expected to be comparable year over year, explained by improved pricing, but offset by lower volumes as mentioned earlier. Managers believe that the increasing cost of untreated railway ties combined with a tighter supply market will lead to continued upward selling pricing adjustments for the quarters ahead. In the industrial lumber product category, sales for 2019 are expected to be slightly below last year given the slow start to the year and lower selling prices to customer as a result of decreased lumber costs. Management closely monitors variations of these commodity prices and adjust its procurement practices accordingly in order to maintain dollar margin on a similar volume. In the industrial product category for 2019, we expect higher sales driven by healthy demand for rail related projects and piling products. It is important to highlight that sales for the logs and lumber product category, an activity used to optimize procurement and which does not generate margin is closely tied to the market price of lumber. For 2019, we expect lower year over year sales for this product category explained by lower lumber prices when compared to 2018 and reduced volumes. The decrease in sales for logs and lumber product category will favorably impact overall margins as a percentage of sales when taken as a whole with other product categories and vice versa. For 2019, we also expect improved year over year margin on a consolidated basis. Higher margin will be primarily driven by increased pricing for railway ties coupled with improved product mix and demand for utility poles. Having said this, given that some railway tie sales have been pushed out over to the next quarters, profitability for 2019 will be impacted. As a result, we have adjusted our EBITDA guidance range to be between $310,000,000 to $315,000,000 Adjusting for this impact of IFRS 16, this will represent a year over year increase of over 11%. Furthermore, we plan on spending $60,000,000 to $70,000,000 of capital expenditures in 2019. This includes the planned expansion at Cameron, Wisconsin as well as the Shelburne acquisition and upgrade. For 2020, based on current market conditions and assuming stable currencies, we expect higher year over year overall sales for Stella Jones, driven by stronger pricing and increased market reach in the utility pole, railway tie and residential lumber product categories. As a result, operating margins in absolute dollars and as a percentage of sales are expected to improve over 2019, primarily driven by pricing improvements and operational efficiencies. Our strategy remains intact as we will continue to focus on optimizing our operations across the organization while seeking acquisitions to further expand our presence in our core product categories. This concludes my prepared remarks and I will now be pleased to answer any questions you may have. Thank Your first question comes from the line of Walter Spracklin from RBC Capital Markets. Please go ahead. Yes. Thanks very much. Thanks for taking my question. I guess focusing here on the 2020 with the push forward of the sales into 2020, would we see and the reduction in EBITDA associated with that, would we see a kind of similar lift to what we would have otherwise expected in 2020 as a result of that push forward. And I don't know if you can give any color around what your view is around the current consensus being around, let's call it, 3.35, 3.40 for next year if that's consistent with what you're seeing in terms of what you can see looking forward into 2020 so far? Great. Thank you, Walter, for the question. So to answer your you got multiple aspects to your question. So the push of sales forward will obviously be accompanied with the EBITDA margin into next year. So you're completely correct that those sales will move some of them will move into Q4 and Q1 of next year and the EBITDA margin will follow as well. With regards to quantifying EBITDA levels for 2020, I will defer to our call, we'll have for Q4 in March. I'm going next week to meet our team at a budget meeting where I'll have better guidance and then a better view on next year's numbers. Okay. Would that apply as well for CapEx program at this point? Or can you give us some indication as to whether just directionally do you see it being up or down relative to 2019? I'd be happy to guide you on CapEx. We believe a $50,000,000 mark would be in line with our historical spend. Okay. I'll queue up. Thank you very much. Thank you. Your next question comes from the line of Hamir Patel from CIBC Capital Markets. Please go ahead. Good morning. Eric, could you speak to the state of the M and A pipeline and if you see any more opportunities in any particular product category? Perfect. So thank you, Hamir. We so as we've discussed in the past, there are several targets that the company has identified in the North American market that we are continually in discussions with. And we're working diligently in discussions with some of these sellers to be able to establish a deal, which obviously would be in line with historical discipline that we have with regards to multiples. Okay, great. Thanks, Eric. And I wanted to turn to the tie side. From your discussions with customers, do you have a sense yet as to whether volumes will be up or down next year? And any differences that you're seeing maybe between the Class Is and the short lines? Certainly. So obviously, as we stated in our outlook, we're seeing improved sales next year and improved margins. So although we're going to budget next week, I do have a sense of preliminary numbers that we based our outlook on. So for Class 1s, overall, we're seeing growth in volume and in the details, there's plus and minuses in there, but net, it would be an increase for us next year. And we see demand for the non Class I market to continue to be strong. And we do plan on taking an opportunistic approach to that market since we'll most likely we'll be doing less boltanizing next year since our dry inventory program is much healthier than it was last year at the same time. Okay, great. Thanks, Eric. That's all I had. I'll turn it over. Thank you. Your next question comes from the line of Benoit Poirier from Desjardins Capital Markets. Please go ahead. Yes. Good morning, Eric. Just to come back on the previous question related to your bolt onization. Could you maybe provide some color about the percentage of your railway ties that is using bolt onization? And where should we see the improvement going into next year? And whether we are looking for a normalized bolt onization going back to 2021? Right. So, Benoit, without quantifying it, I can tell you this year Q2 and Q3 heavily used the bolt mizing process as we saw depletion in our inventory levels and that is related to availability of product in the market or the untreated tie in the market. What we've seen in the last few months, our key procurement areas have dried up and we are seeing hardwood logs made available to sawmills and our procurement team is quite happy, quite pleased actually with what we've been able to procure on a monthly basis. So we are building our DRiVE program slowly but surely coming into closing the year and going into next year. So definitely, the bolt mining process will be used much less. The gain there for us is the throughput or the quantity of ties we can produce at a given facility in 1 month. Obviously, as we've discussed in the past, when you bolt onize your cycle time is much longer than when you use a dry tie that has properly air season. Therefore, having more products being available for sales, we can probably we will most likely make better advantage of requirements in the non Class I business. Okay, perfect. That's great color. And could you maybe provide some color about the railway ties, the composite aspect, whether there's been some change in the market demand given the we are dealing with a wet environment. Have you seen any change on the composite tie demand with respect to that? Great question, Benoit. Thank you. So we have ongoing discussions with other railroads in North America being Class 1s and either short lines and so on. And we're not seeing a shift from wood or away from wood to substitute products. So there's no change in trends. Several of our clients do not spec either composite or concrete. And those that do, well, actually will procure small quantities annually simply for their own purposes. Okay. That's pretty good. And when we look at utility poles, given the wildfire, we've seen some strong growth so far. But could you comment about the organic growth expectation for Utility Pool? And also given the technology that you have in terms of putting a mesh on the wood, about the update on the success so far? Okay. So, well, obviously, the wildfires on the U. S. West Coast are very, very unfortunate. We have our emergency teams ready 24 hours 7 and we've been supporting our clients for quick adjustments to supply product. Then we'll come the phase of rebuilding. And that will stretch over several quarters, Benoit. So it's not as if we will see a huge spike. It will be a lift over, let's say, the 3 or 4 next quarters of next year. But you should not expect us to have a big spike in comment in a conference call that we've got increased sales because of these events. This is always also a great opportunity for us to leverage our network and to demonstrate to our customers that we've got strong inventory levels and have the ability to service them from different locations. Okay. And when we look at 2020 for residential lumber, what would you expect given the dynamics I'm talking here pricing versus volume for 2020 for residential lumber. Any color you could provide, Eddy? Well, it's always difficult to predict the cycle on the lumber markets. And we've seen sawmills closed in Canada in recent months and hard to predict that impact as well. So what we're seeing now is we're seeing an opportune time now to procure lumber at a reasonable price and we're actually getting into more longer term commitments to ensure that we're building next year's program. So I would suspect that on the revenue side, what is going to be driving the increase is very much related more to volume. Okay. Okay. That's great color. And when we look at your inventory of railway ties, could you maybe provide some color about the what we should expect in terms of working cap for the full year in 2019, but also next year, given you might be able or you'll be successful in building more inventory. Just wondering if there's a big impact we should expect in terms on the working capital. So I do expect a cash draw in our cash flow on that inventory line. Last call, I guided around $40,000,000 I would say it's in that range of $40,000,000 to 45, Obviously, if we can procure more railway ties, we will. It's also a question of so the hardwood logs have become available, the sawmills are cutting them, and we're buying everything we can to build our drive program, but also keep in mind that there's a rhythm to which the sawmills can deliver. But if for any reason we can optimize and get more inventory in, we will definitely take that opportunity. So but right now, I will guide to 40,000,000 to 45,000,000 dollars For 2019, I think, or even for next year? No, for 2019. And honestly, I mean, probably most likely for next year because it is going to take us several months into next year to continue rebuilding that dry inventory level. Obviously, it depends on the pace, but yes, I would suspect there could be a drug again next year. Okay, perfect. And for the total working cap, okay. And with respect to the CFO role, could you provide an update on the CFO search, Henrik? Certainly. So we have engaged a 3rd party firm to help us recruit, and we're right now in the thick of the process. Things are moving along very well. I'm quite pleased with the process. And it's always difficult to predict when these processes conclude. But let's say, I'm hopeful that in the next few months, we'll be making an announcement to the market for a replacement for the CFO position. Okay. That's great color. Thank you very much for the time, Haik. My pleasure, Benoit. If there are any additional questions at this time, please press star 1 on your telephone keypad. Your next question comes from the line of Michael Tupholme from TD Securities. Please go ahead. Eric, can you provide any further details around the customer decision to defer sales and if you do have a sense and it's possible to share that. But also, is it fair to say that this is not in any way indicative of any kind of a general trend and it's a specific situation? So thank you, Micah. So I don't want to talk customer specifics. So but I did mention the fact that it's a customer say it is not an industry spread trend and there is no change in trend. As much as I can say, we have good relationship with these customers and with these customers and have a long term relationship and we're supporting them in this change. My understanding is that they're better managing their own internal inventory and we're just pushing some sales into next year, But we know that we'll have strong demand from them in the coming year. Okay. You've talked a little bit about improving conditions on the procurement side in terms of raw fiber availability. Just wondering, you've also talked about expecting some price driven growth in the ties segment in 2020. And I'm just trying to square those two comments. If availability of raw material is improving, yet you're still confident in seeing some pricing growth. Is that just that the comps are a little bit easier maybe in the first half? Or is this a function partly of your commentary about trying to be more opportunistic in the non Class I market? Yes. And that's exactly it. It's in the non Class 1 market because the first half of twenty nineteen saw some price increases in the railway times. So year over year in the first half of next year in that non Class 1 business, we'll have opportunity to nudge up pricings just a bit exactly. So you're spot on. Okay, perfect. And then with respect to the utility poles segment, still healthy growth this quarter, but it did come down from where it was in the Q2. And if I recall, the last conference call, you had talked about the potential for seeing double digit organic growth for the full year 2019. Any commentary on sort of if there's been any changes in the, I guess, in the outlook or the organic growth outlook for the U-twenty coal segment? No, not at all. So when you compare year over year, I can say as much as in 2018, we did have in Q3 an important transmission project, which we obviously ended last year and we did not have a replacement project, if you want, for that specific sales volume for this year. But demand remains healthy. And to your point, I am hopeful to see strong close to the year, call it like the mid single digits, but it still will be very healthy. Okay. Perfect. And then just lastly, the 2019 EBITDA guidance range that you provided, just to be clear in terms of sort of what's driving you towards that type of range versus what you'd previously communicated? Is that mainly a function of this, the shift in deliveries for this one particular customer into next year on the tie side? Or are there other factors that went into that change? That is the main factor, Mike. Okay. All right. Thank you. My pleasure. Your next question comes from the line of Maxim Sytchev from National Bank Financial. Please go ahead. Hi, good morning. Good morning. Eric, I just had one question, and I'm not sure if you can provide this data point. But in terms of if you're going to be doing less boltanizing next year, can you maybe walk us through in terms of how we should be thinking about this in terms of the margin impact, the potential lift from that? Can you maybe quantify that? Quantifying is difficult. So there's 2 aspects to it. So one is, when we have to use the bolt mining process, it is in accord our customers and we do get a bit more of a compensation for it. Where the cost efficiencies are a bit higher, there's less absorption of fixed costs because we absorb our fixed costs based on volumes produced. So there's definitely a better allocation of our fixed costs and there's definitely an uplift. Difficult for me to quantify it. It's a good question. I mean, I could have one of our analysts run some models on it and could follow-up with you eventually, but it's not a data point I would have at this point. But still just in terms of how we should think directionally, it should help the margin profile. Is that a fair assessment? It would. But it would be like in decimals of a percentage point, right? We're not taking significant lift. Okay, okay. That's great. That's it for me. Thank you very much. Thank you. There are no further questions at this time. Mr. Vachon, I turn the call back over to you for closing remarks. Thank you for joining us on this call, and we look forward to speaking with you again at our next quarterly call.