Earnings Call: Q2 2019

Aug 7, 2019

Earnings release

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to Stella Jones Q2 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 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 Wednesday, August 7, 2019. I would now like to turn the conference over to Brian McManus, President and CEO. Please go ahead. Thank you. Good morning, ladies and gentlemen. I'm here with Eric Vachon, Chief Financial Officer of Stella Jones, and thank you for joining us for this discussion of the financial and operating results for the company's Q2 ended June 30, 2019. Our press release reporting Q2 results was published earlier this morning. It, along with our MD and A, can also be found on our website at www.stella jones.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 the 2018 reporting period. Please refer to the MD and A for further details. Let me now begin with a brief overview of the quarter. We are pleased with our Q2 results given the short term challenges experienced in certain markets. Sales were stable at $661,800,000 and decreased $18,200,000 or 2.7 percent when excluding the currency conversion effect. This variation is primarily explained by lower sales for railway ties due to some temporary shipment delays, decreased sales lumber as a result of wet weather conditions and reduced sales of logs and lumber due to lower selling prices and volume. These factors were offset by higher sales and healthy demand for utility poles. We saw our profitability increase driven by improved pricing, better operational efficiency in the U. S. Southeast as well as lower lumber costs. Net income for the quarter was $52,300,000 or $0.76 per diluted share compared to $48,100,000 or $0.69 per diluted share last year. We also continued to follow our strategy of Continental expansion by completing one tuck in acquisition in Ontario in April and finalizing our client expansion in Cameron, Wisconsin. In a moment, Eric will discuss the financial performance of the company in greater detail. Looking at the Q2 results by product category. Utility pole sales reached $206,300,000 up 15% from sales of $179,400,000 last year. Excluding the currency conversion effect, utility pole sales increased $20,300,000 or 11.3%, primarily driven by increased sales prices and continued volume increases in the U. S. Southeast and overall healthy demand in the United States. Railway tie sales amounted to $194,700,000 representing a decrease of 3.2 percent from sales of $201,200,000 last year. Excluding the currency conversion effect, railway ties decreased $13,200,000 or 6.6 percent. This variance is mainly explained by delayed shipments due to low railcar availability, as well as the longer treating cycle times, which pushed the delivery of certain orders to the second half of twenty nineteen. The longer treating cycles are a result of the tight supply market for untreated railway ties, which requires the company to treat railway ties that are not air seasons. Sales in the residential lumber category totaled $194,800,000 down 4.3% from sales of $203,500,000 last year. Excluding the currency conversion effect, residential lumber sales decreased $11,200,000 or 5.5%. This variance primarily resulted from lower demand due to wet weather conditions in Eastern Canada and to a lesser extent by lower pricing. Industrial product sales reached $38,800,000 compared with $32,900,000 last year. Excluding the currency conversion effect, sales increased $4,500,000 or 13.8%, largely as a result of stronger rail related product sales. Sales in the logs and lumber product category totaled $27,100,000 compared with $45,300,000 last year. Excluding the currency conversion effect, sales decreased by $18,600,000 This variance is a result of reduced selling prices driven by lower lumber market a decrease in lumber transaction volumes as well as lower log sales due to the timing of harvesting activities. Eric will now provide further details on our Q2 results and financial position. Eric? Thank you, Brian. Gross profit amounted to $108,200,000 or 16.3 percent of sales in the Q2 of 2019 compared with $100,200,000 or 15.1 percent of sales last year. The increase is explained by higher selling prices and better operational efficiencies in the U. S. Southeast. These factors were partially offset by lower volumes and slightly higher production costs for rail and ties. EBITDA stood at $94,200,000 or a margin of 14.2 percent versus $80,100,000 or a margin of 12.1 percent last year. The increase in EBITDA is explained by higher gross margins and the adoption of IFRS 16, which effectively subtracted $8,100,000 in right of use, asset depreciation and $1,000,000 in financing expenses from cost of sales in the Q2. With 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, which in this case is $9,100,000 for our Q2 2019 EBITDA to make it comparable. Operating income stood at $76,700,000 or 11.6 percent of sales in the 2nd quarter compared to CAD71 1,000,000 or 10.7 percent of sales last year. Net income for the Q2 of 2019 was $52,300,000 or $0.76 per diluted share, up from $48,100,000 or $0.69 per diluted shares last year. Turning 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 $95,300,000 in the 2nd quarter, up from $82,200,000 when compared with the same period last year. Cash flows provided by operating activities generated $25,600,000 in liquidity versus $62,400,000 last year. This is primarily explained by an increase in working capital. We use this liquidity and our credit facilities to support purchases of property, tenant equipment for $27,500,000 including the April Shelbourne, Ontario acquisition for $9,200,000 and dividend payments of CAD19.4 million. During the quarter, we amended our credit agreement and increased our credit facilities by US100 $1,000,000 now providing financing up to US425 million dollars This will provide us with greater flexibility to manage our working capital requirements and make strategic acquisitions. As of June 30, 2019, our long term debt, including the current portion was $619,700,000 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 Shelbourne, partially offset by the effect of local currency translation on U. S. Dollar denominated long term debt. Finally, the Board of Directors of Stella Jones yesterday declared a quarterly dividend of $0.14 per common share payable on September 20, 2019 to shareholders of record at the close of business on September 2, 2019. Turning to our outlook, we reconfirm our general outlook for 2019. We expect higher year over year sales based on current market conditions, the current level of lumber prices and assuming stable currencies. This increase is driven by stronger pricing for railway ties and utility poles as well as increased market reach for the utility pole product category. This overall increase in sales is expected despite lower sales in the logs and lumber product category. We also expect improved year over year margins on a consolidated basis. Higher margins will be primarily driven by increased pricing and volumes for railway ties, coupled with improved product mix and demand for utility poles. More specifically, in the utility pole category, sales and margin for 2019 are expected to increase year over year, driven by both pricing and healthy demand for replacement programs. In the railway con category, sales and margins for 2019 are expected to improve year over year, primarily driven by pricing. Sales in the latter half of twenty nineteen will benefit from 2nd quarter delayed sales and healthy demand. We believe that the increasing cost of untreated railway ties, combined with the tighter supply market will lead to continued upward selling prices adjustments for the quarters ahead. In the residential lumber product category, sales for 2019 are expected to be stable year over year as higher demand and market reach are expected to be offset by lower selling prices to customers as a result of lower longer costs. 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. 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 the logs and number product categories will favorably impact overall margin as a percentage of sales when taken as a whole with other product categories and vice versa. Furthermore, we plan on spending between $60,000,000 $70,000,000 in capital expenditures for 2019. This includes the plant expansion carried out in Cameron, Wisconsin as well as the Shelbourne acquisition and upgrades. Our strategy remains intact and we will continue to focus on optimizing operations across the organization while seeking acquisitions to further expand our presence in our core markets. Before we open the call up for questions, Brian would like to say a few words. Brian? Thank you, Eric. As you all may know, this will be my last conference call as President and CEO of Stella Jones. I will be stepping down in October after over 18 years. It has been a real privilege to lead this company and I'm confident that our management team continue to build upon the excellent culture we have formed together while writing some new and exciting chapters of their own. Let me take this opportunity to thank all the employees of Stella Jones for their dedication and the investors in our company for their support. I look forward to watching the company as it continues to grow. Eric and I will now be pleased to answer any questions you may have. Your first question comes from the line of Hamir Patel from CIBC. Your line is open. Hi, good morning. Good morning. Brian, you previously guided for a full year EBITDA in the $325,000,000 to $330,000,000 range. I think you said plus or minus $10,000,000 last time. Has there been any change to that outlook? No, there hasn't, but I'll get Eric to reconfirm since he's going to be living at the back end of the year. So, Amir, yes, we confirm our outlook for the guidance on the EBITDA is the same. Okay, great. That's helpful. And in Q2, you guys pointed to some deferred sales in Q2 due to shipment delays on the tie side and weather headwinds in res lumber. Could you quantify what those were in each segment and how much of the res lumber would you expect to pick up in Q3? The easier answer will be on the railway tie side of things just because of it's, I call it, easier to quantify. I would say we're looking at roughly between $10,000,000 deferred sales part for the railway ties. When you look at the residential lumber, I think what we started to see already July was actually a good month for us and we're hopeful that we'll play in some catch up on the bad weather we experienced in April May. So it'd be very difficult to give a number around the residential except obviously you can see in the results that we're a little bit below what was last year. Some of that, of course, is the pricing because of the lower lumber costs. Thanks, Brian. And then just turning to the pull side, it looks like revenue growth there was still pretty healthy double digits. How much of that was price and how much was volume? It was kind of well, it was a bit of both and it was even some mix because what we're also seeing is we saw some healthy demand on the transmission side poles as well, and that's expected also to continue, certainly for the back end of the year and even as well into 2020. Great. That's all I had. I'll turn it over. Thanks, Chris. Thank you. Thank you. Your next question comes from the line of Michael Staphong from TD Securities. Your line is open. Thanks. Good morning. Hi, Michael. Good morning. On an overall basis, you're continuing to guide to year over year revenue growth in 2019. Just wondering when we think about the overall business, your revenue growth on an organic basis in the first half is sort of flat. How should we think about the quantum of organic revenue growth in the back half? Eric, did you want to? Yes, certainly, Mike. So looking at the considering stable FX impact, I think we could see in general terms some low single digits organic growth for the second half of the year. Okay. And that's with the benefit of some of the deferred sales from Q2 coming through in the second half? Yes. Okay. And are all of the issues you encountered in the ties segment in the Q2 in terms of availability of railcars, Is that all overcome now or is that back to normal? Yes. For the most part, it is back to normal and we expect to see strong shipments in the back half of the year. In addition to that too, as we mentioned, one of the things we're up against is dealing with a very tight supply market right now the untreated ties. And so that's forcing us to do our boltanizing process, which requires us to balance the capacity of our facilities. So that's going to push out some of the deliveries later in the year as well just in terms of the availability of the finished product. Okay. And I know you didn't mention that in the release, but the sort of the tight availability of raw material in the Tides segment, that's been an issue for a while. Was that already kind of contemplated in your outlook for the year when you communicated that to the market earlier? Or was the expectation that you were going to see some improved availability? The expectation that we were going to see some improved availability kind of during Q2, but unfortunately, as you'd be aware, Louisiana got hit with a I'm not sure if it was classified as a hurricane or a tropical storm, but a lot of additional wet weather moved into that area. And we've also seen record rainfall in a lot of our other procurement areas. So again, the positive news is we've seen some good improvements in the very recent weeks in terms of availability of what's coming in. And but we've got catch up to do in terms of replenishing the end of the white stock, if you want to call it, the untreated stock. Okay. And then just looking at the outlook commentary, I know you indicated that in general, it hasn't really changed on an overall basis. But if we look at the commentary as it relates to the margin outlook, you're talking about higher year over year margins in all product categories previously, whereas now we're simply talking about higher on a consolidated basis. So can you just speak to specifically what's changed on the margin outlook? It sounds like overall, it's not necessarily different, but some of the underlying pieces sound like they may be changed a little bit. No, not significantly, Michael. I guess we're more comfortable with the overall approach. Obviously, we've seen a bit what's going on with the residential lumber and the log prices or lumber prices, that's a bit harder to predict. So that might be a bit more flattish than progression. But I think overall, we still remain very confident with the general outlook and the main product categories. Okay. I'll turn it over. Thank you. Your next question comes from the line of Benoit Poirier from Desjardins. Your line is open. Good morning, Brian. Good morning, Eric. Hi, Benoit. Good morning, Benoit. Yes. First question, when we look at the overview of railway tie industry, we look at the inventory closer to 12,000,000 €13,000,000 which is really below the historical trough, the inventory to sales ratio at 0.62. Could you talk a little bit about the dynamics and the confidence that eventually the inventory will get replenished? And also talking to Class 1, what do you foresee in the future? When I look at the CapEx, it sounds overall stable for the next 2 to 3 years. So any thoughts about what we should expect from Class 1 railroads given the slight decline in volume? Thanks. Certainly, overall demand from Class 1s is expected to continue to be healthy. We continue to see them invest in maintenance of their rail lines. And your point on near historical lows in both in terms of inventory and inventory to sales on the railway tie side is clearly a good indication of a healthy market for us or opportunities for us going forward. Really, it's just a matter our procurement team is doing an outstanding job of getting everything that's available out there into our plants and they'll continue to do that. And we just recently had a meeting on that and they remain confident of continuing to get what we need. It's a little hand to mouth, but we're making it work. Okay. And with respect to bolt onization, would you be able, Brian or Eric, maybe to quantify the impact on the margins and whether you have enough capacity to for a balkanization going forward given the current low inventories? Yes. Really, the effect on margins is rather minimal overall, especially when you consider that there's often additional charges or we have to build it into our pricing on it for what we're doing there. It's more to your second part of the question, which is the capacity at our facilities from a standpoint of the longer cycle times do tie up a bit more capacity. But we have a very strong network and what we're doing, the team is doing a great job of shuffling that capacity to meet the customer needs across the network. So we have enough capacity to treat what's coming in and we'll continue to do that. So as we continue to move forward and we hopefully continue to see the strong incoming untreated ties, that's going to further help us as we start to get more and more ties up in the deck to dry. Okay. And for the profitability of the utility pole, you've been working to improve profitability in the U. S. Southeast. Could you maybe give an update on where you are? And maybe comment about the overall M and A opportunities you see in the segment and the overall business? Sure. I'll comment just sort of on our success we've realized in the Southeast. It's as people know, we've been speaking about it for a little while, and we were a little slower than we would have liked to in the rationalization of the acquisitions we had done there and the integration. But we're certainly well not all the way there. We've seen some very good improvements and that's certainly showing through in our costs overall. In terms of the opportunities from acquisitions, Eric, I'm happy to let you comment on that. Certainly. So we're Benoit, our plan is unchanged. We're still considering the similar targets in our plan over the next several months, and that hasn't changed. We still have ongoing discussions with different parties. Okay, perfect. And last one for me. When I look at the and then the work the change in working cap, obviously, the impact on the residential lumber has made some impact in Q2. How should we be looking at the working capital movement in the later part of the year? And maybe if you could give kind of the expectation for the full year and the implication on a balance sheet standpoint maybe? Well, Benoit, where we stand today, if we look at a few of our product categories, first, the railway ties, we know we need to replenish a bit more inventory on that. And so we can definitely expect a bit of cash draw on the railway tie side. There's some also some opportunities in the residential lumber right now. The market is I don't want to qualify if it's at a low, but it's historically, it's attractive. So we definitely will be looking to before the end of the year to prepare for next year's season in the residential lumber. So I do expect a cash draw, call it, some between $30,000,000 $40,000,000 on a drop at the end of the year. Okay. For the total year, so a big boost in the second half and okay, some catch up, meaning that your debt to EBITDA ratio will improve from the level at the end of Q2? Exactly. Okay, perfect. Good color. Assuming no acquisition. Yes, yes. That's perfect. Thanks, okay. Thank you, Benoit. Your next question comes from the line of Walter Spraguely with RBC. Your line is open. Thanks very much. Good morning, everyone. So Brian, lots of inbound questions after your announcement, speculation as to why you're moving. It does seem to be all of a sudden, it wasn't kind of sensitive the market wasn't really sensitized to it, if you want to put it that way. Anything you can provide in terms of how we could answer those questions when they come in? I'm sure you've gotten a few and it's interesting how you've been answering them. I've been answering them exactly the same way for everybody. Walter is really after 18 years at the helm. There's never really a good time or there's never necessarily how much time is the right amount of time. But I'm extremely confident in the position we are today. I'm also extremely confident in the overall team that we've built over these past 18 years that really I chose this time to step aside and at an age where if I was going to have another chapter in my career, shall we say, I viewed it as this could be more or less the best time. I didn't want to leave at a point where the company was in really bad shape or certainly not at a point where the company had peaked out, I didn't think that would be right to our team. So I think there some great opportunities that lie ahead for the company. And I'm pleased with my personal decision, if you want to say, and on here till October to help with the transition and working closely with the Board and management to ensure a smooth transition. Certainly wish you the best of luck in that next chapter, Brian. Thank you, Walter. Yes. And Eric, this has been certainly a growth story driven by acquisition. And the question becomes now whether given the acquisition pace has certainly slowed and whether you see going forward a significant pickup in that pace and therefore kind of that growth trend to reestablish itself from an M and A perspective? But if not, would you consider reexamining how you how the capital structure of the organization runs? Specifically, would you look at higher leverage and a higher dividend payout ratio in the event that you are not able to identify your target level of acquisitions? So thank you, Walter. I read 2 parts in your question, the M and A portion and capital allocation. The second part of your question, the capital allocation piece, I think it's too early to have that discussion. And there's just an internal discussion that's happened with the Board. What I can tell you is that we do have our sights on certain acquisitions expanding our network through a potential M and A or not potential, but upcoming M and A. There are ongoing discussions with different parties. As you know, these discussions take their own time. They have their own pace. Each acquisition has its own nature, but I'm quite confident that there's still some attractive acquisitions that will keep adding to our presence in North American market in our product categories. Okay. If they were to not come to fruition, would that be one of the Yes, certainly. I'm quite optimistic that there are Yes, certainly. I'm quite optimistic that there are some acquisitions that are ahead of us. But to your point, yes, we're not going to stand idle and win around. We're definitely going to have an action plan. Okay, great. Your guidance for CapEx was similar to last year, I think last time I jotted it down. Is that it seems that you did have a fairly significant pickup in the Q2 here. Would you is that guidance still in place for similar to last year? Well, we did reiterate that it's going to be we didn't reiterate. We put that it's going to be a bit higher than last year, but most of that is explained by the acquisition that we did in Q2 because of the way it's getting treated. Normally, the acquisition would not be part of the CapEx, but it's being treated as an acquisition of assets got my accounting skills, but and that's really why you see the slight change in terms of the uptick in our expected. That combined with the fact that we're also planning on upgrading the facility. And so you had 51 last year, up 9 for the acquisition, gets you to 60, up what, another 5 for reinvestment of the facility? Yes. We put, I think, approximately 6 in the MD and A. We guided between 6074 for the year. Looking at your pole segment, I think you had a good quarter. You had been guiding high single digit organic growth in 2019. It was up 11 over 11% in the 2nd quarter. Are you still are we dipping into double digit now given how the Q2 has trended? Or are we going to see a step down because some of that the moving parts of the Q2? Sorry, Walter. We just for some reason, we missed part of that question. I believe your question was related to whether we expect to kind of see that slightly higher than high single digit growth to continue for the balance of the year. Was that That's right. Given how well you did in the Q2, even if we keep you at high single digit, you're going to be into the double digit territory. Yes, Walter. We're seeing very strong obviously coupled with price increases that we've been passing through because of higher raw material costs. But yes, I would agree with that. Okay, great. That's all my questions. Thank you. Thanks, Martin. Your next question comes from the line of Mark Neville from Scotiabank. Your line is open. Hey, good morning guys. Maybe just a couple of points of clarification. The revenue guide for ties being up, residential being flat, I'm not certain or sure that it's is that including sort of FX gains through the first half? Or is that sort of like an organic number aside from that? It's just not that clear to me. That would be including FX gains. Yes. As if we're starting to date, I think. Right. Okay. And then the working cap number, Eric, I think you said $30,000,000 $40,000,000 investment. I wasn't sure if that was resi later in the year or that's sort of like an annual number for the consolidated business? That's a consolidated. It would be a draw for total inventories. Okay. And then on the availability of Thai supply, just are you actually I mean, you guys have enough inventory? Are you able to source what you need? Or is there sort of any cost for concern or issues there on your end? There's certainly no cost for concern from the standpoint of it growing in the forest. If we look at the availability of hardwoods that are out there, there's certainly more than enough. It's really just getting access to it given the some of the weather conditions that have been experienced. And again, we've seen record rainfall levels in some of the key procurement areas. Now again, it's a little early to call it that it's we're back on track, so to speak, but we've certainly seen some good improvements in the last probably 3, 4 weeks in terms of the inbound of what's coming in. So there's no fundamentally fundamental change, if you want to call it, from that standpoint, and I think that was more of your question. Yes. I guess I presume it's sort of an industry wide issue. And any extended Oh, yes, yes. Certainly, absolutely. Yes. And any extended lead times with your customers, I mean, they're understanding why? Yes, yes, very much so and working with us as best they can. Right. Okay. Thanks for taking my questions. And Brian, congratulations and good luck on whatever you decide to do. Thank you very much. Thanks. Your next question comes from the line of Michael Tupholme from TD Securities. Your line is open. Thanks. Just a couple of follow ups here. The Industrial Products segment had a very robust organic growth in the quarter, 13.8 percent. I think you said that was attributable to demand for rail related products. Is that I guess, any more color as to why it was so high? And is that a level you think you can maintain in the second half? So Michael, to answer your question, the rail related products would be the bridges and the crossings and so on. And the demand really is the functionality of projects when the railroads do the maintenance and they become a cross and each for these products, we're always there to supply them and we have capacity allocated through that. I think we will see some good growth here for well, as we as our outlook says for the whole year, we will have growth in sales and margin and that product category is included. It might not be to the tune of that percentage for the quarter, but that quarter is part of what is boosting the cat or supporting the categories growth for the year. Okay. And then you've been or this has come up a couple of times, but just on working capital, just so I'm clear, the $30,000,000 to $40,000,000 that you referenced a few times, Eric, that is the investment you expect in the second half of the year? Or is that for the full year? Yes. Yes. So how should we I mean, maybe to I guess we can do the math on this, but what is the expectation for the full year in terms of changes in noncash working capital? Yes. So I'm sorry, Michael. So the change for the full year will be if I look at the cash flow at the end of the year, there'll be a drop $40,000,000 for the inventory line. But that's a better way to put it. Okay. Okay, sorry. And then the CapEx guidance you provided, can you just reiterate that, please? Yes, certainly. So we had given guidance, I believe so our guidance now is $60,000,000 to $70,000,000 and we had given guidance of $40,000,000 to $50,000,000 The incremental portion, if you want, is the Shelbourne acquisition. It was treated as a purchase of asset and not a business combination. So that $9,200,000 falls under the PP and E line. So that's a better part of the explanation. And then following this acquisition at the Shelbourne facility, we're doing upgrades at the facility to the tune of approximately $6,000,000 Okay. And then just lastly, I mean, I realize this hasn't been that much time since Brian, since you may be or the company may be asking about your decision to step down. But is there any update at this point on the search for a new CEO? I guess, really all I can tell you at this point is that the Board of Directors has put together a committee. They have started a process and they've engaged an outside third party to be part of that process as well. Okay. And sorry, I don't recall if this was mentioned, but was there any sort of timelines put around how long that process is expected to take? There's not and really that will be up to the Board, but I think the Board certainly wants to ensure that it's done in a timely fashion as close to possible with my exit. But they'll take the time that's required. Right. Okay. Thank you very much. Thanks. There are no further questions at this time. I will turn the call back over to the presenters. Thank you for joining us on this call. We look forward to speaking with you again at our next quarterly call. This concludes today's conference call. You may now disconnect.