Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Stella-Jones Fourth Quarter 2018 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. If anyone has any difficulties hearing the conference, please press star followed by zero for operator assistance at any time. 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 Friday, March 15th, 2019. I will now turn the conference over to Brian McManus, President and CEO. Please go ahead, sir.
Thank you. Good morning, everyone. I am here with Eric Vachon, Chief Financial Officer of Stella-Jones. Thank you for joining us for this discussion of the financial and operating results for the company's full year and fourth quarter ended December 31st, 2018. Our press release reporting Q4 results was published earlier this morning. It can also be found on our website at www.stella-jones.com and on SEDAR. Let me remind you that all figures expressed on today's call are in Canadian dollars unless otherwise stated. I will begin with a brief overview of our full year results. In 2018, we experienced our 18th consecutive year of sales growth. Our sales increased in all product categories, driven by a combination of sales prices, market demand, acquisitions.
Our EBITDA modestly increased to CAD 244 million when compared to 2017. It was negatively impacted by a CAD 7.9 million non-cash mark-to-market loss on derivative commodity contracts in the fourth quarter. Excluding this non-operational item, EBITDA would have reached CAD 252 million, representing a year-over-year increase of about 4%. Let me provide you with a bit more color on this. We use these derivative commodity contracts to protect our future cash flows from the price fluctuations related to diesel and petroleum. We have used these derivative instruments for several years. In late 2018, we entered into a new hedge agreement covering diesel requirements for 2019 and 2020, which represents about half of our anticipated needs. This is the first time we have experienced such a large loss in one quarter as fuel prices sharply declined within a few weeks.
What is important to highlight is that this is non-cash. As of today, about 60% of the loss has already reversed in the first quarter. For 2018, total sales reached CAD 2.12 billion, an increase of 12.6% over the previous year. Excluding acquisitions and the currency exchange effect, organic sales increased by approximately CAD 190.2 million or 10.1%. Net income for 2018 amounted to CAD 137.6 million or CAD 1.98 per diluted share, down from CAD 167.9 million or CAD 2.42 per diluted share in 2017. The year-over-year decrease is primarily explained by a one-off non-cash tax benefit of CAD 30 million recorded in the fourth quarter of 2017, resulting from the remeasurement of deferred tax liabilities following a reduction in the U.S. top federal corporate income tax rate. Turning to the fourth quarter results. Total sales in the fourth quarter amounted to CAD 432.8 million, up 14.7% over the previous year.
Excluding acquisitions and the currency conversion effect, sales increased approximately CAD 35 million or 9.3%. Sales of railway ties reached CAD 127 million versus CAD 118 million last year. Excluding the currency conversion effect, railway ties sales rose 4.8%, driven by price increases. Utility pole sales amounted to CAD 192 million, up 17.9% from CAD 162.9 million last year. Excluding the contribution from acquisitions and the currency conversion effect, sales grew 15% as a result of greater market reach in the U.S. Southeast, increased project activity requiring transmission poles, healthy demand for replacement programs, and requirements following the California wildfires in late 2018. Residential lumber sales reached CAD 60.3 million, up from CAD 48.6 million last year. Excluding the contribution from acquisitions and the currency conversion effect, sales grew 8%, reflecting stronger volume in Canada, partially offset by lower selling prices in the U.S.
Industrial products sales amounted to CAD 23.1 million, up from CAD 20 million a year ago. Excluding acquisitions and the currency conversion effect, sales decreased 6% as a result of lower bridge and timber demand. Finally, logs and lumber sales totaled CAD 30.4 million versus CAD 27.9 million last year. Excluding the currency conversion effect, sales grew 7.9%, driven in most part by heightened pole procurement efforts to support the utility pole product category, partially offset by lower selling prices on lumber. Eric will now provide further details about our fourth quarter results and year-end financial position. Eric?
Thank you, Brian. Gross profit amounted to CAD 67 million, or 15.5% of sales in the fourth quarter of 2018, compared with CAD 53.5 million or 14.2% of sales in the fourth quarter of 2017. The increase as a percentage of sales mainly reflects better year-over-year overhead absorption driven by greater production activity. EBITDA for the fourth quarter of 2018 stood at CAD 41.8 million, or a margin of 9.7%, versus CAD 38 million, or a margin of 10.1% for the corresponding period last year.
EBITDA was impacted by a non-cash loss of CAD 7.9 million related to the mark-to-market fair value on diesel and petroleum derivative commodity contracts, as Brian explained earlier. Operating income stood at CAD 31.8 million, or 7.4% of sales, compared to CAD 29 million, or 7.7% of sales in the fourth quarter a year ago. Net income for the fourth quarter of 2018 was CAD 20.6 million, or CAD 0.30 per diluted share, down from CAD 51.1 million, or CAD 0.74 per diluted share in the fourth quarter of 2017. The year-over-year decrease is attributable to the deferred tax liability remeasurement following the December 27th U.S. tax reform. 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 or recovered, was CAD 262.3 million for the year, compared to CAD 248.2 million for 2017.
However, given unfavorable working capital variations primarily linked to increases in inventory, we generated cash flow from operating activities of CAD 128.1 million in 2018, compared to CAD 301.1 million for 2017. In 2018, we used our cash to make acquisitions for CAD 54.5 million, invest in property, plant, and equipment for CAD 51.6 million, and provide a return to shareholders in the form of dividends for CAD 33.3 million and share buybacks for CAD 4 million. Stella-Jones concluded 2017 with a healthy financial position. As at December 31st, 2018, our long-term debt, including the current portion, was CAD 513.5 million versus CAD 455.6 million as at December 31st, 2017. The increase mainly reflects higher working capital requirements, financing for acquisitions, as well as a currency conversion effect. As a result, our total debt to EBITDA ratio was 2.1 versus 1.9 as at December 31st, 2017.
Finally, the board of directors of Stella-Jones yesterday declared a quarterly dividend of CAD 0.14 per common share, representing an increase of 16.7% over the previous quarterly dividend, payable on April 26th, 2019, to shareholders of record at the close of business on April 5th, 2019. This represents the 15th consecutive year of dividend increase. I will now turn the call back to Brian for the outlook. Brian?
Thank you, Eric. For 2019, based on current market conditions and assuming stable currencies and the current level of lumber prices, we expect higher year-over-year overall sales for Stella-Jones, driven by stronger pricing for railway ties and utility poles, as well as increased market reach for the residential lumber and the utility pole product categories. We also expect improved year-over-year margins across all our product categories. Higher margins will be primarily driven by increased pricing and volume for railway ties, coupled with improved product mix for utility poles. In the railway tie product category, sales and margins for 2019 are expected to increase year over year, primarily driven by pricing. In fact, we believe the increasing costs of untreated railway ties, combined with a tighter supply market, will lead to continued upward selling price adjustments for the quarters ahead.
In the utility pole product category, sales and margins for 2019 are expected to increase year-over-year, driven by both pricing and strong demand for replacement programs and increased project-based sales. In the residential lumber product category, sales for 2019 are expected to be stable year-over-year, as higher market demand and reach are expected to be offset by lower selling prices to customers as a result of the lower lumber costs. Finally, it is important to highlight that sales for the logs and lumber product category, an activity used to optimize procurement in which does not generate margin, is fairly tied to the price of lumber. Therefore, a decrease in the price of lumber will lead to lower sales, but higher overall margins when taken as a whole with other product categories and vice versa. Two points to keep in mind for 2019.
First, the 2019 EBITDA will be positively impacted by the implementation of IFRS 16, while net income will be negatively impacted by higher financing expenses. We will provide you with more information on this with our first quarter results. Finally, we plan on spending a similar level of capital expenditures in 2019 as compared to 2018, and it will include a plant expansion in Cameron, Wisconsin. As always, we will continue to remain focused on optimizing our operations across the organization while diligently seeking market opportunities in all product categories. Eric and I will now be pleased to answer any questions you may have.
At this time, if you would like to ask a question, please press star followed by the number 1 on your telephone keypad. If you are using a speakerphone, please lift the handset before pressing any keys. Your first question comes from the line of Walter Spracklin from RBC Capital Markets. Please go ahead.
Thank you very much. Good morning, everyone.
Hi, Walter.
Good morning.
The first question is, Brian, your margin kind of outlook for 2019 is fairly consistent with what you'd been saying before. I think it's fair to say that the improvement in margin has come a lot slower than we were expecting, and I'm wondering what you could provide in terms of color as to what occurred over the last, let's say, year or two with regards to perhaps the lack of margin improvement, and if there's any additional comfort that you have that you can provide investors that margin improvement is more likely to be more meaningful going into 2019.
Sure, Walter. I think really when we look back over the last 12, 18 months, what we've really faced is increased raw material costs, particularly as it relates to railway ties, we also saw the same thing happen on our lumber. We've been chasing an increased raw material cost, which makes up substantially a good part of our input costs. As a result, while we were continuing to adjust pricing up, the impact on our margin percentages, we continued to kind of get squeezed over this period of time. I think what we've seen is some stabilization in most areas. We've actually seen some declines, for instance, on the residential lumber side. That is giving us more confidence in terms of seeing some margin expansion.
We're also in certain markets because of the tightening of supply, we're realizing higher selling prices as well that are further helping our margins overall. We're certainly entering 2019 with more confidence of increasing margins. As you recall, last quarter, I think the lesson learned is the volatility in the lumber pricing that can happen, particularly on our residential lumber side. We're more looking towards a number as opposed to a percentage, which tends to be a little easier for us to guide towards, if you want to say. That's going to be sort of our move going forward because, once again, if lumber prices spike, then it can put pressure on our percentage margins, but yet our dollar margins will hold to where we anticipate they'll be.
In terms of dollar margins then, consensus is in just kind of shy of just around CAD 290, I guess. Is there any reason why that might be building in some expectations that you would indicate that perhaps should be revisited at all?
Not including the uplift that we will get from IFRS 16.
IFRS, yeah.
In terms of the benefit on the lease accounting, I would say we're comfortable with that number.
Okay.
That would be the best answer I can give you there.
No, that's a good answer. Okay. The dividend increase that the board approved here, a fairly meaningful one. I just wanted to make sure, when you look at your M&A environment, it's not that you don't see opportunity and therefore you're hiking your dividend more than normal, or maybe walk us through the rationale of this shareholder return decision and touch on whether we're just seeing a, maybe for longer period, where acquisition opportunities are not as prevalent.
Great question, and it's funny that this exact topic was discussed at the board that would it actually signal that there's not opportunities out there? In fact, I appreciate you asked the question because that is not the case at all. We actually are seeing some great opportunities. We do expect to be closing on some within the next 12 months. So that was certainly not the signal we wanted to send. I think it was just more a confidence signal by the board of the upcoming year and our future cash flows.
Perfect. That's great clarity. I appreciate it. Thank you very much.
Thank you, Walter.
Your next question comes from the line of Hamir Patel from CIBC Capital Markets. Please go ahead.
Hi, good morning.
Good morning.
Brian, I just wonder if we could maybe clarify that your commentary on EBITDA growth for 2019, excluding the uplift from IFRS 16, is there a range of EBITDA that you'd be pointing to for 2019?
Yeah, I think, let's call it ±5% around the consensus number that Walter brought up of CAD 290.
Okay. Eric, any sense yet what the impact of IFRS 16 will be on EBITDA and net debt?
Well, we'll be reconciling those numbers in the first quarter. I hesitate to give you guidance. Ballpark, I think IFRS 16 could add something around CAD 23 million-CAD 25 million in depreciation to our P&L for 2019. That, again, is approximate and an estimate.
Okay, great. No, that's helpful. Brian, how much of the 15% organic growth in poles was driven by the wildfires and what sort of organic growth are you expecting in poles in 2019?
I would say of that 15%, it would be not quite half. There was a lot of deliveries made in the fourth quarter to help support our customers. Maybe a third. Let's use about a third, I think would be a better answer to that. In terms of growth for 2019, I think we're looking in certainly the strong single digit on the pole side. We're seeing a lot of activity, a lot of projects out there, so we're confident on some continued growth into 2019.
Okay, great. That's helpful. Related to that, Eric, were there any increased provisions for credit losses in the quarter related to PG&E?
There was a small adjustment, not necessarily material. We believe that going forward, we don't expect any more adjustments.
Okay, great. That's helpful. That's all I had. I'll turn it over.
Thanks.
Great. Thank you.
Your next question comes from the line of Benoit Poirier from Desjardins Capital Markets. Please go ahead.
Yes. Good morning, Eric. Good morning, Brian. My first question is on the railway tie. The RTA is putting a new report that look at the green tie pricing. I was just wondering, given the increasing pricing for green tie, your ability to pass through those price increase to customers, and I'm also wondering if the lower inventory to sales ratio will bring on some Boultonization in 2019 and maybe going forward.
Going to be simple answers to both those questions is, we will continue as prices continue to move up on railway ties, continue to pass them through. Boultonizing for sure. It's going to be a tight market until we can see the procurement improve. We have capacity, and we'll be responding to the market needs. We're comfortable that our procurement team will succeed in getting us what we need.
Okay. Perfect. Should we expect any big move on the cost side given the Boultonization, or it's mostly again another pass-through in terms of pricing, Brian?
Yeah. Nothing of material nature, we certainly will be able to pass that through.
Okay. Perfect. Just in terms of working capital for 2018, there was a drag or a usage of almost CAD 76 million driven by higher inventory. I was wondering if it was mostly related to the transition to black tie model, and also what we should expect in 2019 in terms of movement in working capital.
Yeah. Good question. You answered part of it yourself, but yes, the transition to black tie certainly had an effect on that for the full year. I would say also, over the year before, what we certainly were able to take advantage of was the softer lumber pricing, and so we were in a better position to get ourselves better set for the upcoming lumber season. That plays into it as well. The combination of those items would speak to most of that change in the inventory. As we move into 2019, I think we're going to have just more of a stable effect on working capital from a standpoint of a change in working capital, if you want to say.
Okay. That's very good. In terms of M&A update, Brian, you mentioned that you're confident to close some in the next 12 months. Any particular segment that we should see more activities?
I don't want to pinpoint a specific one, but it'll certainly be in one of our core product categories. How's that?
Lastly, you're investing for the plant expansion in Wisconsin. I was wondering how much does it represent, and what kind of incremental revenues it could add, or the rationale for the plant expansion in Wisconsin, Brian?
It's a little over CAD 10 million will be the total cost, roughly. The rationale behind it is just that we tapped the capacity out at the facility. It will become much more efficient when the second cylinder is in place. In terms of the potential revenue out of that, back of drive, it's somewhere between CAD 15 million-CAD 20 million a year, once again, we've reached the capacity on that cylinder. I would point out, we actually have room for a third.
Okay.
continue to see the demand, we can add another one.
Okay, perfect. Thank you very much for the time.
Okay, thanks very much.
If there are any additional questions at this time, please press star followed by the number 1 on your telephone keypad. Your next question comes from the line of Justin Keywood from GMP Securities. Please go ahead.
All right. Good morning. Thanks for taking my call.
Hey.
Hi. I just want to go back on the commentary around the California wildfires leading to certain requirements. Just wondering if you're able to elaborate what those requirements are, and if it was specific to California or more broadly across the states.
The question was relating to the growth we saw in the fourth quarter, around that was kind of what percentage of that growth could have been attributable to the California wildfires. Really what it was replacement poles getting sent in for ones that would've come down because of the fires. Specifically related to the growth, the rough estimate was about a third of the-
Growth
third of the 15%, if you want to say. Not a third of our overall poles sales, I'm just referring to the growth.
Okay. That's helpful.
I'm not sure if I answered your question, Justin, we did see growth pretty well spread out everywhere. Certainly concentrated. There was some concentrated growth in the fourth quarter related to the California wildfires as we responded to our customer needs.
Understood. I'm just wondering if the situation there and the major bankruptcy of one of the utilities, is that leading to other utilities across the states maybe potentially addressing the liability of end-of-life poles and maybe increasing their CapEx expenditure?
We would certainly hope we could see that. Feel free to give them some calls and suggest it to them. Joking aside, I suspect it's probably discussions that would be happening within those utilities, that I think as responsibilities for ensuring the proper maintenance of lines, I would like to think is probably a key topic with many of the utilities. I certainly see it as a potential positive force or a driver going forward in the years ahead.
Okay. Thank you. Just finally on M&A, I'm just wondering if you're seeing similar multiple levels than in the past, kind of slightly below the one-time sales.
We'll continue with our disciplined approach. That's the best way I can answer that.
Okay. Thank you for taking my questions.
Thanks, Justin.
Your next question comes from the line of Michael Tupholme from TD Securities. Please go ahead.
Thanks. Good morning.
Hi, Michael.
Brian, I think you've talked, in response to a couple of questions, about the impact in the quarter on utility poles as a result of the additional volumes related to the wildfires. I don't know, did you comment specifically in a little bit more detail on the 2019 outlook? How you said sales for poles should be higher year-over-year, can you provide a bit more granularity?
Sorry. From a standpoint, I said we're expecting sort of a high single-digit growth on utility poles in 2019. That's going to be pretty well spread out. There's a lot of projects going on, a lot of maintenance demand, and continued market reach as well.
Okay. This sort of builds on one of the last questions there, do you see this as sort of being partly driven by finally tackling the large install base that is nearing the end of its useful life, or is this more just still normal course type growth?
I think we're starting to see hints of it because I know a lot of our customers are referring to pole replacement programs or grid hardening and these types of things. I'm a little nervous to point directly to that, but I would say it's certainly a positive sign. We're feeling pretty good in terms of what we see the market doing.
Okay. I guess similarly to what I just asked about in terms of the 2019 outlook for poles, if we switch over to ties, again, I think you're calling for some growth there, but can you talk to the sort of the components of that growth volume versus price? Prices seem like they're up and they're maybe still climbing in terms of the pass-through. How do we think about, I guess, the two pieces of volume versus price for ties in 2019?
Most will be price. Volumes, well, we suspect a healthy demand. It's really going to be ensuring that we can get enough white ties to meet that demand, and that kind of goes back to another question about the need to be doing a lot of Boultonizing in 2019 is certainly going to be something we're going to be doing. I would say the anticipated growth is going to come mainly from pricing.
Okay. I know in the last couple of years, you've been playing some catch up as far as seeking higher prices to offset the higher untreated tie prices, and untreated tie prices are still quite elevated, obviously. Where are you at as far as sort of catching up and restoring the margins in that business to sort of more historical levels? I know you don't want to talk about margins as far as the overall 2019, but in that, have you largely restored them now as we get into 2019, or is that still happening as you move through the year?
As long as we still see pressure on the supply and still see pressure on the raw material cost, we're still going to be chasing it slightly, but I would say the pace has at least slowed down. We're closer to grabbing hold of it, maybe is the best way to express it. We're getting there, and I think outside of the contractual obligations, that's been able to be adjusted much more quickly. We're seeing improvement for sure.
Okay. I apologize if I missed this, but I think there was a question earlier about changes in non-cash working capital. Eric, did you provide some outlook or guidance for that for 2019? Or if you didn't, could you?
Actually, I provided it, but Eric can repeat it.
Exactly. Mike, to reiterate what Brian mentioned, we think it's going to be relatively stable for the remainder of the year.
Got it. Okay. Just one last one for you, Eric. I think in the context of IFRS 16, you were talking about the expected increase in EBITDA, you were suggesting net income would be lower due to, I think, higher finance expenses. My understanding of IFRS 16 was that there was typically relatively little impact on the bottom line. Are you simply pointing out that there's going to be some incremental interest expense, or is net income actually going to decline?
No. Essentially, the message is that there is going to be some interest expense related to the accounting approach.
From a net earnings perspective, it should not have. The offset is, I guess, the rent expense that you won't be incurring in the SG&A line.
Right. It could have a slight impact. I don't expect anything too significant, it could have a slight impact, Mike.
I see. Okay. All right. That's all for me. Thank you.
Thanks.
Your next question comes from the line of Benoit Poirier from Desjardins Capital Markets. Please go ahead.
Yeah. Just to come back on the high single-digit growth expected for utilities. Brian, were you mostly referring to volume or overall revenues?
Combination of the two, Benoit.
Okay. Mostly driven by volume, I would assume?
In the case of utility poles, I would agree with that, yes.
Okay. Perfect. For residential lumber, you mentioned some color about a flattish revenue, but driven by lower pricing and strong demand. What type of volume growth should we be looking for for residential lumber in 2019? Is it mostly driven by market share gain from your customer?
Well, not only from our customer, but also just from additional customers that we're taking on as we continue to expand our market reach. You'll remember that we did an acquisition last year that expanded our geographical footprint and has allowed us to further expand in that market as well. A combination of hooking our wagon to the right course as well as just our ability to expand our market reach. I would say on the volume side, we're probably low mid-single digit, I would say, on the volume side.
Okay. That's really great color. Just in terms of cash deployment opportunities, obviously the balance sheet 2.1 is strong, especially the working cap is going to be more flattish this year as opposed to a usage similar to last year. I'm just wondering, as you build up EBITDA free cash flow, any thoughts about the cash deployment opportunities, or given the M&A pipeline is still there, that it will still be the first usage to make, Brian?
Absolutely. That's always our best return for shareholders is the acquisition pipeline. I certainly hope that's going to be my number 1 use of cash this year.
Okay, perfect. Thanks again for the thought.
Thank you, Benoit.
Your next question comes from the line of Michael Tupholme from TD Securities. Please go ahead.
Thanks. Just one follow-up. In terms of the incremental volume you saw in the pole segment due to the wildfires, would the margins on that business have been consistent with the rest of your poles sales? Or was there any difference in the margin profile of that incremental work?
It would've been consistent.
Okay. Thank you.
Your next question comes from the line of Mark Neville from Scotiabank. Please go ahead.
Good morning, guys.
Hi, Mark.
Sorry, I just wanted to clarify just two things, I guess. Just on the working cap, excuse me, is it that it's neutral for the year, or it sort of grows with sales? Because it sort of sounds like there'll be some pretty good growth in sales this year, so I would assume some investment in working cap.
There will be some, yes. It's more of an effect that if you looked on a year-over-year from 2018 to 2017, we had quite a bit of a swing on the working capital. It was related to some timing events on stocking up of inventory. I was just more pointing to more of a neutral effect. You're absolutely right. There will be some use to respond to increased sales.
Okay. Just on the guidance, again, the CAD 290, the ±5% around that, again, that could be a reasonable or it could be a pretty material difference either way. I'm just sort of curious as to some of the puts and takes and some of the things that may lead to +5% or the -5%, just sort of some of the things you're looking at.
I think really it's just we're early in the year and I'm hedging my range at this point in time. I would say I would tend to lean at this point in time, we're fairly bullish for the year ahead. All indications are that we're going to have a healthy year, but there's things beyond our control. We've certainly learned that lesson well over the last few years. Giving a tight number, there's certain things beyond our control. I just wanted to provide a bit of a range.
Good to know, sir. All right, thanks.
There are no further questions at this time. Mr. McManus, I turn the call back over to you.
Good. Well, thank you everybody for joining on this call. We look forward to speaking with you again on our next quarterly call. Have a great day.
This concludes today's conference call. You may now disconnect.