Earnings Call: Q4 2018

Mar 15, 2019

Earnings release

Morning, ladies and gentlemen. Thank you for standing by. Welcome to the Stella Jones 4th 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. Before turning the meeting over to management, please be advised 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 15, 2019. I will now turn the conference over to Brian McManus, President and CEO. Please go ahead, sir. Thank you. Good morning, everyone. I'm here with Eric Basham, 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 Q4 ended December 31, 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 and acquisitions. Our EBITDA modestly increased to $244,000,000 when compared to 2017, as it was negatively impacted by a $7,900,000 non cash mark to market loss on derivative commodity contracts in the 4th quarter. Excluding this non operational item, EBITDA would have reached $252,000,000 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 2020, which represents about half of our anticipated needs. This is the first time we've experienced such a large loss in 1 quarter as fuel prices sharply declined within a few weeks. What is important to highlight is that this is non cash and as of today, about 60% of the loss has already reversed in the Q1. For 2018, total sales reached $2,120,000,000 an increase of 12.6 percent over the previous year. Excluding acquisitions and the currency exchange effect, organic sales increased by approximately $190,200,000 or 10.1 percent. Net income for 2018 amounted to $137,600,000 or $1.98 per diluted share, down from $167,900,000 or $2.42 per diluted share in 2017. The year over year decrease is primarily explained by a one off non cash tax benefit of $30,000,000 recorded in the Q4 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 4th quarter results. Total sales in the 4th quarter amounted to $432,800,000 up 14.7% over the previous year. Excluding acquisitions and the currency conversion effect, sales increased approximately $35,000,000 or 9.3%. Sales of railway ties reached $127,000,000 versus $118,000,000 last year. Excluding the currency conversion effect, railway ties sales rose 4.8%, driven by price increases. Utility pole sales amounted to $192,000,000 up 17.9 percent from $162,900,000 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 $60,300,000 up from $48,600,000 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 product sales amounted to $23,100,000 up from $20,000,000 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 $30,400,000 versus $27,900,000 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 Q4 results and year end financial position. Eric? Thank you, Brian. Gross profit amounted to $67,000,000 or 15.5 percent of sales in the Q4 of 2018, compared with $53,500,000 or 14.2 percent of sales in the Q4 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 Q4 of 2018 stood at $41,800,000 or a margin of 9.7% versus $38,000,000 or a margin of 10.1 percent for the corresponding period last year. EBITDA was impacted by a non cash loss of $7,900,000 related to the mark to market fair value on diesel and petroleum derivative commodity contracts, as Brian explained earlier. Operating income stood at $31,800,000 or 7.4 percent of sales compared to $29,000,000 or 7.7 percent of sales in the Q4 a year ago. Net income for the Q4 of 2018 was $20,600,000 or $0.30 per diluted share, down from $51,100,000 or $0.74 per diluted share in the Q4 of 2017. The year over year decrease is attributable to the deferred tax liability remeasurement following the December 27 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 $262,300,000 for the year compared to $248,200,000 for 20.17. However, given unfavorable working capital variations primarily linked to increases in inventory, we generated cash flow from operating activities of 128 $100,000 in 2018 compared to $301,100,000 for 20.17. In 2018, we used our cash to make acquisitions for $54,500,000 invest in property, plant and equipment for $51,600,000 and provide a return to shareholders in the form of dividends for $33,300,000 and share buybacks for $4,000,000 Stella Jones concluded 2017 with a healthy financial position. As at December 31, 2018, our long term debt, including the current portion was $513,500,000 versus CAD455.6 million as of December 31, 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 31, 2017. Finally, the Board of Directors of Stella Jones yesterday declared a quarterly dividend of $0.14 per common share, representing an increase of 16.7 percent over the previous quarterly dividend payable on April 26, 2019 to shareholders of record at the close of business on April 5, 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, 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 cost of untreated railway ties combined with a tighter supply market will lead to continued upward selling price adjustments for the quarters ahead. In 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 and 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 Q1 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. 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, welcome. Good morning. So the first question is, Brian, your margin kind of outlook for 2019 is fairly consistent with what you've been saying before. But I think in most 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 is there any what you could provide in terms of color as to what occurred over the last, let's say, year or 2 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, but we also saw the same thing happen on our lumber. So we've been chasing an increased raw material cost, which makes up substantially a good part of our input costs. And as a result, while we were continuing to adjust pricing up, the impact on our margin percentages, we continue 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. So 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. And then so we're certainly entering 2019 with more confidence of increasing margins. But as you recall, last quarter, what I'm I think the lessons 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. And that's going to be sort of our move going forward because once again, if lumber prices spike, then we can push the pressure on our percentage margins, but yet our dollar margins will hold to where we anticipate they'll be. And in terms of dollar margins, then consensus is in just kind of shy of just around $2.90 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 in terms of the benefit on the lease accounting, I would say we're comfortable with that number. Okay. That will be the best answer I can give you there. No, that's a good answer. Okay. The dividend increase that you the Board approved here, a fairly meaningful one. I just wanted to make sure, does that not when you look at your M and 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 a 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 opportunities out there. And 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. And 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? Yes. I think, let's call it, plus or minus 5% around the consensus number that Walter brought up of $290,000,000 Okay. And Eric, any sense yet what the impact of IFRS 16 would be on EBITDA and net debt? Well, we'll be reconciling those numbers in the Q1. I hesitate to give you guidance. I mean, ballpark, I think IFRS 16 could add something around $23,000,000 to $25,000,000 in depreciation to our P and L for 2019. So that's again, it's approximate dividend and an estimate. Okay, great. No, that's helpful. And 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 Q4 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 bull 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. And related to that, Eric, were there any increased provisions for credit losses in the quarter related to PG and E? There was a I'd say, there was a small adjustment, not necessarily material. We believe that going forward, we don't expect any more adjustments. 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, Edith. 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. So 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 bolt onization in 2019 and maybe going forward? It's going to be simple answers to both those questions is, are we will continue as prices continue to move up on railway ties, continue to pass them through, boltingizing for sure. It's going to be a tight market until we can see the procurement improve. But 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. Okay, perfect. And should we expect any big move on the cost side given the balkanization or it's mostly again another pass through in terms of pricing, Brian? Yes. Nothing of material nature and we certainly will be able to pass that through. Okay. Okay, perfect. And just in terms of working capital for 2018, there was a drag or usage of almost $76,000,000 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? Yes, 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. So that plays into it as well. So the combination of those items would have been 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, okay. That's very good. And in terms of M and A update, Brian, you mentioned that you are confident to close some in the next 12 months. Any particular segment that we should see more activities? I think we'll I don't want to pinpoint a specific one, but it will certainly be in our one of our core product categories. How's that? Yes. Okay. Okay. Perfect. And 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 $10,000,000 will be the total cost roughly. Incremental or the reason the rationale behind it is just that we tap the capacity out at the facility. It will become much more efficient when the second cylinder is in place. And in terms of the potential revenue out of that that could drive somewhere between $15,000,000 $20,000,000 a year once it's once again we reach the capacity on that cylinder. And I would point out, we actually have room for a third. So if we continue to see the demand, we can add another one. Okay, perfect. Thank you very much for the time. Okay. Thanks, this time, please press star. Follow-up at the number one on your telephone keypad. Your next question comes from the line of Justin Keywood from GMP Securities. Please go ahead. Good morning. Thanks for taking my call. I just want to go back on the commentary around the California wild fires leading to certain requirements. I'm 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 4th quarter and around that was kind of what percentage of that growth could have been attributable to the California wildfires And really what it was, was replacement poles getting sent in for ones that would have come down because of the fires. And so specifically related to the growth, the rough estimate was about a third of the 15%, if you want to say. Not a third of our overall pool sales and just referring to the growth. Okay. I mean, if that answers your question, Justin. But we did see growth pretty well spread out everywhere. But certainly concentrated there was some concentrated growth in the Q4 related to the California wildfires as we responded to our customer needs. Understood. And I'm just wondering if the situation there and the major bankruptcy of 1 of the utilities, is that leading to other utilities across the states maybe potentially addressing the liability of end of life poles and maybe kind of increasing their CapEx expenditure? We certainly hope we could see that. Feel free to give them some calls and suggest it to them. But joking aside, we 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. So I certainly see it as a potential positive for us or a driver going forward in the years ahead. Okay. Thank you. And then just finally on M and A, I'm just wondering 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. But I don't know, did you comment specifically in a little bit more detail on the 2019 outlook? I know you said sales for poles should be higher year over year, but 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. But 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. And is it your I mean, this sort of builds on one of the last questions there, but do you see this as sort of being partly driven by finally tackling the large installed 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. But I'm a little nervous to point directly to that, but I would say it's certainly a positive sign. So we're feeling pretty good in terms of what we see the market doing. Okay. And then I guess similarly to what I just asked about in terms of the 2019 outlook for pools, 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? I mean, prices seem like they're still they're up and they're maybe still climbing in terms of the pass through. But how do we think about, I guess, the 2 pieces of volume versus price for ties in 2019? Most will be price. Volumes, while we suspect a healthy demand, it's really going to be ensuring that we can get enough white side to meet that demand. And that kind of goes back to another question about the need to be doing a lot of boltanizing in 2019 is certainly going to be something we're going to be doing. But I would say the anticipated growth is going to come mainly from price. Okay. And then I know in the last couple of years, there's 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. But 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 within 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. So we're closer to grabbing hold of it, maybe is the best way to express it. So we're getting there. And I think outside of the contractual obligations, that's been able to be adjusted much more quickly. So we're seeing improvement for sure. Okay. And then 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 Eric can repeat it. Yes, exactly. So, Mike, so to reiterate what Brian mentioned, we think it's going to be relatively stable for the remainder of the year. Got it. Okay. And then just one last one for you, Erika. I think in the context of IFRS 16, you were talking about the expected increase in EBITDA, but you were suggesting net income would be lower due to, I think, higher finance expenses. So 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? There is going to be essentially the message is that there is going to be some interest expense related to the accounting approach. But from a net earnings perspective, it should not have I mean, the offset is, I guess, the rent expense that you won't be incurring in the SG and A line? Right. It could have a slight impact. I don't expect anything too significant, but 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. Yes. Just to come back on the high single digit growth expected for utilities, Brian, were you mostly referring to volume or overall revenues? Combinations of the 2 have been 1. Okay. And mostly driven by volume, I would assume? In the case of utility poles, I would agree with that, yes. Okay, okay. Perfect. And for residential lumber, you mentioned some color about kind of a flattish revenue, but driven by lower pricing and strong demand. What type of volume growth should we be looking for residential lumber in 2019? And 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 further expand in that market as well. So a combination of hooking our wagon to the right course as well as just our ability to expand our market reach. So 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, really great color. And just in terms of cash deployment, unfortunately, obviously, the balance sheet 2.1 is strong, especially the working cap is going to be more flattish this year as opposed to usage similar to last year. So I'm just wondering, as you build up EBITDA, free cash flow, any thoughts about the cash deployment opportunities or given the M and A pipeline is still there that it will still be the 1st usage to make, Brian? Absolutely. That's always our best return for shareholders is the acquisition pipeline. And that's I certainly hope that's going to be my number one use of cash this year. Okay, perfect. Thanks again for the time. 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 pools segment due to the wildfires, would the margins on that business have been consistent with the rest of your pools sales or was there any difference in the margin profile of that incremental work? It would have been consistent. Okay. Thank you. Your next question comes from the line of Mark Neville from Scotiabank. Please go ahead. Hey, good morning guys. Hi, Mark. Sorry, I just wanted to clarify just 2 things, I guess. Just on the working cap, is it that it's neutral for the year or it sort of grows with sales? Because it sort of sounds like you'll see some pretty good growth in sales this year. So I'm going to assume some investment in working capital. There will be some, yes. It's more of an effect that we if you looked on a year over year from 2018 to 2017, we had a bit quite a bit of a swing on the working capital and it was related to some timing depends on stocking up of inventory. I would just more point to more of a neutral effect. But you're absolutely right, there will be some use as to respond to increased sales. Okay. And just on the guidance, I think in the 290, the plus or minus 5% around that, again, that could be a reasonable or sort of 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 maybe get plus 5% or the minus 5% is 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. So given a tight, tight number, there's certain things beyond our control. So I just wanted to provide a bit of a range. Okay. No, that's fair. 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 and we look forward to speaking with you again on our next quarterly call. Have a great day.