Earnings Call: Q2 2018

Aug 8, 2018

Earnings release

Ladies and gentlemen, thank you for standing by. Welcome to Stella Jones Second 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 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 8, 2018. 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 Bacheon, Chief Financial Officer of Stella Jones. Thank you for joining us for this discussion of the financial and operating results for the company's 2nd quarter ended June 30, 2018. Our press release reporting Q2 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 the quarter. Our 2nd quarter results demonstrated strong sales growth. Sales increased in the utility pool, residential lumber and logs and lumber product categories, driven by increased selling prices and market demand. This performance was partially offset by the continued temporary headwinds in the railway ties product category, primarily related to the transitioning of a Class 1 railroad customer to a full service program. We are also pleased to see our operating margins improve sequentially by 1.8% over the Q1, in line with our expectations. Overall revenue amounted to $662,300,000 versus $594,200,000 in the same period last year. The contribution from acquisitions was $26,000,000 while the currency conversion effect had a negative impact of $18,600,000 on sale. Excluding these factors, sales increased $60,700,000 or 10.2%. Net income for the quarter was $48,100,000 or $0.69 per diluted share compared to $0.71 per diluted share a year ago. In a moment, Eric will discuss the financial performance of the company in greater I will now address the 2nd quarter results by product category. Railway tie sales reached $201,300,000 down from $214,200,000 for the same period last year. Excluding the currency conversion effect, sales declined $4,700,000 or 2.2 percent, primarily as a result of the company supporting the transition of a Class 1 railroad customer from a treating services only program to a full service black tie program. We expect that this transition will negatively impact sales to this customer until the latter part of Q3. The sales decrease is also due to continued soft pricing environment, which we have already started to see improve in most regions. Turning to utility poles. Sales amounted to $179,300,000 up from $167,500,000 for the same period last year. Excluding the contribution from acquisitions and the currency conversion effect, sales increased by approximately $17,600,000 or 10.5%. This growth was driven by higher volume for replacement programs, coupled with increased sales prices from standard contract escalation and renewal clauses. In the residential lumber category, sales were $203,600,000 up from $153,200,000 for the same period last year. Excluding the contribution from acquisitions and the currency conversion effect, sales increased by approximately $33,800,000 or 22.1%. This favorable variance is primarily explained by higher selling prices as a result of lumber cost escalations being passed through to customers and to increase volume due to the company's expanding market presence. In the industrial product category, sales reached $32,800,000 up from $27,100,000 for the same period last year. Excluding the contribution from acquisitions and the currency conversion effect, sales increased 3.3%, explained in most part by projects requiring our treated laminated products. Finally, in our category of logs and lumber, revenue stood at $45,300,000 up from $32,200,000 in the same period last year. This significant increase reflects higher selling prices due to increased lumber costs coupled with increased harvesting activity related to procurement activities to support strong gold sales. Turning to our network. During the quarter, we acquired Wood Preservers Incorporated, which manufactures, sells and distributes marine and foundation filing and treated wood utility poles located in Virginia. We are currently in the process of integrating both WP and Prairie with Prairie Forest Products acquired in February in our operation. Once fully integrated, our network will be that much stronger. Eric will now provide further details about our 2nd quarter results. Eric? Thank you, Brian. Gross profit amounted to $96,700,000 or 14.6 percent of sales in the Q2 of 2018 compared with $99,000,000 or 16.7 percent of sales in the Q2 of 2017. The decrease in absolute dollars is primarily explained by the transition of a Class 1 railroad customer from a treating services only program to a full service black tie program. To accelerate this transition, the company acquired untreated railway ties from the Class 1 railroad customer, which increased cost of sales once these ties were treated and sold. Railway tie margins were also impacted by increasing untreated railway tie cost in the Q2. The decrease in gross profit is also attributable to higher operating costs in the U. S. Southeast where Stella Jones continues to work on reducing its cost base and improving logistical flow. In addition, the higher lumber costs, which are passed through to customers via higher selling prices, have contributed to increase the cost of sales, but have also put downward pressure on margins as a percentage of sales. These cost increases were partially offset by the effect of currency translation. As a result of the reduction in gross profit, operating income stood at $71,000,000 or 10.7 percent of sales, down from $74,500,000 or 12.5 percent of sales in the 2nd quarter a year ago. As we explained last quarter, we expected our margins to be softer in the first half of the year. Note that margins in the second half of the year are expected to improve over the first half. Similarly, net income for the Q2 of 2018 was $48,100,000 or $0.69 per diluted share, down from $48,900,000 or $0.71 per diluted share in the Q2 of 2017. Cash flow from operating activities before changes in non cash working capital components and interest and income taxes paid was $81,700,000 for the Q2 of 2018 compared with $83,200,000 for the same period in 2017. However, given higher working capital requirements this year versus last year, Cellozone generated cash flow from operating activities of $62,400,000 in the Q2 of 2018 as compared to $94,400,000 for the same period last year. In the second quarter, our cash was primarily used to finance the Wood Preservice Incorporated acquisition of $28,000,000 invest in CapEx for $12,500,000 and pay dividends of $16,600,000 As at June 30, 2018, Stella Jones' long term debt including the current portion was $581,200,000 versus 455 point $6,000,000 as at December 31, 2017. The increase mainly reflects higher working capital requirements, financing for the acquisitions of Prairie Forest Products and Wood Preservers, higher capital expenditures as well as the effect of local currency translation on U. S. Dollar denominated long term debt. As a result, Stelladones' total debt to EBITDA ratio was 2.5 versus 1.9 as at December 31, 2017. Finally, the Board of Directors of Stella Jones yesterday declared a quarterly dividend of September 21, 2018 to shareholders of record at the close of business on September 3, 2018. I will now turn the call back to Brian for the outlook. Thank you, Eric. Based on current market conditions and assuming stable currencies, we expect higher year over year overall sales for Stella Jones, driven by pricing as well as increased market reach for the residential lumber, utility pole and logs and lumber product categories. Operating margins are expected to improve in the second half of twenty eighteen when compared to the first half of the year. However, the progression of operating margins in the second half of twenty eighteen will be slowed down by increasing untreated railway tie cost until sales prices can be adjusted. As a result, we expect 2018 overall operating margins to be slightly lower than last year. Having said this, in 2020, we remain confident that our EBITDA margins will return to the 15% range on an annualized basis. In addition, we plan on spending between $30,000,000 $40,000,000 on property, plant and equipment in 2018, and our overall effective tax rate is expected to be approximately 26.5%. Let me discuss our outlook by product category. In the railway tie product category, pricing is expected to improve in the second half of twenty eighteen, but the related margin gains will be partially offset by rapidly increasing cost of untreated railway ties. We expect that this raw material cost increase will lead to continued upward selling price adjustments in the quarters ahead. The spot market pricing should also benefit from the tightening of the untreated railway tie supply. These adjustments will have a positive effect on margins in 2019 and going forward. In the utility pole product category, sales in the second half of twenty eighteen will benefit from both pricing adjustments and strong demand. We also expect a better sales mix within the product category for the upcoming quarters. However, these factors will be partially impacted by slight cost increases for certain wood species and the timing of price adjustments. In addition, we continue to work at optimizing our operations in the U. S. Southeast, which will lead to improved margins in the second half of 2018. In the residential lumber product category, sales for the second half of twenty eighteen are expected to increase year over year as we expand our market reach and benefit from increased pricing driven by higher wood costs. The effect of adjusted residential lumber selling prices as a result of higher wood costs will have a slight downward impact on margins as a percentage of sales for the year. Finally, sales for the logs and lumber product category will continue to grow as a result of increased harvesting activities and the impact of the higher cost of lumber. Since this business does not generate any margin, sales growth in this product category will further reduce overall margins as a percentage of sales. In the short term, we will focus on integrating the recent Prairie Forest Products and Wood Preservers Incorporated acquisitions, as well as optimizing operating capacity and minimizing costs throughout the organization. As we indicated in the last conference call, we commissioned additional pole treating capacity at the end of the second quarter, which will help improve customer service and our operating costs in the U. S. Southeast. Over the long term, our strategic vision focused on continental expansion remains intact as we believe that the fundamentals of each product category remain strong. Our vision is to solidify Stella Jones as North American leader in the pressure treatment of wood for railway ties and utility poles, while diversifying into other product categories that are aligned with the company's established confidence. As we have done for over a decade, we are committed to our established business while pursuing disciplined program of acquisition. This strategy has helped us to consistently enhance shareholder value and we are confident we'll continue to do so. Eric and I will now be pleased to answer any questions you may have. Thank you. Your first question comes from the line of Hamir Patel from CIBC. Please go ahead. Hi, good morning. Brian, you pointed to the escalation in untreated cross ties as tempering the margin recovery over the rest of the year. How long do you think it'll take to pass it on based on the timing of your contracts? For the most part, it depends at what point does the we're kind of chasing the higher cost up. But I would suspect by the end of the year into the Q1, we'll have already had price adjustments through and we'll see at that point if the upward pressure on untreated ties continues. But we've certainly seen a sharp increase in the last several months. Okay, great. Thanks. That's helpful. And do you have a sense yet as to how the Class Is are thinking about their type purchase programs for 2019? Is it looking flat? Or are you expecting some growth there? It's a bit mixed. Some are probably going to be down a bit, while others are up. So I think on balance, the mix within our customer group will probably going to be up a bit overall in the Class 1. I. Great. Thanks. That's all I had. I'll turn it over. Great. Thank you. Your next question comes from the line of Leon Agassarian from Bank Financial. Please go ahead. Hey, good morning guys. Good morning. Great performance on the residential lumber side. I mean, the organic growth number was quite strong there. I know you mentioned lumber prices were a pretty big factor. Can you help us quantify that a little bit? I mean, was it a big volume impact Or was it really on the pricing side? Just maybe help us understand that a little bit better, please. Sure. About twothree would be related to price and onethree would have been volume. Okay. And you also mentioned that you're on the lumber side as well as some of the other segments that you're seeing an increased market reach. Can you explain to us what that means about that? Are you in more geographies now than you were before? Are you in different contracts that you've gained? Or how should we see that side of things? A bit of both. We're in more geographies because of our acquisitions or our acquisition related to Prairie Forest Products. So that geographically got us into a region where we weren't before. And then additionally, within the same geographical areas where we've expanded some of what we refer to as our dealer network, which would be the non box store. Okay. And just two quick kind of clarification things from my end would be on the CapEx, you mentioned $30,000,000 to $40,000,000 for 2018 and you've already spent north of 25 dollars in the first half of the year. So is that to understand that the second half is going to be very minimal in terms of spend or is that an additional $30,000,000 to 40 No. Our guidance is for 30 to 40 for the whole year on the CapEx. That's what I thought. I just wanted to clarify. And then the last point would be on the logs and lumber side. Obviously, that number was quite high as well. And you mentioned that it is low margin to no margin. So just trying to understand, like, if it wasn't for logs and lumber, what kind of EBITDA margin would be looking at for the quarter? The impact if we would have had it, call it the same or no growth maybe in that product category, it had approximately about 0.5% on the EBITDA margin. Great. Thanks. I'll turn it over. Thanks, Dan. Your next question comes from the line of Benoit Poirier from Desjardins. Please go ahead. Yes. Good morning, gentlemen. Just related to the outlook, could you mention some color with respect to the railway tie, but mostly for the non class railroad for 2018 2019? In terms of where we expect demand to be? Is that I'm sorry, just a little unclear on the Yes, exactly. In terms of demand, what you would expect from the non class railroad for the remainder of 2018 2019, Brian? Yes. We expect actually that it will continue to be healthy. I think certainly we've seen a real tightening in inventories as an industry and that is certainly going to help us from a hopefully from a profitability standpoint and margin standpoint in the quarters ahead. But we've worked through as an industry, the pendulum has probably swung in the other direction now. We went from too much to now we're seeing a real tightening in the untreated availability of ties. So that's going to, I think, help us in the quarters ahead. Okay, perfect. And maybe the question is for Eric. When you say about a slight decline in the overall EBITDA margin in 2018, could you provide some color or quantify a little bit what is the overall EBITDA number we should expect for the whole year, Eddy? Are you talking in the absolute dollars or percentage? In percentage. Either? Yes. About 12.5% annualized, Benoit. Okay. For the full year. Okay. That's great color. And when we look at the utility pull, given the trend or higher interest, could you provide some color on if it impacts the outlook for your utilities, whether it could trend into lower CapEx or whether you haven't seen any impact so far? We haven't really seen any impact so far. I think we remain fairly bullish that we're continuing to see healthy maintenance programs. Okay. That's very good. Very good. And could you comment a little bit about the outlook for M and A now that you perform some acquisition this year, whether there's still a pipeline for 2018 or mostly 2019? I would say, we're always as you're aware, we're always looking at opportunities. I think the timing of those opportunities is difficult to judge sometimes just based on everything from due diligence requirements to the sellers' interest themselves in terms of the timing. So, I would say, we're confident we have some other ones ahead of us, Whether that will hit 2018 or 2019, it's hard to say at this point in time. Okay. And last one for me. Could you provide an update on the progress related to the growing the U. S. Residential lumber? You made some comments in the past quarter. So I was just curious to know if there's kind of an evolution in terms of U. S. Residential lumber? Thank you. On the U. S. Residential lumber side, I mean, we continue to see a healthy program being driven out of the Northwest at our Tacoma facility. I think at this point in time, our focus on acquisitions is going to remain primarily on the pole and tie side. And I think to expand beyond a residential presence in the U. S, we'll take acquisitions of assets. So I would say that's still a wait and see and probably a little further out. Perfect. That's great color. Thank you very much. Thank you. Thank you, Benoit. Your next question comes from the line of Justin Keywood from GMP Securities. Please go ahead. Good morning and thanks for taking my call. Hi Justin. Hi. On the working capital, as you mentioned, it was high in the quarter and the accounts receivables seem to spike. I'm wondering is this just normal seasonality and should we expect that to come down substantially in Q3? You're exactly correct, Justin. It is a seasonality. These sales are very stable comparable year over year and no collections issues, but you're right, the higher amount is related to the volume of business. Okay. And then on the debt ratio, it was 2.5 in the quarter and there was an amendment on the accordion loan that expands the available credit quite substantially. I'm wondering what's the comfort level for you on the debt ratio? And is this affecting any acquisition plans? Historically, our comfort level is when we start to approach 3 or just a little bit over 3 times EBITDA, where I would say we start to feel a little uncomfortable. We do get the benefit in any acquisition, not from a reporting standpoint for a ratio, but for how the bank would view our ratio is that we get to include the pro form a of any acquisitions that we would have done. So that would help bring the ratio down. So we still have some good horsepower available for the acquisitions that we have in the pipeline. So we're still sitting good now and we expect as we roll through Q3 to further see debt levels come down for sure. Okay. And then just finally on the growth in residential lumber, there was mention of increasing market share. I'm wondering is this capturing new customers or just expanding with existing? It's actually a bit of both. We've picked up some new customers and of course our existing customers continue to perform very well. So we like to think because they're with the right supply partner. Okay. And is there opportunity to increase that share more or are you kind of reaching the limits? I think we're still able to expand on the dealer side of the market and we'll certainly help our existing customers to continue to grow. So I think there is opportunity. I think the greater opportunity as per one of the previous questions would eventually lie in the U. S. But at this point in time, like I said, our near term focus will be on the poles and ties. Great. Okay, great. Thanks for taking my questions. Thank you, Justin. There are no further questions at this time. I turn the call back over to Mr. McManus for closing remarks. Great. Well, thank you everyone for joining us on this call and 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.