Earnings Call: Q1 2018

May 3, 2018

Earnings release

Afternoon, ladies and gentlemen. Thank you for standing by. Welcome to Stella Jones First Quarter 2018 Earnings Conference Call. Before turning the meeting over to management, please be advised that this conference call will contain statements that are forward looking and subject to a number of risks and uncertainties that could cause actual results to differ materially from those anticipated. I would like to remind everyone that this conference call is being recorded on Thursday, May 3, 2018. I will now turn the conference over to Brian McManus, President and CEO. Please go ahead, sir. Thank you. Good afternoon, ladies and gentlemen. I'm 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 Q1 ended March 31, 2018. Our press release reporting Q1 results was published earlier this morning. It also can 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 results were in line with our expectations. Our railway tie category continued to face headwinds from short term pricing pressures, while sales in our utility pole product category increased on replacement programs and our residential lumber category benefited from the increased pricing environment. Overall revenue amounts to 390 $8,800,000 versus $396,900,000 in the same period last year. The contribution from acquisitions was $3,100,000 while the conversion effect from fluctuations in the value of the Canadian dollar had a negative impact of $16,100,000 on the value of our U. S. Dollar denominated sales. Excluding these factors, sales increased $14,900,000 or 3.8 percent. Net income for the quarter was $23,100,000 or $0.33 per diluted share compared to $0.37 per diluted share a year ago. In a moment, Eric will discuss the financial performance of the company in greater detail. I will now address the Q1 results by product category. Railway tie sales reached $146,400,000 down from $158,500,000 for the same period last year. Excluding the conversion effect, sales declined $4,900,000 or 3.1 percent. This variation was primarily as a result of continued pricing pressures in certain regions combined with lower sales from a Class 1 railroad customer, which commenced the depletion of its inventory as it transitions to a full service black tie program from a treating services only program. We expect that this transition will negatively impact sales to this customer until the latter part of Q3. Turning to utility pools. Sales amounted to $152,900,000 in line with the same period last year. Excluding the contribution from acquisitions and the currency conversion effect, sales increased by approximately $8,000,000 or 5.3%. This growth was driven by higher volume for replacement programs. In the residential lumber category, sales were $50,300,000 a 30.3% growth over the same period last year. This favorable variance is primarily explained by higher selling prices as a result of lumber cost escalations passed through to customers, while the Prairie Forest product acquisition completed in February contributed $2,400,000 In the industrial product category, sales reached $20,800,000 down from $21,900,000 for the same period last year. Excluding the contribution from acquisitions and the currency conversion effect, sales decreased 2.6% mainly due to the timing of projects related to bridges and timbers. Finally, in our category of logs and lumber, revenue stood at $28,300,000 up from $26,900,000 in the Q1 of 2017. This variation reflects higher selling prices due to increased lumber costs. Turning to our network. In recent months, we continued to follow our strategy of Continental expansion with 2 tuck in acquisitions. During the quarter, we acquired Prairie Forest Products, which includes a wood treating facility and a pool peeling facility located in Manitoba, a province where we previously had no operational presence. In addition, following the end of the quarter, we acquired Wood Preservers Incorporated, which manufactures, sells and distributes marine and foundation piling and treated with utility poles located in Virginia. These acquisitions further reinforce the reliability of our production network and distribution capabilities. Eric will now provide further details about our Q1 results. Eric? Thank you, Brian. Gross profit amounted to $56,500,000 or 14.2 percent of sales in the Q1 of 2018 compared with $68,800,000 or 16.1 percent of sales in the Q1 of 2017. The decrease in absolute dollars is explained in most part by the company supporting 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 this customer, which increased cost of sales once these ties were treated and sold. Moreover, cost of sales was slightly impacted by increasing utility pole fiber costs, which will be mitigated as selling prices will progressively be adjusted over the upcoming months. These cost increases were partially offset by the effect of currency translation. As we explained last quarter, we expected our margins to be softer in the first half of the year. We anticipate it will progressively improve in the second half. As a result of the reduction in gross profit, operating income stood at $35,500,000 or 8.9 percent of sales, down from $40,800,000 or 10.3 percent of sales in the Q1 a year ago. Similarly, net income for the Q1 of 2017 was $23,100,000 or $0.33 per diluted share, down from $25,900,000 or $0.37 per diluted share in the Q1 of 2017. Reflecting the decrease in net income, cash flow from operating activities before changes in non cash working capital components and interest and income taxes paid was $45,000,000 for the 1st 3 months ended March 31, 2018, compared with 50 $400,000 for the same period in 2017. Cash flow provided by operating activities used $64,600,000 in liquidity in the Q1 of 2018 versus an inflow of $7,200,000 last year. This variation is primarily explained by normal seasonal working capital requirements in anticipation of increased demand during the peak period, specifically the 2nd and the 3rd quarters as well as the timing of certain purchases and the value of inventory acquired to support a Class 1 railroad customer's transition to a full service black tie program. As a result, in the Q1, we used our credit facility to finance the Prairie Forest acquisition for $26,500,000 and CapEx for $11,500,000 As at March 31, 2018, Stelladona's long term debt, including the current portion was $565,400,000 versus $455,600,000 3 months earlier. The increase mainly reflects higher working capital requirements as per normal seasonal demand, financing required for the acquisition of Prairie Forest and the effect of local currency translation on U. S. Dollar denominated long term debt. As a result, Stella Jones' total debt to EBITDA ratio was 2.41 versus 1.89 3 months earlier. Finally, the Board of Directors of Stella Jones yesterday declared a quarterly dividend of $0.12 per common share payable on June 27, 2018 to shareholders of record at the close of business on June 6, 2018. I will now turn the call back to Brian for the outlook. Brian? Thank you, Eric. Our outlook has not changed since last quarter. Based on current market conditions and assuming stable currencies, Stella Jones' total sales and operating margins are expected to improve progressively in 2018. We expect operating margins to remain softer in the first half of twenty eighteen. Over the next 24 months, we are confident that our EBITDA margins will return close to the 15% range on an annualized basis. More specifically for 2018, in the railway tie category, we expect sales to remain stable as compared to 2017, with softer pricing negatively impacting operating margins in the first half of the year. In the utility pole category, following a return to normal demand patterns in 2017, we expect a better sales mix within the product category in 2018. However, these factors will be slightly offset by cost increases for certain wood species and the timing of price adjustments. In the residential lumber product category, sales are expected to be on the rise as the company benefits from increased demand for new construction and outdoor renovation projects in North America and higher pricing, reflecting higher wood cost. 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. We will also be commissioning additional pole treating capacity in the second quarter, helping to improve both customer service and our operating costs in the U. S. Southeast. Over the long term, the company's strategic vision focused on continental expansion remains intact as management believes the fundamentals of each product category will remain strong. Our vision remains one of solidifying Stella Jones as a North American leader in the pressure treatment of wood for railway ties and utility poles, while diversifying to other product categories that are aligned with the company's established confidence. As we have done for over a decade, we remain committed to our established business, while pursuing a disciplined program of acquisitions. This strategy has helped us consistently enhance shareholder value. We are confident we'll continue to do so. Eric and I will now be pleased to answer any questions that you may have. Your first question comes from the line of Benoit Poirier from Desjardins Capital Markets. Please go ahead. Yes. Good afternoon, gentlemen. Good afternoon, Benoit. Yes. Could you provide some color around your 2 acquisitions that you've announced in terms of revenue and also margin profile? And what also type of synergies you could achieve for from those 2? Certainly. In terms of Prairie's Forest Products, as we've shown, the purchase price was approximately CAD25 1,000,000 For 2017, they had sales right around CAD35 million. And the margin profile, it will be improved to come close to ours in the coming, call it, next 9 months or 12 months. We just have to roll through kind of this season. It's a great fit. It expands geographically our ability to service that market primarily on the residential lumber side. And as we've stated, it also does some utility pull. So it will play a role in helping streamline some of our deliveries in that area. As for the second acquisition that we completed in April after the end of the quarter, actually very close to the purchase price and sales of Prairie Forest except in U. S. Dollars. Purchase price was approximately US25 $1,000,000 and the sales were approximately US35 million dollars in 2017. This will help us expand our industrial products category because of their presence in the marine piling, something that we feel we can continue to grow as the synergies will fit well with our ability to access more white wood for them. So definitely something positive that we look forward to. Margin profile, fairly similar to ours actually. Okay. Okay. Hopefully, that answers all your questions. Yes. No, no, no. That's pretty good color. And could you talk about the potential pent up demand when we look at the railroad ties, we've heard a lot about congestion. Some customers are beefing up their CapEx spending for this year. So could you talk about whether we're going to see some pent up demand for railway ties in the back half or maybe 2019? I think it probably will go more to 2019. I think what we're going to have in 2018, we're kind of seeing a mix right now, Benoit. We have some that have actually taken down a bit the programs. And as we talked about in just a couple of minutes ago, the move from one of our clients to a black tie program will result in a deferred sale as we're stacking now the white wood ties for future sales, and they're going to deplete their existing inventory. So I think we're going to have a mix of that. And then we've also had another some other clients have actually increased their programs for 2018. So I feel we will see more activity overall in 2019, but I think we're there's some puts and takes here and there. But overall, for 2018, we feel it's going to be very similar to 2017 for us on the railway tie side. Okay. And when we look at M and A prospect, now that you've announced 2 other, could you talk about whether you still foresee M and A prospect and how the acquisition of Cox Industry by Koppers have changed the or you would expect to change the dynamic on the utility poles, Brian? Kind of 2 different questions there, Benoit. I'll start with the first one in terms of acquisition opportunities. Clearly, our very short term focus will be integrating the ones that we've recently completed. I would say we still have other opportunities out there that we're in discussions or looking at. So we expect there could be other opportunities that develop over, call it, the next 12 months. To the second part of your question in regards to copper's acquiring COGS, it doesn't change much in our market. It's just really a different owner of those assets. And we've competed against the coppers on the railway tie side for many, many years, and they're a good competitor. And we expect that they'll be the same when it comes to the utility poles. Okay. Thank you very much. Thanks, Manavar. Your next question comes from the line of Walter Spracklin from RBC. Please go ahead. Yes. Thanks very much. Good afternoon, everyone. So with regards to the Class 1 rail moving, I think we have a sense of who that might be, but is that essentially going to mean a much better margin for you once that once we get through this period of inventory drawdown and then they move into the black into your black tie service? Should we see margin improvement on a similar level of revenue from that customer? No. Margin percentage wise generally will be somewhat similar. I think our dollar margin for, call it, time in the cylinder may be slightly higher, but it'll be a similar profile. So will you generate higher revenue growth from this customer then or higher revenue from this customer? Yes. Yes, we will because we'll be selling a complete railway to it. Right. So that will on a similar volume metric, we'll effectively see a higher, I guess, unit price achieved in 2019 on a year over year basis? Yes. That's a fair way to look at it. Exactly. Presumably that I guess that's where I was getting the higher margin because you're getting a bigger price from that same customer for the same volume, I guess. Correct. But it'll be on a percentage basis, it tends to be slightly a little bit lower, but the overall dollar margin will be slightly higher because of it's on a larger number. And is there a sense of order of magnitude of this customer compared to your overall book of business? Is it a number of 3 customer or number 10 customer? It would be in our top 5 on the railway tie side. Okay. So that's great. And then looking at your residential lumber, you had some good trends there. Is the growing sales kind of connected with your big box customer win or are you getting traction or deepening relationship elsewhere? It's a little discussion on that, particularly what regions you're seeing stronger growth in that residential lumber side would be helpful. Actually, there's two things driving it. One is definitely the pass through of the whitewood cost increases that we're seeing as we've seen in the market that the price of lumber itself has continues to escalate. The other part is increased volumes as well. And that's getting driven both by just increased sales from our big box customer as well as, I would say, increased market share of some of what we refer to as the dealer market. Got it. And then finally, on utility poles, you're having a nice volume lift here. I'm trying to get a sense of obviously utilities can be a little bit more lumpy when they come in with purchases. Is this something that you think we should build in our model as a sustainable kind of run rate trend? Or should we view the volume lift this year as kind of specific to certain level of customer activity that might be different or lower next year? I wish I had that clear crystal ball, but I would say we remain sort of confident that the demand from most of our customers will continue to increase in the medium term as they continue to many of them, not all of course, but we see a lot of pole replacement programs coming in place. So we're kind of comfortable guiding with a middle single digit growth on the utility pull side. Okay, fair enough. Okay, that's all my questions. Thanks very much. Thanks, Mohan. Your next question comes from the line of Mona Nazir from Laurentian Bank. Please go ahead. Good afternoon. Thank you for taking my questions. Hi, Mona. Hi. Sorry. So my first question just has to do with the customer shift to the black tie model. I'm just wondering what kind of an impact was that on the top line, if it was meaningful or quantifiable? And also, you mentioned lower railcar availability. I'm not sure if you have those numbers off hand or you could provide. I prefer not to, Mona. Okay. But the railcar is actually something that will be pushed just pushed further into Q2. I think railcar and trucking issues right now, not only our company, but a lot of industries are struggling with right now. And we certainly hope to see it improve as the year goes on. Okay, perfect. And that's a perfect lead into my next question. So a U. S. Peer appear for you on the tie and pull side now reported earlier and we saw 20% decline there on the revenue side and margins continue to be weak. Now I don't want you necessarily to discuss their results, but it's just surprising given the drastic variance between your results and their results and especially given the similar end markets. I'm just wondering if you could take this opportunity to shed some greater light on potential industry issues and how you are able to curtail or reduce the risk to you or on the flip side, just competitive advantages that you have, whether it be your network or anything else? That's a difficult question to answer, Mona. I think the reality is, in some ways, we're fortunate with our overall customer base, and I will also give a lot of credit to both our operational and sales team for navigating these last 12 to 18 months. So I think it's a combination of a number of factors, but it's difficult for me to speak about a competitor. I think they would have to answer some of those questions. But I we're doing the best we can to deliver the best value we can to our customers. Okay. And then I'm debating okay. So speaking to investors, there's a lot of questions surrounding long term growth for the company. As you've largely consolidated the tie side and the pole market continues to shrink and you're consolidating it. You have a history of calculated a prudent strategy and you've guided to kind GDP like organic growth, but M and A remains a significant part of the strategy. Knowing what you know, is it feasible that we could expect 15%, 20% top line growth in the coming years? Or what kind of sales figure could you conceivably add via M and A over the next few years? I think there's I'd be comfortable in saying there's several $100,000,000 of available M and A for the next couple of years, certainly closer to our key product categories. And then the question mark remains, do we expand as we've done within Canada to a greater extent in the U. S. On the consumer lumber side. But I think our near term focus, as we've been saying on a regular basis, will certainly be to our railway ties and utility poles, primarily on the utility pole side. And then we've also seen that we've done some growth on our industrial products with the recent acquisition in Virginia That's expanded our piling market on that front as well. Okay. That's very helpful. Thank you. Thank you, Mona. Thank you. Your next question comes from the line of Michael Tuphloem from TD Securities. Please go ahead. Thanks. Good afternoon. Hey, Michael. Hey, Michael. Brian, the overall outlook for the Railway Ties segment, you continue to call for relatively stable tie revenues year over year, full year 2018 versus 2017. So that's unchanged and you've had that outlook for a little while now. Notwithstanding the fact that I guess you highlighted a few things this quarter, which had a bit of a negative impact or a drag on results and it sounds like some of these things are going to continue. So specifically the transition issue you highlighted and the railcar availability. Did you anticipate some of that, those factors when you originally gave the guidance? Or are there some things that have offset those on the positive side that have allowed you to keep the overall guidance for the ties business unchanged? No. We anticipated most of it. I the part we didn't anticipate was certainly some real car issues that is, for the most part, beyond our control. But the transition of the of 1 of our Class 1 customers to a black tie program was definitely part of our forecast or expectations. Okay. And you mentioned that the sort of the negative drag while you're in this transition should continue to affect you into the Q3. But come the Q4 then, we should see a step up in revenue as that transition issue is complete and you fully move to the Black Tie model? We would expect that. I think some of it will be dependent upon as we often see in the Q4 is how much the various Class I customers are taking for their 2019 program because a lot of the Q4 sales often result is desire to get ties out to the field and ready for the program in the following year. So that often is a bit of a question mark, but I think we would expect to see certainly some uplift in the Q4. Okay. And what are you seeing in the non Class I market as far as the industry inventory position in that market, which had been there'd been an excess inventory position for some time that was part of the issue that led to some of the pricing pressures. What are you seeing there? Any comment on that? I think we're seeing it improve substantially in some regions. And in others, we're still a bit in an over inventory position, but it continues to improve. And I think as we get more into the season of where we'll see a lot more replacements happening or activity, I think it will right itself as we move through the first half of the year. And just on from a pricing perspective, if you look at raw tie prices, it seems as though they have firmed up and actually look to be up on a year over year basis now just in the last little while. At what point would you expect that to hopefully flow through to the pricing that you get on the finished tie side and begin to get some better pricing for your products? That because of just the lag effect that will start to flow through towards the back end of Q2 and then into the back half of the year. But yes, we are starting to see white tie prices start to increase again. Okay, perfect. And then just lastly, with respect to the Wood Preservers acquisition, what would be the split for that acquisition in terms of the revenues between pilings and utility poles? Most of their sales would be around what we would put into our industrial products category. So call it close to 90%. Okay. All right. Thank you very much. Thank you. Your next question comes from the line of Brian Powell from Acumen. Please go ahead. Good morning. Hi, Brian. Hi, Brian. So I just wanted to sort of follow-up a little bit about the quarter, just sort of understand whether there was sort of any benefit from a tough winter or if some of the demand that would be created from the harsh winter might be a positive driver in Q2 for just maybe give us some color on the weather impact on your business? A bit surprisingly actually and really the weather impact that generally has, I would say, our product category that tends to be hit the hardest on a slow start to the spring, if you want to say, is definitely revolves around our residential lumber. And it surprisingly was up quite a bit. So we're hoping that, that certainly continues as we hope to start to see spring weather or summer weather in most parts of the country take hold. So I would say neutral for the quarter, Brian. And probably even, like I said, we're a little surprised on some of the demand we saw on the consumer lumber side. Okay. And then again, just looking at the programs that you're seeing with the utility poles, again, most of that relates to just the lifespan of Poles and less so to sort of weather impact over the last year or so. Correct. You mean sort of impact from special storms or something like that? Yes, special storms. And again, just let's say, I mean, we had a pretty harsh winter out here. I know the East did as well. So just curious whether any of those utility pull programs would be cranking up more because of weather or if it's just really finally these guys are looking at the fact that they got a 40 year inventory they need to do something with? I'm hoping it's the latter. I think we'll see as we progress through the year. But for the most part, it's been pretty regular maintenance programs. Some of the more special projects, actually some that we expected that would occur in Q1 have just been deferred from a delivery standpoint into Q2. So we expect some uplift from some additional projects outside of just what I would call is regular demand growth. Okay, great. And then on the Thai side, we've been hearing through some of our clients and things like that that some of the margin pressure that you're seeing maybe hang on longer term that the railways are sort of have squeezed everywhere else in terms of where they can on pricing and they're pushing back a little bit on suppliers like yourselves. Maybe just comment on that for us. I think that started 18 months ago. So it's I would comment that it's not new. But I think as the market tightens up from an inventory standpoint, it's going to come to a point where we'll see an overall, I believe, uplift in the market. Okay. Thanks for the color. Appreciate it. All right. Thanks, Brian. Your next question comes from the line of Mark Neville from Scotiabank. Please go ahead. Hi, guys. Hi, Mark. I just want to make sure I'm understanding some of the comments on pricing. I think last quarter you said you're seeing sequential pricing improvements in ties. Again, it sounds like maybe second half you'll benefit as well as your costs are going up. But you're also calling out softer pricing in the tie business. So I'm not sure if it's if I'm just misunderstanding or if it's different markets or what exactly is happening there? Well, I think our outlook that we talked about last quarter was really we indicated that we expected sort of the margins to be softer in the first half of the year and picking up in the back half. And that's really what we're referring to in terms of the pricing. There is a, call it, a bit of a mixed bag of pricing in different regions. We're seeing more pressures more in the Southeast and some improvements in the North, but that's something that will hopefully continue to improve as the year carries on. So I'm not sure if I answered the question or Yes. So there hasn't really been any incremental change in the past couple of months, I guess, to that outlook. It's just regional No. Not at all. Okay. And then I guess on the margin guidance itself, I think last quarter you said maybe 150, 200 basis points second half better than the first half. Is that still roughly what you're thinking? Yes, I think it's fair at this point. It might actually be a little more spread through the year, meaning that it might see a little bit better improvement in Q2 than we expected. So but that's kind of $150,000,000 to $200,000,000 might go over the 3 quarters as opposed to more on the back end. We'll see. Yes. Okay. And sorry, just one on the poles. I think you said mid single digit growth. That was is that just volumes? Because again, I think you're expecting improved pricing just again as you're Yes. I'm sorry. That's a really good question, Mark. I was referring to volumes. Okay. Yes. So pricing increases would help boost that a bit more. Okay. And then sorry, I missed the comment on the 15% EBITDA margin. I think that was prepared remarks. You mentioned something about that. I just didn't catch exactly what you said. We just we expect that within the next 24 months that we'll we should be around that target. Okay. All right. Thanks a lot. Thanks. There are no further questions at this time. Mr. McManus, I turn the call back over to you. Great. Well, I want to thank everyone for joining us on this call, and we look forward speaking with you again on our next quarterly call. Have a great afternoon. This concludes today's conference call. You may now disconnect.