Canfor Corporation (OTCPK:CFPZF) Q3 2022 Earnings Conference Call October 28, 2022 11:00 AM ET
Company Participants
Don Kayne – President and Chief Executive Officer, Canfor Corporation
Kevin Edgson – President and Chief Executive Officer, Canfor Pulp
Pat Elliott – Chief Financial Officer, Canfor Corporation and Canfor Pulp and Senior Vice President, Sustainability
Kevin Pankratz – Senior Vice President, Sales and Marketing
Conference Call Participants
Mark Wilde – Bank of Montreal
Paul Quinn – RBC
Operator
Good morning. My name is Michelle and I will be your conference operator today. Welcome to the Canfor and Canfor Pulp Third Quarter Analyst Call.
During this call, Canfor and Canfor Pulp’s Chief Financial Officer will be referring to a slide presentation that is available in the Investor Relations section of the company’s website. Also, the companies would like to point out that this call will include forward-looking statements. So please refer to the press releases for the associated risks of such statements.
I would now like to turn the meeting over to Mr. Don Kayne, Canfor Corporation’s President and Chief Executive Officer. Please go ahead, Mr. Kayne.
Don Kayne
Thanks, operator, and good morning, everyone. Thanks for joining the Canfor and Canfor Pulp Q3 2022 results conference call. I’ll make a few comments before I turn things over to Kevin Edgson, Canfor Pulp’s President and CEO; and Pat Elliott, Chief Financial Officer of Canfor Corporation and Canfor Pulp and our Senior Vice President of Sustainability. In addition, we are joined by Kevin Pankratz, Senior Vice President of Sales and Marketing.
The third quarter resulted in reduced margins in our lumber business as prices moved lower throughout the period. However, we continue to benefit from the diversification of our earnings stream as Europe and the U.S. South generated solid returns. Our strategic growth in regions that have strong and competitive fiber baskets, the U.S. South, Sweden and Alberta will allow us to generate more consistent earnings throughout the cycle.
In British Columbia, the allowable annual cut continues to decrease due to the mountain pine beetle damage, government policy decisions, species at risk and wildfires. We continue to assess our operating rates against the available fiber supply in the region and remain focused on producing higher value products and managing production to meet market demand in order to maximize the value of every consumer law. As a result, Canfor took operational downtime throughout the third quarter with the majority of our BC sawmills continuing to operate today on a reduced basis. I want to acknowledge our employees for their ongoing hard work and dedication. Through the downtime, we have worked to support our employees and thank them for their flexibility.
U.S. lumber demand in the repair and remodel sector remained solid throughout the quarter. However, with rising interest rates, ongoing inflationary pressures and reduced housing affordability, slowing new home construction activity in the U.S. led to lower demand in that segment. In Europe, our largest or our lumber business generated solid financial results in the third quarter despite the impact of seasonal downtime, principally in July. Rising interest rates, inflationary pressures and soaring energy costs in Europe have, however, contributed to a sharp decline in lumber consumption in recent months, particularly for the retail sector. Even though pricing is anticipated to remain relatively solid, we will continue to evaluate market activity levels and manage production as necessary through the fourth quarter to align with current demand. To date, the mills have taken minimal downtime.
Notwithstanding the current macroeconomic uncertainty, North American lumber prices continue to trade above pre-pandemic levels, supported by lean inventories throughout the supply chain, steady underlying demand in the repair and remodel sector and pent-up demand for new home construction in the United States. While inflationary pressures are anticipated to persist in the near term, we remain focused on growing our lumber business on a global basis currently through three major capital projects in the U.S. South.
I will now turn it over to Kevin to provide an overview of Canfor Pulp.
Kevin Edgson
Thank you, Don and good morning everyone. Canfor Pulp had a strong third quarter with solid financial results, driven by the sustained strength in global pulp pricing and an improved operational performance. This contributed to a 4% increase in pulp production despite planned maintenance downtime at Northwood and Intercon during the quarter.
As previously discussed on these calls, the management team at Canfor Pulp remains focused on improving asset reliability and running the mills more consistently. We have seen some positive momentum in this regard over the last few months, and I expect continued progress over the coming quarters.
Sourcing economic fiber remains a challenge in BC due to the decrease in residual chip supply and inflationary cost pressures on pulp loss. As a result, we recently announced extended downtime at our Intercon mill in order to better balance our chip supply for the winter. Transportation networks improved through the third quarter, and in general were able to support our production volume. Our Taylor mill continues to be faced with supply chain challenges. And at this time, we are not anticipating a restart before the spring of 2022.
While we are encouraged by recent operational performance, we are prepared to adjust future operating plans to match available logistics and economically available fiber. We appreciate the resilience and dedication of our employees as we manage through these headwinds.
I will now turn it over to Pat to provide an overview of our financial results.
Pat Elliott
Thanks, Kevin, and good morning. The Canfor and Canfor Pulp quarterly results were released yesterday afternoon and come together with our overview slide presentation in the Investor Relations section of the respective company’s websites.
In my comments this morning, I’ll speak to quarterly financial highlights, a summary of which is included in our overview slide presentation. Our lumber business generated operating income of $102 million in the third quarter, which included a net duty recovery of $98 million and a $90 million inventory write-down related to logs in British Columbia. Results reflected a steady decline in global lumber prices throughout the quarter as well as the impact of significant operational downtime in Western Canada.
As Don mentioned, we continue to realize the benefit of our diversification strategy with our European operations contributing $57 million in cash earnings in the third quarter despite taking its traditional summer downtime. Looking ahead, we anticipate a more challenging fourth quarter, reflecting current lumber market conditions as well as the impact of downtime on unit manufacturing costs. While we expect BC stumpage rates to fall in the fourth quarter, it would likely take much of the quarter before we realize those lower prices into our results. Our Pulp business generated an operating income of $19 million in the third quarter, an improvement of $27 million quarter-over-quarter.
As Kevin mentioned, third quarter results benefited from significantly higher sales realizations and improved productivity offset in part by increased fiber costs. Despite significant challenges in recent quarters, Canfor Pulp has maintained its strong balance sheet and remain focused on improving productivity, closely managing inflationary cost pressures and optimizing the available transportation and economically available fiber. Capital expenditures were approximately $139 million in the third quarter, including approximately $29 million for Canfor Pulp. We project capital spend of approximately $450 million for our lumber business in 2022 and approximately $110 million for Canfor Pulp.
Looking ahead to 2023, we are currently forecasting a capital spend of approximately $500 million for our lumber business, including the remaining spend on our DeRidder greenfield sawmill, which is currently on track for completion in the first quarter of 2023. We also anticipate being modestly active on Canfor’s share buyback program in the fourth quarter. As Canfor Pulp continues their focus on asset reliability and productivity improvement, our expectation for capital spending in 2023 is $60 million to $80 million depending on market conditions.
And with that, Don, I’ll turn the call back over to you.
Don Kayne
Thanks, Pat. So operator, we’re now ready to take calls from questions – excuse me from analysts.
Question-and-Answer Session
Operator
Thank you. [Operator Instructions] Our first question comes from Mark Wilde of Bank of Montreal. Please go ahead.
Mark Wilde
Thanks. Good morning, Don, Kevin, Pat.
Don Kayne
Good morning.
Mark Wilde
First question I have, Don, if you could just give us a little more color on the European lumber situation because it sounds like you might be taking a little less downtime than you were pointing to a month or 2 ago?
Don Kayne
Yes, for sure, Mark, and that’s correct, first of all. And we anticipate initially that we would be taking a little more than we’ve had to. And – but we’ve been fortunate despite the challenges in our key market in the UK, we’ve been able to do a really good job. The guys are on the ground here have done a really good job along with our marketing group in Vancouver to move a lot of that volume quicker and more expeditiously than we would have thought to alternative markets. So we’ve been a real, real surprise, and that’s one of the reasons why we would have done that.
Mark Wilde
Okay. Is it possible, Don, to get some sense of how much price has moved in the European market? I know it moves differently than it does here in North America, but if we could just get some sense of price movement?
Don Kayne
Yes. Kevin, do you want to talk about that?
Kevin Edgson
Yes, for sure, Mark. I would say in that 10%, 12% range down is on quarter-over-quarter. There was a bit more pressure towards the end of Q3, but that’s in that range is sort of what we experienced.
Don Kayne
One thing, Mark, just to quickly add, in terms of our European business, and you’ve heard us speak about this before, but one of the reasons and I keep saying this, but we will say it again, one of the reasons why we focus heavily on Europe and we have for a while, there is a flexibility that it presents us, that you often don’t see that in other markets. So we really see that to move around as we seek to take advantage of market levels as we see fit, right? So it’s really – that part of our acquisitions really turn out as leases go better than we ever expected?
Mark Wilde
Yes. And just one more on your – what’s your expectation as we look into ‘23 in terms of European volume into the North American market? I mean demand is down in both markets, but the euro is quite weak now, which you might think would push a little more volume over toward North America.
Don Kayne
Yes. And I’ll let Kevin talk about that for sure. You can add on, Kevin. But I mean, yes, that’s clearly what we’re seeing, and that’s one of the alternatives that we – that’s really come – that is come about here over the last little while here. But yes, certainly, we see an increase in North America. To what degree? Actually, to a very good degree actually, and it’s going to help us a lot in North America with some of the BC shuts that we’ve been experiencing. Kevin, do you want to add more?
Kevin Edgson
Yes. Well, just what I’m hearing there too, Mark, is that underlying demand is pretty good. The big issue that they are dealing with over in Europe is really around energy and really how it’s going to play out over the next 6 to 8 months. And then I think if energy prices come down to a certain degree, then you could see potentially a pickup in some European demand. But short-term, for sure, I think you can expect to see increased volumes coming into North America and actually other markets as well.
Mark Wilde
Okay, alright. And then the other question I have is just on capital allocation and the share repurchase. If I go back to 2018, you bought a couple of million shares up at $28. And today the stock is $20 a share, you have got over $10 a share in net cash and $7 a share in deposits. It looks like a far better value than it was in ‘18. So, I am curious as to why we are not seeing a little more activity there? There was – didn’t look like there was anything in the third quarter?
Don Kayne
Pat, why don’t you talk to Mark a little bit about that and we can maybe talk about overall capital allocation and what we are thinking.
Pat Elliott
Yes. Sure, Mark. So, yes, I am not sure I can reconcile the math to 2018 directly. What I would say is we have kind of been thinking that there is a pullback coming, I don’t think that’s a big surprise. We have made some significant capital investments, three big projects, as Don mentioned in the U.S. South, that got the $500 million. And I just think we kind of took a little bit of pause and assessed how things are going to play out. We do have a very strong balance sheet, and we want to have a very strong balance sheet. But we also want to be able to build and diversify our business, either through organic growth or M&A. And frankly, I think arriving into a weak market with a balance sheet like we have is going to be a strategic advantage. So, we are always going to do this on a modest basis anyway and some of the background on that liquidity in our stock. So, as I said in my comments, I think we will be active again, but it will remain a modest part of our overall capital allocation.
Don Kayne
So, for sure, absolutely. And if you look at it overall that we do, and we have been feeling this way for a while now, probably a late half of the second quarter, the things are going to – the math is going taper it quite a bit due to affordability and probably carry on through the quarter of 2023. So, we try to be extremely disciplined here and call it conservative, whatever, a lot of patience around the fact that we do believe we are going to get opportunities here over the next 12 months to 18 months for a better value which we are assuming in the last 24 months.
Mark Wilde
Okay. And just one more, Pat, you mentioned that those log costs in BC take a while to work their way through your inventories. Can you give us just a little more color on that?
Pat Elliott
Yes. For sure, we basically Q3 and Q4 – Q3 log costs were up $35 – logs metered up and came down roughly about in Q4. And that lags probably two months to three months, something like that into Q1. So, we are going to probably drop in the order of $5 cubic meter, right. So, lags probably two months to three months, something like that, of course, because of not much of harvest. So, that’s our – would be our guess right now.
Mark Wilde
Okay. Alright. That’s helpful. I will turn it over.
Operator
Thank you. The next question comes from Paul Quinn, RBC. Please go ahead.
Paul Quinn
Yes. Thanks very much. Good morning guys.
Pat Elliott
Hi Paul.
Paul Quinn
Just trying to understand this European dynamic with lumber prices and log prices. So, what I have seen it in the past was if lumber prices come down, log prices are coming down as well. So, that margin sort of sees a little bit more stable than what you typically experienced in North America. Is that the case right now?
Pat Elliott
Yes. I think for the most part, I mean we all try to compare it a little bit to the Western Canadian and so in other parts as well. Certainly, European log prices are up, but they are being definitely manageable for sure. And most of that increase is due to some of the pressure around the pulp and energy primarily, and which is really, obviously, as you have – we have seen significant increases in energy costs, particularly in Europe, all across Europe. So – but again, it’s – obviously, it’s a bit of – more of a change there in the past, but it’s still definitely manageable not anywhere near like it is here in North America.
Paul Quinn
Okay. And then maybe over on Canfor Pulp side, just the BC log supply continues to decline. Just wondering when you look at future chip availability for the Canfor Pulp mills, does that equate to all the existing mills that you are offering right now or is it more prudent to take one mill out of the quiver as opposed to taking some rotating downtime because of the lack of chip?
Kevin Edgson
Thank you for the question, Paul. I think we all can recognize the fact that there have been both indefinite and permanent curtailment within BC on the sawmilling side. There have been a number of pulp assets that have likewise been either curtailed permanently or indefinitely. It would be my opinion that for the industry it’s not yet done. As to where we fit will be a function of how well our assets run and what the fiber supply is in our region versus other regions within BC.
Paul Quinn
Okay. And then just maybe on a – I think it’s strategic here. There is a couple of pulp mills that are available in Eastern Canada. Is that something that you guys would be interested in growing that pulp business on the Canfor Pulp side?
Kevin Edgson
Well, I think today, our primary focus is ensuring that the assets we have are well capitalized and running well before we start looking at expansion. And so at this point, I don’t think that that’s really a key focus for us.
Paul Quinn
Alright. That’s all I have. Best of luck.
Pat Elliott
Thanks Paul.
Operator
Thank you. There are no further questions. I will turn the call over to Don Kayne for closing comments. Go ahead, sir.
End of Q&A
Don Kayne
Alright. Thanks operator and thanks everyone for joining the call, and we look forward to talking to you as the year progresses here. Thanks.
Operator
This does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.
Be the first to comment