Conifex Timber Inc. (OTCPK:CFXTF) Q2 2022 Results Conference Call August 9, 2022 5:00 PM ET
Company Participants
Ken Shields – Chairman, President and Chief Executive Officer
Winny Tang – Chief Financial Officer
Conference Call Participants
Hamir Patel – CIBC
Paul Quinn – RBC
Operator
Good afternoon, ladies and gentlemen. Welcome to the Conifex Timber Inc. Q2 2022 Results Conference Call. I would now like to turn the meeting over to Mr. Ken Shields. Please go ahead.
Ken Shields
Well, thank you, Oscar, and good afternoon, everyone, and welcome to this call covering our second quarter 2022 results. Our CFO, Winny Tang, is here with me today and available to respond to questions that any of you may have following my prepared remarks.
Quickly dealing with a housekeeping item. We will be making forward-looking statements and references to non-IFRS measures and therefore call your attention to the complete warning statements that are set out on Pages 1 and 2 of our MD&A dated August 9 that we released earlier today.
Our second quarter results were consistent with the guidance we provided on our last call when we indicated that the 30% sequential quarterly increase in lumber shipments we were targeting would offset the effect of lower price realizations. We didn’t expect Canadian dollar benchmark prices to decline by as much as 35%, but it did. And we are therefore pleased that our Q2 net earnings did come in at $12.3 million, equivalent to $0.31 per share, which, of course, is $0.03 per share higher than the $0.28 we reported in Q1. On 20% higher revenue of $85 million, we matched our Q1 EBITDA of $20.1 million.
The first half 2022 operating income of $34.7 million that we reported is after expensing $12.2 million in duty deposits, which is equivalent to $125 per thousand board feet of lumber we produced and shipped in the 6-month period. These duties caused our operating income per thousand board feet of lumber produced and shipped to come in below the levels reported by the 2 largest lumber producers in Canada, even though our operating income before duties was in line with the per unit operating income the 2 industry leaders reported for the opening 6 months of 2022.
Putting this another way, duty deposits represented 35% of our operating income in the first half of 2022, compared to somewhere between 2% and 6% for Canada’s 2 largest public lumber producers. Naturally, we’re pleased that the duty deposit rates were just reduced from 17.9% to 8.6%, and we expect a further reduction 1 year from now. Since our operating income has been held back by duty impositions more than has been the case for any other public company, it follows that our operating income would be expected to recover by more when duty rates are further reduced or eventually eliminated. These lower duty rates will help us report operating income per thousand board feet of lumber produced and shipped more in line with the leading public lumber producers.
On June 30, our potentially refundable duties on deposit amounted to USD 29.1 million or around CAD 0.92 per share, before allowing for any holdbacks and income taxes. While we appreciate that the likelihood and timing of a full or partial refund is highly uncertain, clearly, our finances will be materially strengthened when the trade dispute is eventually settled and the cash refunds that we expect show up in our bank account. We are not aware of any other publicly traded lumber producer where potential duty refunds represent an equally high portion of their equity market capitalization as is true for our company.
Looking ahead to our Q3 results. They will be largely shaped by lower lumber prices, the delayed restart of our power plant and by some minor sawmill downtime necessitated as a result of our successful installation of new log scanning and positioning technology to improve lumber recovery at our Mackenzie site. Through the first 5 weeks of the third quarter, our average lumber sales known at price realization are roughly 35% to 40% lower than our second quarter average.
Our MD&A discloses that we have approximately $100 million invested in our power plant, and this represents 2/3 of our total investment in long-term assets. With the power plant temporarily idling, the result in EBITDA drag is expected to offset much of the EBITDA we expect to earn from our lumber operations. When we report our Q3 results in early November, it is likely that we will not be sufficiently advanced on our insurance claims to record any business interruption insurance proceeds. However, we expect to book some insurance proceeds during the closing quarter of 2022. Without insurance recoveries, we expect our consolidated Q3 EBITDA will be materially lower than in Q2, but we still expect it to remain positive.
I’d like to spend the next 10 minutes or so describing our journey to develop what we hope proves to be the most economically viable and environmentally sustainable integrated softwood lumber processing site in the interior region of BC. We should start with the updated information we received about future sawlog availability and quality in our supply region and why we expect improved operating performance and cash flow generation in 2023 and beyond.
On July 15, the Ministry of Forest released its long-awaited public discussion paper, setting out its estimates of the maximum volume of timber available for harvesting in the Mackenzie timber supply area, which they express as cubic meters of wood on an annual basis. Key information on this topic can be found on pages — on Page 2 of our Q2 MD&A and on Slide 7, 8 and 9 in the deck we distributed a short while ago. At present, our Mackenzie sawmill complex is the only sawlog processing facility operating in the Mackenzie timber supply area.
Our facility has an annual 2-shift capacity of approximately 240 million board feet. A general rule of thumb that I use is that about 3.5 cubic meters of sawlogs are required to produce 1,000 board feet of lumber. On this basis, it follows that we require an annual harvest of approximately 860,000 cubic meters of sawlogs to support full capacity at our sawmill. This is represented by the red line covering the 2022 to 2030 time frame set out on Slide 9.
The ministry disclosed that it established a base case indicating that the Mackenzie TSA can sustain a sawlog harvest of over 2.5 million cubic meters annually for 10 years before stepping down by 10% to 15% or so. The ministry’s base case sawlog availability projections are represented by the green bars on Slide 9. The key point here is that the ministry’s calculations indicate that the sustainable harvest in our viable catchment area can support roughly 3x our annual sawlog returns.
Most timber supply areas in the interior region of BC has 2-level supply relative to the installed lumber capacity, which exposes those operators to the risk associated with a heavy reliance on open market log purchases. We believe we can operate our sawmill at full capacity when other mills in the interior region of BC will likely be forced to eliminate shifts due to fiber supply shortage.
Since we’ve discussed fiber availability, let’s quickly review fiber quality. On our previous calls with you, we discussed how over the past several years we were forced to direct most of our annual harvest to beetle-killed trees and reserved the green timber for harvesting once the beetle-salvaged phase ended. Since the economic value of beetle-damaged timber deteriorates each and every year after they’re cut, our operating performance and financial results over the past few years have been adversely affected. The harvest level projections the ministry released last month indicated that beetle-killed timber is forecast to account for between 0% and an outside chance of a maximum of 10% of the harvest established for the Mackenzie TSA. We expect the Chief Forester to release his decision on the new AAC for the Mackenzie TSA prior to the end of 2022.
Our first half 2022 results reflect the benefits of a minor shift over to green stems, and we expect materially greater benefits when we fully transition to a green log diet in 2023. A green log diet reduces harvesting cost, sawmill conversion costs, it improves lumber recovery and provides us richer lumber grade outturns, and it also boosts average lumber selling price realizations and EBITDA per thousand board feet of lumber produced and sold. All these benefits are expected to combine and move us to a lower and much more enviable ranking on the lumber industry cost curve.
I’d now like to review another component of the opportunity we perceive to be available to us to develop and operate the most economically viable and an environmentally sustainable softwood lumber processing site in the interior BC. Over the past decade, at Conifex, we’ve gained considerable knowledge and expertise from successfully developing and building our power generation cash flow stream, operating our plant 24 hours a day for up to 365 days each year and producing something like $1 million on average in monthly EBITDA. This power sector knowledge and expertise provides us a launch pad to develop additional complementary cash flow. The potential opportunity we are exploring is described on Page 3 of our MD&A.
We’re examining the feasibility of developing data center hosting activities in Northern BC to consume surplus power that BC Hydro expects to have available in our region through 2030 and beyond. We’re pursuing this opportunity in partnership with the Tsay Keh Dene First Nations. Our partnership commenced hosting an initial 1.5 megawatts of capacity last December on a trial basis, and a second trial of 1.5 megawatts began in March of this year. The results from the 3-megawatt trial have been encouraging, and we gained valuable experience about the core competencies necessary to successfully host high-performance computing operations under a variety of climatic and operating conditions.
Besides generating positive net income and validating our belief that our power and corporate services teams have the expertise to successfully service HPC customers, the trial provided the input we required in order to assess the merits of standing up our hosting services over the next few years. The partnership is now investigating the feasibility of building out a hosting business at other potential sites in Northern BC.
The intention is for the partnership to expand its hosting business in phases, utilizing cash flow generated from the initial phases to fund the development of subsequent phases. We look forward to providing further details about our progress on this potential initiative in the third quarter of 2022 earnings release. However, at this time, there’s no assurance that the partnership will definitively establish a data center hosting business.
Turning to our balance sheet. Overall debt was $57.5 million at the end of Q2, mainly represented by our long-term power loan. No amounts were drawn against our secured revolving credit facility. After deducting cash balances, we ended Q2 with net debt of approximately $10 million and a modest net debt-to-capitalization ratio of roughly 6%. This solid financial position enables us to endure a lengthy period of low lumber prices in the event this should occur.
At our meeting earlier today, our Board of Directors instructed management and legal counsel to work to obtain regulatory approval to reinstate a normal course issuer bid entitling us to repurchase and cancel approximately 10% of our public float over a 12-month period, likely commencing around September 1 of this year. We note that our shares trade at a much steeper 50% discount to net book value per share compared to the other public lumber companies.
We understand that if investors expect the company will likely generate lower returns on shareholder investment, we understand the shares will trade at a lower multiple of book value per share, but we believe our return on shareholder investment will increase to levels common in our industry as we move to a greener log diet and as export duties are reduced or eliminated. Our intention to reinstate a normal course issuer bid is underpinned by our belief that the trading price of our shares reflects absolutely 0 value for our [Mackenzie] sawmill complex.
As of June 30, after giving effect to the payment of the special dividend, we had about $0.80 per share of unrestricted cash. Our noncash working capital, namely inventories and receivables plus payables, amounted to $0.85 per share. On top of this, cash and net cash subtotal of $1.65 per share, we believe that the equity in our power plant is worth at least $1 per ton of ex share. It follows that since these add up to well more than our recent trading price, no value is presently accorded to our Mackenzie sawmill complex.
Before signing off on this call, our Board of Directors and leadership team asked me to reemphasize that our number one priority continues to be protecting the health and safety of employees and their family. The men and women at our harvesting sites, sawmill complex and power plants deserve the credit for ensuring a safe work environment while we successfully work through the numerous challenges we face.
In closing, we believe Conifex is well positioned with an excellent safety culture, a high degree of fiber self-sufficiency, near-term opportunities to improve fiber quality and product mix. We also have industry-leading power generation assets and a strong balance sheet.
We thank you for taking the time today to learn more about our company. We would be pleased to respond to any questions analysts or shareholders may have. And I’ll now turn the meeting back to the operator.
Question-and-Answer Session
Operator
[Operator Instructions] And the first question is from Hamir Patel.
Hamir Patel
Ken, I kind of — first, I want to ask you about in terms of market conditions. I was curious, what are you seeing in offshore markets? We’re hearing more reports of excess inventories in both China and Japan. So how do you see your geographic mix of business evolving in H2?
Ken Shields
Okay. Well, first of all, we sell very nominal amounts to China, virtually 0, although we suspect some of the deliveries that we make to Canadian customers reexported to China. Our Japan business, we’ve got a couple of really key customers there, and it’s been a pretty steady and financially rewarding business for us. But Hamir, the real impact of less lumber going to the Pacific Rim markets is that when a railcar in the old days was floated up in Prince George, say, and shipped to Vancouver and unloaded to be shipped over to Asia, that railcar returned to Prince George, say, 5 or 6 days later after shipment.
But with the drying up of those Asian markets, the railcars are going a lot further into the U.S., and they’re taking a lot longer to get back to Canada. So what we have experienced is that this shift in market destinations has resulted in longer cycle times for railcars and it’s creating the low shipment to production ratio that has taken place in BC for some months now. And it, of course, has triggered some of the shift curtailments that certain of our competitors have elected to take in the last little while.
Hamir Patel
And I know Conifex in the past has made use of lumber futures. I was just curious, given the changes that are, I guess, recently implemented on lumber futures, do you expect to increase your use of futures going forward?
Ken Shields
Well, Hamir, we had a very interesting discussion about that at our Board dinner last night. And I’d summarize it by saying that the new future contract probably on balance will be a deeper, more active market. But in terms of our position as a commodity lumber producer, we’re not sure that it will have any impact on our decision to use futures to hedge lumber prices. We haven’t been in the future markets for several months and have no present intention of reentering it.
Operator
And the next question is from Paul Quinn, RBC.
Paul Quinn
Just maybe start on softwood lumber because you brought it up, Ken. Any movement that you’ve seen on that file at all? I mean it doesn’t sound like it from talking to the rest of the guys, but you might have different contacts on the U.S. side.
Ken Shields
No, we have no individual information that is more encouraging than you’re hearing from everyone else.
Paul Quinn
Okay. And then it looked like — obviously, lumber prices started correcting in March and came down to a pretty low level and bounced up when stumpage came up in BC, and it seems to be sort of tracking that. What’s your expectation in October for stumpage? And do you expect lumber prices to fall off going through ’23 as well?
Ken Shields
Well, Paul, we are in a pretty unique geographic area, so we know a lot about stumpage in the area. I’ve heard that the June 30 stumpage rates are going to be high in the — in most interior BC TSAs and lower in Q4, but our view is that all the study and analysis we did indicates that sawlog availability is very constrained here in BC. And we don’t believe this industry has the sawlog availability to get anywhere near historical deliveries and production. And so we think the supply/demand balance is such that lumber markets are unlikely to be heavily oversupplied in the face of falling demand.
I guess the real question, Paul, is, what are the incremental cash cost of producing lumber in BC? And our assessment is that we can’t quarrel with some of the statements that people such as yourself and others on the line that have made that it’s around USD 600 to maybe as much as USD 650. But clearly, we think lumber prices will be probably slightly below that range in Q3, and we expect to have positive lumber EBITDA. So our best guess is that our anticipated cash costs would enable us to generate positive EBITDA even if prices are below USD 600.
Paul Quinn
Okay. That’s helpful. And any update on what the process is on Canfor selling their sawmill site and the plans on the new company buying.
Ken Shields
No. The understanding we have is that Canfor tenures are being sold to 2 First Nations entities. We also are not sure whether the Bill 22 approval process will be launched immediately. I know that Canfor and the purchasers has filed certain material, but I’m not aware of any ministry actions to solicit stakeholder feedback on the transaction. And so I’m not sure when that’s to close, but we have 3 potentially needle-moving announcements coming from the Mackenzie TSAs. One is the harvest level determination, which I said earlier we expect before the end of the year. And we think that the Bill 22 approval will happen shortly thereafter.
But once that happened, it will be quite a while before the apportionment decision is made, and that apportionment refers to how the ministry allocates the harvest areas for various licensees with the objective of being sure that every license has comparable log quality and operating conditions and year-round accessibility of the fiber. So that’s going to take — that third process is going to take quite a while. And it will be well into 2023, in my opinion, before we’re able to get through all of those topics.
Operator
[Operator Instructions] We have no further questions at this time. I would now like to turn the meeting back to Mr. Ken Shields. Please go ahead.
Ken Shields
Okay. Well, thank you all for listening in on our call today. As you can probably tell, we think that fiber availability is taking a turn for the better for us. And we are very pleased with our ability to move the Conifex sawmill complex to a much lower ranking on the lumber industry cost curve. So we’ll keep you posted as to how well we do. Thank you, and enjoy the rest of your day.
Be the first to comment