PotlatchDeltic Corporation (PCH) Q3 2022 Earnings Call Transcript

Operator

[Operator Instructions] Your first question comes from the line of Mark Weintraub with Seaport Global.

Mark Weintraub

As you’re thinking about capital deployment, so you talked about you’re going to have a special dividend. You talked about an appetite for share repurchase with the stock where it’s at. You’ve done a number of acquisitions. Are you still on the lookout? Is that still part of likely capital deployment in the next six, 12 months? And then tying it all together, what type of balance sheet or other metrics should we focus on in understanding what your comfortability and target type ranges are?

Eric Cremers

So, Mark, this is Eric. Yeah, our appetite is — we want to continue to try to grow the company through timberland acquisitions. And you’re right we’ve been successful this year, not just with CatchMark, but also with 46,000 acres and $101 million or so that we spent on the bolt-ons. What I’d tell you is that the timberland market is getting in our opinion a little bit overheated. For example, we competed here recently in two different tracks. We lost these deals. One of them was attracted in Georgia. We went to nearly 22.5 times EBITDDA. And the other one was in Alabama. We lost this one as well. We went to 23.5 times EBITDDA. Both those transactions we went to the low end of our discount rate range. We lost both of them. And we were told we were in the middle of the pack of bidders. So that means people are paying north of 22, 23, 24 times EBITDDA for timberland. And that’s the max that we’re going to go, given our current discount rate range.

So while we like to continue to grow and we will continue to compete and we’ll try to take down timberland M&A because we think it’s a very attractive asset class. There is a point at which it no longer creates shareholder value. And so in our mind, we’re going to have to pivot here — with our strong balance sheet, with our cash that we have on the balance sheet we’re going to have to pivot into other capital allocation priorities. And coincidentally, our average analyst estimated NAV is up around $63 a share. And as we sit here today, we’re at I don’t know $44 a share. We’re trading dramatically below what people believe our NAV is. And so it seems to us like it presents just a fantastic time.

We — honestly, we’ve been waiting for this opportunity to step in and buy shares for some time. We’ve said all along we want to buy stock when it’s depressed, not when it’s at fair value. And well guess what? Today it’s depressed and it’s time for us to step in and put our money where our mouth is. And that’s going to start happening about a week from today. So I’m going to let Jerry answer the second question on balance sheet. But does that answer your question on the first half?

Mark Weintraub

Yes, that’s super. Thank you.

Jerry Richards

Yes. So Mark, picking up on the kind of the balance sheet part of that question, I would say overall really no shift or change given our posture and our metrics in terms of how we manage that balance sheet. I mean at a high level, having strength and flexibility has served us well in the past and we plan to maintain that going forward.

And as a reminder, our EBITDDA leverage, which is a key metric that we monitor and talk to our credit rating agencies with, is EBITDDA leverage and we continue to expect to maintain that in the 3.5 to 4 times range. Today, we find ourselves under one. So, a lot of flexibility there.

But the long-term goal through a cycle, which I should emphasize here, really remains in that 3.5 to 4 times range. And we like to have a bit of cash, again to be opportunistic and have some flexibility. In the past, we’ve talked about having a minimum of $100 million of cash — on the balance sheet. So, no change there.

Mark Weintraub

Okay, super. That’s very helpful. And obviously, when you’re talking about 3.5 to 4 times, that’s kind of over the cycle. So, we can’t necessarily look at the current EBITDA, which is presumably — you have been at extremely high level. So, you’re presumably using different numbers internally when you think about what that translates into in terms of a gross number. Is that fair?

Jerry Richards

That is spot on Mark. We — when I look at that 3.5 to 4 times target, we’re really modeling and stress testing a low point in the cycle kind of perspective, because we want to maintain debt levels kind of under that range even at a low point.

Mark Weintraub

Okay. Thank you.

Operator

Your next question comes from the line of Kurt Yinger with D.A. Davidson.

Kurt Yinger

Great. Thanks, and good morning, everyone.

Jerry Richards

Good morning.

Kurt Yinger

Just wanted to start out on the special dividend. And Eric, you touched on it a bit in the prepared remarks, but I mean with three quarters in the books and some stability here in the lumber markets, is there any way you could maybe help us quantify a range of what that might look like, as well as how you’re thinking about any discretionary component versus share repurchases or other capital deployment opportunities?

Jerry Richards

Yes. So, I’ll actually take that one Kurt. This is Jerry. In terms of stepping back, as a reminder for the group we mentioned this in the prepared comments, but we paid a $4 per share special dividend last year. And I think we’ve had a position — at least the last couple of quarters, it feels like where we said, this year’s special dividend is going to be significantly lower.

And there’s a number of factors that play in. And first and foremost, it’s really important. I think we must have mentioned between Eric and I four times in the prepared comments, the priority that share repurchases and the attractiveness of share repurchases at the current discount that we trade.

And deviating a little bit here, and I’ll get back to the point of the question, we just put a new $200 million share repurchase authorization in place. Our window reopens November 1. So, to the degree we can shift capital to share repurchases from a special to the degree we have that discretion. That makes all the sense in the world to us again given the discount that we trade at today.

When you go back to that $4 per share special dividend that we paid in December of 2021, I mentioned this on last quarter’s call, but there is a 40% discretionary component to that. I mean overall, the special dividend is primarily to protect our REIT status by kind of purging excess cash from the taxable REIT subsidiary, but we also included a 40% discretionary component on top. And as a reminder, we’re trading around $60 a share last year versus the $44 that Eric talks about today. So, clearly that capital allocation set of priorities have shifted.

And when you think about other moving parts, Idaho sawlog prices, when you step back for the full year, probably down about 30% year-over-year so that’s going to reduce kind of the amount that’s needed for a special dividend. Lumber prices are down as well. Again, that really goes into the amount of cash that we have to purge out that taxable REIT subsidiary. And we’ve also grown the regular dividend.

Payout, for example, just with the shares we issued in the CatchMark merger, is up $20 million year-over-year and that effectively shifts — potentially would have been special dividend dollars over into the regular dividend bucket.

So, for all those reasons, it’s hard to pin down the number exactly this year. We’ll sit down with the Board in early December when we review it. But it feels like, it’s probably in the $1 per share range, maybe just a bit under $1 per share just to give some benchmarks.

Kurt Yinger

Got it. Okay. That’s all very helpful. And then, I guess, in terms of northern sawlog prices for the — Waldo project you’ve used $500 and we’re about there now. So we will just use that. But I mean there’s some variability with the timing of indexing and log density. But I guess, if you were to kind of use that $500 per thousand assumption. Is something in the $130 a ton ZIP code for Northern sawlogs, kind of, a reasonable starting point?

Jerald Richards

Yes. And I guess to clarify Kurt, I’m assuming you’re talking 2023 in its entirety and if that’s the case that is a reasonable proxy.

Kurt Yinger

Okay. Got it. And then lastly, log costs were a slight sequential benefit in Wood Products in Q3, but maybe a bit less than I expected given the decline in your own Idaho realizations. Is that just a timing factor around when inventories were built at the mill? And any thoughts around the benefits on the wood product side from at least the lower sawlog costs in Idaho in Q4 and maybe even the early part of next year?

A – Jerry Richards

Yes. I would say, Kurt the premise behind your question is spot on. It’s really all about timing. And when you think about it there’s seasonality around the log deck and when it gets built and when it gets torn down. And a lot of the high-priced logs that the mill has been — the complex has been processing even in the third quarter really purchased earlier in the year when lumber prices and index log prices were much higher certainly a bit of relief.

As that averaging kind of takes place and the log deck is kind of torn down. We’ll start building that log deck in preparation for spring break up here. In fact that’s already in the works and well down the road. So you’re averaging lower-priced logs into that log deck. So expectation is you’ll see a little bit more price relief from a log cost standpoint in Idaho in Q4 and then you’ll probably get to a new run rate as you think about your model as you move into 2023.

Kurt Yinger

Got it. That’s superful helpful. Appreciate the color and I’ll turn it over. Thank you.

Jerry Richards

Thanks.

Operator

Your next question comes from the line of George Staphos with Bank of America Securities.

George Staphos

Thanks very much. Hi, Jerry. Hi, Eric. How are you? Good quarters here. Quick question for you on Northern harvest and contractor availability what are your plans? How do you expect to be able to get more contractors and more production in the fourth quarter? If you could give a bit more color that would be great.

Jerry Richards

You bet. It feels — so this is Jerry, George. It feels a lot like what we experienced in the South a year or two ago when we had contract availability issues. And really starts with — there isn’t really much in the way of surge capacity when you think about log-in haul contractors. I mean over time hear about tight labor markets and it also feels like there’s been a bit of migration as the contractor workforce ages out.

So I think there’s a challenge in, kind of, replenishing the folks that are working in that space. So you start with a pretty tight surge capacity. Our team does a really good job over time managing in that tight environment. But when you layer on top of it things like equipment breakdowns the contractors have and then all of a sudden supply-chain issues and getting critical spare parts and delays it starts to have a kind of a ripple effect.

And then once you get behind without that surge capacity it’s really hard and quite frankly it’s impossible to get caught up. So that’s a bit of what the team was wrestling and came to the forefront in Q3.

Now in terms of what do you do to manage through that as a large player in Idaho that certainly helps because we have deep and long-term relationships with some good quality contractors. So just really effectively managing and leveraging those relationships to make sure we get the, kind of, the focus that we need and when I think about just in terms of some color on where do we think we’ll land in the harvest in Idaho for the year?

We’re about 200000 tons short against our plan year-to-date in the end of Q3 the team — if things weather holds and having said that it’s got a little wet here so it either needs to dry out or freeze up. I can’t be in this middle ground. But if weather holds, we’d probably make up about half of that shortfall and end up about 100,000 tons short. Now flip side is we’re obviously running well ahead in the South. So overall from a harvest volume standpoint we’re actually up versus what we had expected at the start of the year.

George Staphos

But aside from leveraging your relationships, I mean, does it mean that the incremental margin on those harvests when they do come in on the production would be maybe a little bit lower in terms of other incentives that you might be even to offer to more availabilities? I wouldn’t imagine there’s much but is there any sort of capital involved in doing that as well, just a couple of quick thoughts on that, as well.

Jerry Richards

So in terms of cost, I mean the big story when you think about log & haul costs this year is really diesel. You step back certainly our log & haul rates are up. But that probably explains something on the order of 75% 80% of the increase in cost.

Now, having said that, there’s fairness in the premise of your question which is that rates have gone up as well because of tightness and that’s true both in the South and in the North.

Eric Cremers

And what I would just add George is when you look at the fourth quarter we’re targeting 450,000 to 500,000 tons of sawlogs more or less and maybe a little bit of pulpwood. All we really need to do in Q4 is to do what we did in Q3.

And Q3 was a challenge for us, no doubt. But we still got nearly 500,000 tons in Q3. So all we got to do in Q4 is, do the same thing. It’s just that we typically build our log decks earlier in the year. We typically build them in Q3. And this year some of that slipped into Q4.

George Staphos

No that’s great. Eric, that makes sense. One sort of quick question kind of a bigger picture one though. So we tend to think about the fourth quartile, being roughly $500,000 per board feet — $500 per thousand board feet on the — and we tend to look at British Columbia as kind of setting that point.

How do you expect the fourth quartile to evolve over the next year or so recognizing it’s hard to project that? Do you think it declined cyclically? Do you think it hangs in at that level and why? And then, on repair and remodel, we understand given all your sources that you expect that that will remain pretty stout into 2023 and 2024.

But intuitively shouldn’t we expect repair and remodel to drop a bit with housing starts and so much a repair and remodel comes from the activity that happens once somebody — I shouldn’t say housing starts but home purchases after the person buys a home and starts remodeling it in that first year. Thanks guys and good luck in the quarter.

Eric Cremers

Yeah. Thanks George. So your question on fourth quartile kind of the cost curve if you will, how is it going to evolve over the next year or two. I frankly don’t think it’s going to change a whole lot. We know where there are structural issues with lumber in North America from a cost standpoint.

And that’s British Columbia and increasingly the Pacific Northwest. The harvest volumes are coming down over on the West side roughly 10% over the next couple of years. It’s not just British Columbia. So frankly it’s going to stress mills for sure. And you’re seeing some curtailments right now up in BC in particular.

But it’s not — all these mill closures are not going to happen overnight. If you ask me 10 years from now where do I think the cost curve is going to be? It will be maybe $450 not $500 for that fourth quartile segment.

But in the next year or two, I think it stays up in that $500 zip code. People are — nobody likes to close sawmill and let employees go. And it disrupts residual streams and that has implications for pulp mills and pulp mills and lots of things. So I don’t think the roster changes materially over the next year or two.

Now with regard to repair and remodel, yeah, sure, you’re right. As new home sales come down that is going to have a tendency. That effect alone will tend to push down R&R. But I think more R&R expenditures are for when somebody buys an existing house or is living in a house that they kind of feel trapped in for a lack of a better word because they can’t afford to move into a new house.

I don’t think people typically go buy a new house and then say, oh, let’s remodel this brand-new house that we just bought. I think it tends to be more, older more existing kind of houses if you will.

So yeah, there’s no doubt. On the one hand fewer new home sales will put some downward pressure on R&R spending. But I think all the other factors that we laid out between record home equity levels, strong job market, consumer balance sheets are in great shape. I think all those factors outweigh the fact that new residential starts are going to be coming down.

George Staphos

Yeah. And I really meant to say existing home sales, trending lower having more of an effect on repair and remodel. But your point is about feeling trapped the age of the home stock …

Eric Cremers

Yeah.

George Staphos

…and so on is important as well. I’ll turn it over. Thank you, guys.

Eric Cremers

Great. Thanks, George.

Operator

Your next question comes from the line of Ketan Mamtora with BMO Capital Markets. …

Ketan Mamtora

Thank you. Eric, can you talk a little bit about, channel inventories on the lumber side, both in Retail as well as on the Pro side?

Eric Cremers

Yes, I can talk about them in general, Ketan. We don’t really track them closely. Once they leave our mills and they go to customers, it’s just anecdotal evidence that we pick up from talking to folks. And our understanding is that they’re at really low levels. And the home center takeaway, it’s at or above pre-pandemic levels. So our home center business is rock solid right now. And our sense is that most of that uptick that strength, if you will, is coming from the pro-contractor side as opposed to the DIY side. But our view is that inventories throughout the channels are relatively low, and especially in R&R demand remains very strong.

Ketan Mamtora

Got it. That’s helpful. And then, maybe switching to the real estate side, Eric can you talk about the opportunity that you have on the CatchMark portfolio, in terms of alternative streams of revenue? If you can touch on — touch upon solar that would be helpful as well.

Jerry Richards

You bet. So, I’ll take that one Ketan. This is Jerry. In terms of CatchMark real estate opportunities, that’s one of many reasons why we’re really excited about having completed this deal. As we laid out in our kind of announcement slides back in May, a lot of CatchMark’s land is proximate to some large population centers and that’s different than what we’ve had in our rest of our southern acres in our legacy holdings. So, that by itself, we think, creates a lot of opportunities. The other trend we’ve seen — and we closed, to our knowledge is the first solar deal earlier this year and the first quarter and that was very attractive. Certainly, we see those kinds of opportunities in CatchMark’s footprint as well.

And the other thing I will share is, once we close the deal, we did the same thing with Deltic, we did the same thing with Luter [ph], which we close last December. As we go through and we actually take our teams, our expertise and knowledge, and we go through it and we stratify every one of those acres. And that process is underway. It will take our team probably six to nine months to really kind of go through the whole portfolio.

It doesn’t mean that we’re not going to sell real estate off a CatchMark land before then. We will. In fact, we expect probably just under 1,000 acres in the fourth quarter, for example, here. But that’s where we’re really kind of surface and start to gauge what is the magnitude of that opportunity above and beyond what CatchMark was doing historically? So, stay tuned. We’ll come back and provide an update as we complete that stratification process.

Ketan Mamtora

Okay. That’s helpful. And then just one other question. What is the right way to think about sustainable harvest with CatchMark sort of completion, and if you can break that between the North and the South?

Jerry Richards

Yes. So in terms of sustainable harvest, I mean one — I mean obviously, we’ve got a lot of moving parts this year with the $101 million of bolt-on timberland transactions. We’ve got CatchMark in the midst. And we’re also in the throes of our budget process. And as part of that we go back and we recalibrate our harvest plans going forward long-term not just for next year.

So, if I were to step back, and we’ll provide guidance once we finish that process here when we release fourth quarter earnings. But give or take, it’s probably around 8 million tons. Again, the actual number will depend upon probably a bit above 8 million tons, but it will be — we’ll come back with that information. And then, you’ve seen the historical run rate in Idaho. We haven’t added or subtracted from Idaho, so a delta is going to be in the South.

Ketan Mamtora

Got it, and that’s helpful. I’ll turn it over. Good luck.

Jerry Richards

Thanks.

Eric Cremers

Thanks.

Operator

Your next question comes from the line of Mike Roxland with Truist Securities.

Mike Roxland

Thanks, Eric, Jerry appreciate you taking the questions. First question, just was on CatchMark. Now that you’ve had some time to digest the acquisition, is there anything that you were not expecting going into the transaction? Just from my background with the industry and certain interactions with the company, CatchMark has historically been, I think somewhat aggressive with their harnessing level.

So I’m wondering if there’s anything that as you’ve had time to look through and look at things more carefully, whether things really did haven’t worked out. And it could be just maybe one or two things that are off a little bit, but is there anything that you weren’t expecting, now that you’ve closed the transaction?

Eric Cremers

Mike, I would — I don’t — I would say, no, to be honest with you like we mentioned in our prepared remarks, the harvest volumes are coming in spot on. And we talked about this when we announced the merger, we’ll be in this 1.6 million 1.8 million tons for the next, who knows eight nine years. It will dip 100,000 tons or so as you get out into the future, for a couple of years and then it comes right back.

So we’re not disappointed with the timber inventory. Pricing has met our expectations. It’s kind of hit our merger model, if you will. And frankly, for the next three to four years as I recall, we really don’t have much pricing increase in CatchMark’s markets. The only real surprise, I would say is — and Jerry talked about, this is our refinance opportunities have only gone up compared to where they were before. So I would say, no, their assets are good.

We’ll see how the real estate stratification plays out. But I’ve got to believe with CatchMark’s ground being closer to major metropolitan kind of urban areas Atlanta, Colombia whatnot, I would have to believe the real estate opportunity is going to be better than what we initially thought too, but we got to give the real estate team time to go through their stratification. But, no, we’ve been very pleasantly surprised so far.

Mike Roxland

Got you. And just last question is on lumber order price [ph]. I think last quarter you mentioned new restructuring at a couple of weeks. Have they shorted it at all just given what’s happened in [indiscernible]?

Eric Cremers

No. They really haven’t, Mike. They’re still in the one- to two-week kind of ZIP code kind of at the traditional levels. And I think it goes back to what I said before. Yes, sure housing starts are under pressure. We all get that. Affordability is an issue. But the R&R side of the equation, we think is hanging in there just fine. So I think those two may be are canceling each other out.

Mike Roxland

Got it. Thanks very much.

Eric Cremers

Thanks,

Operator

Your next question comes from the line of Paul Quinn with RBC Capital Markets.

Paul Quinn

Yes, thanks for that. Good morning, guys.

Eric Cremers

Good morning.

Paul Quinn

Just a question on timberland markets. It sounds like you lost a couple of deals, and it seems like I’m seeing timberland prices remaining strong despite rising interest rates and therefore, discount rates why is that?

Eric Cremers

Paul, I think people love the timber asset class number one, this notion that it’s a hedge against inflation, scarce resource. I honestly think, carbon is starting to get priced into some of these valuation models. We haven’t explicitly priced it into our model, yet. But I’ll tell you, we are working on some carbon projects. So I would not be surprised, if at some point in time in the future, there’s a line item in our cash flow statement that says carbon.

I think the other thing, is kind of interesting is that, non-traditional buyers increasingly are showing up to bid on these tracks. And I’m referring to Apple. I’m referring to IKEA. IKEA now has — this is a furniture retailer IKEA, now has I don’t know nearly 150,000 acres of Southern Timberland. So I think the asset class is increasingly attractive, not just from carbon but also these other nontraditional buyers. And it’s putting — and one also you look at what’s happening up in BC and the Pacific Northwest with harvests coming down, the action is in the South and that’s where most of the deals are happening.

Paul Quinn

All right. And then specifically on carbon, how are you going to monetize that, or what’s the framework we should be thinking about, if we wanted to pencil some value in for carbon?

Eric Cremers

Well, I would tell you that it’s very early stages, number one. But number two, at this stage of the game, carbon values don’t compete with sawlog values. They’re not even remotely close. But I will tell you, there are some tracks that maybe are not super highly attractive plantation-style forestry, maybe like a hardwood stand for example, where carbon values could outpace what that hardwood value might be. And it’s too soon for me to say, because we’re at the early stages, talking to a couple of different parties, about monetizing some of this ground, but we’ll see how it plays out.

Paul Quinn

Okay. And then just switching over to real estate at a high level. What are your expectations for 2023 in that portfolio?

Jerry Richards

So, I appreciate the attempt, Paul. But like I said, we’ll come back in our Q4 release and we’ll provide guidance on 2023. I mean historically, rural — and we’ve been in that 20,000-acre range. That’s certainly going to be lower because, Minnesota, as we’ve mentioned in the last couple of quarters is essentially done. So, I don’t know if it’s half, a little more than half of that 20,000 is a decent placeholder at this point. And then, our average in all run rate for residential lot sales has been somewhere in the 150, 160 lot range. Now, we’re at 180 this year. But obviously — and we still see some relative strength in that market, but it’d be a little premature to look forward to ’23 and say we’ll have a repeat at the 180-lot level.

Paul Quinn

Okay. That’s helpful. Thanks very much guys.

Jerry Richards

Thank you.

Operator

At this time, I am showing there are no more questions. I’ll now turn the call back over to Jerry Richards.

End of Q&A

Jerry Richards

All right. Thank you, Lisa. And thanks everybody for your questions and your interest in PotlatchDeltic. To recap, our year-to-date 2022 results are very strong. We look forward to providing updates on the performance of our leverage to lumber strategy, our integration at CatchMark and our progress on increasing shareholder value.

Operator

This concludes today’s conference. You may now disconnect.