Stella-Jones, Inc. (OTCPK:STLJF) Q2 2022 Earnings Conference Call August 10, 2022 10:00 AM ET
Company Participants
Eric Vachon – CEO, President & Director
Silvana Travaglini – SVP & CFO
Conference Call Participants
Hamir Patel – CIBC
Michael Tupholme – TD Securities
Benoit Poirier – Desjardins Securities
Operator
Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Stella-Jones Q2 2022 Earnings Conference Call. [Operator Instructions].
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 today, Wednesday, August 10, 2022. I will now turn the conference over to Eric Vachon, President and CEO. Please go ahead, sir.
Eric Vachon
Good morning, everyone. I’m here with Silvana Travaglini, Chief Financial Officer of Stella-Jones. Thank you for joining us for the discussion of the financial and operating results for Stella-Jones’ second quarter ended June 30, 2022. Our press release reporting Q2 results was published earlier this morning. Along with our MD&A, it can be found in the Investor Relations section of our website at www.stellajones.com and will be posted on SEDAR today as well. As a reminder, all figures expressed on today’s call are in Canadian dollars unless otherwise stated.
I will begin by providing a business update and overview of our quarter, and we will then turn the call over to Silvana to review our results in greater detail. I will then return with concluding remarks before opening the call for questions.
I’m pleased to report that Stella-Jones delivered a robust above-market second quarter performance. 10% organic sales growth in our infrastructure-related product categories, better-than-anticipated results for residential lumber as well as sequential EBITDA margin growth evidenced by strong cash flows generated in this quarter are all the testament to the strength of not only our business, but our expert team.
These results are attributable to our expenses network and their capabilities in terms of procurement and logistics. Our utility pole category continues to see overall growth powered by both pricing and volume gains. We are expanding our capital investment program to increase capacity and support rising demand driven by ongoing maintenance demand and broadband network development. In addition, we are leveraging the acquisitions of Cahaba, which are fully integrated into a fold and played a pivotal role in our continued growth, particularly considering current demand.
Turning to railway ties. Though volumes were affected by the lower maintenance programs of certain Class 1 operators, product demand remains steady, with price adjustments implemented in the first half of the year and more to come by the end of 2022. We are confident in our continued ability to push through higher input costs.
The tightness we’ve observed in access to untreated ties is showing signs of stabilization and even recovery as certain regions have started to generate more volumes. Sustained demand for utility poles and railway ties, combined with contractual price adjustments allow us to better navigate cost increases brought on by an inflationary climate, while maintaining healthy margins.
We work closely with our clients who appreciate our ability to deliver on their needs while consistently providing quality and timely service. The performances of our infrastructure-related product categories largely offset the anticipated pullback in residential lumber sales, which was eased by the higher-than-expected lumber market pricing and set the stage for a strong first half of the year than initially forecasted. Though Q2 started on slower note, our team did an outstanding work in navigating a volatile market and delivered healthy results.
We ultimately concluded the period with solid demand and on-target inventory position. Subsequent to quarter end, on July 22, we acquired the specialty carrier and transportation business of Dinsmore Trucking. Dinsmore was a longstanding and trusted logistic partner of Stella-Jones’ with a strong operational presence in Ontario and Alberta, and extended reach across Canada and certain regions of the United States.
Our sound logistics are fundamental to our business. Securing these trucking, hauling and delivery assets will help us better serve our network and clients through increased control and flexibility in our transportation, operations and costs. I would like to thank the Dinsmore team for their partnership and welcome our new employees to the Stella-Jones’ family.
With a healthy balance sheet, resilient margins and cash flows, this quarter builds upon the momentum generated since the start of the year while continuing to deliver on a 3-year strategic plan.
With that, I will now turn the call over to Silvana for a more detailed view of our financial results.
Silvana Travaglini
Thank you, Eric, and good morning, everyone. This morning, we reported net income of $94 million or $1.51 per share for the second quarter of 2022 compared to $150 million or $1.76 per share last year. During the quarter, Stella-Jones generated sales of $907 million compared to $903 million for the same period in 2021.
Excluding the contribution from the acquisition of Cahaba Pressure and Cahaba Timber of $15 million and the favorable effects from currency conversion, pressure-treated wood sales held steady compared to last year. However, factoring out the pullback in residential lumber sales compared to the exceptional growth last year, we observed that our infrastructure-related sales were up a robust 10% as Eric pointed out.
Looking at the results by product category, sales of utility poles amounted to $316 million in the second quarter this year, up from $236 million last year. Excluding the Cahaba acquisition and the currency conversion effect, sales rose 23% led by selling price adjustments in response to cost increases and sustained strong maintenance and project related demand.
Railway tie sales reached $215 million this year versus $216 million last year. Sales decreased by 4% organically, mostly due to the reduced maintenance demand of certain Class 1 customers compared to last year. This decrease was partially offset by the continued selling price adjustments realized during the quarter to cover higher costs.
Residential lumber sales totaled $286 million, down from $330 million last year. Excluding the currency conversion effect, sales decreased 14% due to lower volume largely stemming from our weather-related slow start of the season and lower pricing compared to last year’s record high market price of lumber.
Industrial product sales were $38 million, up from $36 million last year, largely due to higher pricing for projects related to railway bridges and crossings. Finally, logs and lumber sales amounted to $52 million versus $85 million a year ago. The decrease stems from lower lumber trading activity compared to the same period last year.
Turning to profitability. Gross profit was $173 million in the second quarter of 2022 versus $197 million in the second quarter of last year. As a percentage of sales, gross profit margin was 19.1% this year compared to 21.8% last year. The decrease in profitability mostly reflected the normalization of residential lumber’s gross profit, which more than offset the pricing gains that yielded higher gross profit margin for utility poles and railway ties.
Nonetheless, we did generate sequentially higher margins. At 19.1%, Q2 gross profit margin marked a significant improvement from 15.4% in the first quarter. Similarly, our EBITDA margin rose from 13.5% in the first quarter to 17% this quarter. While inflationary pressures impacted cost of all our product categories, a large part of Stella-Jones’ infrastructure-related sales are contractual and include tight adjustment mechanisms to cover cost increases, a core attribute of our business model.
Turning to cash flow. During the quarter, the company generated $228 million of cash from operations, driven by the strong results and favorable movements in noncash working capital components. Changes in noncash working capital increased liquidity in the second quarter, primarily as a result of the seasonal decrease in inventory and increase in accounts payable and accrued liabilities.
As of June 30, our financial position remain solid with $228 million of liquidity available under our credit facility. Long-term debt stood at $820 million with a net debt-to-EBITDA ratio of 2.7x, primarily driven by the lower trailing 12-month EBITDA.
During the quarter, we repurchased close to 1.3 million shares under our normal course issuer bid program for a consideration of $45 million. Since initiating the program last November, Stella-Jones has repurchased more than 3 million shares out of an optimized maximum number of 5 million shares for a total consideration of $115 million.
Finally, the Board of Directors declared a quarterly dividend of $0.20 per common share payable on September 23, 2022 to shareholders of record at the close of business on September 6.
I will turn the call back to Eric for concluding remarks.
Eric Vachon
Thank you, Silvana. We are proud of the performance we’ve seen in the first half of 2022. We are equally pleased with the initiatives put forward to further enhance our network. Stella-Jones is more than ever in a solid position to build upon the strong fundamentals. The acquisition of Cahaba late last year gave us added manufacturing capabilities to meet strong demand, while the addition of the Dinsmore Trucking business is further enhancing our logistical capabilities.
Internally, we are on track to invest approximately $100 million of capital expenditures in 2022 to support growing demand from our infrastructure-related customer base and to continue to upgrade our facilities. This includes the addition of new treating cylinders, wood drying capacity and pole peeling yards.
We are also proceeding with the conversion of certain facilities to ease the planned phase-out of pentachlorophenol and introduction of DCOI for utility pole treatment. As we are at the midpoint of the year, I can report that these initiatives are proceeding on schedule and within budget.
Stella Jones is a leading manufacturer of pressure-treated wood products in North America. Our coast-to-coast footprint second to none production, procurement and logistics capabilities as well as solid customer and supplier relationships are key attributes that will contribute to a sustained growth.
We welcome a steady demand flow from our business, mostly based on replacement and maintenance-driven requirements of critical infrastructure-related products. This, in turn, ensures we maintain a sound financial position, which we can further invest in our operations, pursue strategic acquisitions to complete our product offering and return capital to shareholders via dividend and share repurchases. In summary, our strong progress this quarter reaffirms our confidence in our ability to meet the objective set for 2022 and part of our 3-year strategic plan.
This concludes our prepared remarks. I will now turn the call over for questions. Operator, please proceed.
Question-and-Answer Session
Operator
[Operator Instructions]. Your first question will come from Hamir Patel of CIBC World Markets.
Hamir Patel
We’ve seen some of the major composite decking producers point to large channel destocking over the next 2 quarters. Do you see any risks of that playing out as well in your res lumber business?
Eric Vachon
So with regards to composite decking as far as we’re concerned, Stella-Jones for our customer the most part, we’re holding that inventory. So we’re managing our supply chain with regards to how demand is evolving, so destocking from the network, I don’t see that as a potential issue. If anything, for the first 6 months of the year, composite sales volume-wise have been very strong, higher year-over-year, very strong demand for that product. So I’m not too concerned about that for the balance of the year.
Hamir Patel
Great. That’s helpful. And Eric, in terms of the cost pass-throughs, have you now caught up with all the inflation that you’ve seen? And if not, what sort of maybe sequential uplift on prices remaining in poles and ties?
Eric Vachon
For railway ties, we’ve seen cases of untreated ties stabilizing the market somewhat in the last quarter. So I would — if this holds, I would suspect that we’d be done with certain — with the fiber pass-through, as I said, by the end of the year. Then there’s some annual adjustments that are still to come, which are sometimes inflationary adjustments to cover labor costs. We’re seeing [indiscernible] cost increases, which as well in discussions to passing through to customers. So for a railway ties, I think we’ll be — something will be done with the fiber adjusted probably by the end of the year and then maybe a bit more to come early into next year where our other cost considerations need to be discussed with our customers.
For utility poles, we keep having discussions with customers and increasing pricing. So we’ve seen pricing gains in Q2 over Q1, and I suspect this will have some more opportunities for price adjustments in the next — in the second half of the year. But then we sort of reset the clock and we’ll start again discussing in 2023 with customers about certain cost increases we’ve seen in ’22. So I would suspect that we could see more price adjustments in ’23 as well in the first half as inflationary costs, you’re putting pressure on labor, on freight and fiber costs.
Operator
Your next question comes from Michael Tupholme of TD Securities.
Michael Tupholme
Maybe to start, Eric, just hoping you could clarify a comment that was included in the press release and then also reiterated at the end of your prepared remarks. So specifically, you noted that based on the strong progress made in the first half of the year, you were confident that the company’s efforts will contribute to the achievement of the objective you set for 2022. Just wondering if you can clarify what 2022 objective you’re referring to there?
Eric Vachon
Well if you recall, Michael, we had disclosed last year in Q3 that we would see sales and EBITDA be comparable in 2022 compared to 2021. We always have internal goals, which are, sort of, not disclosed, but we’re well on our way with a strong start to the year in achieving those.
Michael Tupholme
Okay. So that annual guidance you had provided, but, sort of, no longer updating regularly you’re suggesting that those numbers or the targets you’d originally set are well in hand at this point?
Eric Vachon
Correct.
Michael Tupholme
Perfect. Maybe, secondly, just if you can provide a breakdown of the utility poles organic growth in the quarter in terms of volume versus price? Certainly sounds like price was a major driver, but just looking for a bit of a breakdown there, please.
Eric Vachon
Yes, certainly. So volumes are approximately 40% of — look, first and foremost, if you exclude FX and the Cahaba acquisition and that our MD&A provides some color there, then I would say volumes would represent 40% of that growth and pricing would be 60%.
Michael Tupholme
Okay. And as we look out a little further, maybe beyond the second half and into next year, how do you feel about your ability to achieve the high single-digit growth that you target, sort of, what a multiyear period in utility poles considering the very strong organic growth you’ve seen this year, which will make for a bit of a tough comp next year?
Eric Vachon
Right. Well, to your point, single digit — high single digit is still what we would see for next year. This year, a bit particular with all the price adjustments or inflationary pressures. But still remain confident on that high single digit. Many customers are talking about further projects and expansion. Very recently, the government of Ontario announced a $4 billion broadband project to which utility poles will be a key component, and we are a key supplier in that market. Similar examples that are not publicly disclosed, we were having discussions alike with other customers. So feel quite comfortable about our projection in a 3-year outlook with that high single digit.
Michael Tupholme
Okay. Perfect. And then just lastly, residential lumber. You talked about the slower start to the quarter, but it sounds like it ended with solid demand. So I guess I’m just wondering of the 10% decline in inorganic growth year-over-year in the quarter, are you able to, sort of, compare what you were seeing early on in the quarter when you add those weather issues versus what you’re seeing later on in the quarter? And then I guess any outlook on, sort of, the second half just as far as demand trends?
Eric Vachon
Right. Look, so to your point, April was a bit more difficult, let me say, weather related. It’s really April that had a bit more slower start to spring, but we then saw healthy demand from our customers and we’re able to also maintain adequate pricing. Although markets have declined or the general lumber markets have declined over that period, we were able to hold our pricing as we had built part of — a better part of our — all our programs for the year. So the decline for the quarter is probably similar — year-over-year similar for pricing and volume, if you like, because obviously last year’s prices were much higher than this year’s. But we’re very happy with the quarter’s volume. We concluded the quarter with optimal, I would say, inventory position. So we’re definitely well positioned to be able to continue to buy and follow the market trend, to be able to adjust our cost, to be able to support our customers.
And to your second part of your question with regards to how we’ve seen the second half of the year, I would say so far volumes have been holding relatively well, definitely better than what we’ve seen last year. If you remember, last year was a bit of depressed quarter as far as demand. So we’re definitely not seeing this trend this year.
Operator
Your next question comes from Benoit Poirier of Desjardins Securities.
Benoit Poirier
Congratulations for the quarter. Yes. Just to come back on the residential lumber, it seems to be doing better than expected. How should we be looking at the second half, given the drop in lumber price? And maybe if you could provide more color about the opportunities to replenish the inventory given the drop in lumber price? I know your built-in typically occurs in Q3, Q4. So I’m just wondering whether you see some opportunities to increase the inventory at lower levels.
Eric Vachon
So that’s also been on my previous comment on optimal inventory signal that we concluded Q2 with inventory levels that are definitely manageable in terms of data sales and we are definitely taking opportunities now proceeding the opportunity to procure lumber at the current market cost. Obviously, as the trend drops, we could expect to see the retail market wanting to reduce their prices. And so we obviously need to participate in that and we need to follow the trends. So at our own rhythm, we will see and participate in the lower retail prices, but we’re in a position now where margins should hold relatively well compared to, if you remember, the last year where we ended the quarter with high inventories and we need to do — we need to do that extra effort to cycle inventory, which is definitely not the case this year.
Benoit Poirier
Perfect. And talking at overall revenue for residential lumber, would it be fair to expect, kind of, flat or slightly up in the back half as opposed to the second half of 2021?
Eric Vachon
Well, compared to last year, Benoit, definitely we would expect to be higher in the residential lumber. Pricing definitely will be more favorable as it stands today. Obviously, as I just explained, our margin profile should hold historical levels if you want simply because we’re not having to deal with, I guess, an overstock of inventory.
Benoit Poirier
Okay. That’s great color. And on the pricing side overall, you’ve seen discipline. Have you made any changes to your pricing strategy and maybe try to shorten the lag impact that typically occurs with the movement in lumber price? Have you made any changes to your strategy?
Eric Vachon
Well, I’ll tip my hat off to our procurement team that did an exceptional job for 6 months of ’22 in procuring and managing the inventory level. So obviously, we never want to run out of inventory in the product mix for your customer, which we have not. Our service levels are extremely high. But we did very well in managing inventory levels and particularly not procuring at very high prices. So it gives us a bit of that opportunity to better manage our inventory. So lessons learned a bit from last year, but very disciplined approach. The team worked together, procurement operations and sales, to ensure that we — as I said, we supply customers all while not overextending ourselves with the volatility of the lumber market.
Benoit Poirier
Okay. And talking about lumber, 2 senators in the U.S. have recently stated that they are interested into a new softwood lumber deal with Canada. So could this be a possible positive for Stella-Jones? Any thoughts, Eric, about the potential agreement on the softwood lumber?
Eric Vachon
So, Benoit, it’s a great question. But we don’t move lumber cross-border. So our Canadian residential lumber category is essentially sourced and managed with Canadian resource and our Canadian facilities, and the same in the U.S. So that — all these tariffs for cross-border movements don’t impact us.
Operator
[Operator Instructions]. Your next question will come from Walter Spracklin of RBC Capital Markets.
Unidentified Analyst
This is James [indiscernible]. I’m on for Walter this morning. Congrats on the great quarter. I hope that one keeping well. On the utility poles business and overall in the supply chain capacity, when I was looking into your competitor’s call last week and they were highlighting some rail labor and trucking issues and you just completed the trucking acquisition to help alleviate some of those issues, I assume. So I was just wondering how much capacity you have in your pole business to meet the really strong demand that’s out there. And do you foresee any constraints either internally related to production capacity or externally related to labor or transportation going forward that would impact your ability to meet the demand that’s out there?
Eric Vachon
Yes certainly. So with regards to procurement, the industry in general is seeing higher year-over-year demand. And obviously, it puts more pressure on all the suppliers. So it is a constant search for the fiber, but the relationship that we’ve established with different suppliers, our own network of procurement in pole peeling yard has given us that opportunity to be able to see the higher demand, thus the volume increase that we’ve seen in our results.
With regards to treating capacity, not an issue. We have sufficient treating capacity currently and our announced CapEx program, if you want, of $100 million dedicated for our utility pole division will cover over the next few years, as I said, extra treating, extra drying capacity and also pole peeling capacity. So right now, we’re — I think we sort of foreseeing — and obviously, we’ve been a bit bullish on our expectations on the volume growth, which is materializing. So our initiation of this CapEx plan is probably right on point to enable us to keep seizing that opportunity going forward.
So on the production and in capacity side, no current constraint. And as you know, as I say, we’re on budget and on time with our schedule, we should be able to have the capacity to meet our requirements going forward that will meet the requirements from our customers.
The last part of your question with regards to logistics. Again, the first and foremost, strong logistics team added Stella-Jones a great relationships with a lot of carriers. Logistics is a very big part of our business. As you mentioned, we completed the Dinsmore acquisition in the month of July, which will essentially service Canada and a bit into the U.S. But we also have a similar fleet in trucking business in the U.S., essentially focused in the Southeast U.S. So railway ties in that region and Southern Yellow Pine poles, which is great flexibility for us.
To your point, finding trucking services is a daily challenge. We’re lucky we have strong relationships with different partners that service us. But the fact that we run, I’ll say, a smaller fleet as maybe services maybe total 5% of our needs, like Dinsmore will be 5% in Canada, and the one we have in the U.S. would probably service 5% of our holineeds in the U.S. It gives us great flexibility to get deliveries on time when customers call us with emergency requirements, gives us that chance to be that supplier that’s always there for them 7 days a week. So it’s been a lot of work, but we’re able to march through and deliver our customers who need the materials for their maintenance projects.
Unidentified Analyst
Appreciate that. That’s good color. And another question on the railway tie business and, kind of, your outlook into 2023. So on one hand, are you seeing the rails delaying any CapEx given how congested our rail networks have been? And if so, do you expect that to drive potentially outsized growth into 2023? And maybe the other part of my question is there’s been some issues with accessing untreated ties. And do you see your businesses scale as being advantages versus smaller competitors and potentially driving some outsized growth versus what potentially the industry might be expecting into next year?
Eric Vachon
Great. So we — our industry always wait with anticipation, the railway tie association meeting that occurs in the fall, where Class I would formally communicate their maintenance programs for next year. So obviously, I have no secrets and like everyone else, we’re waiting to see. What we are seeing is, in general, Class 1 customers are maintaining their networks at, I would say, well, they have historical levels, and they’re — they’re trending upwards a bit. And I think that’s what we’re seeing right now and we talk about certain Class I maintaining a bit less than previous years.
That being said, to your point, networks have been bogged out for the year. There’s been lots of traffic on the rail networks in general, which is creating usage of the network and will eventually lead to some required maintenance. Now, will that come in ’23 or early ’24. I think it’s somewhere in that 12- to 24-month window that we know we’ll see that increase. I don’t expect it to be like a big jump. I think it will be just a gradual pickup. I fully — I have great confidence in the engineering departments at the railroad companies in the matter of being able to monitor the network usage and being able to run their networks in a safe manner. And I’m quite confident that for those reasons, we will see the maintenance requirement increase in that window.
Unidentified Analyst
Okay. Perfect. And just a quick follow-up, and then I’ll turn to the line over. You had on the utility poles, you had mentioned high single growth was going to happen in 2023. And again, that was on top of potentially 2022 growth that’s going to come in above the high single-digit range that you had guided to?
Eric Vachon
That is correct.
Operator
Your next question comes from Michael Tupholme of TD Securities.
Michael Tupholme
I just want to clarify or ask you a question about the margins. So certainly, it sounds like in the quarter, the margins you generated, maybe you can just clarify, it sounds like this is a fairly, sort of, normalized level of margins or something unusual going on? And I guess, I’m just wondering, if we look forward, is this sort of level of margins? I know there’s some seasonality, but are you performing a fond of a normalized rate from a margin perspective? And is that, sort of, expectation to be able to carry on going forward here?
Eric Vachon
Well, obviously, the second quarter is typically our highest EBITDA margin quarter. And I think that’s probably an indication of what we’ve seen. So far, is to your point, normalized compared to historical, no, excluding last year results, which were a bit exceptional. So going forward, I would suspect that Q3 and Q4 would be more or less in line with what we’ve seen in previous years, maybe slightly better as a percentage simply because of our pass-throughs and pricing, both on the railway ties and utility poles.
Operator
There are no other questions from the phone line. I would like to turn the conference back to Mr. Vachon for closing remarks. Please go ahead, sir.
Eric Vachon
Well, thank you, Michelle, and thank you to everyone for joining us this morning, and have a great day.
Operator
Ladies and gentlemen, this does conclude your conference call for this morning. We would like to thank everyone for the participation and ask you to please disconnect your lines.
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