Interfor Corporation (IFSPF)
Q3 2022 Earnings Conference Call
November 4, 2022, 11:00 am ET
Company Participants
Ian Fillinger - President & CEO
Rick Pozzebon - EVP & CFO
Bart Bender - SVP, Sales & Marketing
Conference Call Participants
Sean Steuart - TD Securities
Mark Wilde - Bank of Montreal
Paul Quinn - RBC Capital Markets
Hamir Patel - CIBC Capital Markets
Presentation
Operator
Good morning, ladies and gentlemen, and welcome to Interfor Quarterly Analyst Call. At this time, all lines are in a listen-only mode. Following the presentation, we'll conduct a question-and-answer session. [Operator Instructions]. This call is being recorded on Friday, November 4, 2022.
I'd now like to turn the conference over to Ian Fillinger. Please go ahead, sir.
Ian Fillinger
Thank you, operator, and good morning, everyone. Welcome to our quarterly analyst call. With me today you have Rick Pozzebon, our Executive Vice President and Chief Financial Officer; and Bart Bender, our Senior Vice President of Sales and Marketing.
Our agenda today will start off with myself providing a recap of our financial results, our strategic focus, and our improvement efforts. I'll then pass the call to Rick, who will cover our financial matters. And then, Rick, will pass the call to Bart who will cover of the markets.
Turning to our financial results. Our Q2 adjusted EBITDA was $129 million. We're continuing to execute on our strategic plan and we're generating industry-leading lumber margins and returns on capital. I encourage you to look through the investor deck on our website.
Our improvement efforts were again balanced across our North American platform. Our production was slightly below the record level of the previous quarter. Our lumber inventory was reduced during the quarter and remains within our target range. Our financial flexibility is strong. Our DeQuincy, Louisiana mill has reached its full two shift capacity. Our Eatonton, Georgia sawmill rebuild is complete and is in the final stages of ramp up. Our new planer mill project at our Castlegar British Columbia mill will be completed in Q4 and we expect a value uplift in great outturns, as this mill pulls from the very high quality fiber in this region of British Columbia.
In total, our CapEx was balanced as we deployed $86 million across four regions.
At the beginning of October, we announced the agreement to acquire Chaleur's two mills in New Brunswick. These two quality assets along with woodlands management business will add value, scale, and further geographical diversification to our portfolio.
Despite persistent inflationary pressures, our SG&A expense continues to decrease quarter-over-quarter as economies of scale are being realized from our strategy.
We also like to provide an update on how our integration is progressing with our Canadian Eastern platform. Our key focus areas in the New York term are to enhance the historical operating performance, to identify further opportunities for operational improvements in synergy realization, and to assess potential long-term strategic investments.
In summary, our balance sheet is in great shape and our 48% year-to-date return on capital again is very strong.
That concludes my opening remarks and I'll now hand the call over to Rick.
Rick Pozzebon
Thank you, Ian, and good morning, everyone.
First off, I'll refer you to cautionary language regarding forward-looking information in our Q3 MD&A.
Interfor's third quarter results were relatively strong given the normalization of lumber prices as market uncertainty, dampen demand. We generated adjusted EBITDA of $129 million and extended our track record of generating the best returns on capital of all publicly listed lumber producers. These positive results demonstrate the significant benefits of Interfor's transformation over the past several years. With significant scale and regional diversification achieved through acquisitions, continuous investment in portfolio optimization, and a focus on operational excellence.
Our capital allocation in the quarter continued to be balanced and driven by our focus on maximizing shareholder value over the long-term. We recognize significant value in Interfor's share price and launched a $100 million substantial issuer bid successfully buying back 6.1% of outstanding shares at a historically attracted valuation of 0.72x book value per share.
We continue to optimize our saw mills through discretionary capital investments at attractive risk adjusted returns. And we seized an opportunity to strengthen our company through the acquisition of two sawmill operations in New Brunswick with an annual capacity of $350 million board feet. These are top quartile operations with attractive fiber costs and fiber security, and are expected to boost Interfor's profitability and returns through all parts of our business cycle.
The renewal of our normal course issuer bid to buy back up to 10% of Interfor's free float provides us flexibility to return capital shareholders and increase leverage to earnings for remaining shareholders. We intend to operate this buyback program under parameters ensuring we purchase shares at an attractive valuation, while remaining within our conservative target leverage range.
Expanding on financial results, third quarter earnings benefited from our larger scale and regional diversification. Interfor shipped to near record $1.1 billion board feet in the quarter with positive EBITDA contributions from each of our operating regions. And earnings also benefited from $26 million of recovery recorded for softwood lumber duties previously expensed as the Department of Commerce finalized duty rates for the 2020 period at a reduced level.
We continue to see transitory cost inflation across several aspects of our business and remain focused on operating decisions to maximize returns and profitability.
From a balance sheet perspective, our financial flexibility remains strong with ample available liquidity on existing facilities of over $600 million with substantially more financial capacity available within our financial covenants if needed.
Pro forma the closing of the Chaleur Forest Products acquisition expected in the current quarter, net debt to invested capital at September 30 would've been approximately 23% and remain within our conservative target range of 5% to 25%.
It's also worth noting that Interfor's softwood lumber duties on deposit totaled US$419 million at quarter end representing $8 per share on an after-tax basis.
To wrap up, I'll highlight that our business continues to be well-positioned operationally and financially to succeed through ongoing market volatility. Our priority will continue to be disciplined capital allocation to maximize returns on capital and shareholder returns over the long-term.
That concludes my remarks and I'll turn the call over to Bart.
Bart Bender
Thank you, Rick. Good morning, everyone.
I'll provide an outlook on lumber markets through quarter four 2022 and into quarter one 2023. The medium to long-term fundamentals remain favorable to overall lumber demand. Demographics support an increased level of participation in the first homebuyers market. Aging housing stocks encourage increased repair and remodel work. Household balance sheets are solid led by equity in their homes and new home construction has lagged underlying demand for some time increasing the pent-up demand from homes in the U.S.
In the short-term, there's some micro -- macroeconomic challenges that are reducing the demand for lumber in North America. Inflation and economic uncertainty will drive conservatism and spending interest rate increases are impacting affordability and new home construction and simultaneously encouraging those with more affordable mortgages to stay in their existing homes. Home builders addressing this to a certain extent through incentives and features, so more is to be seen on that side of it. Repair and remodel is impacted, however, to a lesser degree, those avoiding the move up housing market will undoubtedly consider more repair and remodel work. Equity in homes will support this. However, to the extent that debt is required affordability could still be a factor.
We've been proactive in addressing the reduction in lumber demand with a reduction in production. The curtailments that we've announced for the balance of 2022 will allow us to align to our customer's needs.
Switching to the supply side of the equation, its times like these that remind us of how important diversity is in our business, making sure we have the right products in the right areas to meet the demands of our distribution partners. Interfor has always had diversification as a part of our corporate strategy, and that continues today.
I'd like to highlight that since 2019 through acquisitions, we've added to that diversification, only supplier with production in four major producing regions in North America. Our SPF capacity has increased from 8% to 25% of our production. We've added the Eastern region and once our most recent acquisition closes increased our capacity to $1.275 billion board feet.
Added dimension in timber production to our P&W regions, which prior to this was a 100% studs. Also acquired three dimension mills in the Southwest region, increasing our ability to service our customers further west in the south.
Interfor has never been positioned better to serve our customers across North America today, which is affording us as a seat at the boardroom table with any distributor in North America.
Overall, we're well-positioned to address the short-term uncertainty in the market, with diversity, and we look to markets to improve as we work our way through the balance of 2022 and through 2023.
With that, I'll turn it back over to you, Ian.
Ian Fillinger
Yes. Thanks, Bart. Operator, we're ready to take our analyst calls now.
Question-and-Answer Session
Operator
Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions].
And we'll take our first question from Sean Steuart with TD Securities. Your line is now open.
Sean Steuart
Thank you. Good morning, guys. Couple of questions. I want to talk about the NCIB renewal and Rick you mentioned that adjusted for Chaleur your net debt to cap is up to 23%, which is towards the upper end of your -- your stated target range. And I'm wondering if Ian or Rick could comment on where buybacks fit into the capital allocation pecking order as leverage is climbed and free cash flow prospects are moderating here. How do you think about the willingness to proceed with that NCIB over the next year?
Rick Pozzebon
Sure.
Ian Fillinger
Yes. Rick, do you want to take that?
Rick Pozzebon
Yes, for sure. Hey, good morning, Sean. Buyback certainly have been a priority for us when there's a disconnect between the share price and what we think is the underlying value of the shares. We'll continue to operate our NCIB program under a few parameters. One is certainly a pricing parameter to make sure we're not overpaying for our shares. And the second parameter would be around leverage. So we don't intend to buy shares outside of our target range in terms of leverage. So we'll be following those just like we have throughout the last couple of years.
Our priority in terms of capital allocation continues to be our internal investment in our saw mills, our discretionary capital program that we have well underway. And certainly growth is an objective of ours and we'll continue to look for M&A opportunities and consider those as they come about.
Sean Steuart
Okay. And just to clarify, Rick, so the 25% net debt to cap is that a ceiling above which you would not consider buybacks, or is there some wiggle room around that depending on how things are shaping up quarter-to-quarter?
Rick Pozzebon
Yes. I would say it's a guideline for us. Is it a hard stop? No, but it's something we want to target staying within that range.
Sean Steuart
Okay. Second question for Ian, wonder if you can speak to fiber costs across your various regions and I suppose specifically in the U.S. South where we've seen some inflation, and I'm hoping you can categorize that as, is this capacity build on lumber in the U.S. South driving increased demand for fiber or is it freight surcharges and contractor cost inflation that that's driving it? And your outlook with respect to that region specifically as we move ahead into next year?
Ian Fillinger
Yes, for sure. Sean, thanks. Well, the South region first off is one of our top performing regions and continues to be right there. The specific to your question on log costs, there have been some minor inflations that we've experienced, but I would say it's less than 5%. And in some cases, this generally flat, there's -- if I had to characterize the whole region from Louisiana to South Carolina, I would say they remain flat and there's pockets of where it's been higher. And then there's pockets where it's been actually lower in some cases, but generally flat across the region. But just some small pockets of dynamics depending upon where the saw mill is located.
Operator
[Operator Instructions].
Next we'll go to a Mark Wilde with Bank of Montreal. Your line is now open.
Mark Wilde
I want to just start off by saying Ian, I have a lot of regard for what you guys have done over the last two-and-a-half years in terms of kind of capital allocation and the balance that you have shown, you've kind of -- you've definitely walked the talk on that. As we look ahead though, I'm just -- I'm curious, we're clearly heading into what looked like much more challenging markets. We've definitely seen tougher markets than we're dealing with at the moment if we just look back over the last four or five years, I'm just curious about your preparations for more challenging markets.
Ian Fillinger
Yes, for sure. Mark, I mean as long as you've been covering this industry and we've worked in it, we've seen these ups and downs. So our playbook is pretty refined on that. It does -- I mean the first lever is making sure that your inventories are matching your order files and your profitability and when some of that starts to disconnect. We feel obligated to make decisions like we did announcing the curtailments in Q4. So that would be the first lever that we look at is just making sure we're not running for the sake of running, and that we're looking at the whole value outlook from a shareholder perspective, so that there's that and then you can get a little bit more specific down to plant level numbers and be prepared for your staff or whatever to do those.
We don't see that coming at us this time. We obviously like others and yourself, think it could be a little bit of a rough 2023. But the difference I think, Mark, when we look at Interfor, the strength of our company today compared to 10 years ago is just dramatically different. And some of that risk that we have in old playbooks is, we've updated and obviously feel that we're a much stronger company if we have some headwinds here in the next 12 months to 18 months.
And so I would say that, and then Mark, there's all kinds of different levers that we can pull beyond that, but the most is just making sure you're not building your inventory and taking write-downs and trying to force a product into a market that doesn't want it. And so we'll monitor that for pretty closely as we are right now for the next several months.
Mark Wilde
Okay. Second question I had, Ian and I know this is a sensitive one for you, but is there any way for you to give us some sense of sort of profitability by region across your portfolio right now?
Ian Fillinger
No, Mark. We can't really do that. I mean what we have shared is just the trend by region over a long period of time. I think its 10 years or so. And what we find is that it's balanced. There's puts and takes at different times. And so we're really pleased with the geographical diversification because we do see that as and especially in lumber for us, which is kind of what we do, being able to have those different regions, which have different log dynamics at different points in times in the cycle, and different product dynamics.
I think when we think about the SPF volume that Bart talked about, that's a big change for us. And we think that's a very positive contributor to Interfor as far as our strength goes as we go forward. But regionally, one year, one region might be stronger than the other, but over a period of time it's pretty balanced across North America in our portfolio anyways.
Mark Wilde
Okay. Last one for me, Ian, I wondered if we just stepped back, I think it was about nine years ago that you bought the Rayonier mills down in the South. That was your first move into the U.S. So can you give us some sense of what you've been able to do both capacity wise and profitability wise at the Rayonier mills since that acquisition?
Ian Fillinger
Yes, that was a great acquisition for us, and you got it right Mark, it was 2013. Those three operations start with Swainsboro and Baxley. We haven't had to put a lot of capital into those plants. They were well run and they have a great product line so those two plants contribute very well today. The Eatonton plant, which was the third of those Rayonier, it's a top quartile, top decile plant right now that we just finished the upgrade and it's going north of $200 million board feet from it was around $89 million when we when we bought it, maybe been a little bit less. But the purchase price that, that that Interfor picked those up, it was so attractive and extremely pleased with those. And we're very pleased to see Eatonton in a highly optimized technical mill, best-in-class engineering and equipment. And so I would say that would be the one that we have rebuilt out of those and it'll be one of the best in our portfolio.
Operator
Next we'll go to Paul Quinn with RBC Capital Markets. Your line is now open.
Paul Quinn
Hey, I just wondering if we assume that 2023 is going to be a very tough year, are you going to change your operating plan from what we're seeing in Q4, or is that where we're going with next year?
Ian Fillinger
Well, I think Paul, we will -- I mean, we look at it on a as you know, a regular basis. So Q4 I think is it just felt and looks like we needed to match production to shipment. We'll see what Q1 looks like. We'll probably have a view of that mid-December-ish. We'd like to run our plants and keep our employees retained and keep the logging contractors and the supply chains to the markets fulfilled. But we're not shy of making decisions. We just see that building inventory is a risk that we don't want to take beyond normal threshold limits, which I would say are tight and we want to keep them that way.
So yes, Paul, I would say mid-December we're probably going to take a view of Q1, see how things are looking and talk with Bart and sit down as a group and figure out what that schedule will look like, but it'll be quarter-to-quarter decision.
Paul Quinn
Okay. And then just over on softwood lumber, I mean, you've got deposits over $11 a share and I understand that you're with the Chaleur acquisition you're taking on those deposits. How much are those deposits sitting at by the time you buy them?
Rick Pozzebon
Works out to about its moving target, Paul, it's Rick speaking, be about $90 million or so U.S. of deposits.
Paul Quinn
Okay. And anything happening on that file or what's Interfor stance on trying to get some of this money back?
Ian Fillinger
Yes, Paul, I'll take that. I mean I guess the short answer is that there's not too much happening. I mean, the CUSMA appeal process is really just getting started. We've now got the panel set up for the original investigative results, so that that process is now underway, took five years to get that far. We do have a sunset review that's coming up where they'll take a look at it and make a determination of whether injury is still possible and whether this continues. We don't expect too much to come out of that. But it is a review process that happens at the five-year mark. Beyond those two things, there's really no extensive conversations beyond the normal. I think that that would point to anything changing in the near-term.
Paul Quinn
Okay. So, just on timing when did the injury review come up? Is that a couple of months and you're now expecting something favorable for the Canadians there?
Ian Fillinger
That’s correct. It's always at the five-year mark. It's called a sunset review. And we'll see what that process brings, but we're -- any of the active participants in this file will be busy preparing statements and whatnot to present through that process. And we'll see where it goes. But again, I -- there's -- you can't really speculate. But I can tell you that generally not many people are thinking it's going to add up too much.
Paul Quinn
Okay. And the timing on the original review that's now underway, is that a yearlong process or is that longer, or what was typical on underway?
Ian Fillinger
So I don't know that you can even look at what's typical. I mean it took five years to get to -- to get a panel struck. So they've got a bit of a catch-up here to go on that. So I think -- I actually don't know Paul. It's one of those things that that goes real time. And I wouldn't want to speculate on exactly how long that process would take. I'm just glad that it's underway.
Paul Quinn
Okay. And Bart while I got you, just pretty familiar with North mark-to-market, if you could just give me a recap of what's going on offshore?
Bart Bender
Sure. I mean I -- the business offshore, I would term it as average. Certainly, our exports to Japan albeit stable, I suppose quarter-over-quarter but I would call them slightly depressed as that market works through what was a fairly significant inventory position. So we'll be looking for that market to improve as we move into 2023. When it comes to the other markets, there's just -- there's some geopolitical issues there that you have to be mindful to. So I don't -- I believe there'll be generally opportunistic markets. I think the price of lumber in North America is attractive. And so that that will spur on some business. However, I'm not looking to the export markets to solve any of the demand side issues that we're going to be facing in 2023. So I think more of the same, I suspect.
Operator
Next we'll go to Hamir Patel with CIBC Capital Markets. Your line is open.
Hamir Patel
Hi, good morning. Ian, can you give us your sense as to how your costs in BC would kind of change in Q4 and Q1? Just at least in terms of stumpage?
Ian Fillinger
Yes. Well, Rick's got, he's pointing at me, he's got the numbers. So go ahead, Rick.
Rick Pozzebon
Hey, good morning, Hamir. It’s Rick speaking. So just looking at BC interior stumpage in Q3, it was about $86 a cubic meter. We're expecting that to dropdown in Q4, about $45 a cubic meter. And then looking out to Q1 2023, it'll be about $30 per cubic meter as an estimate.
Hamir Patel
Okay, great. Thanks, Rick. That's helpful. And just the last question I had was just on CapEx. What should we expect for full-year 2022 in any sense yet on 2023?
Ian Fillinger
Yes, it's about $300 million or so. Is that right, Rick?
Rick Pozzebon
That's right. And looking out to 2023, we're still going through our budgeting planning process, but you can expect it to be in the same ballpark as this year, so around $300 million.
Operator
There are no further questions at this time. I'll now turn the call back over to Ian Fillinger for any additional or closing remarks.
Ian Fillinger
Okay. Thank you, Operator. In closing we're focused on maintaining the health, safety and wellbeing of our employees. We continue to drive cost reductions across our company. We're matching our production rates to our order files, and we're continuing with a balanced approach to capital allocation.
I'd like to thank everyone for dialing in and participating in our call this morning and your interest in our company. If you have any further questions, please feel free to reach out to myself, Rick, or Bart at any time. Thanks, and have a great day.
Operator
Ladies and gentlemen, that concludes the conference call for today. We thank you for your participation. You may now disconnect.
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Interfor Corporation (IFSPF) Q3 2022 Earnings Call Transcript