Canfor Corporation

Don Kayne - CEO Alan Nicholl - CFO

Sean Steuart - TD Securities Paul Quinn - RBC Capital Markets

Thank you, operator and good morning everyone. Thank you for joining the Canfor and the Canfor Pulp quarter two 2017 results conference call this morning.

I'll make a few comments before I turn things over to Alan Nicholl, Chief Financial Officer, for both Canfor Corporation and Canfor Pulp. Alan will provide a more detailed overview of our performance in Q2 and then we will take questions.

In addition to Alan, on the line with me today are Brett Robinson, President of Canfor Pulp; Peter Hart, Vice President of Pulp Sales; Wayne Guthrie, our Senior Vice President of Lumber Sales and Marketing; and Stephen MacKie, our Senior Vice President of Canadian operations. I'll start off with just a few comments on the wildfire situation in British Columbia.

Our Wynndel mill was shut for one week due to an evacuation order and the fire danger in the area. Several of our competitors were forced to take shuts in the Cariboo and the Southern Interior regions and nearly 40,000 people were evacuated from their homes.

Weather has been a factor here and we're hoping firefighters get a break. But we do recognize we all -- we have all of August ahead of us.

We are seeing some breaks here lately in the weather, particularly, the last week or so. All of us at Canfor, the industry, and the Province of British Columbia are deeply appreciative of the many firefighters, contractors, and employees who have been on the front line of this difficult fire season.

Moving on to our results, beginning with Canfor Pulp, market demand continues to be strong and the company generated solid results in spite of significant plant's seasonal maintenance downtime. The company continues to be focused on operational performance and optimizing its sales mix.

Global demand was solid during the second quarter, but leveled off somewhat in June with significant new softwood and hardwood capacity entering the market over the next several months, we do see some price risk later this year and on into 2018. Yesterday, we announced two large capital projects in Northwood and Taylor, totaling $105 million.

These projects will further reduce our energy consumption and improve efficiencies at both mills. We expect both projects to be completed by the end of Q1 2019.

Finally, we completed a new four-year labor agreement with our pulp unions, which will ensure stability for our excellent labor force as well for our customers. Switching to our Lumber business, our operations ran well in the quarter and prices were up strongly overall for SPF.

Southern Yellow Pine prices showed a more modest increase in the quarter, and overall, our operating results continued to improve relative to the prior quarter. North American demand continues to be strong in both new home construction and repair and remodel markets.

Our view is that that the current demand and supply situation going forward will continue to support solid price levels. Our key offshore markets continue to be very strong in the second quarter and our shipping volumes to China and Japan remain steady.

In terms of the Softwood Lumber Agreement and in addition to the CVD rate of 20.26% imposed in May, Canfor was incest an anti-dumping duty of 7.72%, effective July 1. We were not subject to a critical circumstances decision.

As a result, we will not be required to make retroactive duty payments. These duties are punitive and completely unwarranted, they are not based on fact, as I said before, but our result of protectionist efforts by the influential U.S.

lumber lobby aimed at artificially restricting supply for their own benefit at a significant expense, ultimately, to the U.S. consumer.

We fully expect this determination by the Department of Commerce will be overturned by independent NAFTA and WTO panels and that the duties will ultimately be rescinded and returned. We've had excellent support in collaboration for the Canadian Federal Government and the BC provincial government and know that our federal Minister is working at the same time to negotiate an agreement that will bring certainty to our industry.

We have every confidence that they will take all the appropriate steps to successfully fight these absolutely ridiculous and outrageous trade actions, as they have done so previously. With that, I will turn the call over to Alan to provide an overview of our financial results.

Thanks Don and good morning everyone. As usual my comments this morning will focus principally on our financial performance for the second quarter of 2017 by reference to the previous quarter.

Full details of our results are contained in the Canfor and Canfor Pulp news releases, both of which were issued yesterday. As always you'll find an overview slide presentation on both the Canfor and Canfor Pulp websites in the Investor Relations section under webcast.

The presentation highlights consolidated and segmented results and I'll be referring to this presentation during my comments. For the second quarter 2017, Canfor reported shareholder net income of $81 million or $0.61 a share, up from net income of $66 million or $0.50 a share reported for the first quarter and well up from net income of $36 million or $0.27 a share reported for the second quarter of 2016.

On slide three of our presentation, we highlight various non-operating items, net of tax and non-controlling interests, which affect the comparability of our results between the quarters. In the second quarter, these items included a $3 million foreign exchange gain on long-term debt and a $26 million expense due to countervailing duty deposits.

After adjusting for the aforementioned items, shareholder net income for Q2 2017 was $104 million or $0.78 a share, compared to an adjusted shareholder net income of $59 million or $0.45 for the first quarter of 2017. Results for the Lumbar segment are highlighted on slide five of our presentation.

The lumbar segment reported operating income of $110 million for Q2, a $27 million increase from the prior quarters. The increase principally reflected the higher Western SPF and to a lesser extent, Southern Yellow Pine prices and a 2% weaker Canadian dollar as well as increased shipment volumes.

These increases more than offset a $35 million expense related to the preliminary CVD rates. Lumber shipments were up 7% in the quarter, reflecting a return to more normal levels following the weather-related transportation challenges experienced in the first quarter, while production was up slightly from the previous quarter.

Unit manufacturing cost were broadly in line as productivity gains and stable U.S. size log cost offset market and weather-related increases in stumpage and purchase wood cost, respectively, in Western Canada.

Canfor's Pulp and Paper segment comprises the results of Canfor Pulp Products Inc. In the second quarter of 2017, the company reported net income of $20 million or $0.31 a share compared to net income of $24 million or $0.36 for the first quarter of 2017 and net income of $2 million or $0.03 a share for the second quarter of 2016.

As you will see on slide six of our presentation, higher average pulp and paper sales realizations largely offset the impact of major schedule maintenance outages on both costs and shipments in the period. Improved NBSK and BCTMP pulp sales realizations largely reflect the strong pricing on shipments through most of the quarter combined with the weaker Canadian dollar.

Pulp shipments were down to 18% from the prior quarter, reflecting the lower pulp production attributable to the scheduled maintenance outages at our Northwood and Taylor Pulp mills in the current period until lesser extent, a delayed 14,000 ton vessel shipment is slipped from December into Q1. Higher unit manufacturing cost largely reflected the aforementioned maintenance outages as well as market-related increases in fiber cost.

Operating income for the Paper segment in Q2 was $7 million, which is broadly in line with the previous quarter. Sales realizations for Paper were up slightly from the previous quarter, primarily reflecting the weaker Canadian dollar.

Capital spending in the second quarter totaled $62 million and included $41 million for the Lumber business and $19 million in Canfor Pulp. The 2017 capital expend is currently projected to be approximately $170 million for Canfor and $70 million for Canfor Pulp.

Consistent with previous quarters, Canfor Pulp's Board of Directors approved the continuance of a quarterly dividend of $0.625 a share for the third quarter. In the second quarter, Canfor Pulp spent approximately $7.5 million on its share repurchase program with the company purchasing close to 608,000 shares and 0.9% of its common shows at an average price of $12.30 a share.

At the end of the quarter, Canfor, excluding Canfor Pulp, had net debt of $179 million with available liquidity of $359 million. Canfor Pulp had net cash of $42 million with available liquidity of $101 million.

Net debt to total capitalization excluding Canfor Pulp was 9.9% and on a consolidated basis was just under 7%. And with that, Don, I'll turn the call back over to you.

All right. Thanks Alan.

So, operator, we're now ready to take questions.

Thanks. Good morning everyone.

Hey Sean.

A few questions. In the $240 million total CapEx budget for this year, how much of the $105 million for the pulp energy projects is in that number?

Yes, good morning Sean. The number is close to $20 million out of that number.

And -- so the bulk of the spend will be in 2018 and will be reflected in 2018's number. And just to give some -- a little bit more context there, we're projecting around $100 million of capital spend to take a kind of that additional spend on those two projects.

And Alan or Don, can you go through the economics of the projects in terms of expected returns, payback period, that sort of stuff?

Yes. No, for sure, John.

So, consistent with other long-term energy-related investments, we're guiding to returns of 15% to 20% just to put it in perspective.

Got it. And wondering on lumber pricing, if you can offer some thoughts on the spreads between Western Canadian and Southern Pine pricing?

A lot of it I suppose is the fire season this year, but any other thoughts on how you expect spreads to normalize over the mid-term as we've seen some volatile trends recently?

Yes. For sure, Sean.

I'll let Wayne comment on that, but I guess at the outset a couple of quick things. I mean, ultimately, some of the things we're seeing despite the impact of the fire and so forth, I think, we are longer term, we would say and we certainly believe that the spreads between Yellow Pine and SPF, which I think what you're referring to, will get back to some of the -- kind of back to normal numbers.

Maybe even a little slightly lower in that $50 to $75 range and we're basing that partly on the fact that we do expect SPF, overtime here, Sean, to reduce in terms of production out of British Columbia because of the Beadle and we do see some upticks in the Southern Yellow Pine production going forward. Certainly, we're seeing that some of that already.

So, I think you know that the spreads that we've seen here in the last 12 to 18 months where they got quite high, as I've no doubt you're aware, we see that moving back to more typical levels over the longer term here.

Okay. That's all I have right now.

Thanks guys.

Yes, thanks very much. This announcement yesterday by a competitor in acquiring a number of sawmills in the U.S.

sales, so just wondering if you guys were part of that auction process. And what you thought of the actual quality?

Sure Paul. I mean -- first of all, congratulations to our competitor.

It was certainly a good acquisition and so congrats to Ted and West Fraser guys. I think from our standpoint, yes, we were in that early on, for sure, like probably a bunch were.

From our standpoint though, we thought that we have other, I guess, other priorities that we thought fit our strategy more longer term that we've talked a bit about in the past, but more so than this particular acquisition. The other -- so I mean ultimately, there's that.

And also some of the current evaluations that are out there and being tossed around, we're a bit concerned about that. So, in terms of how we are looking at it now we probably -- there's three areas, I mean, clearly, is there organic growth opportunity within the company that certainly we're aggressively working on and we'll speak here more of that here going forward.

Just straight M&A itself, which again, is concerning because of the valuation piece that we see increasing like I mentioned. And then the Greenfield, Brownville options, which we talked about a bit in the past, but I think that's another area there that certainly is -- warrants more consideration as well and we'll be warranting more consideration, so that's how we looked at it.

Certainly, from our standpoint, strategically, we're focused a lot on the fiber piece and being able to -- in areas that really significantly differentiates us from a fiber and our market product mix opportunity right. And so that's a bit of a color around that from Canfor standpoint and from our standpoint, Paul.

Okay. And then just one of the few characteristics from those of six sawmills is that they really handle a small log diet.

Do you see that as a benefit? Or is -- you guys seem to be more weighted to the larger log wider width in the U.S.

sales and I suspect you're thinking that the historical premium will return to that area, is that true?

Yes. I mean, I think there's an arguments, of course, for profile -- narrow profiles and wider profiles.

And ours belief is that we're probably more heavily weighted to the wider profiles because it give us additional flexibility that we think will be prudent longer term here in terms of flexibility of product mix and opportunities, potentially offshore and so forth. So, that's really -- and also higher quality log too typically you get into when you get into the wider diameter fiber.

So, that's -- but everybody has different strategies and that would be more closely aligned with ours though, the larger log strategy.

Sure. And maybe you could make a general comment on many opportunities and what those valuation metrics have looked like in the last six months, post sort of preliminary duties on countervailing and antidumping?

Have the valuations moved up significantly because the U.S. owners think that their assets are worth a lot more given the current duty structure?

Yes, I think that's for certain. In this industry, everybody thinks their assets are worth more than everybody talks about.

But we're certainly seeing that down there with no question. And we've commented on that before that, that I mean, the last 12 to 18 months, I think it would be safe to say that valuations, in general, in the South, continue to increase.

And a lot of these guys have taken the approach to wait and see to what happens when the Softwood Lumber Agreements in place. There's a view that that would accelerate or not accelerate, but increase the valuations even more so.

So, those are all reasons. So, I think right as we sit today, there's probably less than there usually is in terms of interest from the American producers in the [Indiscernible].

Okay. And then just maybe turning to the softwood lumber file, there's a lot of rumors that there are M&A deal and handshake agreement, et cetera.

How do you guys view the current talks right now? And has there been any change in the U.S.

side who the Canadian government is talking to as we try to negotiate an agreement?

No, I don't think so. The things dripping along here as it has been quite a long time.

I think that there has been some progress. I do think that the federal government -- and I know they are, they are in discussions with the U.S.

side. We've been real clear on our position in Canada and also from a British Columbia standpoint.

I think that there is some -- I think there is some urgency perhaps to try to see if there's a deal that can be done before the NAFTA starts to kick in the place here but time will tell on that. But I think clearly, I think from, just speaking from Canfor and BC perspective that we've been very, very clear with both the federal government and the provincial government in terms of what might constitute a fair deal, if there is to be a deal.

And if we have to go to a wall on this deal, we'll do that too. It just completely depends on what agreement is in place.

One other things that we're very, very solid on here is in British Columbia is to make sure. Number one; that we get the interprovincial allocation there, we feel we deserve in British Columbia for all the work that we have done and continue to do on offshore market development.

It's significant, it's taken a lot of resources the last 15 years and there's lots more opportunity going forward. But we need to get recognized for that, so that's one of a few areas that are extremely important to us.

Okay. And then just lastly.

It sounds like you're characterizing the federal government is wanting to give a feeling out, I don't know maybe I'm putting too strong words on them, but feeling a little bit under pressure to try to get a deal before the NAFTA negotiations start in the 16th of August. How does Canfor feel about -- do you -- are you nervous about -- do you feel compelled to get a deal?

Or you feel pretty strong with the legal case that we have on the file?

We feel absolutely strong on the case we have on the file for sure. And without question and like we've said before, if we can't get right deal, we're not interested in a deal and we'll go to the wall, like I mentioned, period.

So yes, there's not -- I mean just feel that the federal government is definitely engaged -- they've been engaged for some time here and I think they're doing what they need to do and what we've got on the table is I think fair for sure and we'll see what happens. So, it's hard to -- I can't really comment any more on that.

I mean that's kind of where we are at. It's dynamic, it's evolving with lots conversation on a regular basis, but we'll have to see how this thing ends up here.

Okay. And just last one may be a clarification.

You sort of expense $26 million for the preliminary countervailing duties in Q2, if I normalize that for a fuller quarter of countervailing duties and adding the anti-dumping duties, you're around that $50 million per quarter run rate based of the prices of that we saw in Q2?

Alan?

Yes. So, yes, so Paul, on that one, I think you're fairly close.

I mean, ultimately, it depend on prices and exchange and so forth. But I'd say, guiding the rule of thumb, $70 million to $75 million for 10% duty is kind of growth on an annual basis, so you can work from that.

But ultimately, depending on the price.

Excellent. Thanks for the help guys.

Best of luck.

All right. Thanks operator and thanks everyone for participating.

And we look forward, as always, to talk in October. Thank you.