Canfor Corporation

Don Kayne - CEO of Canfor Corporation and Canfor Pulp Alan Nicholl - CFO for Canfor Corporation and Canfor Pulp Peter Hart - VP of Pulp Sales Wayne Guthrie - SVP of Lumber Sales and Marketing

Paul Quinn - RBC Hamir Patel - CIBC Sean Steuart - TD Mark Wilde - BMO Markets

Thank you, operator and good morning everybody. Thank you for joining the Canfor and Canfor Pulp Q3 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 Q3 and then we will take questions.

Joining Alan and I today to answer your questions are Brett Robinson, President of Canfor Pulp; Peter Hart, Vice President of Pulp Sales; Wayne Guthrie, Senior Vice President of Lumber Sales and Marketing; and Stephen MacKie, Senior Vice President of Canadian operations. First of all I'd like to acknowledge Wayne Guthrie as this is his last analyst call.

He'll be retiring at the end of the year after 33 years with Canfor. We will truly miss Wayne for his many contributions over so many years, but being the true leader that he is, he is leaving us with a strong sales organization with lots of depth in our sales and marketing group.

Kevin Pankratz will be taking over the leadership of our wood products sales and marketing group starting in January and Kevin has been with Canfor since 2005, most recently as Vice President of Sales and Marketing and has 27 years of experience in markets around the world. As you are aware, the third quarter brought significant challenges in the form of natural disasters.

DC recorded one of the worst fire seasons on record and two significant hurricanes in the United States. Canfor was somewhat fortunate to avoid significant damage or destruction to our operations and continued to run almost uninterrupted throughout the quarter.

Taking a look at our results, beginning with Canfor Pulp, the company generated solid return despite of a stronger Canadian dollar and a planned outage of 10,000 tonnes at Intercon. Markets were relatively stable in the early part of the quarter then began increasing in early August.

The late quarter improvement in pricing in demand was a result of a number of factors including supply disruptions at existing facilities, for maintenance and Chinese import restrictions on recycled paper. We expect these pricing increases will have a positive impact on returns during Q4.

While these factors are positive for market prices in the near term we continue to be somewhat cautious about new hardwood and softwood supply expected to come on the market in late 2017 and into 2018. Moving to the lumber business, our operations run well in the quarter despite some challenges in British Columbia with log procurement mostly related to the forest fires.

North American demand continues to be steady in both new home construction and repair and remodel markets, steady demand in North America combined with supply disruptions from British Columbia and strong offshore markets resulted in prices climbing steadily in Q4. Our key offshore markets continued to be solid in the third quarter with shipment volumes to China and Japan remain positive and on plan.

As you are aware countervailing duties were temporarily suspended in August, while we have not been subject to countervail duty since that time, we have continued to pay anti-dumping duties. The final countervail duty determination deadline has been extended to November 4, the ITC final decision typically takes 45 days on top of this, which is expected to result in a final duty rate effect in January 2018.

We’ve had excellent support and collaboration from the Canadian federal and provincial governments and know that our federal minister is working on negotiating a fair agreement that will bring certainty to the industry. Finally, we have announced a new organic capital program of 350 million board feet and are currently evaluating a Greenfield construction project.

Combined these projects would increase our US Southern Yellow Pine capacity by 600 million board feet or approximately 40%. We strongly believe in the long-term positive fundamentals for fiber, people and markets in the US South region and are excited about expanding our capacity there further.

I will now turn it over to Alan to provide an overview of our financial results.

Thank you Don, and good morning everyone. My comments this morning will focus principally on our financial performance for the third quarter of 2017 by reference to the previous quarter.

Full details of our results are contained in the Canfor Pulp and Canfor new releases both of which were issued on Friday of last week. As always you'll find an overview slide presentation on both the Canfor and Canfor Pulp websites in the Investor Relations section under webcasts.

This presentation highlights consolidated and segmented results and I’ll be referring to it during my comment. For the third quarter of 2017, Canfor reported its shareholder net income of $66 million or $0.51 a share, down from net income of $81 million or $0.61 a share reported for the second quarter and up from net income of $51 million or $0.38 a share reported for the same quarter of 2016.

On Slide 3 of our presentation we highlight various non-operating items net of tax and non-controlling interest, which affect the comparability of our results between the respective quarters. In the third quarter these items totaled $18 million and included a $24 million expense related to countervailing and antidumping duty deposits, $4 million foreign exchange gain on US dollar denominated long-term debt and a $2 million reversal of a previously recorded closure provision at our Canal Flats sawmill.

After adjusting for the aforementioned items, shareholder net income for Q3 was $84 million or $0.65 a share compared to adjusted shareholder net income of $104 million or $0.78 a share for the second quarter. As highlighted on slide 5 of our presentation the lumber segment recorded operating income of $93 million for Q3, down $18 [ph] million from the previous quarter.

The decrease principally reflected a 7% stronger Canadian dollar and a decline in Southern Yellow Pine commodity lumber prices combined with higher log cost of the BC interior largely reflecting the weather and fire related challenges in the region. These factors were somewhat mitigated by higher US dollar Western SPF prices.

Lumber shipments were up slightly compared to the previous quarter for the most reflecting a 6% increase in Southern Pine shipments, while total number production was in line with the prior quarter despite the various weather and fire related challenges. Canfor’s pulp and paper segment comprises the results of Canfor Pulp Products Inc.

The company reported net income of $13 million or $0.19 compared to net income of $20 million or $0.31 a share for the second quarter and net income of $22 million or $0.34 a share for the third quarter of 2016. As you see on Slide 6 of our presentation, our results reflect a significant impact of the stronger Canadian dollar on average pulp and paper unit sales realizations which more than offset the benefit of a decline in scheduled maintenance outages.

Global softwood pulp prices bottomed out through the first part of the quarter before rebounding towards the end of August with the net result, but there was no change in quarter-over-quarter US dollar prices. The benefits from the positive priced momentum seen in September will be largely realized in the fourth quarter.

Pulp shipments were up 10% in the third quarter reflecting the decline and scheduled maintenance outages from the previous quarter, partially offset by a 14,000 vessel slippage into October which is subsequently shipped. Unit manufacturing costs improved from the previous quarter mostly due to the lower scheduled downtime and to a lesser extent seasonally lower energy costs.

Operating income for the paper segment in Q3 was $5 million, down $2 million from the previous quarter with the stronger Canadian dollar again being the major factor. Capital spending in the third quarter totaled $58 million and included $37 million in the lumber business and $19 million in Canfor Pulp.

Our 2017 capital spending is currently projected to be approximately $175 million for Canfor and $60 million for Canfor Pulp excluding capitalized major maintenance costs. Looking out to 2018, we currently anticipate higher capital spending for lumber to be in the region of $240 million reflecting the organic growth that Don referred to previously and about $90 million for pulp reflecting mostly the spending on the two recently announced energy projects at Northwood and Taylor and on a new ERP implementation.

Consistent with the prior quarters on Friday Canfor Pulp’s Board of Directors approved the continuance of a quarterly dividend of $0.0625 per share for the third quarter. Also in the third quarter of 2017 Canfor spend $75 million on its share repurchase program purchasing approximately 3.5 million of its common shares at an average price of $21.27.

Canfor Pulp repurchased 576,000 shares in the period at an average price of $12.67 per share for a total investment cost of $7.2 million. At the end of the third quarter, Canfor excluding Canfor Pulp had net debt of $183 million with available liquidity of $358 million.

Canfor pulp had net cash of $31 million with available liquidity of $101 million. Net debt to total capitalization excluding Canfor Pulp was 10.2% and on a consolidated basis 7.6%.

And with Don, I'll turn the call back to you.

Okay Thanks Alan. So operator, we're now ready to take questions from the analysts.

Just wondering if you could give us a little bit more detail on the accelerated CapEx spend in the US projects here, what projects and what mills you're looking at upgrading.

Hi Paul, it's Don. For sure it's something we’ve been working on for some time because we recognized there has been - there are some opportunities there in the south to increase some of the spending on - in terms of organic capital.

But it really comes down to our allocation process, Paul. And we as you know we've kept an eye on debt here significantly for the last several years trying to get our balance sheet in good shape which we think it is today.

And that’s presented for a bunch of reasons mostly due to some of the M&A activity that's out there we think some of the opportunities are pretty expensive. So we really focused hard on trying to maximize the production out of our own facilities and so we've done an evaluation so there's probably three or four mills that we think there's a significant opportunity in the sawmill and in some cases in the finishing en and also on the [indiscernible] side to spend additional dollars.

So we've - that's really how we're focused on that and then also eventually here as we've mentioned in the press release talking about potentially for our Greenfield project which we’ll be evaluating now and making a decision on at the end of January. But it really comes down to really looking hard at our priorities now that we have our balance sheet in good shape.

And fortunately this allows us to really take an increased look there at organic, which we think is probably one of the best opportunities that we have.

And just I think we've talked in the past about expansions in the US South and it's - I think the focus is for you guys has always been on M&A. I guess the change in direction to potentially Greenfield is because of the expensive nature of the M&A transactions right now?

Yeah, for the most part, I mean, it’s clearly there are still on the radar screen, Paul on M&A because there is odd opportunity out there. But frankly we believe that between organic and then certainly with the cost increases on the M&A side potentially; it's made the Greenfield more attractive so that's why we put in a lot more effort into evaluating the Greenfield side as well.

So if you had to rank them now it's probably organic, Greenfield and then M&A probably a close third.

And then just says switching over to pulp, as realization sort of seem to lag in the quarter and I expected a little bit more out of it, but it seems like quite a bit was loss I guess in the 14,000 tonne vessel that get moved in October, so that explains some of it. You still sound -- you sound optimistic on Q4, but cautious going forward and you sounded, I think you guys have been cautious for the last two years, despite robust markets.

I mean I've been in the same camp with you and we've both been wrong, but what -- besides the capacity additions, are you seeing something different out there that gives you caution in the medium to long term.

Yeah. Maybe I'll let Peter comment on it, but sometimes, I think caution is pretty good.

Well, certainly, the fourth quarter is going to be -- is going to be a strong quarter for us and take us into 2018 at a higher starting point than we would have envisioned a few months ago. So as we look at 2018, there's -- we would expect at some point in the year to have some downward momentum, but having said that, the average price for next year would be, looking forward, higher than we would have thought a few months.

Okay. That's great.

And just last question on CapEx spending, you outlined 2018, can we assume the same sort of levels for 2019 as well?

Well, I think as a general statement; yeah, fairly close in 2019. Pulp may be a little lower than the 90, but reflecting the projects that I outlined earlier.

Yeah. So fairly close for 2019 would be my guess.

Don, could you speak to some of the factors you're considering when you're deciding where to position this potential Greenfield? Are there certain regions in the south where maybe you want to expand your platform and where -- from a wood basket perspective, where do you sort of see the most attractive market right now?

Well, I think, overall, the Southeast to be general, because we haven't landed on a specific state yet or a city or anything like that at this point, but clearly, as we always have and it goes for pretty much everything we do, we look at two things. Number one is fiber, quality of the fiber and availability of the fiber and the competitiveness of the fiber on a long term basis.

And then also the other area is people, right. Those would be the two key factors.

Leaving aside that we -- in terms of distances to tide water because we think they're down the road here, there's going to be more and more opportunities for export, would be critical. Those will probably be the three, probably the three key areas that we would -- assuming that we're in an area which is Southeast as anyways, very positive for lumber consumption period.

And so we're not obviously concerned about customer base or any of those sorts of things. But we will have the three things; fiber, people and access to tide water I think would be critical, those three.

And if you do go ahead, what's the sort of typical timeline you'd expect to completion from when you announce something and similarly what's the sort of capital spend for Greenfield at the moment?

So, we haven't announced anything around the capital spend yet. I mean I guess a good guidance might be though the GP mill that you heard recently announced, I think that was around 100 million.

That's probably in the hunt, Hamir, and then in terms of timing, we expect to make a decision sometime in Q1 and assuming that's done and the end of Q1 is probably 12 months after that, we would expect to be operational.

Great. And just a final question I had was on the lumber business, I’ve been seeing reports that Chinas sort of cracking down on some of their polluting manufacturing assets, how permanent do you think that is and what do you think that opportunity is for North American lumber exporters?

Yes. Maybe Wayne, why don’t you talk about that, why don’t you give Hamir bit of an update there?

I think, Hamir, we're going to see some of those smaller operations that we’re converting logs in the lumber that are going to be permanently eliminated. So I think that is long term more opportunity for all lumber shippers into China and including Canada.

So I think it’s a long term trend. I think it's here to stay and I think it's positive.

Wayne, any guess on maybe how much sort of board feets coming out of those facilities?

Oh, you know what, I don't have, I’m going to guess it's -- but it's material. It’s -- remember, there was an offset.

So those logs will likely get converted into lumber somewhere else, maybe on the Russian side of the border and then come into China. So, there is a bit of an offset there, but short term, it’s certainly created an opportunity for SDF.

I think you’re seeing too, Hamir and Wayne, in terms of on the panel side or in domestic panel use in China, on the furniture side, lot more conversion from some of the panel uses for furniture over to solar wood as well. And if that's what you're referring too as well, I think that will have an impact as well in terms of how much volume, I'm not sure, but it’s positive for sure.

Thanks. A couple of questions.

I’ll start with the pulp business. Alan, you referenced some better unit costs, I guess, based on production with lower down time this quarter.

That didn't flow through to unit cost relief on the shipment side, is that just the vessel delay, maybe help reconcile I guess the lack of relief on the unit cost based on shipments this quarter?

Yeah. I mean, Sean, I say, it fundamentally depends on your kind of reference period, but as a general statement, our cost trended down.

I appreciate we’re coming from new, we can chat a bit afterwards, but the timing of the sizable slippage did have an impact, inventory movements did as well and we saw a couple of other smaller factors, but by far, the biggest impact on our overall earnings was the foreign exchange impact. That’s what I outlined.

I mean I would say as a general guidance, with the maintenance behind us, we are expecting normal service to be resumed here in the Q4.

Okay. And just a follow-on question on the organic sawmill investment program in the south.

If we're talking about I guess roughly 360 US per 1000 board feet for the Brownfield expansion, that would be a bit of a discount to Greenfield cost. Maybe, it's not something you're prepared to answer yet, but can you give us an idea of the expected return differential of Brownfield versus Greenfield as you think about this growth plan.

No, I think other than to say, I think you're right in your assumption that organic will be the least expensive of the two. We're not -- at this point, we're too early on in the evaluation of the Greenfield to give you any firm numbers yet, but I certainly would with -- over the next while, we will be in a better position to give you some more information on that, Sean.

Just to start off, I wondered if you could help us just with the quarter-to-quarter decline in duties. It would have seemed that maybe duties would be flat to up a little bit just with increased volume and the fact that you've got the anti-dumping duty in for the full period.

Sure, Mark. Alan, why don’t you?

Yeah. So I think essential, it comes down mostly I would suggest to timing.

I think we got a benefit from some of the timing of customs paperwork, a bit of a lag there, that gives a bit of respite there. I think the other thing that you're seeing is clearly some intentional allocation of our product offshore and so we saw a bit more product going offshore as well, Mark.

And then I'm just curious Don, down south right now, are you having -- seeing anything in the way of kind of freight and logistics issues, either going into the mills or going out of the mills, because we're just -- we're hearing about a lot more trucking demand that kind of brings supplies into some of those hurricane hit regions.

Absolutely. Our trucking business down there is doing real well right now.

But yeah -- and as a result of the fact that we've had some significant issues with some of the rail lines down there in the south for delivery, absolutely. So we've been experiencing what you've been hearing for sure and a lot more demand on trucks and of course with our trucking business down there is actually been pretty solid.

So we maybe benefited a bit from that and have been able to assist some of our customers that have been having difficulties in receiving lumber.

Do you think Don, that’s contributed to kind of the recent strength that we've seen in the lumber market, just the fact that it's more difficult for people to get it right now?

I don't think so and the reason I don't is our inventory levels really haven't changed. I mean, if anything, they've gone down significantly, well, in British Columbia, significantly in the Southern Yellow Pine, they’ve also gone down though.

So that would just be one indication maybe that still the takeaway is still happening.

And then I wondered if you guys can just help us with sort of cadencing in these pulp price increases as we move to kind of into the fourth quarter from the third quarter.

Yeah. For sure, Mark.

Maybe, Peter why don’t you speak to Mark about that.

Thank you. If you look at the third quarter, the weakest two months in the market this year would have been June July timeframe.

So June would of course be invoiced especially for some Asian countries in the months of July and early August. As you look at the September increase, which was the largest increase in the third quarter, that invoicing will go through for some markets starting in October-November.

So the higher prices in the third quarter and what we’re seeing in the fourth quarter will be certainly realized, all by November December timeframe.

Okay. And I don't want to get too far in to weeds here, but I was kind of curious the performance in paper was down, it's not a huge business for you, but my impression is that the craft paper market has done nothing but get tighter over the last several months.

The crap paper market is healthy. I think what you're seeing there is more the effect of what Alan talked about on currency.

We expect the paper market to continue to be healthy going forward.

Okay. Right.

And then finally, I wondered if you could give us a little more color on the Asian export market, you said volume was strong, but another thing you've talked about over time has been kind of improving the quality of the mix that you're exporting over there, so if you could talk about those issues and also just what you're seeing in terms of export volumes coming out of the US south going into Asia?

For sure. Wayne, why don’t you give Mark update on that?

Sure. So first of all, on the [indiscernible] business into Asia, it's been a little bit better than we expected.

Japan has been stellar, both price wise and volume wise and we expect that to continue right through Q4 and into next year, very, very, very pleased with Japanese business. The China business is, as you say, the overall volume doesn't change much, but the value of what we're shipping there continues to move higher, significant year-over-year increase in price, but also in the value of the products we are going in there.

So we continue to focus on higher value. The Europeans have had great success in China the last couple of years and we kind of drafted it behind that higher value furniture components and that future looks quite good in China.

So going into 2018 should help a lot. Yellow Pine will be very interesting to watch.

We do a little bit export business to Yellow Pine and during that -- when Yellow Pine got a little soft there, for the last quarter or so, all of a sudden, lots of opportunities start to show up around the world. So if other species continue to be stronger and continue to get stronger, which the fundamentals suggest they will, Yellow Pine is going to find itself quite competitive into China and into other markets in Asia and we would expect that Yellow Pine export volume to grow over the next couple of years, starting even in 2018.

All right. Thanks, operators and thanks to everyone that participated on the call today and we appreciate it and we'll look forward to talking to you at the end of Q4.

Have a good day.