Canfor Corporation

Don Kayne - Chief Executive Officer, Canfor Corporation and Canfor Pulp Alan Nicholl - Senior Vice President, Finance and Chief Financial Officer Stephen Mackie - Senior Vice President, Canadian Operations Brett Robinson - President, Canfor Pulp Kevin Pankratz - Senior Vice President, Sales and Marketing

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

All right. Thanks, operator, and good morning, everyone.

Thanks for joining the Canfor and Canfor Pulp Q4 2017 results conference call this morning. I’ll make a few comments before I turn things over to Alan Nicholl, our Chief Financial Officer for both Canfor Corporation and Canfor Pulp.

Alan will provide a more detailed overview of our performance in Q4 and for 2017 overall, and then we will take questions. Joining Alan and I today are Brett Robinson, President of Canfor Pulp; Peter Hart, Vice President of Pulp Sales; Kevin Pankratz, our Senior Vice President of Lumber Sales and Marketing; and Stephen Mackie, our Senior Vice President of Canadian Operations.

So taking a look at our results beginning with Canfor Pulp, the company generated a record high quarterly operating income of $67 million in the quarter, surpassing the previous high by $14 million. Demand for pulp was very strong in the last-half of the year, driven in part by China and its new restrictions on the import of recycled paper.

After an unexpected 11,000 tonne outage in November, the mills ran well in December and production was in line with the previous quarter. The pulp market appears well-positioned for the remainder of the first quarter and into the standard spring maintenance period in Q2.

We continue to be cautious around incremental pulp supply, but are encouraged by good demand from most regions. Moving to the lumber business, our operations ran well, but faced a number of transportation issues and weather challenges that impacted production and also shipments at year-end.

North American demand was strong and supply constraints kept prices high through most of the quarter. In our view, the gap between SPF and Southern Yellow Pine will be lower than we’ve seen historically due to the continuing reduction in supply from Canada.

Offshore markets were particularly good in Japan and Canfor had a record year in Japan in 2017. China continues to be stable with increasing volumes of higher value products.

Our outlook for 2018 is for continued slow improvement in market demand and ADD rate that will offset incremental supply in the US South. Challenges to new capacity additions and better than expected demand will result in strong prices going forward.

And finally, yesterday we announced that our Board of Directors has approved construction of a greenfield sawmill in Washington, Georgia. Late last night, we were advised by our contractor of a previous commitment that may prevent them from constructing the mill.

Clearly, it will take some more time to get a fuller understanding of the situation, but we remain fully committed to building a greenfield mill. The impact of this event in terms of timing cannot be quantified at this time, but we will provide further updates as they become known.

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

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

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

The presentation highlights consolidated and segmented results, and I’ll be referring to this presentation during my comments. For the fourth quarter of 2017, Canfor reported shareholder net income of $132 million, or $1.02 a share, up from net income of $66 million, or $0.51 a share reported for the third quarter of 2017, and net income of $38 million, or $0.29 a share reported for the fourth quarter of 2016.

On Slide 3 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 fourth quarter, these items totaled $17 million, the largest item relating to recovery with respect to countervailing and antidumping duty deposits.

After adjusting for the aforementioned items, shareholder net income for Q4 was $115 million, or $0.89 a share, compared to $85 million, or $0.65 for the third quarter. As highlighted on Slide 5 of our presentation, the Lumber segment reported operating income of $155 million for Q4, that was up $62 million from the previous quarter.

The increase reflected both solid lumber demand and CVD/ADD true-up adjustments in the fourth quarter. U.S.

and Canadian housing starts were both up from the previous quarter and the improving market conditions translated into increasing Western SPF and Southern Yellow Pine sales realizations, which more than offset a 9% decline in lumber shipments due to capital-related downtime in the US South and weather-related production and transportation challenges in Western Canada. As you can see on Slide 6 of our presentation, adjusted operating income included a $45 million recovery of countervailing and antidumping duty deposits.

This recovery was comprised of two components. Firstly, the adjustment of CVD and ADD preliminary deposit rates from 20.26% and 7.72%, respectively, with final determination rates of 13.24% and 7.28%.

And secondly, a subsequent true-up of the ADD accrual rate from 7.28% to 1.1% to reflect current 2017 sales and cost data versus the 2015/2016 period overview. Of the $45 million net recovery, $16 million pertained to the fourth quarter.

Unit manufacturing costs were moderately higher than the previous quarter with the severe weather conditions contributing to higher purchase wood and log hauling costs, as well as lower productivity. Canfor’s Pulp and Paper segment comprised the results of Canfor Pulp Products Inc.

As highlighted on Slide 7 of our presentation, the company reported a record high net income of $45 million, or $0.69 a share in Q4 2017, compared to net income of $30 million, or $0.19 a share for the third quarter and net income of $10 million, or $0.15 a share for the fourth quarter of 2016. Adjusted shareholder net income for Q4 is $48 million, or $0.73 a share, compared to $13 million, or $0.19 for the third quarter.

As you’ll see on Slide 8 of the presentation, Canfor Pulp’s results reflected the continued strong demand for global softwood pulp in Q4, in part reflecting new Chinese government restrictions on imports of recycled mixed paper. The average China NBSK pulp list price was up 29% from the previous quarter, resulting in improved sales realizations quarter-over-quarter.

Pulp shipments were broadly in line with the previous quarter with the benefit of a 14,000 tonne vessel shipment slippage from late September, being cancelled out by a vessel delay at the end of December due to the adverse weather. Pulp production was also in line with the previous quarter, as improved productivity later in Q4, largely offset an unscheduled outage at the Northwood mill future Chipley in the number five recovery boiler.

Unit manufacturing costs were consistent with the previous quarter. Operating income for the Paper segment in Q4 was $7 million, up $3 million from the previous quarter, with increased paper sales realizations and shipments more than offsetting higher slush pulp costs.

Capital spending in the fourth quarter totaled approximately $94 million, including $65 million for the lumber business and $28 million in Canfor Pulp. Our total 2017 capital spend was approximately $170 million for Canfor and $80 million, including major maintenance for Canfor Pulp.

For 2018, after taking into account of our a nine greenfield sawmill, we anticipated capital spending for lumber will be in the region of $340 million and for Canfor Pulp about $90 million. Consistent with the prior quarters, Canfor Pulp’s Board of Directors yesterday approved the continuance of a quarterly dividend of $0.0625 per share.

Also, in the fourth quarter of 2017, Canfor spent about $16 million on a share repurchase program, purchasing approximately 633,000 shares at an average price of $24.80. At the end of 2017, Canfor excluding Canfor Pulp had net debt of $174 million, with available liquidity of $356 million and Canfor Pulp had a net cash of $77 million, with available liquidity of $101 million.

Net debt to total cap – capitalization, excluding Canfor Pulp was just over 9% and on a consolidated basis 4.6%. 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. Thank you.

Hi, good morning.

Good morning.

Don, I was wondering how much flexibility do you have in the South to maybe modify some of your mills to make more 2x4, given the pricing premium versus the wides?

Yes, I think – it’s good question, Hamir. I think, for the most part, we’ve got a fair bit of flexibility.

And we’ve sort of built and focused hard on trying to work on diversifying our production to incorporate not only 2x4 with some other wider which too, because we in a lot of cases it provides a lot more opportunity for more of the higher-value products. So that’s what we’ve tended to do.

But yes, we’ve got – we can make more 2 before if we choose to. But at this point, the balance that we have today is probably pretty close to where we will be – what we will be seeing in the future, too.

Okay, fair enough. And Don, I want to talk about exports.

It looks like, I think, in your annual report that they were up year-over-year. Just curious given the strong pricing we’re seeing in the U.S.

How do you think about where those export volumes trend? And then maybe what’s the opportunity to grow exports out of the US South?

Yes. Well, first of all, I think, there – on the second part of the question, I think, there’s opportunities, or I know, Kevin, may want to talk about it a bit more here with you now or later.

But yes, certainly, we think a big part of what we’re doing down in South is in terms of where we’ve been trying to locate our mills. A good consideration has been to be close to tidewater, because we do believe there’s a significant opportunity.

In the past what we’ve found is in the U.S., there’s not – there hasn’t been an awful lot of folks on offshore and export business. But clearly, with India starting to become a bit bigger factor in some of their opportunities in Asia, we do believe there’s a material opportunity to increase shipments over there more and more.

Thanks on that. That’s helpful.

I just want to ask you about some of the labor constraints you’re seeing in the U.S. I know we’re seeing some of the builders explore factory-built homes.

Just curious how you’re maybe positioning yourself to serve that segment of market to – and maybe how big is that in terms of overall demand?

Yes, that’s – I think that’s the next transformation – transformation is going to take place in the industry frankly, Hamir, over the next five to 10 years, I mean, clearly, driven by labor and difficulties that are currently exist – that currently exist, but also more importantly, we’re going to get even worse, in our view, down the road here. So in the – the construction business in the U.S., I think, certainly, the major builders have recognized that themselves.

And I believe that we’re going to see more and more of them researching and actually developing more of the prefab plants and more industrial plants that will produce wall panels or trusses and so forth. I think, that’s a longer-term deal.

That’s probably over the next one, two to five years. But it is something – that model is in existence in Japan and most other countries frankly.

And so our belief is that that will continue to increase as we move forward as the construction industry transforms into more a factory-built housing.

Okay, great. Thanks, Don.

That’s all I had. I’ll turn it over.

Okay. Thanks, Hamir.

Thanks. Good morning, everyone.

Good morning, Sean.

Good morning.

A couple of questions, guys. So as we come back to this one every couple of quarters, but broader capital allocation question.

Canfor Pulp is trading less than four times trailing enterprise value to EBITDA. And I appreciate, we’re at the arguably closer to the peak of the pulp cycle.

But can you explain your thinking on allocating capital between discretionary growth in your lumber business, whether it’s a greenfield mill, or organic CapEx of the existing asset base versus buying Canfor Pulp back in at the Canfor level?

Yes. Sure, Sean.

We’ve been talking an awful lot about that as you can imagine over the last several months here. Maybe, Alan, why don’t you speak to Sean a little bit on the detail there you might find interesting.

No, for sure. Good morning, Sean.

So clearly, as you’ve detected from our recent press releases and just some of our general commentary, we’re very keen to grow our lumber platform most recently with its nice greenfield site. So US South clearly is a key focus for us as to is preserving our top quartile performance right across our whole fleet of assets in North America.

So the lumber business and related activities is clearly a big focus for Canfor and takes a higher priority than the other one I just highlighted. In term – I mean, in terms of Canfor Pulp, clearly, I think all of us have been pleasantly surprised by just very stronger markets even in the last six months, and even as we look out quite frankly through the first-half of next couple of quarters.

So our cash position is much better quite frankly than we forecasted even six or 12 months ago, and we’re very motivated to make that cash work. And so we’re very keen now to look more closely at growth and acquisitions.

We believe our balance sheet could support this quite comfortably today, whereas we may have had a few more reservations today even 12 months ago. So I think we’re feeling pretty good.

I think, growth for both lumber and our pulp businesses and that’s really the priority for us today, Sean.

Are you guys seeing pulp mills come to market for acquisition?

Right now we’re not hearing a lot of that. But our view is – our view, I mean, there’s not a whole lot of really high caliber pulp mills, we talked about this before in previous calls.

But listen, the way I look at it, Sean, is that we’ve got an excellent cash position and we are keen to look more closely as – particularly as we go through maybe some softness here in the back-half of the year, then that’s something that may come into play. The other thing is relevant to, of course, is the energy side of things we’ve done well there.

In terms of our investments, we’re very pleased with what we’ve done. And we do believe that there could be potentially more energy place that we want to look at more closely, particularly in the next 12 to 18 months.

Okay. Thanks for that, Alan.

And a question on the greenfield project in Georgia, and it seems like this is maybe a developing topic for you guys. But can you just speck to any recourse you might have with your contractor with respect to potential delays?

Any insight you can provide there?

Yes, Sean, it is real fresh. I mean, this is late last evening, as I think we might have mentioned and maybe not in our press release.

But yes, there’s nothing more than I can clear you onto this page, I mean, clearly, we – we’ve got – we’re looking into it further as we speak. And – but I – all I will say though is, as we learn more about it, we will definitely communicate it to everyone exactly our position.

But right now, I can’t really share too much more on it right now just frankly, because we’re still trying to make sure, we got all the right factor as well.

Understood. That’s all I have for now.

I’ll get back in the queue. Thanks, guys.

Thanks, Sean.

Good morning, Don.

Good morning, Mark.

I wonder just coming back to the greenfield down in Washington. Is that a – like – can you give us some sense, is that a – like a national or international contract?

I mean, would they have issues with being able to do that work in another location if you moved to a like a Plan B site?

Yes, I mean, potentially. But I mean, I think that the contractor is – for sure operates in and so pleasure interracially.

I think, if we chose to move, we don’t even understand that we chose or move yet. At the end of the day, we’re still trying to understand the situation 100% first.

But I think, the contractor may have other – there may be other commitments also. But at this point, literally, Mark, I’m not trying to dance around the question.

But we really got aware – we became aware of this late last night. So we really at this call early questions, but we really haven’t got all the details here frankly then.

But we will have them shortly, and Pat or Alan will certainly update all of you as we – as they become known here [indiscernible]

Yes. Can I just go back to sort of the original decision to kind of cite there.

And can you just give us a sense of sort of what were the critical factors for you in that location?

Yes, for sure. I know, there’s three really, I mean, there are two main ones.

But the two factors that are clearly the key considerations and that we did the most due diligence on a significant due diligence, that’s why it took so long to come to a conclusion is number one is residuals and residual off-takes, and that’s been a huge challenge for some companies down there. And so we recognize as we wanted to make sure wherever we went that we had that off-take, or at least the solar plant for that.

The other one is obviously people, right? As you probably heard maybe not.

And I – down there that’s getting tough everywhere and no different down there as we wanted to make sure we are in a location that was close to major metro areas of possible, where we had a larger base to draw from. That’s why we chose where we did, right?

So, those were the two main ones. Of course, the other one that we always have anchored any acquisition on is a fiber quality and volume sustainability.

There’s a bunch of smaller ones, like I mentioned earlier, I think around access to tide water and those sorts of things. But clearly, the residual piece and the employment piece and availability of human resources is probably the key ones.

Yes. Well, I can see where you would be very good for both residuals and for people, because you’re pretty close to the university Georgia there, as well as Augusta, I wondered though, Don, in regard to that site, I mean, we just had an announcement Tuesday night that Georgia Pacific was going to build an even bigger sawmill about 35 miles away.

Can you talk about sort of what impact that would have just in sort of fiber supply in that basket?

Yes, for sure. And we – for us, we’ve done – we began the work basically.

We – first of all, we knew that mill is there. We weren’t sure what was going to happen there.

But clearly, we built that into everything that – in terms of our planning there, Mark. So we felt and still feel that there is significant fiber of the quality and the size that we believe we need to run the mill.

So we’re not – we weren’t concerned about that at all and we’re still not 100%.

Okay.

So it’s just a really significant area for fiber and we actually – we made a trip down – well, several trips down there. But actually, we’re down there a couple of weeks ago with a couple of our Board members do and we had chance to see some of it firsthand.

But there’s clearly a lot of it down there. That’s what we put a lot of effort in the last six to nine months, assuming that there could be some changes there that actually materialized two days before we announced.

Yes. Okay, all right.

And then I wonder if we can just talk a little bit about Western Canada and you can give us some sense of kind of where that log costs you think are going to be moving in 2018? I’m just curious here, we know that supply has become more of an issue in the BC interior.

Yet, at the same time, we know there’s probably going to be a lot of salvage logging takes place after the fires. And I just wondered if you could kind of help us as we think about the puts and takes there?

Yes, for sure, Mark. Well, what I’ll do, I’ll pass it over to Stephen, because I know that him and his folks have put a lot of work into that exact question and concerns.

So, Stephen, why don’t you update if you don’t mind, Mark, around that?

Yes, sure. Okay.

Good morning, Mark. So, yes, obviously, as we’ve seen and you can see in our results, we will continue do experience log cost escalation in BC as a result of some of the fiber supply constraints in our post Mountain Pine Beetle area, as well as the implications of the forest fire season we’ve seen in BC.

And we see some of others reaching out into our traditional operating areas and some significant pressure on purchase wood, as well as lots of constraints related to weather and trucking capacity. There has been some significant challenges through Q4 in getting fiber supply to our operations, and those challenges have persisted through Q1, and we would anticipate continued upward pressure on log cost in British Columbia through the balance of 2018.

Okay. And then see what if I could just the big uptick that we’ve seen in like SPF pricing.

To what degree is that thrown a lifeline to some marginal mills, mills that you might have expected exit the market over the next year or two?

Yes. So good question, Mark, for sure.

And I think, our position would be that there is certainly – there’s a need for a capacity rationalization in British Columbia that’s better aligned with the available sustainable fiber supply. Obviously, the market conditions that we’ve got today in the U.S.

and quite frankly, in every market around the world are supporting operations and allowing people to reach out further, go further to get fiber supply and pay more, and we’re seeing that in some of the extreme bidding behavior in the province of BC. So I think, generally, everybody is making money today and has profitable operation.

So that is going to create some challenges, obviously, and have people operating longer. So it certainly has changed the picture.

We would still say now although that we – our belief would still be consistent that we think over the next two, three, four years here, and it’s kind of increasing their focus here, six to eight mills are going to need to shut here at some point.

Yes, absolutely, Don. We – the fiber supply won’t support that capacity that we have today, but it’s going to drag it out for a while.

Okay.

Yes, okay. That’s what I was getting at.

Last question I have for right now. Just Alan, can you give us some sense in 2018 here what we’re looking at for both kind of a reported tax rate, as well as where you think your cash tax rates are going to come in?

Yes. So I think without getting into lot of detail, we can maybe do a little bit of this offline, Mark.

But it’s very consistent with where you expect to go in light of the recent tax changes, both in Canada and the U.S. So effectively it is around 25% something like that just.

Okay. And then the cash rate?

Yes, roughly, it’s something in that order of magnitude as well.

Okay, that’s helpful. I’ll jump back in the queue.

Thanks, guys.

Thanks, Mark.

Yes, thanks very much. Good morning, guys.

Good morning, Paul.

Hey, just question on pulp. Sounds reading through the press release that you’re slightly optimistic over the next couple of quarters.

What do you see in the longer-term for softwood in terms of capacity adds, because I’m not seeing a lot, and I think the market could last a little bit longer in a couple of quarters?

For sure, Paul. Brett, why don’t you take that?

We see some class be coming on in Q2 and then further out. There’s not a lot of growth other than create in the existing mills, so pretty low growth.

And on that subject, what are you guys using as an assumption? Is that 1%?

Is that what you’re seeing in the Canfor mills?

Well, obviously, we want to grow anything we see as a good opportunity high-return project. But typically, over history, that’s about what we’ve seen, yes.

Okay. And then just flipping over to the lumber side on the growth idea and M&A opportunities.

We saw a pretty high benchmark evaluation last year with the Gilman transaction. Has that caused some of the potential sellers to ask for the M&A at this point, or are there still opportunities out there?

For sure, it’s had an impact. I mean, I think that maybe folks that weren’t interested before come back and say, if you’re willing to do this or that, they might be more interested.

But frankly, we’ve always kind of positioning here, we’re not over period. We’re not – and which would also cause us to look at other opportunities, such as Greenfield, right, Paul.

And so we’re going to – we’ll keep looking at it. But right now, we think the valuation are high and at this point, right?

So we’re just continuing to – we’re not – there’s no rush here. We – hopefully, this will – the greenfield that we’re talking about will come to fruition here, of course, and plus we add to that organic growth.

And we think we can build that a bit more economically through those channels and then possibly on M&A. Although, there – as things – we’re still looking at M&A as it comes up right and still the odd thing that pops up here and there.

But nothing at this point that I could tell you on anymore around any pending deal or so forth, right, so. But clearly, they’ve gone up the multiples for sure.

Okay. And then you guys mentioned India is a growing destination.

What kind of volumes do you sell into India in 2017? And what do you think you could do in like five years?

I’ll let Kevin talk about that. He was just there for the last couple of weeks.

And so maybe, Kevin, why don’t you fill everyone in on it.

Sure, Paul, thanks. Yes, I mean, volumes have been quite limited to date.

But what we see there is some really good opportunity in a lot of different segments be it furniture, doors and even some wood frame construction. So we’re quite optimistic about it in a five-year time period, but still lots of work to do there.

We’re seeing that softwood lumber and logs are starting to make a little bit more of an impact compared to five years ago. And we see that trend continuing and we remain optimistic about the opportunities in India.

All right. That’s all I had.

Thanks, guys.

Thanks, Paul.

All right. Thanks, operator, and thanks, everyone, for joining the call.

We appreciate your interest in Canfor, and we look forward to talking to you at the end of Q1. Have a good day.

See you.