Canfor Corporation

Thank you, operator and good morning everyone. Thank you for joining the Canfor and Canfor Pulp Q4 2018 results conference call.

I’ll make a few comments before I turn things over to Alan Nicholl, our Executive VP of Canfor Pulp operations and Chief Financial Officer of Canfor Corporation and Canfor Pulp. Alan will provide a more detailed overview of our performance in Q4.

Joining and Alan and I today are Kevin Pankratz, Senior VP of Sales and Marketing and Stephen Mackie, Senior Vice President of Canadian Operations. I would also mention that in January Kevin Pankratz assumed the responsibility for the sales and marketing of our Pulp group in addition to our Lumber group and Brian [Indiscernible] who has had several years of increasing responsibilities in our pulp group was appointed Vice President of Pulp paper sales and marketing.

Before I discuss the fourth quarter, I’d like to make a couple of comments about 2018. Canfor Pulp reported record operating income of $247 million and a return on invested capital of 37%.

Canfor Corporation reported operating income of $609 million, the highest in over 10 years and a return on invested capital of 19%. These results were achieved in a year which featured extreme transportation challenges, extreme weather events, significant forest fires, log supply constraints, significantly higher log costs, and market volatility.

Despite these many challenges, our people performed exceptionally well under these difficult circumstances. During the year, we completed our 100 million investments in Green Energy, upgrades at Taylor and Northwood.

In addition, our 350 million board foot, $125 million U.S. dollar organic capital program at our U.S.

sales operations remains on track to be substantially completed by the end of 2019. The spending includes large sawmill rebuilds at Camden and Moultrie, Georgia, a new planer at Fulton Alabama and continuous dry kilns at Darlington, South Carolina and Urbana, Arkansas.

Now turning to the fourth quarter, earnings were significantly impacted by a sharp decline in market pricing for both lumber and pulp with a consolidated operating loss of $79 million dollar. For Canfor Pulp, the company had a challenging quarter generating operating income of $16 million, which was down significantly from the third quarter, principally due to lower shipment levels reflecting repair work on our recovery boiler at Northwood, and a natural gas pipeline explosion near Prince George.

Total scheduled and unscheduled downtime reduced our NBSK production by 90,000 tons. Global softwood crop pulp markets are projected to remain steady throughout the first half of 2019, reflecting a forecast increase in demand in China and reduced supply due to the traditional spring maintenance period for our pulp mills.

Moving to our lumber business, we reported an operating loss of $88 million. Lumber production was down significantly in the quarter, reflecting a series of production curtailments in British Columbia and inclement weather in the U.S.

South which impacted log inventories, blog profiles and overall manufacturing cost. We have further curtailed our BC operations in Q1 by 90 million feet across our system, primarily at [Indiscernible] Houston and McKenzie due to continued log supply constraints, significantly increased log costs and market conditions.

We will continue to review our operating rates as market conditions warrant. Current markets have been challenging.

However, our outlook is for pricing to stabilize and gradually increase, which we have begun to see in early 2019. We expect a normal seasonal pickup in demand to coincide with relatively low inventory and supply chains and have seen strong increases in both our retail and builder business.

Demand from offshore markets continues positive after a strong Q4 and expected to remain solid through the first quarter of the year. Overall supply continues to be impacted in BC with an estimated 1 billion board feet of announced temporary or permanent capacity reductions.

We are encouraged that a memorandum of agreement for a new five year term has been reached with the USW. The agreement includes seven of Cantor certified mills in British Columbia.

The USW will be conducting ratification votes on the agreement over the coming weeks. In addition, we have three mills represented in the negotiation process being led by the Interior forest Labor Relations Association.

We remain optimistic that a settlement will be reached between the Association and the USW. Transportation networks have been generally good.

But we are seeing increased challenges due to significant cold weather in parts of Western Canada. With respect to our previously announced Greenfield mill in Washington, Georgia we are deferring any decision on this project to the end of 2019.

This decision is based on challenging market conditions and inflationary cost pressures. In terms of softwood lumber agreement, there are currently no negotiations underway.

In early December, a NAFTA panel was formed that includes three Canadian and two American panelists. We'll be following the decisions of the panel very closely.

Finally, we are anticipating closing the VIDA transaction shortly. We are extremely excited about our investment in Europe, as it further diversifies our business from both a geographic and product profile standpoint, and earnings profile that is much more consistent than what we typically see here in North America.

This purchase supports our long term strategy of growing our high value and non-commodity lumber businesses, and further positions the company for strong, stable earnings in the future. I will now turn the call over to Alan Nicol, who will provide an overview of our financial results.

Well. Thank you, John and good morning everyone.

My comments were focused principally on our financial performance for the fourth quarter by reference to the previous quarter, and full details of our results are contained in the Canfor Pulp and Canfor news release, 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” and the presentation highlights, consolidated and segmented results.

And I'll be referring to this presentation during my comments. For the fourth quarter of 2018, Canfor reported to shareholder net loss of $52 million or $0.42 a share, down from net income of $125 million or $0.98 a share reported for the third quarter and net income of $132 million or $1.02 a share reported for the fourth quarter of 2017.

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 fourth quarter of 2018, these items totaled $24 million, the largest being a $29 million expense really related to Countervailing and Anti-Dumping Duty deposits.

After adjusting for these non-operating items, the shareholder net loss was $28 million or $0.23 a share for Q4 compared to net income of $167 million or $1.23 a share for the third quarter. As highlighted on slide six of our presentation, the lumber segment recorded an operating loss of $88 million for Q4, down $237 million from the previous quarter.

After adjusting for CVD and ADD as highlighted on slide 5, as well as an inventory write down of $37 million at year end, the Q4 operating loss was $11 million down $203 million from a similarly adjusted operating income of $192 million in Q3. The major variance reflected substantially lower Western SPF and Southern Yellow Pine lumber prices, which translated into materially lower unit sales realizations.

These declines were accompanied by higher unit log costs in Western Canada and lower production and shipments. The significant price erosion reflected slowing North American demand coupled with excess inventory in the supply chain.

The North American Random Lengths Western SPF price averaged US$327 per 1000 board feet down some 32% from the previous quarter, while prices for other grid saw a more moderate correction. Southern Yellow Pines sales realizations reflected a 6% decline in the benchmark 2 by for price, but declines in a wider wood dimensions were more pronounced some of which was attributable to seasonal factors.

As a result of these weaker market conditions as well as log supply constraints and allocated log costs, the company took approximately 100 million board feet of curtailment at BC lumber operations in Q4. And this was the primary contributing factor accounting for a 12% decline in production, and a 14% decline in shipment of volumes in the quarter.

The higher unit manufacturing costs in Q4 reflected a 10% increase in Western Canadian log costs resulting mainly from the timing of market via stumpage increases, higher purchased wood costs, and log supply shortages, as well as lower productivity in both regions reflecting both the impact of curtailments in BC as well as weather related challenges the company's U.S. site operations.

Log costs in the U.S. site remains stable through the quarter.

Canfor's Pulp and Paper segment comprises the results of Canfor Pulp Products Inc. As highlighted on slide 7, the company reported net income of $14 million or $0.21 a share for the fourth quarter of 2018, compared to net income of $43 million or $0.66 per share for the previous quarter.

Slide 7 highlights the Q4 financial results reflected the continuation of their scheduled maintenance outage at Northwood from the previous quarter. The previously announced compares to Northwood’s number five recovery border, on schedule downtime taken as a result of a third party natural gas pipeline explosion in Prince George just in -- early in the quarter until a lesser extent several other operational challenges during the quarter, all of which reduced NBSK pulp production by approximately 90,000 tons.

In addition, BCTMP production was impacted by a seven day curtailment in late December as a result of reduced residual fiber availability following various supplemental curtailments in the region. At the end of December and into January, the company experienced kiln related operational disruptions at two of its NBSK pulp mills.

While these challenges have not been resolved, the related production loss was approximately 20,000 tons early in the first quarter of 2019. Unit manufacturing costs in Q4 were significantly higher than the previous quarter as a result primarily of the lower Q4 production as well as higher related maintenance, energy and chemical costs associated with unscheduled outages particularly at Northwood.

Sales realizations were broadly in line with the previous quarters as weaker U.S. dollar and list prices to China were partially offset by higher list prices to North American and proportionately higher shipments to the U.S.

until lesser extent Europe. Operating income for the Company's paper segment in Q4 was $4 million, up slightly from the previous quarter reflecting solid operating performance of the Company’s PG [ph] paper machine and steady paper unit sales realizations.

Capital spending for the fourth quarter totaled approximately $140 million and included approximately $100 million for the lumber business and $40 million in Canfor Pulp. In 2018 capital spent totaled just over $400 million and priced $272 million for lumber and $121 million for pulp.

As Don mentioned, the company continue to execute on the US$125 million organic growth program, targeting an additional $350 million board feet of production in the U.S. And we remain on schedule to have this program substantially completed by the end of this year.

Including organic growth, our 2019 forecasted capital spend is approximately $300 million with approximately $190 million for lumber and $110 million for pulp. At the end of the year, Canfor excluding Canfor pulp net cash of $246 million and drawn debt of $408 million.

This $450 million of available liquidity under its operating line as well as additional 100 million Canadian dollar and a US$100 million term that facilities both of which are currently undrawn. All of our operating and term credit facilities now go out to 2024 or later.

It's currently contemplated that the feeder [ph] acquisition price will be paid from the Company's cash on hand, the additional term debt facilities and the balance from the operating line. We are currently forecasting Canfor’s net debt to total capitalization at the end of Q1 to be approximately 30% when we typically have our peak log inventories.

This is significantly below the level at which any financial components would kick in. And while these debt levels are relatively high with the Canfor standards we anticipate a healthy reduction in the second quarter as our Western Canadian log inventories consumes during spring break up.

Canfor pulp had net cash of $7 million with available liquidity of $99 at the end of the year. Net debt to total capitalization excluding Canfor pulp of 7% and on a consolidated basis was 6%.

Yesterday, Canfor Pulp's Board of Directors approved the continuance of a quarterly dividend of $0.0625 a share for the fourth quarter and finally the right information, our earning in 2019 will reflect the transition to new lease accounting standards. And as a result our EBITDA is projected to increase by approximately $30 million for lumber and $1 million for pulp.

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

Right. Thanks Alan.

So, operator, we are now ready to take questions from the analysts.

Thanks. Good morning, guys.

So, I understand the Western Canadian lumber production this quarter. You took 100 million board feet of downtime related to markets and fiber availability constraints.

Your production was down 130 million board feet sequentially in Western Canada as the rest is holiday shuts and that's the component we would expect to come back in Q1? Is that the right way to think about it?

Yes, no, for sure Sean, maybe I’ll get Steve to give you an update on our current and forward planning around their shutdowns.

Yes. Sure.

Thanks, Don and good morning Sean. Just in terms of the gap between 100 million capacity reduction and 30 million, incremental 30 million that we were off there, some of that was just operational challenges related to the fourth quarter winter weather, log profile and delivery issues as well as we work through the USW negotiations and some operating rate changes in terms of labor disruption that were associated with those negotiations.

Okay. So, the tough weather extending into Q1, if I'm thinking about 90 million board feet tied to weak markets and log availability issues.

There could be incremental curtailment on top of that related to weather that sort of stuff?

In terms of the forecast for Q1, I think what I would say there, Sean, is that, we did take additional capacity reductions as you say, for the 90 million. We have experienced some extreme weather conditions as we work our way Q1 here that have had some impacts and we’ve only just recently included and are pleased as Don indicated in his comments with the memorandum of agreement we signed that impacts majority of our USW certified mills.

So we’re hoping that a lot of that will be behind us as we work through the balance of Q1.

Okay. I think you said Western Canadian log cost were up 10% sequentially.

Can you give us a sense of how you’re expecting your log cost to trend over the short to midterm in Western Canada the next few quarters?

Sure. Sean, Stephen here again.

I’ll tackle that one. So, we did see 10% as Alan referenced in quarter-over-quarter increase in Q4.

We were expecting those trends to kind of continue through the balance of 2019 compared to what we saw in 2018. Q4 numbers were disproportionately a little bit high in terms of that increase as we prioritize shipments of some purchased wood and deferred quarter deliveries to capitalize on a softwood reduction that was coming due here in January.

We are anticipating lower stumpage for the first half of 2019 as a result of the market conditions that we experience in the back half of 2018. But then stumpage will increase again in the second half of 2019.

So, all-in-all, we do expect continued upward pressure on log cost in British Columbia and we would expect that trend to continue until we see some material rationalization and permanent capacity reductions.

Okay. And maybe to that point Steven, you guys more referenced potential for permanent shuts I suppose in this call.

But your thoughts on how much more supply and the interior needs to come out permanently across the industry to right size the production base to the fiber resource going forward? Do you have any thoughts there?

Sean, its Don. Just on that as we’ve kind of talked about before.

Our view has been and continues to be in total that we believe there has to partially seven or eight mills that need to go. We have about 2 billion overall roughly in terms of production.

So, it's depend on size of the mill gives you bit of a sense overall. What we’ve seen so far between -- like I mentioned I think in my comment, maybe I didn’t, but in terms of the permanent shuts and what we seeing so far it relates to about a billion of that, the lot of that’s not permanent of the rate.

So we still think there’s a fair bit of rationalization that has take place and certainly with the way things are looking right now and the challenges of British Columbia, we think that might be – maybe advanced and we may see some of that, not ourselves but I think we’ll see that across the industry more in probably 2019 than we would have originally thought.

Okay. I’ll get back in the queue.

Thanks very much.

Thanks, Sean.

Good morning, Don, Alan.

Good morning, Ketan.

First question, can I just talk a little bit about housing upfront on right now and back half of last year, but in the last couple of months rates come down a lot and we’ve had affordability to last year. Can you talk about what you guys are seeing right now in terms of activity and your expectation for the spring season?

Sure. It’s a Kevin Pankratz here and you’re right, we did a little bit of a pause in Q4 on housing, but our expectations is that housing is going to come in around 1.26 for the year.

I think we’ll get a final results here next week on February 26 when we get the actual confirmation. But that is our expectation.

And for 2019 based on our intel and conversation with customers we expect to see a modest pickup for 2019, maybe approaching [ph] 1.3.

Ketan, maybe one thing to add, Kevin, to that is because it’s interesting and it’s actually a bigger consumer of lumbers on a retail side. And we through the back half of the year and we’re seeing that continue into Q1 also is a very positive numbers in terms of DIY side of the business or retail side of the business with the big boxes and the home-depot [ph] and those types and that's encouraging.

And it's been a significant increase. They're more than we've seen in past years.

So that gives us a lot of good – a fair bit of encouragement in terms of trying to gauge consumer confidence and the consumer sentiment going forward. And so, I guess that maybe the only thing that would add to that in addition to the comments or that Kevin responded to around the home building site about it.

Got it. That's very helpful.

Can you also talk a bit about offshore demand in China, both in lumber as well as in pulp?

Well, maybe Kevin, you can – why don’t you answer that one.

Sure. On the on the lumber side here, we've actually seen some pretty good demand here really picking up in Q4, where we've had significant increase in our shipments starting really being impacted in November and December.

And based on our current order filed, we have that trend continuing well into Q1 and into April. So, pretty strong demand in order files in place for China from the lumber perspective.

And Brian, maybe just a comment on the pulp side.

Sure, Kevin. Good morning.

Yes, on the China side, we saw the market bottom out at the end of 2018. Since then we've seen that the market has stabilized, and in fact as China comes back to rebuild their pulp stocks, we've seen an uptick in softwood demand.

So we anticipate that moving forward, optimistic that prices will be trending up.

Got it, that's very helpful. And then one last kind of clean up question.

This is regarding the duties. So we saw a pretty saw sharp drop in Western SPF prices, your volumes of SPF were also down quite a bit, yet the duties were down only two million quarter-over-quarter.

Now, what am I missing?

Yes, good morning, Ketan. So it's a fair question.

So the duties in Q4 reflected a higher ADD with that applied not just to the quarter but actually to the 18-month period under review and that was largely a factor of dynamics in BC, principally the higher cost and the lower pricing. We did offset that Ketan as you probably gathered by shipping more offshore and obviously the production curtailments were just in line to be shipped in the quarter as well.

So hopefully that helps answer your question.

It does. That's very helpful.

I’ll turn it over. Good luck in 2019.

Yes. Thanks very much, Ketan.

All right. Thanks operator and thanks to all of you that were on a call.

We appreciate your interest in Canfor and we’ll talk to you at the end of Q1.