Canfor Corporation

Thanks very much, operator. Good morning everyone and thank you for joining the Canfor and Canfor Pulp quarter three 2019 results conference call.

I'll make a few comments, before I turn things over to Alan Nicholl, our Executive Vice President 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 quarter three.

Joining Alan and I today are Kevin Pankratz, our Senior Vice President of Sales and Marketing; Stephen MacKie, our Senior Vice President of Canadian Operations; and Brian Yuen, our Vice President of Pulp Sales and Marketing. As everybody is aware in August, Great Pacific made a non-binding proposal to acquire all the outstanding common shares of Canfor.

Canfor's board of directors has formed a special committee of independent directors to review the offer in consultation with its legal and financial advisors. The decision to proceed or not proceed with the proposal is in the hands of the special committee and ultimately the shareholders if recommended by the special committee.

While that process is underway, we continue to focus on operating our business as usual and unfortunately do not have additional information in regard to timing or outcome at this time. As such, we cannot speculate on either the timing or the decision to proceed or not during this call, as I'm sure you all will understand.

Moving to our specific Q3 results, the quarter was challenging for both our pulp and lumber businesses, resulting in us having to make very difficult decisions that involve temporary and permanent curtailment in British Columbia. On the pulp side, we took base lumber curtailments at our Intercon, Northwood and Prince George NBSK mills, as well as at our BCTMP mill in Taylor.

While these curtailments are difficult, we believe they will support a quicker market recovery in addition to solidifying our chip inventory over the winter months. On the lumber side, we made a very difficult decision in July to indefinitely curtail our Mackenzie sawmill.

At the same time, we also announced the permanent elimination of one shift at our Isle Pierrre mill and we announced a temporary sawmill curtailment mostly in July and September. We have not taken any of these curtailments decisions lightly.

However, they reflect a very challenging lumber market conditions in combination with high fiber costs in British Columbia. On behalf of myself and the entire executive team, I want our employees to know that we deeply regret the very real impacts these decisions have had on them, our contractors and the local communities.

With the exception of Mackenzie, all of our sawmills and pulp mills are currently operating. Now we'll go into a bit more detail on each of our business lines.

Beginning with our pulp business. We were challenged with weak global pulp market conditions, significant market related downtime and fiber supply issues in British Columbia.

This was a third straight quarter of weak demand, combined with excess inventory in the supply chain, most notably in China and Europe, which significantly impacted global pulp prices. On the positive side energy revenues increased in Q3, largely driven by Northwood's new turbo generator condensing turbine and higher energy prices.

Looking forward it is expected that global pulp pricing will gradually improve in Q4 and into 2020 as global inventories will come back into balance. Moving to lumber.

In June, we announced the permanent closure of our Vavenby mill and subsequent agreement with Interfor to sell them the associated tenure for $60 million. The tenure transfer is subject to approval by the Minister of Forests, and we continue to work through that process.

We anticipate the sale will close in Q4. SPF pricing continued to be challenging in Q3 with excessive inventory impacting overall price levels.

While several industry curtailment announcements were made over the last six to nine months. We believe we are just now seeing the impact of these curtailments in the market.

U.S. housing starts increased modestly over the quarter and we anticipate that that trend will continue to the balance of the year.

Lumber prices in Asia, particularly in Japan are expected to return to more normalized levels in Q4. Our lumber operations in Alberta, the U.S.

South and Europe remain strong. The price of Southern Yellow Pine remained steady over the quarter.

Although our sales were slightly lower than last quarter. Our European lumber business saw tempered pricing in the quarter as a result of global market weakness, but was somewhat insulated from broader pricing declines due to the relatively higher value customized products that beta produces.

This pricing pressure is expected to continue to the balance of the year and should stabilize in early '20 as global inventory levels continue to come back into balance. We remain focused on continuing to reduce our debt levels and continue to strengthen our balance sheet.

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

Well, thanks, Don and good morning everyone. As Don mentioned, the Canfor and Canfor Pulp quarterly results were released yesterday afternoon.

These results come together with our quarterly overview slide presentation in the investor relations section of the respective companies' websites. In my comments this morning, I'll expand a little on a number of Don's points and also speak specifically to several quarterly financial highlights.

Our Lumber segment reported an operating loss of $70 million for Q3, compared to a loss of $61 million reported for the previous quarter. Results included a net duty expense of $54 million restructuring costs of $6 million and a $5 million reversal of a previously recorded inventory write-down provision.

After adjusting for these items, the lumber operating loss was $16 million. Lumber segment results continued to reflect the ongoing weakness in Western SPF lumber prices, high duties and elevated log costs in British Columbia.

As Don mentioned, Canfor took significant market related curtailments and capacity reductions in Q3 and as a result, shipments were down by 16% compared to Q2, while overall sales revenue declined 12%. Average Western SPF sales realization saw a modest increase from the prior quarter, largely reflecting a small increase in benchmark prices and our sales mix.

For our U.S. side business, average sales realizations were slightly lower than the previous quarter as a modest improvement in a 2x4 #2 price was more than offset by lower prices for wider-width dimensions.

European sales realization saw small decrease with the region's higher value sales mix, partially offsetting a decline in European benchmark prices. Our pulp and paper business reported an operating loss of $44 million for the third quarter, down $62 million from the $18 million profit reported for the second quarter.

The loss reflected a very weak global pulp market conditions that Don mentioned, as well as the significant fiber supply disruptions from industry wide, sawmill curtailments in the BC Interior over to summer months. Average sales realizations were well done compared to the second quarter reflecting this backdrop.

Pulp production was down 43% from the previous quarter, principally reflecting the impact of 135,000 tons of market related downtime. Pulp unit manufacturing costs were significantly higher in the current quarter, largely due to the curtailment and to a lesser extent the advancing of some planned maintenance work during the downtime.

Fiber cost showed a small decrease quarter-over-quarter with the impact of lower market prices for sawmill residual chips tied to market pulp prices, helping to neutralize the effect of an increased percentage of higher costs for last year. Capital spending for the third quarter, totaled approximately $76 million and included approximately $50 million in the lumber business and $26 million in Canfor Pulp.

For 2019, we are forecasting a total capital spend of $180 million and $80 million for Canfor and Canfor Pulp respectively. We currently anticipate much lower capital spending in 2020, following the completion of our U.S.

$125 million organic growth program and several other major upgrades by early 2020 and our strong focus on their production. During the third quarter, Canfor increased its operating line of credits from $450 million to $550 million, maturing in January 2024.

In addition, Canfor Pulp extended its operating line of credit through 20 April 2023 and added a new 3-year $50 million term loan expiring September 2022. At the end of the third quarter, Canfor, excluding Canfor Pulp at had net debt of approximately $1 billion and a scalable liquidity of just over $300 million.

Canfor Pulp ended the third quarter with net debt of approximately $30 million with available liquidity of just under $100 million. And lastly, Canfor Pulp's directors approved the continuance of a quarterly dividends of $0.625 per share for the third quarter.

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

Thanks, Alan. Operator we're now ready to take calls from our analysts.

Thank you.

Good morning, Don. Good morning, Alan.

Good morning.

Good morning, Mark.

Don, I know you can't really say much about this Patterson, but I'm just curious if it is possible to put any color around the selection of Greenhill as the advisor. I've been doing the -- covering the sector for about 30 years, they have not ever been a real active player, a real knowledgeable player around this sector.

So I'm just curious about how that decision might have been made?

Yes, I guess, first of all, I can't say much at all, Mark, as you probably understand, as I mentioned earlier, I just know that they went through a process, the committee and I wasn't involved in it. And so they chose Greenhill.

And that's all I can really say.

Okay. All right.

Fair enough. I wasn't sure you really -- okay.

Alright. Let's turn to the business then.

First of all, I wondered if you could talk about just sort of lumber demand at the moment and how you guys see kind of lumber inventories in the channel?

Yes, okay, I mean, I'll talk a bit about that at a high level and turn it over to Kevin who's bit closer to it, a lot closer to it actually than I am. But I think like everybody else we've been over the last few quarters concerned as to where that was headed.

But it does and because it's been several false starts over the last probably couple, three quarters. But we are seeing -- and partly because inventory levels, we think are starting to decline a bit more rapidly.

Now, it's taken some time, due to these announcements that were made, six or nine months ago, it's taken a lot longer to see that in the supply chain that we would have anticipated. And so -- but we do think now, we're starting to see the result of that.

And so that combined with, pretty decent housing starts and permits in North America, a bit of an improvement in China around inventory levels and in Japan, just over there recently seems to be pretty good. So between all those things, demand wise looks it's not a big increase, but it's -- at least it's sort of, I think it's started to at least look a little bit more positive.

And supply is -- supply we're starting to the inventory starting to have an impact on that. So that's kind of so overall right now going forward, I think we would see things, probably looking slightly better over the next couple of quarters.

Kevin, you were over there recently yourself in China in particular.

Yes, so we're seeing some good inventory, depletion at the major ports. And to your point there, Don, we're starting to see a little bit more tension in the market compared to what we have seen earlier in the year, which I think is just boasting for a little bit more of a positive uptick for the balance of the year at this point in time.

Okay, then Don I wondered if we could just talk for a minute about this European spruce beetle and the impact of that on the beetle business over in Europe, and then also sort of any ripples into the southeast US lumber operations and also potentially into your Chinese export markets?

Yes, for sure. Well, I can say this at the start that the beetle issues that's being faced in Europe right now are probably more severe than most people probably have had expected them to be.

And so in Germany, Austria, and certainly all of Czech is pretty serious, right. And so, as a result of that, there's a lot of log, a lot of the fiber there's been -- has been and will be degraded quite significantly, which is resulting in more commodity products being produced.

For -- some of that's going into North America, obviously, some of that's going into China and so forth and just having some impact. If you look at the North America though, particularly compared to where it was 10 to 15 years ago, when we were importing in the past, nowhere near the same amount.

We still don't see anywhere near the same amount of volume coming into North America that we saw back then, and we don't -- and neither do we expect that to happen either. There's been a bit more in China too, but it's even there, it's not really having a significant impact on our business for sure.

In terms of -- a good questions, how does that look, how's that going to impact us in Sweden. Actually, I mean the one thing as we -- and we went through exactly the same thing, when we got into this booth or the pine beetle in British Columbia, there what we just saw as pretty quickly an immediate reduction in the amount of prime percentage and premium products.

That's exactly what's going to happen in Europe as well, who in the past has been pretty significant high value product producers in Europe. So in Sweden, because we don't have the beetle or is the 1% or less there mostly probably less.

We actually think with that reduction in high value products coming out of Austria, Germany and Czech is actually going to benefit us up there in Sweden, because they don't have to deal with that and they do mostly make high value products. So it actually, for us at least we'll have that.

We think a positive impact on our Swedish returns on a long-term basis.

Okay, and just one more for me. I wondered Alan, when we look at sort of the first three quarters of the shoot out here with Vida, the numbers have been coming down steadily.

I wondered if you guys can just address sort of whether this changed your view of earning stability at Vida. And also in the third quarter if you could just help us understand how much of a decline was kind of price versus the summer outages?

Yeah, I hope I can help you a little bit there, Mark. In terms of your first point, I think clearly as Don guided there's somewhat downward pressure there.

But I think we're comforted I think with how well those businesses are running. We are seeing low cost respond accordingly.

So that's clearly going to be mitigating impact. But I think it is probably appropriate caution for some conservatism in your numbers, but I think we're comforted by some of the mitigating factors there as well.

In terms of the third quarter as I think we disclosed in our press release, Vida did take a month's downtime. And clearly that weighed on their shipments and the cost and so on.

So, one just has to take that into account. But as I mentioned earlier, our sales mix in some of what Don outlines clearly helping us mitigate some of the impacts from more of the commodity pricing movements in Europe today.

Okay, I'll turn it over. Thanks.

Thanks, Mark.

Thanks. Good morning everyone.

Few questions. First, on the timber sale to enter for you guys indicated you still expect or you do expect a Q4 close.

This is dragged on a little bit longer than initially thought. Could you give us a little bit more detail on the process with the government approval and what have been the hang ups and what gives you confidence that this will close in the fourth quarter?

Yeah, I think first of all, we're confident that it will close in the first quarter or fourth quarter. Sorry, I'll say that right away.

I think, we expected this thing to maybe close maybe a month or two quicker than it has. But clearly, I mean us being the first ones to really go through these processes, as you go through it, there's some things that you learn and things that maybe take a bit longer than you thought, perhaps.

But we really, at the end of the day, so far, it's kind of gone as we expected. I don't think we've had any major surprises at all.

Some areas we've probably had a little more work into and so forth, but for the most part, I think it's kind of -- it's just, other than taking a bit longer we haven't had any real big material surprises whatsoever. And then as we I said at the start, we do expect it to close in Q4.

Okay, thanks for that. And then question on the pulp operations.

Post the heavy downtime you had in Q3; can you give us an idea of what percent of the fiber will be tied to whole log chipping on a normalized run rate going forward? And an update on the cost differential between whole log chipping and residual chips right now?

Yeah, it's a good question there Sean. So I think clearly what I would say is that the actions is tough as they were in the third quarter positions us well here to run through the winter months.

And we're in a much, much better position and clearly had to take responsibility. In terms of your question around a whole log chipping, I would say that historically it's been a lot lower than it is today.

But looking forward, I think you could use something like 30% or a third. That's what we're kind of anticipating, something like that.

And the cost differential between that and residual chips right now?

Well, yeah, so it really depends on many factors. And clearly, we're motivated to apply a lot of cost discipline there as well.

But it's a fair statement to say it comes out of healthy premium to some of residuals today.

No, no details on that Alan. That's as much as you're prepared to say.

Not anymore that I can share with you, no, not on the call, no.

Okay, that’s all I have for now. Thanks guys.

Thanks Sean.

Yeah, thanks very much. Good morning guys.

First question just, maybe just on the log cost side, what you’re seeing whether you’re seeing any replacement in the U.S. federal?

I suspect bidders’ costs are coming down slightly and then, Alberta versus DC?

Steve, you want to give an update on cross-border regions?

Sure, yeah hi good morning, Paul. So I think, I’ll start in BC Paul and maybe contrast against Alberta.

I mean, clearly there’s a stumpage differential between BC and Alberta, so we enjoy that benefit in our Alberta operations. You’re aware obviously that the July 1st stumpage increase was pretty significant in British Colombia.

But we’re pleased with some of the actions we’ve taken internally to mitigate those impacts. So relatively speaking quarter-over-quarter pretty flat log cost.

And starting to see some relief in British Colombia on pressure on purchased wood prices, and big behavior differ in terms of BC PF sales, which we’re seeing a little bit of benefit from, so we’re expecting relatively flat log cost in BC. And similar situation in Alberta.

Alberta will be pushed up a little bit as market improves as Kevin and Don indicated earlier. The guys have touched on Vida; we’re seeing corresponding reduction in log cost that reflect market conditions and d downward pricing pressure that Don indicated.

So, in Europe we’re pretty pleased with d responsiveness of the market. And U.S.

south is really quite flat, there’s abundant of timber n high quality fiber available there, so flat.

Okay. And just maybe just a follow up on the BC.

You’re expecting log cost to be flat going forward. But my understanding was you did quite a bit of logging in front of the July 1st stumpage increase.

So even that can be a that increase will be effective on August cut that you’re logging through the balance of the year and in the first half in next year, won’t that increase your overall cost?

Yeah, we’re expecting. There’s some upward pressure there for sure Paul.

And we’re in pretty good shape with healthy inventories, obviously we’ve taken some pretty significant downtime in capacity reductions across our operations and taken lots of steps to reduce some of the high cost target that we’ve got into our mills. So, we’re confident we can offset that to a large degree.

So, I think I would guide to relatively flat quarter-over-quarter log cost.

Okay, and then maybe just flipping over the pulp side. Pulp costs were up significantly quarter-over-quarter, a lot of it attributed to downtime.

Just wondered, how much, like how much can we put on that market related maintenance downtime in terms of the cost increase quarter-over-quarter?

No, totally fair question Paul. I mean, I think honestly the lion share of that delta was I think, the maintenance, the transiting of the plant maintenance work was a smaller percentage, just to put in the context of $7 million or $8 million.

But I think the principal reason clearly was tied to the curtailments.

Okay, and just while I get on. Sounds like you guys were more bullish and mostly other people I’ve seen out there on hope turnaround here are you expecting any gradual increase in pricing in Q4?

What gives you that level of confidence?

Yeah, so I’ll maybe pass it over to Brian to speak to that. But I think in our minds we didn’t think we’re being extremely positive by talking about the modest recovery, Paul.

But I’ll maybe just ask Brian to speak a little bit more to what we’re seeing in the market and why we’re expecting prices to trend here.

Sure, I can speak to that Alan. Good morning, Paul.

We’re actually seeing a stabilization in the market for sure, with the price corrections over the summer. We’ve seen an uptick in Chinese demand.

Paper board, tissue producers, these guys are all making solid profits, given the lower fiber costs. And there are relatively stable paper board, tissue prices.

We are in fact, actually seeing some modest improvements going into fourth quarter in Chinese pricing. What we are keeping a close eye on however are the hardwood inventories.

For sure, this seems to getting balanced before we see any significant improvement in pulp price.

Okay, great, thanks for the color. Good luck going forward.

Thanks guys.

Thanks, Paul.

Guys, just want to go back to these log costs because on Page 3 of the release, you talk about the increase in stumpage in BC and there’s a line in here that says this will materially impact BC log costs in the upcoming quarters. So, I just wondered if you can kind of square that with what we just heard about stable log cost.

For sure, Mark. I’ll get Stephen to comment on that.

Yeah sure, Mark. I think that while we certainly do expect pressure on stumpage and again back to the July 1st stumpage update and increase.

And we'll also see some further upward pressure as a result of improving market conditions and AMV updates that will push stumpage up. I guess it's a bit of a function of some of the actions that were taking internally to mitigate those costs.

And really that great effort by our teams across the BC business to be responsive to the economic times that we're facing and a lot of good work. So I'm probably a little bit more optimistic on what we're able to achieve there to try to try to mitigate those cost increases.

Okay. Any examples of things you can do?

Not, probably not a lot of stuff that I'm going to disclose here, Mark. But I think, fair to say obviously, the capacity reductions across BC our own and others' temporary and permanent, are having an impact on the purchased wood market.

And we're seeing a change in bidding behavior that is helping offset some of those high cost fibers.

Okay, that's helpful. Don, any thoughts on just sort of the potential for some rightsizing in Western Canadian pulp capacity just given the fiber constraints?

Yeah, but it's hard to say at this stage yet. But I mean, just like we've seen happen on the lumber side.

I mean, ultimately there is probably going to be some impact down the road yet. And we're certainly looking at that, aware of that, and watching that carefully ourselves.

But as Alan mentioned, I believe in his comments. I mean, we think with the work that we've been doing on our chip supply and our raw material supply for the pulp mills, at least for now, we can certainly move forward with the production levels that we have today.

Yeah, okay. That's, that's helpful.

I think that's it for me.

Okay, well, thanks, Mark. Good to talk to you.

Thanks, operator. And I look forward to talking to you all soon.