Canfor Corporation

Thank you officer and good morning. Thank you for joining the Canfor and Canfor Pulp Q1 2020 results conference call.

I will make a few comments before I turn things over to Alan Nicholl, 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 Q1 as well as the numerous initiatives underway to mitigate the financial impacts of this downturn.

I would like to start by thanking our incredible employees who are dealing with the unprecedented challenges of the COVID 19 pandemic with perseverance, resilience and an unfailing dedication to health and safety while at the same time focusing on executing on our strategy. In the last several weeks, our organization has been almost exclusively focused on our COVID 19 response.

Our top two priorities are protecting the health of our employees and executing on our strategy to sustain the business for the long term. In terms of our people, we quickly implemented a COVID-19 action plan which has continued to evolve.

This plan includes implementing physical distancing measures including at our facilities, having as many employees as possible work from home, restricting all travel, implementing cleaning and hand-washing protocols and implementing self-isolation and quarantine policies. As a result of the pandemic, we have had to take extended downtime across all of our operating regions with our sawmills in British Columbia impacted the most.

These are very difficult decisions as we know. They are having a significant impact on our employees, contractors, communities and customers, which we deeply regret.

Across our organization, our employees are making a number of very difficult sacrifices to ensure we are removing as many discretionary costs as possible. I also want to thank the federal and provincial governments who have provided additional support at this difficult time.

Turning to our markets and beginning with lumber. The company anticipates conditions will remain extremely volatile and challenging through the second quarter.

Global lumber market demand in recent weeks has declined sharply in the wake of the closures of nonessential businesses and lockdowns implemented in many parts of North America and Europe. The company currently anticipates that North American home construction activity will remain at reduced levels with significant regional demand volatility.

Following a steep reduction in pricing from mid-March through early April, prices have stabilized somewhat in response to a material reduction in supply in recent weeks. We are anticipating that the second quarter will have limited demand, particularly for April and early May.

Looking further ahead to the second half of 2020, it is anticipated that supply and demand balance will improve and support a modest improvement in prices later in the year. Lumber prices to China are seeing more moderate declines than North America, as that region is gradually returning to more normal business conditions following the early outbreak of the COVID-19 pandemic, while short term prices to Japan are anticipated to be in line for the current quarter.

European lumber markets and pricing are also being materially impacted by aforementioned global economic downturn and the company currently anticipates market conditions are expected to remain challenging through the second quarter before improving later in the year. Global softwood pulp demand is currently projected to be solid through the second quarter of 2020, particularly from China as that region continues to gradually recover from the pandemic, while containment measures across Western Europe and North America are forecast to weigh on market demand for printing and writing paper.

While pulp and paper operations are designated as essential services in many regions, it is projected that supply disruptions will continue in various regions as a result of the pronounced effects from COVID-19 on various business sectors, including lumber manufacturers. The current weakness in lumber markets is resulting in numerous sawmill curtailments in the BC interior and lower volumes of sawmill residual chips available to pulp mills.

So this brings with it the risk of additional downtime and not only the company's operations, but also across the industry. And with that, I will turn it over to Alan to talk about the quarter and some of the initiatives that we have underway to enhance our already sold liquidity position.

Well, thank you Don and good morning everyone. The Canfor and Canfor Pulp quarterly results were released Wednesday afternoon and come together with overview slide presentation in the Investor Relations section of our respective company's websites.

In my comments this morning, I will speak briefly to quarterly financial highlights and expand, As Don mentioned, on a number of initiatives that the company has put into place in response to the COVID-19 pandemic, a brief summary of which is included in our overview slide presentation. Our lumber segment reported an operating loss of $89 million for the first quarter of 2020 compared to an operating loss of $27 million for the previous quarter.

Results included a net duty expense of $44 million and $63 million inventory write-down provision that reflected a steep decline in lumber prices towards the end of the quarter and into early April. After adjusting for these items, the lumber segment generated operating income of $19 million.

Lumber segment results benefited from moderately higher sales realizations in North America, reflecting strong U.S. housing activity earlier in the quarter, as well as continued solid results generated by the company's European operations at an annualized rate of $90 million in the quarter.

However, as Don mentioned, these positives were overshadowed by the rapid deterioration in global lumber market conditions in March as the effects of COVID-19 spread globally resulting in significant price declines thereafter. Our pulp business reported operating income of $6 million for the first quarter compared to an operating loss of $24 million reported in the previous quarter.

Results for the current quarter reflected a solid operating performance as well as an $11 million recovery of a previously recorded inventory write-down provision. Pulp shipments were up 9% in the quarter reflecting a 4% increase in pulp production as well as a modest improvement in purchasing from China, particularly for tissue.

Pulp unit manufacturing costs reflected this improved productivity and slightly lower fiber costs in the quarter. As Don mentioned, in response to the unprecedented challenges presented by COVID-19, the company is undertaking a series of measures to mitigate the financial impacts from deteriorating global lumber demand.

These included extensive capacity reductions across all our operations, reduced capital spend for both the lumber and pulp businesses, as well as numerous initiatives put into place to support both company's financial positions through the pandemic. At the end of the first quarter, Canfor excluding Canfor Pulp had net debt of approximately $1 billion and available liquidity of $400 million.

Canfor Pulp ended the first quarter with net debt of $43 million with available liquidity of approximately $100 million. Looking ahead, Canfor's cash flow is forecast to benefit from a seasonal reduction in working capital in the second quarter and the receipt of approximately $125 million of tax refunds over the balance of 2020.

This combined with the reduced capital spending and the suspension of all nonessential overhead will improve the company's liquidity and help preserve its solid balance sheet position. For our pulp business, recognizing the material challenges facing the global economy and the supply disruptions resulting from extensive sawmills downtime that Don mentioned, Canfor Pulp's Board of Directors have decided to suspend the quarterly dividend for the foreseeable future as part of its cash preservation efforts.

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

Yes. Thanks Alan.

So operator, we are now prepared to answer any questions that the analysts may have.

Hi. Good morning.

Good morning Hamir.

Don, we have seen Alberta give a six-month interest-free deferral of stumpage dues? Are you seeing any signs that BC may implement a similar program?

Yes. Thanks Hamir.

We are looking at several opportunities in British Columbia around on the stumpage side. Clearly, that will be one of the options and alternatives that we are looking out and have had conversations about.

So it's a little too early to tell you the result of that yet, but hopefully we will see some positive responses on a few issues and possibly that one as well.

Great. And Don, could you give us a sense as to what you are seeing in the repair and remodel channel?

It seems like perhaps that's may be held up the best. And if you could just remind us how the pricing mechanism works for that book of business?

Yes, for sure, Hamir. And you are accurate there for sure.

I mean, the R&R business has been surprisingly resilient. It's a bit regionally based, though I will say, as it was not all over North America.

But certainly there is areas where it's really done well. From our own standpoint, it's up about 20% quarter-over-quarter, so pretty significant.

And so that's one area that we are pleased with and feel good about it is that whole R&R side. And you know, at this stage at least, we think that should continue going forward.

We have heard some pretty positive results there from some of our customers in that DIY space. So definitely a pretty decent looking picture there.

In terms of the pricing mechanism there, the way I think pretty much everybody is the same. We just have an agreed upon premium that we have over and above the random like prices to reflect the high quality product and the merchandising that we have to do for those products.

And it reflects a significant premium as a result of that.

Okay. Great.

Thanks Don. That's helpful.

Alan, I was wondering if in the financials in the COVID-19 risk section, there was some mention that depending on the duration and intensity of the pandemic, it could affect the valuation of your long-lived assets. How should we think about the conditions that would cause a write-downs of your mill carrying values?

Yes. Good morning Hamir.

I think what you saw in that section really is what would typically be expected in the risk and uncertainties area. I mean I think for now we were not concerned about that.

But clearly if a situation were to unfold that our mills were down for significant longer and we have to, in some cases, indefinitely idle a mill, those would be the sorts of triggers. Hence that would clearly warrant us to have a closer look at potential impairment.

It's not something today that we are particularly concerned about. It's just more that we have put it in as part of that standard disclosure.

Okay. Great.

And Alan, what's your sense as to the absolute bare bones CapEx of the business if we did have a prolonged period of weak markets?

Yes. Again, a fair question, Hamir.

I mean I think what we are guiding to for 2020 is probably close to bare bones. I think we could maybe take a little bit shift, a little bit off in terms of our lumber business.

Although my operating colleagues would probably have issue with that. But I think we could probably take a little bit off that.

But I think what we have got in there today, which is close to $65 million for lumber and $25 million for pulp is pretty much close to the bottom.

Great. That's all I had.

Thanks.

Thanks Hamir.

Thank you Hamir.

Thanks. Good morning everyone.

A couple of questions. I mean you are expressing, I guess, confidence in your liquidity position.

A couple of your competitors did expand available liquidity, one of them heading into the pandemic and one of them more recently. Are you guys pursuing any initiatives to further boost liquidity with additional borrowing capacity?

And more generally speaking, can you speak to comfort on your covenant headroom as we go through the next few quarters?

Yes. No, for sure, Sean.

Good morning. So I think, as I said in my opening comments, I think we feel that we have ample liquidity here to see us through this pandemic impact.

So today, I think we are guiding to north of $450 million liquidity by the end of the second quarter, clearly contingent upon certain things materializing as we expect them to. But at the same time, we are looking at a couple of near term opportunities, just to top up our liquidity and give us a little bit more of an extra cushion, if you will.

And so we hope to have new and updates on that before we get to the end of this quarter.

Okay. And then I suppose on of the other bright spots or relative bright spots are lumber demand is Asia right now.

Can you give us a sense over the next couple quarters, how much incremental Western Canadian volume you think you can move into Asia? And maybe the better way to ask it is, what was the percentage of volume heading there prior to the pandemic?

And how do you think that can trend into the summer?

Yes, for sure. Well like maybe in terms of, first of all in Japan, I will talk with Japan.

That's been consistent, Sean. We went into the year strong in the quarter and we were just basically sold out through the second quarter.

And based on production levels and whatnot, we are pretty -- at this point anyway, we are confident that Japan will continue to be relatively flat. Most of the business that we have in Japan is with a similar customer base and mostly end users.

And so it is pretty consistent, notwithstanding that there are some elevated concerns in Japan around COVID-19, as you will be aware of. And so we are watching that very closely.

But at this time, one thing about Japan is, you normally have a fairly solid order file that normally extends out there quite a long ways compared to other markets. So that's, from our standpoint, we are pretty comfortable there with Japan but watching it closely.

In terms of China, that has been again another positive surprise, as you articulated. Business, going into the year, we would have expected that we would have done in the neighborhood of 20% to 25% of our business there.

They have been much more active now with their recovery from COVID-19. So I heard of other and maybe even to a greater degree than ourselves, but you were to use 25% as a base, I think it's reasonable to expect that we could get, we could increase another 10%, if we chose to.

So it is, in one way, a bit of a back stop. There also is a bit of additional opportunities that we think we have to insure ourselves against additional weakness in North America.

Great. Thanks Don.

I will get back in the queue.

Okay. Thanks Sean.

Good morning Don. Good morning Alan.

Good morning.

Good morning Mark.

Just to start off, I wondered, Don or Alan, any update to kind of the Q2 production schedules that you have put out there?

Yes. Well, I think maybe, Alan, I will just touch on that here and you can talk about pulp as well.

But in terms of on the lumber side, clearly we are watching it real closely. I know that you are referring probably to the announcements we made up until May 1 and what's going to happen beyond that.

Currently, we are watching it very closely. I think I alluded in early part of the conversation here that we are seeing some areas that are a bit better than what we would expect.

But the decisions around that, we haven't made them yet. We are looking at hopefully and possibly making a couple of adjustments there going forward.

But as you can appreciate it, it's extremely dynamic and we want to make sure that we make a decision that we have got some sustainability there too in terms of increasing. A couple of quick things, maybe on that, Mark, that you might find helpful here is that, first of all, right now the supply and demand is extremely sensitive and we are watching that carefully also because we don't want to tip it in the wrong direction there.

Our internal analysis and analytics that we do is that we figure that 2020 demand overall will be down about six billion feet. That's what our number show us as a result of the COVID-19.

On the supply side though, we think there is corresponding decreases there that's going to be probably pretty close to that, if not a bit more than that but certainly in that neighborhood as well. So we figured, over the next month, two, three here that we are going to be in relative balance, so to speak.

So that's why we have taken a very cautious approach here in terms of when and if to increase production levels. But certainly, it is something that we are looking at on a daily and weekly basis.

It's helpful. It's very helpful.

I wondered, Alan, do you want to say anything about the pulp side?

Yes. No, maybe just to add to that.

So I think as Don outlined in his comments, clearly the pulp business is very much dependent on sawmill operating rates. And so clearly, we are not immune from some of the challenges that we have seen impacting us all, most particularly in BC.

And so we are tracking that very closely. I think we guided to the downtime at Northwood which just started yesterday and that will be for three weeks or just over three weeks.

But we are watching it closely, similar to what Don outlined for the sawmills, Mark.

Okay. And then just staying on pulp, I wondered if you can just help us in thinking about sort of medium term BC fiber supplies and what that implies for pulp mill capacity in BC?

For example, do you have adequate supply for your four mills, if we look out over the next two to three years?

Yes. Thanks Mark.

I mean I think as you may recall at our last conference call, I made reference to the fact that we have been successful procuring additional supply both on the sawmill side and sawmills residual chips side and indeed, more whole log chips as well. So we feel we are pretty good there.

I mean things are tight and I think every producer today, quite frankly, would say that things are tight and all of us recognize that as an industry, we don't have an abundance of fiber. But we watching the position very closely.

We clearly, I think, are going to be impacted by extensive curtailments. But then I think we are not alone in that regard.

Looking out, Mark, it's clearly hard to call and it's probably unhelpful to speculate too far. But right now, we feel as if got a reasonable balance.

Okay. And then last one for me on this ground.

I wondered if you guys can just walk us through kind of demand pricing and cost trends over Vida and particularly sort of where things are right now versus kind of the first quarter numbers?

Yes. I can maybe start with that, Alan.

I think, first of all, in Europe, I will say that after the quarter, we are definitely satisfied and actually feel good about the results in Q1 from our European operations. Clearly, January, as you might remember, we got off to a little bit of a rough start there because the weather was so serious there and also there was a lot of rhetoric around Brexit and so forth and a lot of speculation and so forth.

But it basically rebounded quite well in February and March. And while there has been some impact in some of the U.K.

business in particular, even there, it's probably I would say or our guys would say, it was a bit better than what we would have expected, particularly again on the home center side and the DIY side. And the other thing over there in Europe, because of the product mix that we manufacture over there, you have got a lot of alternative markets that you can go to, which is what we have been able to do there relatively well, for sure.

So in terms of the operational performance and as a result of COVID-19, we really haven't had any real impacts at all. We are running about 80% of our production right now.

We have got two mills that are curtailed. All the rest are running 100% capacity.

And we haven't had really any issues from an absenteeism point of view or COVID-19 impact point of view at this stage. And they are running it fairly well.

And the other thing I would say in Europe, just to fill out all the variables here, Mark, is around log costs. And one thing and I think we spoke about this before, Alan or I have, is that the one thing in Europe is they are very responsive to market prices.

So when market prices are under pressure or we see any kind of deflation on lumber prices, you typically see a corresponding albeit a bit of a lag reduction in log cost. And that's what we are seeing again.

And so that helps to preserve the margins that you are forecasting. So overall, I would have to say that in Europe, at this point, it's living up to what we expected and it's been relatively positive here and we expect that to continue at this stage at least going forward.

Okay. So Don, from what you said, then it's sort of 185 drop just year-over-year that you flagged in the release.

It is not corresponding to kind of a similar drop of like 1,800 bips in your margins over in Sweden. Is that correct?

That's correct.

And did I hear you say that the run rate in the first quarter for Vida equated to about $90 million a year?

No. I didn't say that.

What I said was, unless you read that somewhere, if you look at our assets --

I thought I heard $90 million in the commentary.

Yes. So Don, maybe I can jump in there.

So Mark, what we were guiding to there is obviously Q1 extrapolated there. and I think the point was to convey that, again, Europe, from our perspective, is still performing well and delivering very solid returns.

So apologies for any confusion caused.

Okay. It sounds good.

I will turn it over and jump back in the queue.

Okay. Thanks Mark.

Yes. Thanks very much.

Good morning guys. Just following up on Mark's R&R question.

You mentioned there is a difference regionally. Maybe you could go through which are the regions that are strong that you are seeing and where are the areas of weakness?

Yes. For sure, Paul.

Right now, certainly the Southeast continues to be, the takeaway there is relatively strong. Certainly, the Midwest has been good.

California is picking up somewhat. Although we don't do a lot of business there, it's definitely getting a little bit better.

Probably the slowest are is certainly obviously the Northeast. That whole area would be the least.

But certainly the Midwest, the Southeast, those are obviously big markets, well, for lumber period but certainly for us. And that's where we have seen most of it.

It's still a little bit slower down in the deep South maybe. But yes, so overall that's kind of how we would look at it.

California was really tough at the beginning but it's starting to come back a bit as is Washington and Oregon.

Okay. And then just on the new home side, what are your customers seeing about how they are looking at 2020 at this point?

Yes. From our standpoint, we are forecasting a million starts this year and basically that's as a result of some of the analytics that we do but also in conversation that we have with a lot of national builders and whatnot.

And there is a lot of initiatives out there. Clearly, that's the one segment where we are going to see the biggest impact.

We need to face the facts on that. We know that.

However there is a lot of initiatives and there is lot of work being done by the national builders through subsidize mortgage rates and several other initiatives that they are looking at to try to preserve as much as they possibly can and keep that whole side of the business going. But if you talk to the national builders, I would say that we would be in that one million kind of area, probably on average pretty consistent.

Okay. And then maybe just overall on COVID-19, how has it affected your operations so far?

Have you got a number of people that have tested? Have you had to shut operations for any period of time?

And how is that split between lumber and pulp?

Yes. So we don't, clearly, the impact, we don't really have, we have got a few cases, for sure between one or two in Sweden and one or two in the U.S.

South. That's the extent of that.

What we have really put in place right from the start, significant amount of work in terms of trying to preserve the health of our people, right. So we put a number of policies in place around social and physical distancing piece particularly and keeping the sites clean.

If there is any suspicion of any area, we shut it down and we will clean it up and we will do whatever we need to do. And we have done a lot of ourselves, checked with a lot, we have actually done a survey of the whole company really to understand what level we are out there and everybody is pretty positive there.

So that's been pretty good. We haven't really suffered anything from the standpoint of increased absenteeism, for the most part.

Probably the biggest issue is just, people are concerned about the longer term and unlike most things we go through, when is it going to end, right. But other than that, it's more of a personal thing.

And so if you just look at the business though, I think we have done a terrific job. Our HR group and all the folks have done a really good job, kind of working their way through this as best one can.

And Europe has been really not really any impact at all. The U.S., the mills that are running are running.

We haven't had rally a lot of issues there. And yes, so overall, obviously a lot of concern, a lot of apprehension, a lot of stress as a result of it.

But we are trying to communicate like we never communicated before and keeping everybody up to speed on what we are doing and recognizing that everybody at this stage of the game is making sacrifices and we are extremely appreciative of that and we understand the stress that's putting everybody under, right. So anyway, that's kind of a long-winded, Paul, but that's kind of how we are going to try and operate through this deal right now.

Great. Thanks for that.

And maybe just last question, Alan, on the pulp side here. It looks like tissue demand is up.

I don't know how much of that is a pull forward but it looks like paper is well off the cliff here and specialty is considered a mix bag. Maybe you can remind us on your sort of percent of those three main end use buckets in terms of your pulp shipments?

Yes. I think you summarized it well there, Paul.

I think just tissue was very good for us. It's still very good.

It's moderating a little bit, normalizing, if you will. I think printing and writing has been hit hard, as you correctly say.

So in terms of answering your question, I think close to 50% of our product base is what we would call specialties and a good third is or more is tissue. So printing and writing, obviously, is a much smaller percentage of our portfolio which is by design, quite frankly.

So our product mix and their customer mix has helped to insulate us against some of the pressure that we are seeing from that segment.

Excellent. Still ahead.

Best of luck guys. Good luck.

All right. Thanks Paul.

Thanks Paul.

Yes. I have got three follow-ups here.

One, first Don, just any kind of thoughts you would want to offer on the sort of how the COVID thing has played out over in Sweden where they have clearly had a little different model than most of the other Western countries? How do you think that's worked or not worked effectively?

Yes. Interesting, that whole situation is quite interesting because as you outlined there, Mark, they have taken taking a bit of a different tact, especially early on.

I think now talking to our folks from Sweden, they are spending a bit more focus now particularly on the social distancing or physical distancing, whatever you want to call it. No question compared to what it was couple, three or four weeks ago.

But still though, if you really look at it, we talked to them, they definitely have a bit of a different model. They differently have a lot of trust in their government and what they are doing around it there.

And so as a result of that, we really haven't seen, it's allowed our mills, the ones that are running there of the operations, albeit two, essentially at 100%. Absenteeism has been very minimal, if at all.

And you probably saw recently, Volvo announced that they are back operating again which is big. They are a big company there and it's symbolic as well.

So from their standpoint, they are very, very confident that they are taking a different tact but that they do think, at this stage anyway, is the right one and is essentially a modified approach than what we have got here in North America for sure. Yes.

So anyway, that's kind of what we see right now. And so far, it seems to be working.

Okay. Next, I wanted to just go over to lumber.

You mentioned how sensitive the whole businesses is to supply/demand balance. I wondered if you could give us some sense of how you see takeaway right now, but also sort of how you see kind of inventory in the channel because it had seemed for the last four to six weeks, like there must be a heck of a lot of inventory coming out of the channel because it didn't sound like anybody was taking away anything from the mills, yet there was still quite a bit of construction activity going on.

Yes. I think that's accurate.

I mean, first of all, the takeaway as I mentioned on our R&R side has been pretty consistent and pretty solid, particularly in some of the regions that I indicated to one of the other fellow's questions. Yes, so on the R&R side, the takeaway has been definitely solid.

In terms of the over inventory in the channel, I think definitely that it's not stressed at all. I think it's going to be stressed from the standpoint of not enough because if you look at all the downtime that's taking place, the premium products in particular that most of the home center look for and the treated guys are looking for, two of the successful areas, they all want a high-end product definitely.

And we feel, when you start to take away production, it has a corresponding increased impact on prime product recoveries. And so that's why we would say, in terms of overall inventory, it's pretty tight and it's going to get tighter, in our view, particularly if demand stays kind of relatively close to what we are seeing today.

If we switch over to the two and better side, clearly with the pros being down a bit more obviously, are down a fair bit, you would think that would have an impact. But there is a lot of two and better down too.

We figure across North America market, the overall production is down 25%. That would be our guess.

And that's across everywhere. And whether it's the U.S.

Northwest, there's examples of seven or eight mills completely down. There is lot of production out, right.

So even on the two and better, I think is relatively tight also.

Okay. Last one for me and this is kind of a sensitive one, I appreciate.

But it's a really difficult period for workers, for communities up in the BC interior. I just wondered, if we just left politics aside, are there any ways in which, if the industry was more consolidated, it might make that process of kind of rationalization and restructuring easier or more rapid, Don?

Yes. I think, our view continues to be and it has been for a long time, long before COVID started, was the rationalization still has to continue to take place in British Columbia and it's due 100% or not 100%, but close to it due to the pine beetle and what we have been faced for a long time there.

So our view still continues to be, there needs to be more production coming out regardless of COVID-19 over the long term here and that's just basic facts. We don't have the fiber going forward like we had in the past.

And we have got a bit of spruce beetle in certain parts of the province too that's adding to that problem. We have had forest fires.

You don't grow those trees back in a week either, right. So you combine all those things in the last couple or three year and it's not hard to conclude that there is going to be needed more rationalization or just little more rationalization across British Columbia.

Okay. Very good.

Thanks.

Okay. Thanks Mark.

All right. Thanks operator.

And I appreciate everyone participating in the call here and all of you please stay safe and we certainly look forward to speaking with you at the end of Q2. So thanks a lot for your support for Canfor and Canfor Pulp and we will talk to you soon.

Thanks.