Stella-Jones Inc.

Good morning, ladies and gentlemen. I’m here with Silvana Travaglini, Chief Financial Officer of Stella-Jones.

Thank you for joining us for this discussion of the financial and operating results for Stella-Jones’ fourth quarter and full year ended December 31, 2020. Our press release reporting Q4 results was published earlier this morning.

It along with our MD&A can be found on our website at www.stellajones.com, and it will be posted on SEDAR today as well. Let me remind you that all figures expressed on today’s call are in Canadian dollars, unless otherwise stated.

Our strong performance in 2020 is a testament to Stella-Jones’ resilient business model. The strength of our team and its ability to effectively adapt and deliver strong results for stakeholders, despite the many challenges faced throughout the year.

I’m extremely proud of the unwavering personal commitment, determination, professionalism and collaboration of our employees that they displayed throughout the year. We concluded 2020 with record sales and profitability.

Sales increased for the 20th consecutive year, while EBITDA rose 23% to $385 million and net income increased 29% to $210 million. Increased profitability translated into record cash flow from operations, which allowed us to return $100 million to our shareholders, while continuing to invest in our network.

In line with our capital allocation strategy, today we announced a 20% increase in our quarterly dividends and an increase to the numbers of shares that can be repurchased under the Normal Course Issuer Bid demonstrating our confidence in Stella-Jones’ strong cash flow generation and our commitment to deliver continued value to our shareholders. Let me begin with a brief overview of our fourth quarter results.

Sales for the fourth quarter of 2020 amounted to $533 million up from sales of $445 million for the same period in 2019. Excluding the negative impact of currency conversion pressure-treated with sales rose $78 million or 19%.

Utility pole sales amounted to $201 million up from $195 million from the same period last year. Since the end of the first quarter, demand, particularly from Canadian customers has been impacted by pandemic restrictions as certain utility companies have continued to limit maintenance activities in an effort to protect their maintenance crews.

As a result, volumes have remained relatively stable quarter-over-quarter. Most of the 4% increase in sales this quarter is attributable to healthier sales mix, which includes the impact of the value-added fire-resistant wrapped pole sales.

Railway tie sales grew $147 million, up from $134 million last year. In line with an improving industry demand trend compared to the same period last year, we realized sales growth of 11% quarter-over-quarter.

This was mainly driven by our flexibility to service Class 1 customers leading to higher volumes and our ability to maintain solid non-Class 1 sales, despite pricing headwinds. Residential lumber sales reached $117 million almost double the $61 million generated for the same period in 2019.

The record high market price of lumber and to a lesser extent, the continued strong demand from home improvement products explained the significant sales increased this quarter. The higher market price of lumber is also a reason that sales of logs and lumber were up 45% compared to the same period last year to $45 million.

Silvana will now provide further details regarding our results and financial positions before I conclude with our outlook. Silvana?

Thank you, Éric and good morning, everyone. Turning to our profitability.

Gross profit grew 21% to $85 million compared to Q4 last year, while operating income was $50 million compared to $41 million in the fourth quarter of 2019. Similarly, EBITDA rose to $70 million up 19% compared to $59 million in Q4 last year.

The increase was primarily driven by higher sales prices for residential lumber, which exceeded the higher cost of lumber as well as the improved sales mix for utility poles. Adjusting for other net losses, EBITDA for Q4 2020 and 2019 were $73 million and $60 million, representing EBITDA margins of 13.7% and 13.5% respectively.

Net income in the fourth quarter increased 21% to $34 million or $0.52 per share versus $28 million or $0.41 per share last year. Let’s turn to a brief overview of our full year results.

Sales in 2020 reached $2.6 billion, excluding the positive impact of the currency conversion, pressure-treated wood sales rose $309 million or 15% with both volume and pricing gains across the Company’s three core product categories, driven by strong sales growth, EBITDA increased 23% to a record $385 million, or a margin of 15.1% up from the $313 million or a margin of 14.3% last year. Adjusting for other net losses of $12 million, EBITDA in 2020 was $397 million representing a margin of 15.6%.

Net income rose to $210 million or $3.12 per share versus net income of $163 million or $2.37 per share last year. Turning to liquidity and capital resources, with our strong financial results this year, we generated $402 million of cash flow from operating activities before changes in non-cash working capital components and interest and income taxes paid.

The anticipated increase in sales in 2021 resulted in an over $120 million build in inventory this year. This largely explains the reduction in cash from operations to $178 million.

We deployed the cash generated to make capital expenditures of $55 million and returned capital to shareholders by paying dividends of $40 million and buying back 1.3 million shares for a total of $60 million. We concluded 2020 with long-term debt, including the current portion of $606 million in line with last year.

We maintain a strong financial position with a net debt to EBITDA ratio, which includes lease liabilities of 1.9 times. And our available liquidity was $190 million.

Subsequent to year end, the amount available under the demand loan facility was increased from $50 million to $100 million U.S. until June 30, 2021, providing the Company with additional flexibility to invest in the inventory required to support the anticipated sales growth in 2021.

Yesterday, the Board of Directors of Stella-Jones declared a quarterly dividend of $0.18 per common share, representing an increase of 20% over the previous quarterly dividend, payable on April 24, 2021 to shareholders of record at the close of business on April 5. This represents the 17th consecutive year of dividend increase.

Finally, on March 9, the Company received approval from the TSX to amend its Normal Course Issuer Bid in order to increase the maximum number of common shares that may be repurchased from 2.5 million to 3.5 million shares. The amendment will be effective on March 15, 2021, and will continue until August 9, 2021.

I will now turn the call back to Éric for the outlook. Éric.

Thank you, Silvana. While the impact of the ongoing COVID-19 pandemic on the demand for the Company’s product is still uncertain.

We expect year-over-year organic growth in sales and profitability for 2021. Based on our current outlook and various assumptions, we expect to generate EBITDA in the range of $385 million to $410 million.

This guidance anticipate headwind of approximately $50 million in sales from the deterioration of the value of the U.S. dollar relative to the Canadian dollar.

Excluding the currency conversion impact, we project sales growth in the low to mid-single-digit range for 2021. Utility poles sales are expected to increase in the mid to high-single-digit range compared to 2020 as we project sustained growth in replacement demand, including an increase in the value-added fire-resistant wrapped pole sales.

For residential lumber, we’re also forecasting mid to high-single-digit growth compared to 2020, and this is driven by the continued strong demand for home improvement projects, current estimates of higher pricing, as well as a projected increase in market reach. The sales of railway ties and industrial product are projected to be relatively comparable to those generated in 2020.

Please consult our MD&A for details of the economic and market assumptions used to prepare this guidance. Stella-Jones’ strategic vision is focused on enhancing the Company’s presence in its core product categories, while seeking other strategic opportunities that leverage the Company’s footprint, customer base, fibre sourcing and other competitive strengths.

We intend to be active on the acquisition front, focus on innovation, continue to improve our operating efficiencies and expand our capacity to sustain our profitability. Our priorities for 2021 include providing continued support to utility pole customers that will transition to an alternate preservative solution in preparation for the gradual phase out of Pentachlorophenol and the successful ERP implementation.

As one of the leading providers of industrial treated wood products, our primary objective is to enhance the Company’s business resilience and generate consistent value for shareholders. This concludes our prepared remarks, and we will now be pleased to answer any questions you may have.

Yes, thanks very much, Operator. Good morning, everyone.

Good morning, Walter.

So I’d like to start with the ties division, obviously covering the rails. We know that that congestion is very high right now.

The railroads have limited ability to kind of take any track offline for upgrades. Understanding that ties are – is not something you can defer too long, but you’re guiding to kind of flat sales here.

Do you think that that guidance is really a reflection of the railroads lack of real incentive to do major maintenance this year? And could we see a lift in future years as you know, as things normalize and the railroads may come back with a little bit of an ramped up rail tie demand profile post-2021?

I think, you’re correct, Walter. The current years of maintenance programs have been announced last year, as you know, and I believe that the railroads will execute on that plan.

From our view, they are at – minimum that they’ve done historically. So to your point, I do believe that we could see an uptake for the Class 1s in future years.

So I think it’s a fair assumption. With regards to the non-Class 1 business, we are seeing still a lot of activity in demand from different market participants.

Obviously, the federal credits are supporting the financing of those projects. There’s also what’s referred to as CRISI grants, which also supports in the same line, the short lines in the non-Class 1 business.

So I do think that that’ll sustain demand going forward. So I think there’s two aspects to what you’re looking at, but I think your assumption is fair that we could see an upward trends, in maintenance volumes in coming years.

Okay. My second question is really around the visibility behind your guidance on the revenue side, can you touch on Éric few of the – which segment do you feel you have the highest visibility either due to the structure of the contracts or the indications you’ve had from customers, and where do you have the lowest visibility kind of on a segment-by-segment line?

Certainly. Well, we just discussed the railway ties 65% of our railway tie division revenues are Class 1, which is supported by annual contracts and all our major customers have provided guidance.

So I would think that is the one where we feel the most comfortable with regards to the guidance going forward. Secondly, I would mention the utility pole product category, where again, we have contracts in place and ongoing discussions with engineering departments that are – at the utilities, our customers where we talk about the maintenance programs.

That one comes in second, essentially, because, so there is a bit of caution with regards to COVID. I’m happy to see the cases down in North America and vaccines being deployed.

So we could think that this could trend back to normal maintenance activities. And third, I would say, the residential lumber there’s obviously no annual contract, and it really depends on market demand.

We’ve been planning the 2021 season with our customers now for several months. These have all been indicating strong demand.

We’ve confirmed this also with several contractors in the market that demand will be strong for outdoor renovations in the coming year. But again, I guess that’s would be the one where obviously, there’s no contracts affirm it up.

So but I have high faith in what our customers are telling us. And as we’re sort of deploying or selling inventory this year, we’re sort of seeing that trend in demand continue.

As we’ve seen actually in December when the volumes were actually up year-over-year, we’re seeing a continued trend on that front.

That makes a lot of sense. Okay, really helpful there.

Last question is on your capital allocation – your free cash flow and capital allocation. It seems that, acquisitions are a little – I know you remain interested, but activity level is fairly low.

I would guess, correct me, if I’m wrong in that. Perhaps sellers target or multiples are elevated.

You ramped up your dividend now. You’ve ramped up your buyback.

Can you cover off what you could see as being your maximum payout ratio, if there were no acquisition opportunities? How high could you see your payout ratio go?

And compared to – how high would you see your leverage go, if you were to start paying out an increasing amount of your free cash flow in the form of either dividends or buyback?

So a lot of aspects in your question there. So did the leading indicator there too, to answer your question would be our leverage, right?

We’ve guide the market as our capital allocation policy of leverage between 2 and 2.5. We are coming out of a very strong year in 2020.

We generated very strong cash flows. And with the current guidance, we’re very confident in our future cash flows as well.

So the strategy behind renewing the NCIB as well as increasing the dividend is to return value to shareholders and maintaining that leverage level. So normal state, I would say, we would lever in that range of the 2 to 2.5.

I’m fully confident that discussions that we’re currently having with targets on M&A will come to fruition at midpoint in the year where we intend on being active on the M&A front. And that’s why we’re structured that way with our capital allocation.

So the 2 to 2.5 is really our steady state business, and we’re ready to lever up let’s hit a three times which is well under our bank covenants to be able to do an acquisition, which has plenty to execute on what we have on the table right now.

Okay. That’s very helpful.

I appreciate your time, Éric.

My pleasure. Thank you, Walter.

Good morning. For the mid to high-single-digit growth expected in poles and resi lumber this year, how much of that is volume?

So for the – yes, we don’t really quantify it. And there’s lots of – we don’t quantify.

There’s many assumptions behind that. Obviously, the pricing depends on where the pricing of lumbers is going to go forward for the balance of the year, which currently our assumption is to maintain steady state.

But – and then we have confidence in the volume. Look, if you need to use an assumption, I would probably say 50-50 and for the residential lumber and for utility poles, I would say something similar as well.

Fair enough. That’s helpful.

And Éric, I wanted to ask you about on the pole side of the business as electric vehicle kind of adoption increases over the coming decade. What kind of impact do you think that could have on pull demand?

I’m just thinking as charging networks get built out and then also kind of connecting all the growth in renewables to the grid?

Any additional demand for electricity on the North American grid would play favorably with regards to demand to support that network, maybe poles or different hardware items. So I think it would be positive most definitely.

Our customers are not necessarily talking about that along those lines. I think that investments related to the such a demand could be accelerated if governments decided to support it, to subsidize it to some extent, to favor electric vehicles.

Otherwise, it will be like a market trend. So to answer your question, I think it would be positive.

It will be positive. It’s just a question of the timing of the occurrence.

Fair enough. And just a last question from me.

Silvana, could you maybe highlight if there are any major capital projects in the budget for 2021?

No, in terms of the guidance, the $50 million to $60 million, we are expecting to be at the high-end of the guidance for 2021, keeping in mind that included in that continues to be our ERP projects. So I would say, one of the more significant ones would be the ERP spend that we continue, as you know, we’re still in the implementation of that project.

Other projects, well, I’ll also, as Éric well mentioned in his priorities looking at the getting our customers and converting some of our cylinders different preservatives for a Penta replacement. So those I’d say would be sort of be that the major CapEx.

Great. Thanks.

That’s all I had.

Yes. Good morning, Silvana and good morning, Éric.

Yes. Just with respect to the lumber inventory, obviously, a great opportunity, you’ve been able to replenish the inventory over the last month.

I was just wondering if you feel that you’re having a competitive advantage versus peers to meet strong demand in 2021, and given all the investment made towards the inventory in the last two years would you expect or reversal at some point? And is it more late 2021 or 2022?

Well, it’s a very good question. So obviously, the inventory volume that we replenished for residential lumber in the fourth quarter and as well in the first quarter of this year are very higher prices compared to last year, right?

If you follow the lumber markets today, roughly, we’re sitting at 2.5 times the price we were a year ago. So obviously, our investment in inventory is higher.

And if the markets the general lumber markets drop, we would see a decline in our inventories. That’s at the end of this year or into 2022.

That being said, I think Stella-Jones is strong balance sheet and strong financials enable us to be able to invest in inventories at that cost, which hard to say, what are our competitors’ debt as far as debt, can accommodate. But we definitely feel that we’re in a strong position to be able to procure sufficient volumes, to execute on our guidance and as well to support our customer’s expectations as far as increased volumes.

Okay. And would it be fair to expect kind of a positive inventory reversal as we go through a more normalized year, let’s say beyond 2021 Éric or Silvana.

So there are two items that play there, right? So one to your point, if the prices and head quoting numbers – but if your prices are declined, let’s say in the next 12, 18 months for lumber again.

Yes. That would pull it down.

But then there’s also another effect of additional volume that we’re gaining year-over-year and do plan on maintaining. As you know, last year 2020, our teams did a spectacular job servicing our customers.

The industry has acknowledged Stella-Jones capability. And as a result, we’ve gained extra volumes, extra market reach if you want.

So that additional volume would carry on in the future. So you have potentially two-off, not perfectly offsetting, but to two different variables that could play against one another in the future.

Okay. That’s great color.

And for residential lumber as Canadian gets vaccinated later, would you expect the residential lumber to look better in Canada versus the U.S. as Americans might be looking to spend differently once vaccinated?

Is there a big discrepancy between Canada and the U.S. on the residential side right now?

That’s a difficult question for me to answer on the dynamics of how the populations will return to a new lifestyle or to their old lifestyle, it’s kind of difficult to predict. What we’re working off of is how we’re working with our customers currently and what they’re guiding.

So I’m quite confident that by mid-year we should be – by mid-year, we should see a good part of our gain realizations. If you remember, May and June – April, May, June are our heaviest months for the sales of residential lumber.

Remember also that the U.S. represents maybe 30% of our product category sales and Canada 70%.

So to your assumption, it’s a bit later in Canada. I think it pulls well to think that we should still have a strong H1 as our customers are indicating.

And I think the whole year should be very healthy on the volume side.

Okay. And last one for me.

Just with respect to the storms we saw in Texas. Just wondering if there was any benefits or maybe some disruption on the supply chain and whether that’s created some pent up demand for Stella-Jones going forward?

Yes. So the storms you saw in the U.S.

Southeast. So when I say storms, there was snow, there was ice storms, there was intense cold, can’t say there were events that required more poles or more railway ties.

So it’s not necessarily a benefit. It would not translate into additional sales.

That being said, the distribution networks were down in the U.S., in particular the rail networks car flow reduced to some extent, it took a while to get back moving. Our facility themselves were actually shut down for a week as there was no power, no gas and so on.

But also to say, no significant impact, I’d say in the utility pole side. Railway ties, we’ll see how quickly we can catch up there.

Is it going to take the month of March or a bit early April to catch up? But the orders are there.

So it’s not a question of missed opportunities, it is the question of just having to live with the consequences of the disruption in the transportation network, if you want.

Okay. That’s great.

Thanks for the time.

Thank you, Benoit.

Thank you. Good morning.

Good morning, Mike.

Éric, on the outlook for 2021, can you talk about your margin expectations and specifically some of the moving pieces we should be thinking about when we look at 2021 versus 2020?

So the margin assumption will vary between the low end and the high end, but call it, we like to aspire that we would maintain a 15% EBITDA margin going forward. And items that could help improve that if you want, or think that to consider, would definitely be with COVID-19 sort of phasing out, seeing a return to maintenance level from our utilities, which would also translate, I believe into also increased sales of our fire-resistant wrapped poles.

Obviously right now, we’re sort of in a positive trend, which makes me quite optimistic about the remainder of the year. Following that, I guess, railway ties, I think we’re relatively stable with our demand.

I don’t see any significant swings in inventory cost for the balance of the year. And then for residential lumber, we need to keep on our radar, how market pressures will fluctuate going forward.

Obviously, if the market pressures would drop, we would adjust pricing at our own cadence, depending on how our average inventory costs would adjust, but still those are things we need to keep in mind.

Okay. And just to be clear, when we’re thinking about the EBITDA guidance range, and I guess, also margins, the guidance range you’ve given for 2021, are you assuming nothing in terms of the other losses line, which I guess, there were some amounts that flow through that in 2020.

Is that nothing for 2021 assumption?

That is correct. That is correct.

Okay. Perfect.

Thanks. Just a question about moving to residential lumber, you’re calling from mid to high single digit revenue growth in the current year here.

Can you talk a little bit about how you see that playing out as we move through the year in terms of maybe Half 1 versus Half 2? I think you sort of a moment ago alluded to, an expectation of a reasonably strong Half 1.

But just, what is going into that full year expectations as it relates to kind of the first half versus second half?

No, definitely. So if I think of last year, there was a significant difference between H1 and H2 last year in pricing.

Obviously, H1 was a very steady price and you could go back to the lumber graph and figure that part out. But then in the second half, we had very higher pricing, which would be closer to what we have today.

We’re still actually today a bit higher than the average of H2 for the last year. So I would definitely think that for H1, we would see volume and pricing being strong contributors to our growth.

And then for H2 pricing, if the pricing has maintained pricing would have less of an impact and then volume would play. Our clients are starting to discuss H2 and they’re still foreseeing a healthy second half of 2021, which is encouraging.

And it’s really to that level of expectations that we’re actually procuring and preparing our season, obviously the peak being in Q2, but obviously the summer months and early fall are also very active months if the weather permits.

Okay. But have you actually – so you mentioned that clients are starting to talk about the second half.

In the outlook for residential lumber that you’ve provided, are you factoring in some of that potential strength in the second half? Or are you taking more of a conservative stance at this point?

It’s really in our range, right? From the bottom to the top, I mean, the top range would bring us to a very strong year in both half of the year.

Okay. Got it.

And then just maybe a bit of a – sort of a bigger picture question as it relates to poles. So you had good – very good organic growth again in 2020 and you’re calling for further strength in 2021.

I’m just wondering if you can sort of try to frame where we’re at in terms of the replacement cycle, if I can call it. I mean, there’s been talk for some time about how there was underinvestment in the North American infrastructure in utility poles area.

We’ve seen good growth for some time calling for further growth. But where do you think we’re at in terms of addressing the need to replace the existing stocks?

So our customers don’t necessarily share their maintenance programs very long-term, we do have a certain insight as to their intentions beyond the current year. We’ve always guided the mid single digit growth for poles, for certain number of years ahead.

I think we’re still in the beginnings, if you compare it to hockey, maybe we’re still in the first period. I don’t know how to better explain that as far as timeframe.

But I think there’s still a lot of work to be done with our customers with regards to planning out more maintenance for several years to come.

Okay. That’s helpful.

Thank you. And then just lastly Éric, you did briefly address sort of the prospect of M&A earlier in the call in the context of a broader question about capital allocation.

But I’m wondering if it’s possible for you to provide any further insights into kind of how you’re thinking about this year, the M&A pipeline, what you think could happen et cetera?

Well, so we intend to be active on the M&A front for 2021. Last time we had a discussion on the topic on our last call, it did indicate that we were talking to certain targets and we continued to do so same targets, nothing has really changed.

The discussions are all progressing at different paces. We as a company remain disciplined in the multiples we’re going to pay, but I would add to that, that is not a headwind in our discussions.

Things are moving positively. And that’s about all I can say really my goal on that front.

No, I appreciate that. Thanks very much, Éric.

I’ll turn it over.

Thank you.

Good morning and congratulations on results.

Thank you, Mona.

Apologies, if you had answered any of the questions, I’m just trying to juggle back and forth and take notes. But just on the residential side, I’m just wondering the mix of pricing versus volume.

I think last quarter you had said it was two-thirds versus one-third. Did you provide what it was this quarter could be?

So for Q4 pricing was really set, I would say roughly 70% of the increases. Your question is with regards to Q4, correct?

Correct. Yes.

Yes. About 70% would be related to pricing year-over-year.

Okay. That’s very helpful.

And then you had mentioned growth in market share gains on the residential side, just now in your commentary, offsetting the contractionary pricing environment in the future. I’m just wondering, if you have started to see any market share gains as of yet.

And I’m just thinking about your guidance for the segment and it’s a bit higher than perhaps, home people, for example. So I’m just wondering about the dynamics there.

Yes. So the industry sets its partnerships if you want, in Q4 of every year.

So right now we know our partners and we have an indication for their volumes for 2021. So to answer your question, we do have relationships in place to be able to support our assumptions on volumes.

And as far as we can tell so far the actual pole on their inventory is following expectations.

Okay. That’s helpful.

And just lastly, on acquisitions, I understand that you provided all the color in the last line of questioning. But just size wise, it should be – the acquisition should be comparable to your prior acquisitions that you’ve done historically.

So like $30 million to $70 million-ish in purchase price/revenue. Would that be correct?

That’s a fair assumption. Yes.

Okay, perfect. And just in regard to the verticals, is poles still kind of the priority for you guys?

Definitely a lot of opportunity in that one. I guess, priority is simply because there’s more opportunities, but if something would come in the railway tie, for example, we know it would definitely be something we would take a look at.

But yes, I would say the more opportunities are with the utility poles.

Okay. That’s very helpful.

Thank you. That’s it for me.

Thank you, Mona.

Thank you for joining us on today’s call. We look forward to speaking with you again at our next quarterly call.