Stella-Jones Inc.

Good afternoon, ladies and gentlemen, and thank you for your patience during our technical difficulties. I'm here with SilvanaTravaglini, Chief Financial Officer of Stella-Jones.

Thank you for joining us for this discussion of the financial and operating results for Stella-Jones' first quarter ended March 31, 2021. Our press release reporting Q1 results was published earlier this morning.

It along with our MD&A can be found on our website at www.stellajones.com and has been 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.

Today, we reported all time record first quarter sales of $623 million, up 23% year-over-year and EBITDA of $99 million. We had an exceptionally robust start to the year fueled by record pricing and volume gains in the residential lumber product category, and by our ability to adapt to the unprecedented lumber market conditions and capitalized on our extensive procurement network and source of supply to deliver strong results.

Our results for this quarter, also benefited from a solid performance in our utility pole category and strong railway tie them in tempered my pricing pressures into non-Class 1 business. In anticipation of continued solid demand in all three of our core product categories, we use our strong balance sheet in Q1 to invest in working capital and in our network.

Subsequent to quarter end, we also secured additional liquidity to enhance our financial flexibility for growth opportunities, as we look to drive continued creation of value for shareholder. I would like to take this opportunity to thank our employees for their commitment in achieving exceptional first quarter results and our suppliers and customers for their continued collaboration and support.

I will now provide you a brief overview of our first quarter results. Sales for the first quarter of 2021 amounted to $623 million, up from sales of $508 million for the same period in 2020.

Excluding the negative impact of currency conversion pressure treated with sales rose $102 million while sales for logs and lumber increased by $36 million. Utility pole sales amounted to $206 million in line with the same strong Q1 sales last year.

Most of the sales increase was driven by upward price adjustments in response to raw material cost increases and a favorable sales mix, including the impact of greater fire-resistant wrapped pole sales volume. Overall, volumes were relatively unchanged compared to Q1 as more project related volume this quarter was offset by lower maintenance demand, particularly in the U.S.

South East due to the extreme winter weather conditions. Railway tie sales were $158 million, down 8% compared to sales of $172 million for the same period last year.

Railway tie sales decreased organically by $6 million or 3%. The overall increase in volume this quarter was more than offset by lower pricing largely due to non-Class 1 business.

Pricing headwinds and an unfavorable product mix explained most of the reduction in the sales price for non-Class 1 business, while some downward pricing adjustments in response to lower fiber costs on favorably impacted pricing for Class 1 customers. Residential lumber sales rose to $166 million, up 134% from $71 million for the same period in 2020.

This significant increase was largely driven by the exceptional rise in the market price of lumber. We continue to benefit from strong demand bolstered by an early start to the season for home improvement projects, also our ability to service our customers led to us winning a greater proportion of our customers' annual programs.

Industrial product sales amounted to $28 million, largely in line with the $29 million of sales generated a year ago. Our bridge sales were lowered this quarter, mainly timing related, but were offset in large part by the increased activity and demand for pilings.

The sales of logs and lumber are product category used to optimize procurement total $65 million, more than double the sales of $29 million generated in the same period last year. This increase is primarily due to the significant increase in the market price of lumber.

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

Thank you, Éric, and good afternoon everyone. Turning to profitability, driven by strong sales growth, gross profit increased 35% this quarter to $112 million, compared to gross profit of $83 million in the first quarter last year.

Similarly, EBITDA and operating income rose 57% to $99 million and 82% to $82 million, respectively. This first quarter record profitability stems from the high market price of lumber that continued strong residential lumber demand and the Company's ability to increase its market reach in residential lumber.

Improved pricing for utility poles and volume gains for railway ties also contributed to higher profitability this quarter were offset by the pricing pressures for the non-Class 1 railway ties business. As a result, net income for the first quarter doubled the $56 million or $0.85 per share, compared to $28 million or $0.41 per share last year.

Turning to liquidity and capital resources. Cash flow generated from operations before changes in non-cash working capital components and income tax paid was $100 million in the first quarter.

The increase in working capital decreased liquidity by over $200 million during the quarter. And this was largely due to the seasonal increase in working capital, the higher level of sales and the increased inventory costs stemming from the higher market price of lumber.

During the quarter, we invested $14 million in capital expenditures and return capital to shareholders by buying back 800,000 shares for a total of $37 million. There are 1.4 million shares remaining in the current normal course issuer bid program.

As of March 31, 2021, Stella-Jones's net debt including a $137 million of short-term debt increased to $935 million and the net debt to EBITDA ratio stood at a comfortable 2.2 times. Subsequent to quarter end we closed a US$350 million senior unsecured credit facility, including a term loan facility of up to US$250 million and a revolving credit facility of US$100 million.

This facility provides us with additional liquidity at very competitive rates to continue to execute our growth strategy. Yesterday, the Board of Directors of Stella-Jones declared a quarterly dividend of $0.18 per common share, payable on June 22 2021 to shareholders of record at the record at the close of business on June 1.

2021, will be the 17th consecutive year of dividend increases. I will now turn the call back to Éric for the outlook.

Éric?

Thank you, Silvana. Based on the strong quarterly performance and the expectation that there are higher levels of pricing for lumber will continue to favorably impact the profitability of the residential lumber product category during the seasonal peak demand period, we now expect EBITDA to be in the range of $450 million to $480 million.

This guidance anticipates headwinds of approximately $90 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 to be ranging between 15% to the low 20% for 2021. We continue to expect utility pole sales 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, while sales for railway ties and industrial products are projected to be relatively comparable to those generated in 2020.

For residential lumber, we are now forecasting sales to increase in the range of 45% to 65% compared to 2020. And this is driven by the current trend of higher pricing, which is projected to continue during the peak demand season.

Please consult our MD&A for a full list of economic and market assumptions used to prepare this guidance. As for our priorities for 2021, 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.

We recognize the importance to integrate environmental, social and governance considerations in key business decisions and strategies. We are focused on enhancing our ESG practices, developing better strategies to meet our goals and creating superior value for all our stakeholders.

This concludes our prepared remarks. We will now be pleased to answer any questions you may have.

So, I want to start in your tie business. You no doubt have heard some of the potential consolidation that's happening particularly with Kansas City, Southern and Kansas City doing their own ties in-house came up on one of the conference calls.

I'm just wondering whether you think that's a threat or an opportunity. Is it an opportunity that should KCS be acquired that you could look to purchase their tie business?

Or is it a threat in that whoever buys KCS may look to maximize more maximized the use of that that business line within KCS? Just curious your thoughts there, Éric.

Thank you, Walter. I think it's an opportunity.

So, we are important suppliers to both the Canada National and Canadian Pacific. Both of those entities of those companies, as you know, do not operate, did their own treating facilities.

I would believe that conciliated group either way would probably lead more towards wanting to divest those assets. But that being said, Stella-Jones operates a facility that is online with the KCS and we do actually supply certain requirements such as bridge timbers and certain tie requirements throughout the year to the KCS.

So, we're very well positioned to benefit from this merger.

Okay. Moving on -- staying with railway ties for a moment, you mentioned that last quarter that you were or I guess the quarter progressed relatively comparable top-line level for railway ties excluding for ForEx.

Just curious whether that view for the top line is changed with your first quarter results here?

Not at all. So, we maintained our guidance for our railway tie product category to be comparable year-over-year, and we based that off the fact that all our Class 1 customers had indicated similar maintenance programs.

And so although we're slightly behind after the first quarter, it's simply a question of timing of orders.

Okay. And like I asked on the last call, any reason why, if there's been any possibility of deferral, they're probably doing it given the amount of traffic and congestion.

It sets up quite nicely for next year potentially if it was deferred to see some of that volume come in 2022. Is that still the case?

Well, yes. What's encouraging is that the major railroads in North America are posting great results.

Traffic is increasing on the rail network, which means more usage, so it will lead to more maintenance. Also very much optimistic about infrastructure spend in the next year or 24 months in the U.S.

whenever that that bill comes through. So, I think, if we look beyond 2021, the future looks relatively encouraging for the rail tie business.

Okay. And then last question here on your poles side, mid-to high-single digit had been the run rate kind of came in that first quarter here now, based on what you're seeing in terms of customer indications, as we turn into the second quarter here.

Are you on pace, would you say to that mid to high single digit x for x for polls as well for this year?

No, definitely lots of inquiries from the contractor side of the pole business. COVID has subsided to some extent in the U.S.

We're seeing activities pick up and just remind also that the listeners that we do expect on selling a bit more volume of our fire resistant wrapped pole. So, it looks very good for us for meeting our guidance for this year.

That's fantastic. Appreciate the time as always, Éric.

Thank you, Walter.

Thank you. Good afternoon.

Good afternoon, Michael.

Éric, the residential lumber business continues to exceed expectations and you're now calling for very strong year-over-year sales growth in the 45% to 65% range for 2021. Certainly, it sounds like you expect growth to continue to remain strong in the second quarter.

But I'm wondering, if you can talk a little bit about, what you've built into the guidance or those expectations as it relates to residential lumber for the back half of this year?

So, you're exactly right, Michael, our revised guidance is now considering higher year-over-year pricing. And if you recall last year's trend, the first half of the year, I would say, had lower sales price on a board foot basis and then we saw prices increase in the second half of the year, so most of the gains would come in the first half of the year.

Mind you after that, when we look at the second half of the year, that's where I guess our range comes more into play, and it really depends if lumber prices are going to subside to some extent or be maintained.

Okay. So at the low end of your range, would that put you into a situation where your year-over-year growth organically and residential lumber turns negative in the third quarter?

Yes, it could slightly be negative.

Yes, okay.

Yes, a bit more towards the last quarter, obviously where depressants were much higher than the third quarter.

Okay. Fair enough.

Now you're just trying to get a sense for, yes, I mean, I realized that there's still a lot of uncertainty and we don't know where prices are going to go, but that that's helpful. Thank you.

On the utility pole side, it sounds like you're still fairly upbeat about the business. I'm just wondering with respect to the, you saw some lower maintenance demand in the first quarter, and then part of that, I guess, was due to the weather events in the U.S.

Southeast. Do you expect to see or have you already seen any kind of a pickup on the maintenance demand side in the early part of the second quarter?

And does that to those do those weather issues in the first quarter? Do they create a situation where you could sort of have some catch up activity in the second quarter?

The vendors definitely adjusting in a sense to trend toward towards our guidance, what we saw in the first quarter is that those winter orders, intense winter conditions, we saw this out. We're not necessarily pull events, we didn't see poles breaking, but power results for the maintenance crews were spent a lot of time, reconnecting the grid and making sure that households, and hospitals and domiciles, got back electricity as fast as they could.

So that's a bit of the reason for that slowdown when we refer to the weather event in the first quarter.

And then just in terms of, I'm assuming, is it fair to say you have now seen some pick back up in that maintenance activity?

Yes. Demand is adjusting back to our expectations and that's why we're comfortable guiding to the mid to high-single-digits for the year.

And then just as far as the new credit facility for your U.S. operations that you entered into subsequent to quarter end.

Aside from the repayment of the bridge loan, what are the goals or the intended uses of that of that financing? And I mean, you can let us know what the thoughts are there.

But you did mention M&A is pretty you're prepared to mark so I'm not sure if this ties back into them?

So, there are a few things, Mike. One, we do have part of our current facility.

There's a $50 million tranche that's expiring in February 2022. So, we're setting ourselves up to be able to accommodate that production.

Secondly, when you look at our goal of wanting to sustain EBITDA leverage from 2 to 2.5 times, if we consider that we potentially want to execute on M&A, we need some dry powder ahead of us to be able to execute as such.

And then just on that point, can you provide a little bit more of an update in terms of the M&A pipeline. And again, you did mention that you intend to be activists here, but any commentary around timing and where you're at with some of the things you're pursuing?

Well, so last time, we spoke on this call, it was maybe whatever, six weeks ago, I'd say, and so there's not much of an update with regards to M&A other than we keep progressing forward, things are clearing up with regard to discussions with our targets. So, we're moving on forward where we're definitely dedicated to expand our footprint and maintain our leadership position in the North American market.

Just to come back on the railway ties, could you talk about the continued pricing pressure experienced with the railway ties and what is driving this pressure?

So most of the pricing pressure is coming from the non-Class 1 business, as we explained to some extent last year we were very good last year and the back half of the year. As I explained, cherry pick a bit of the orders where we wanted to commit ourselves trying to manage our margin best we could.

Right now what we're seeing is, we saw a bit of a more aggressive pricing again in the fourth quarter. The orders we took in the fourth quarter were actually now sold in the first quarter, the first half of the year.

So, it's a bit of a continued trend with regards to pricing pressure. I think it's also related to availability of ties, which we're starting to see tighten up slightly, because obviously, large demand for grade lumber and for pallet stock, which is competing with the center and the log for ties, which is actually a good thing.

I think a bit of tightening in the market will actually give us a chance to revisit pricing upwards, but that would most likely be in the sector in the second half of the year.

And just for residential lumber, could you maybe break down the components between pricing and volume and also maybe for the quarter but also with respect to the 45% to 65% of the mix overall in terms of pricing and volume.

So for our first quarter, the split is really 70% pricing 30% volume. Our guidance right now is in better part related to pricing.

Okay, that's great. And for the new accretive facility, any thoughts about the interest rates whether it's accretive and bid dilutive versus the previous terms of it?

Silvana, do you want to take this one, you negotiated the agreement, I'll give you credit for doing a great job there.

So because, Benoit, it's part of the U.S. farm credit system, the interest rates, even though they're pretty much sort of competitive with our current facility.

We will benefit from patronage dividends. So overall, our pricing would be lower than what we currently have with our facilities.

Okay, that's great color. And for in terms of working cap for 2021, any color given that you're building out the inventory for residential lumber, what we could expect, let's say working capital change for to the full year, Silvana?

Yes, we're pretty much forecasting a similar trend as in Q4 of last year, given the strong residential lumber demand. We expect that we're going to have to build up inventory similarly, like we did last year in the fourth quarter at higher costs.

So if we would have to sort of put that best guess we would say that probably the buildup will be similar to Q4 of last year.

Éric, I wanted to get your thoughts about, the sort of Biden infrastructure plan and some of the proposals that are out there? What sort of the impacts and how meaningful do you think that could be for both tie and pull demand?

Well, it's a difficult question to answer Hamir. What I've read so far, there's several areas in the current bill that offer opportunities for us, it does talk about rail track maintenance and upgrades.

It does talk about construction of new roads and road repair, often when new roads or highways are fixed to utility poles are either changed out or added in the case of new construction. There are discussions about bringing broadband to rural areas.

There's also lots of talks or descriptions about encouraging green energy initiatives, which would obviously, you would need some sort of electrical grid to bring the power into the network. So, I see multiple aspects in the current bill where we could benefit from.

Now, we'll have to wait and see what the final bill looks like. I believe there's still a lot to be done until we see a final bill.

But I think it is most likely encouraging, for our future business, given the large presence that we have in both ties and poles, we should at one point benefit from it.

Éric, and I just want to come back to M&A. I know in the past, Stella's has spoken about potentially considering about fourth pillar to expand into.

Anything you can share there about where the board is at in terms of that sort of process. And if you have any thoughts you can share on potential markets or product categories that could be of interest?

Well, certainly, I mean, I can't divulge any details because we are having discussions. The board has tasked me to come up with a strategic review for the next let's say three to five years as where we're going with our core products.

And then as I mentioned in my prepared remarks, we're also looking into how we could leverage our strengths as a company may be or our network or our customer base and so on, to be able to see what could be a great fit for Stella-Jones into those areas. So, I can't answer specifically, but I'm definitely being asked to explore and see if there's any great idea to keep going our business within the categories, but something also within adjacencies of what we do currently.

Great. Thanks, Éric.

So last question from me, the fire retardant wrapped poles, how -- what sort of proportion of your mix in poles would you expect that to be in '21?

Approximately 5% of overall sales.

Okay. And where do you see that going?

Is there a max that just given sort of weather constraints maybe max left?

Yes. I mean, five issues is our goal.

I mean, I would say this year expectation was for a full year of sales of that product to a certain number of customers. Had a bit of a slow start the beginning of the year, but let's say using a 5% is good.

We could revisit this question in future quarters, as we're definitely going to start introducing this product in other regions of North America, where forest fires are regular events, but right now where we're sort of projecting it at the 5% level.

Great. Thanks, Éric.

That's all I have.

Thank you, Brett, and thank you everyone for joining us for this call today. We look forward to speaking with you again at our next quarterly call.