Stella-Jones Inc.

Thank you, and good morning. 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' third quarter ended September 30, 2021. Our press release reporting Q3 result was published earlier this morning.

It, along with our MD&A, can be found on our website at www.stella-jones.com and will be posted on SEDAR today as well. We also published our 2020 Environmental, Social and Governance report today.

It can also be found on our website in our Investor Relations sections under Environmental, Social and Governance. I invite you to read our report and learn more about the steps we have taken to refine our ESG strategy and build upon the integration of our priorities of environmental matter, environmental commitment – sorry, product stewardship, our valued employees and our governance principles.

Let me remind you that all figures expressed on today's call are in Canadian dollars unless otherwise stated. Before I review the results, I would like to touch on our recent announcements.

Last week, we announced that we entered into an agreement to purchase the shares of Cahaba Pressure Forest Products and Cahaba Timber, Inc. for $66 million and $36.5 million respectively subject to post-closing working capital adjustments.

Cahaba Pressure is an oilborne preservative treater of wood poles, crossties and posts, and also provides custom treating services. Cahaba Timber is a waterborne preservative treater of utility poles and piling and engages in a raw material procurement.

Both facilities are located in Brierfield, Alabama. The combined sales of Cahaba Pressure and Cahaba Timber totaled approximately $97 million for the year ended 2020.

Both entities were subcontractors of Stella-Jones, and our purchases represented approximately 20% of their annual sales. Both transactions are expected to close prior to the end of December 2021.

We are very excited of these acquisitions that will expand our capability to supply the growing needs of North America's utility pole industry. In addition, they will further support the preservative offering to our customers and optimize the overall efficiencies of our continental network.

Turning to our quarter, our third quarter results reflect the impact of the normalization of lumber market conditions and the increase in the cost of untreated railway ties which outpaced price adjustments. Sales for the third quarter of 2021 amounted to CAD679 million, down from sales of CAD742 million for the same period in 2020.

Excluding the negative impact of currency conversion of CAD25 million, pressure-treated wood sales decreased CAD32 million or 5%, while sales for logs and lumber decreased by CAD6 million. More specifically, by product category, utility pole sales increased to CAD256 million, compared to sales of CAD251 million in the corresponding period last year.

Excluding the currency conversion effect, utility poles sales increased by CAD16 million or 6%, driven by improved maintenance demand for distribution poles and sales mix, including the impact of additional sales volumes for fire-resistant wrap poles. This sales growth was partially attenuated by the decrease in project-related volumes.

Railway ties sales were CAD179 million, compared to sales of CAD188 million in the same period last year. Excluding the currency conversion effect, railway ties sales were stable, as lower volumes for Class 1 customers, largely due to the timing of shipments, were compensated by continued strong demand and improved pricing for non-Class 1 customers.

Residential lumber sales were CAD170 million, down from sales of CAD220 million in the corresponding period last year. Excluding the currency conversion effect, residential lumber sales decreased CAD47 million or 21%.

While residential lumber pricing remained higher compared to the same period last year, it was not sufficient to offset the drop in demand. Industrial product sales were CAD32 million, compared to sales of CAD34 million in the third quarter last year.

Excluding the currency conversion effect, industrial product sales remained relatively unchanged. The sales of logs and lumber, our product category used to optimize procurement, totaled CAD42 million, down compared to CAD49 million in the corresponding period last year.

Sales decreased mostly due to a reduction in lumber trading activities. Silvana will now provide further details regarding our results and financial position, before I conclude with closing remarks.

Silvana?

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

Gross profit was CAD82 million this quarter, down compared to CAD147 million in the third quarter last year. This decrease in profitability is largely explained by higher fiber cost for residential lumber and railway ties, combined with lower residential lumber sales volume.

These factors were partially offset by the realization of higher pricing across most of the product categories. Gross profit for the quarter was also impacted by a CAD7 million inventory write-down provision related to our residential lumber finished goods.

Similarly, EBITDA and operating income decreased to CAD69 million and CAD51 million respectively. Net income for the third quarter decreased to CAD34 million or CAD0.52 per share, compared to CAD79 million or CAD1.17 per share last year.

Turning to liquidity and capital resources. We generated CAD225 million of cash from operations in the quarter, primarily reflecting favorable movements in non-cash working capital.

During the quarter, we used the cash generated from operations to invest CAD14 million in capital expenditures and returned CAD38 million of capital to shareholders through dividends and the buyback of about 628,000 shares. In total, we repurchased 3.1 million shares at an average price of CAD45.40 under the NCIB program that expired on August 9.

We also used that cash to reduce our debt. At the end of the quarter, Stella-Jones' net debt, including lease liabilities, stood at CAD679 million versus CAD745 million at the end of December 2020.

We maintained a strong financial position with a net debt-to-trailing 12-month EBITDA ratio of 1.6 times, and we had available liquidity of CAD540 million. During the quarter, we obtained a one-year extension of our unsecured syndicated revolving credit facility to February 27, 2026.

All other terms and conditions remain substantially unchanged. Subsequent to the end of the quarter, on November 8, the TSX accepted Stella-Jones' notice of intention to make a Normal Course Issuer Bid.

Pursuant to the notice, Stella-Jones may purchase for cancellation up to 4 million common shares representing approximately 8% of the public float during the 12-month period commencing on November 12 and ending November 11, 2022. Yesterday, the Board of Directors of Stella-Jones declared a quarterly dividend of CAD0.18 per common share payable on December 17, 2021, to shareholders of record at the close of business on December 1.

I will now turn the call back to Éric for concluding remarks. Éric?

Thank you, Silvana. While we recognize that the quarterly results were lower than expected, I would like to highlight the solid year-to-date performance.

Sales for the first nine months of the year were up 15% organically, compared to the same period last year, and EBITDA grew 10% to CAD348 million. The softer quarterly results has led us to revise our full-year 2021 EBITDA forecast to about CAD400 million.

Excluding the impact of currency conversion, the company expects sales growth in 2021, compared to 2020 to be in the low- to high-teens range. The company remains confident that it will deliver solid EBITDA in 2021 and that its EBITDA margin as a percentage of sales will be comparable to 2020.

Based on current market conditions and assuming the conclusion of the acquisitions of Cahaba Pressure and Cahaba Timber, we're forecasting sales, EBITDA, and EBITDA margin in 2022 to be comparable to the solid results expected in 2021. The company anticipates that the robust demand for utility poles and the contribution from the pending acquisitions will offset the normalization of residential lumber sales in 2022.

Our priorities to create superior value for our stakeholders have not changed. We intend to continue to be active on the acquisition front, continue to improve our operating efficiencies and expand our capacity to increase our profitability.

With our financial strength, scale and focus on execution and innovation, we continue to be well-positioned to drive continued growth and generate solid return for our shareholders. This concludes our prepared remarks.

We will now be pleased to answer any questions you may have.

Yeah. Thanks very much, operator.

Good morning, everyone.

Good morning, Walter.

All right. So, I wanted to ask you, Éric, about the normalization comment and how that ties into your 2022 outlook?

I know you benefited from a significant and a little bit hard to predict increase in demand, and now, as that normalized, that's also hard to predict and, of course, guidance has had to move alongside that difficulty to predict. My question, I guess, when you referenced normalization, what confidence do you have as you go into 2022 that normalization has occurred and that the guidance that you provided for around CAD400 million or similar to last year – or this year is, what visibility and confidence do you have in that outlook?

Yeah. Thank you, Walter.

So, you're completely right. The guidance review or adjustments that we've been making this year are mostly all related to the residential lumber changes we've seen in pricing and in demand.

When we look currently at the forecast for volume for this year in 2021, I would argue that it will be most likely comparable to what we were seeing – we have seen pre-pandemic in 2019. Talking with our customers, contractors, and different expectations for household improvements, forecast for the coming years, we feel that going into 2022, we'd be looking at these similar volumes in 2019.

So, when we talk about normalization, as we went through the swing of the high prices of lumber which increased our pricing and our half-year sales. And then, since July – end of June or July, we've seen volumes normalize if you want.

And by that, I mean, being comparable to what we've seen historically. So, right now, as we're sort of landing towards the end of 2021, we see volumes to be comparable, and that's how we're drawing our assumption that for 2022, we would be seeing this similar volume levels.

Okay. That's very helpful.

Thank you. And just as my follow-up question with regards to the M&A pipeline.

First-off, you're including Cahaba in your EBITDA for next year. We've estimated that at about CAD18 million.

If you could – I'm not sure if you can give us a sense of whether that's accurate or not in terms of how much that will be contributing to next year, and then just your overall thoughts on the M&A environment? I know there was a pole acquisition that you were zeroing in on, if you could update us there and just generally the overall pipeline would be very helpful?

Thank you.

Yeah. Thank you, Walter.

We have not provided specific guidance on EBITDA margins for the acquired companies of Cahaba. However, I can tell you we've paid in our traditional multiple range.

We've always talked about a 6 times to 7 times traditional multiples. I think that gives you a good indication about how accurate your number is.

With regards to the pipeline, so you referenced a pole acquisition, so this would be one of them. The Cahaba Pressure and Timber combined would be one of the projects we were working on since the beginning of the year that we've alluded to in previous calls.

That being said, I did discuss in previous calls about potentially looking at several other projects. And we're still actively discussing with potential target acquisitions.

Our balance sheet is strong. We definitely have the leverage to accommodate more M&A and we remain focused on those projects.

Okay. Thank you very much, Éric.

My pleasure.

Thank you. Good morning.

Good morning, Mike.

Maybe just a clarification to begin with, the new 2021 EBITDA guidance of about CAD400 million, that includes the negative impact of the CAD7 million inventory provision taken in the third quarter?

Yes, it does.

Okay. Perfect.

Thank you. Second question, the various factors that have been pressuring results lately, so namely greater-than-expected margin compression for residential lumber, higher untreated railway tie costs, and anticipated softer demand for Class 1 railway customers.

To what extent do you see those factors continuing to pressure results in the fourth quarter?

So, those three factors are incorporated in, I guess, the adjustments in our guidance. So, when you look at – consider the midpoint or the guide – the EBITDA that you had previously to what we're talking about today, we're looking at the contribution for those three items to be part of the scenario.

So, I would say, probably 50% of that is related to residential lumber. If you include actually the write-off that was not in our forecast, you could call it probably closer to 70%, 75% and the balance of that would be railway ties.

Now, I'd like to add the fact that although we've seen our fiber cost for railway ties increase, we do have the opportunity, in many cases on a quarterly basis, to adjust our pricing. So, we have, on October 1, to a certain Class 1; and for others, we'll have another opportunity early in January.

So, I – we do feel that will subside over time.

Okay. So that was actually sort of going to be my next question is the extent to which these factors are expected to be an ongoing issue into next year.

You sort of answered it there, I guess, with respect to the ability to pass costs through on the ties side. But more holistically, are any of these factors going to continue to weigh on results next year in a material way in your opinion?

No, I don't think so. And maybe it's an opportunity for me to talk a bit about the write-down.

So through the third quarter, we did not see residential lumber volumes move as fast as what we wanted to. So, at the end of September, we sort of took a hard look at our inventory position, the average cost and what we need – or what we needed to achieve our December 31 goal of having the proper cost of inventory to be able to address 2022 in a more historical margin fashion if you want.

So that write-off gets us exactly where we need to be for the end of December. It's certain items that we've gone out to the market now and offered at a very attractive price, which I would say, are in better parts sold as I speak today.

So, we're in very good shape to put this residential lumber inventory adjustment behind us.

Okay. That's helpful.

Thank you, Éric. Maybe circling back on one of the questions that Walter asked about the outlook you provided for 2022 which implies about CAD100 million of EBITDA next year.

I think you've touched already on your – on some of your assumptions regarding the residential lumber business in terms of assuming it looks similar to 2019 levels, but can you talk maybe about some of the other assumptions you made around the rest of the business? And I guess, beyond the specific assumptions just your level of confidence in this number you provided for next year, and obviously, there are various risks and uncertainties, and this year was – that was very clear this year with the way the year played out, but to what extent have you buffered that number you've put out there, is it a conservative number, have you factored in various risks and uncertainties or how confident are you in that CAD400 million?

So, let's start with the residential lumber part. We're talking about assumptions, there are a couple of assumptions that I would like to add to the comment.

So, we talked about similar volumes in 2019. Assumption, obviously, is FX price of lumber is quoted under Random Lengths market in US dollar, so obviously there's a currency conversion potential impact.

And lastly, there is the price of lumber itself. The Random Lengths average in 2019 was around CAD500 a 1,000 board foot.

You are – currently, futures looking into early to late spring seem to be indicating pricing between $650 and $700 per 1,000 board foot. So I guess, if you think about that delta of CAD150 to CAD200 per 1,000 board foot, that is an assumption that could change over time to back to your comment about volatility if you want in the pricing.

So, other than that, when you think about our CAD400 million, so we have, as we mentioned in our remarks, there will be a bit of a pullback on the residential lumber and it will be offset by two things. One is growth and utility poles.

We've always guided to mid- to high-single-digit growth, and I think we're all set up to see that continuing for coming years. So, next year is not an exception to that.

And then obviously, with the conclusion of the Cahaba transaction, that sort of gets us more or less to where we need to be.

Okay. Thanks for the time.

Could – I'm not sure if you have any indication yet from the Class 1s as to the volume commitments for next year. I know a couple outlined their intentions at an industry conference recently, but any color you may be able to share about the sort of the picture across maybe some of the Canadian ones as well?

Yeah. So, well, great question.

As you might know, at the – not all Class 1s were present at the conference this year. So, we did get color from a certain number of them.

They seem relatively slightly upbeat, I would probably say, not relative but slightly upbeat. I mean, most of them are up a few hundred thousand ties in their annual maintenance program for coming year.

So, I think that's positive. I think it's an indication of something that we've been talking about of increased traffic on to rail networks.

Obviously, that leads to more maintenance. And I think railroads have been focused so far this year, probably a bit more on executing on logistics and delivering products.

And that's why we're seeing a bit of a slowdown in Class 1 maintenance in the second half of this year. But I think looking forward into the second half of 2022 and going into further years, I do see the potential for maintenance to be up.

Okay. Great.

And, Éric, in your outlook, you factored in – or I guess, to what extent have you factored in the US infrastructure plan? And then specifically related to that, on the railway ties side, when I understand a lot of that investment is planned with Amtrak.

And so, if you could speak to – I'm not sure what their sort of wood or concrete tie mix is, but color you might have there?

Yeah, certainly. So, to answer the first part of your question, the infrastructure bill impacts are not factored in our guidance for next year.

Tough to say to what extent it could impact next year. And what I mean by that is, by the time the program gets set up and/or presented to the market and funds are allocated, could we see some effects in the latter part of next year?

Yes. I think, ultimately yes, in 2023, we should see its impact to our result or we should see part of that demand come to our business.

With regards to Amtrak, they are a customer of ours. We do service them from time-to-time.

They're part of, I guess, I would say, the non-Class 1 or commercial business. So, it's a corded business.

But we have serviced that network in the past. And so, I do expect that we'll be at the table discussing for that business.

Okay. Thanks.

That's helpful. And Éric, just trying to the poles side of the business, I know there's been some media reports lately of PG&E potentially spending $20 billion to underground a portion of their power lines.

Are you seeing signs of any other utilities considering moves like that, and what's the sort of company's response given your – some of the fire retardant poles that you have in the market now?

Well, first, we haven't seen any slowdown from demand from our customers, and the plan for next year is still growth. That includes fire wrap products.

So, the press release you're referring to the PG&E is, I guess, it's a project that they're studying internally. My understanding is that it takes a lot of planning and engineering to be able to execute.

It will take several years to be able to execute. And I guess, we'll see where that goes.

We're good partners with those customers. And the project that they're announcing represents probably maybe a third of their network.

So, there's still another great part of their network that will require maintenance and our products. So, we're not necessarily concerned with that part.

And last but not least, we're not seeing any other of our customers having discussions or thoughts about putting a certain part of their network underground.

Okay. Great.

Thanks. That's helpful.

And just last question for me for Silvana. Could you comment on, for the CapEx for 2022, are there any larger investments being considered to grow capacity at the existing assets and anything you might have planned at Cahaba?

So, yes, for 2022, we would – we could expect our CapEx to be above our range, exactly to what you mentioned. We are looking at various initiatives to expand our capacity to support the additional poles growth that Éric just mentioned, and we do have some CapEx also dedicated to the conversion of our penta assembler .

So, in terms of amounts and timing, we're still in the process of completing up our budget. So, we don't have those numbers as of yet.

But, yes, we would expect it to be above the CAD60 million. For Cahaba, nothing significant.

They are pretty much in line with, I think, our overall – I guess, corporate percentage of maintenance annually is what we're seeing also at Cahaba.

Yeah. I would add, Hamir that the Cahaba assets are of extremely good quality, very well-maintained by the previous owners, so we're very proud to be able to add those plants to our network.

Okay. Great.

Thanks. That's all I had.

I'll turn it over.

Thank you.

Yes. Good morning, everyone.

Good morning, Benoit.

Yes. Just to follow up on the previous question, Silvana, could you talk a little bit about the working capital movement we might expect in light of the move in residential lumber for 2021 and 2022 at first glance ?

Yeah. So for the last quarter of 2021, as we've mentioned in the past, we are expecting a favorable working capital movement, exactly as you mentioned, Benoit, as we continue to draw down on our residential lumber inventory, and even still less of a build than in past years for railway ties given the tighter supply of untreated ties.

For 2022, assuming no one expected – unexpected, I guess, market movements, we would be budgeting a typical build in inventory to support sales growth over the following years. So, typically, our CAD50 million or so, I think at this point given that we're still in the process our best guess.

Okay, okay. That's great.

And just in terms of share buyback, how should we be thinking about the allocation of capital going forward versus the M&A opportunities you might have for 2022?

So that's pretty consistent with, I guess, what we've been seeing in the past. Obviously, as you know, the new program is there to be used.

So, we do expect to continuously use it, but always keeping in mind our target leverage ratio and to remain within our target ratio and prioritizing obviously the acquisitions.

Okay, that's great. And any thoughts about the look of the fourth leg of growth?

I'm just wondering how this initiative has progressed so far in 2021, whether you have a better picture on the ability to have the fourth leg of growth down the road?

Yeah. So, I'll take that question, Benoit.

I think for the next foreseeable future, call it, 12 to 24 months, there's still a lot of opportunities that are closer to our core competencies of wood treating. I think so, you'll see our team being focused on M&A with that nature.

Silvana spoke a bit about capacity expansion to address upcoming demand where M&A is not necessarily readily available. The other aspect that you're referring to is something that we're still studying and investigating and discussing with the board, but I think for the next short while, you will still hear us talk about the treated lumber in all three of our product categories.

Okay. And last one for me, could you talk about the penta preservative?

I know there's change going on and it will eventually rundown. So, just some color about the market acceptance for the other preservative that will eventually replace the penta?

Yeah, certainly. So, the current manufacturer of penta is closing shop at the end of this year.

We will be doing – performing the transition away from penta in the next 18 months. We have sufficient supply to provide penta treated poles to certain customers that are very much interested in taking that product for as long as we can provide it.

We have discussed with all of our customers their preferences for conversion and they are of – many avenues. Certain customers will move to waterborne preservatives such as CCA.

Other utilities are discussing about the opportunity to move to DCOI, which is an oilborne preservative, such as penta. Last but not the least, another option that is offered is a product called copper naphthenate that we also offer within our network.

I would say, the interest for that product is lesser than DCOI at the time being, but we've got a plan laid out with most of our customers. At this point, we have an 18-month plan to sort of progressively phase-out certain plants and convert certain customers, and we're sort of working collectively with those customers to be able to address it in an orderly fashion.

Okay. And with respect to those preservative, are there some additional costs due to be expected or margins – fair to expect that margins will remain about the same, given the change in – with penta?

Yeah. I suspect that the margins will stay similar there.

In both cases, when we convert away from penta, usually the customers will prefer to, if you're an old – if a utility prefers an oil-based preservative, it will most likely move to another oil-based preservative and the margin profile would be similar.

Okay. Thanks for the time.

My pleasure.

Éric, I just wanted to circle back to M&A. And I guess, my question around this, are we in the process of identifying kind of needle-moving opportunities or how should we think about kind of the quantum of revenue contribution that could be coming from acquisitions over the next kind of 12 to 24 months?

Yeah, certainly. So, Maxim, our industry, in all three product categories, have many participants, but family-owned business of various sizes.

We've always said, it vary between the CAD3 million to CAD100 million mark depending on the size. So, I mean, to be respectful, needle moving for Stella-Jones is now sitting today at CAD2.7 billion revenue, you might argue that it's not necessarily needle moving, but this is how we built our network over the last 15 years is by adding to our network, adding these smaller companies, consolidating our respective markets, and becoming a strong presence for current customers and future customers.

Right. No, fair enough.

And then, is there – I mean, obviously, as you mentioned, other potential sort of legs of the stool being considered as risky , but in terms of providing incremental services to your existing customers, is there some thought process on that front from a strategic perspective?

Yes, definitely. It's – there are activities, products and services that are closely adjacent to what we do, for which we do have internal expertise.

That discussion with customers would see us favorably addressing those. And back to Benoit's question a few minutes ago, when he was talking about a fourth leg, I know we can talk about a fourth leg, but I think it's enhancing our offering to our customer base if you want, but definitely, there are items in those categories that we're definitely looking into.

Right. And I guess, is it fair to say that you're not limiting yourself just to kind of like capital-driven businesses, but also sort of a service type potential is what would make sense for you?

Yes. We're not excluding anything at this point.

If we have the internal knowledge and the capacity to execute, it is accretive to our margin profile, it's something we'll definitely consider. So, I'll be hard pressed to address a business that would lower our average EBITDA margins.

So, there's a few criteria we're looking at, but we've always said it needs to be accretive. It needs to be somehow close to our core competencies and we're trying to stick to those criteria.

Okay. That's great.

Thank you. And then maybe just a quick question for Silvana, in terms of synergies on the acquired assets, anything that you can suggest to us?

I think we are fairly confident as in the past transactions that we'd be able to pick up half a turn to turn on the traditional multiple that Éric exposed earlier. So that would include any optimization of customers, of procurement, and some SG&A synergies.

Okay. Silvana, thank you.

And then, last question, Éric, are you seeing any – obviously, lots of discussions around supply chain bottlenecks, wage pressures, kind of labor availability, and so forth. Anything you can share with us on these fronts?

Yeah. Maybe a few little things.

Like any company in North America, holding on to your labor force is a bit more difficult. We have adjusted internally our wages to our employees and keep being very mindful of market dynamics on that front, but I think we're holding our own pretty well on that front.

With regards to tightness, so we didn't necessarily talk about it, but we are seeing tightness in the untreated tie market. So, less untreated tie availability is putting some pressure on procurement.

Nothing to be overly concerned about, but we are seeing some decline in our inventory levels since, let's say, the last few months. And I think it will subside somewhere probably early next year.

So, we're definitely adjusting to that. That being said, being mainly a black tie supplier, we have a large inventory of ties at our facilities.

So, we can definitely – we're in a good position to address that. Last but not least, which is not directly tied to us, but we are hearing certain utilities that are faced with a challenge to find complementary products that they need for maintenance and installation, cabling, hardware, transformers and things of the like.

Nothing alarming, but we are hearing that general supply constraints in North America for all sorts of products is not – is impacting to some extent our certain utility customers. But nothing that would change our views on our guidance, but I'm just throwing it out there, as I wanted to answer your question.

Okay. That's great.

Thank you so much. That's it for me.

Thank you.

Thank you, Julianne. And thank you, everyone for joining us for this call.

We look forward to speaking with you again at our next quarterly call.