Interfor Corporation (OTCPK:IFSPF) Q3 2023 Earnings Conference Call November 3, 2023 11:00 AM ET
Company Participants
Ian Fillinger – President & Chief Executive Officer
Rick Pozzebon – Executive Vice President & Chief Financial Officer
Bart Bender – Senior Vice President of Sales & Marketing
Conference Call Participants
Roshni Luthra – BMO Capital
Kasia Kopytek – TD
Paul Quinn – RBC Capital Markets
Operator
Good day, ladies and gentlemen. And welcome to Interfor Quarterly Analyst Call. At this time, all lines are in a listen-only mode. Following the presentation, we will conduct the question-and-answer session. [Operator Instructions] This call is being recorded on Friday, November 3, 2023.
I would now like to turn the conference over to Mr. Fillinger. Please go ahead.
Ian Fillinger
Thank you, operator and thank you everyone for joining us this morning. With me today on the call, I’ve got Rick Pozzebon, our Executive Vice President and Chief Financial Officer, and Bart Bender, Senior Vice President of Sales and Marketing
Before we get into our normal course call, I’d like to welcome Geoffrey Evans to our Board of Directors, and we look forward to working with Geoffrey and his contributions over the years to come. I’ll start off by providing a brief recap of our quarter and then I’ll pass the call on to Rick and Bart.
Turning to our quarter. We generated a positive $32 million of adjusted EBITDA during a very challenging quarter that was impacted by both wildfires and price – lumber price movements. We advanced our capital projects in the US South and remain flexible to adjust our plans in line with market conditions. Our balance sheet remains well-positioned.
During the quarter, we reduced our leverage and improved our liquidity. With respect to our outlook, we feel housing demand has been relatively strong in the face of rising interest rates. But the most recent round of hikes appears to be having an impact. And combined with this lower – slower time of year, it has resulted in buyers being extremely cautious and limiting purchasing to immediate needs only.
On the supply side, inventories at both the producer and supply chain level are low and operating on a just-in-time basis for shipments. And production curtailments are anticipated from the industry, if the current prices continue. In closing, barring any winter transportation issues or unforeseen events, lumber prices are expected to remain at or near industry breakeven levels for the remainder of the year.
I’ll now turn the call over to Rick, who will run you through the financials.
Rick Pozzebon
Thank you, Ian and good morning, all. Please refer to cautionary language regarding forward-looking information in our Q3 MD&A. From a high-level perspective Interfor’s Q3 results reflect the ongoing lumber market uncertainty, driven by the higher interest rate environment and delayed supply side responsiveness. Regardless, Interfor remains well positioned to successfully navigate through this environment with its high quality and recently diverse portfolio of operations.
In terms of Q3 earnings, Interfor generated adjusted EBITDA of $32 million on total sales of $828 million. Compared to Q2, revenue benefited from a slight 2% increase in the average realized price on lumber sales, which was more than offset by a 10% decrease in shipments. The lower lumber shipments were mainly due to temporary operational disruption caused by wildfires in B.C.
Production costs on a per unit basis were higher quarter-over-quarter, due mostly to Q2 costs benefiting from a $28 million reduction in the reserve against inventories, whereas Q3 only benefited from a $3 million reduction of the same. The operational disruption in B.C. caused by wildfires also contributed to higher costs in the third quarter.
From the balance sheet perspective, financial flexibility improved in Q3, with a net debt to invested capital ratio dropping to below 29%. This improvement was driven by cash flow from operations, totaling $107 million including $71 million of income tax refunds related to the prior year. A portion of this cash flow was used to fund capital expenditures totaling $39 million, of which the majority was on strategic mill improvements in the US South.
Looking ahead, we still expect to receive an additional US$25 million of income tax refunds before the end of this year. And we’ll continue to execute on monetization of our coastal B.C. operations to further bolster the balance sheet.
In terms of capital allocation, our key priority is to continue managing our balance sheet leverage towards our target range while also continuing to invest in select US sales operations where attractive opportunities exist to optimize returns. We continue to anticipate capital expenditures for 2023 to total about $210 million. For 2024, we estimate capital expenditures will total about $140 million.
To wrap up, we will continue to focus on operational excellence to maximize margin on each segment while conservatively managing through the ongoing market uncertainty.
That concludes my remarks. I’ll now turn the call over to Bart.
Bart Bender
Thanks Rick. As usual, I’ll provide comments on our market outlook. In general, the outlook varies whether you’re focusing on the medium-term or the short-term. In the medium-term, the market fundamentals remain encouraging buoyed by tailwinds on several key factors such as underbuilt housing, demographics, age of housing inventory, household formation rates, et cetera. All of these indicators support increased lumber demand in the future.
In the short-term, the market outlook is less certain. Affordability a combination of both the price of the house and mortgage rates is impacting the demand for homes and consequently build our confidence. This is causing some volatility in the housing starts and within housing starts the percentage of multifamily versus single-family.
With new home construction accounting for approximately 30% of lumber demand and single-family construction consuming three times out of multifamily construction, this volatility is impacting lumber demand. With that being said, recent data in the last few months has been encouraging with the percent of single-family starts stabilizing closer to 70% of total US starts. This will be a key item to focus on going forward.
On the repair and remodel component of end use, which accounts for approximately 40% of lumber demand our takeaway remains stable. With many existing homeowners remaining in place, remodeling opportunities have increased. This is helping to keep repair and remodel lumber demand steady.
When you combine all the lumber demand sectors in one and consider current supply dynamics including the impact of European imports, the short-term outlook for 2023 and into early 2024, shows few signs of improvements from current levels. Our market intelligence suggests end market lumber inventories are stable on the low end of the spectrum.
It’s important to recognize that the lumber market is very sensitive to demand and supply dynamics. As we work through these short-term uncertainties, we know that markets can improve quickly. We will continue to manage our business accordingly, matching our production demand as we work through the short-term headwinds and move closer to medium-term tailwinds.
With that, back to you Ian.
Ian Fillinger
Okay. Thanks Bart. Operator, we’re ready for questions.
Question-and-Answer Session
Operator
Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Your first question comes from Roshni Luthra from BMO Capital. Please go ahead.
Roshni Luthra
Hi, good morning. Could you talk about some demand trends that you’re seeing in new deal and R&R just since the end of Q3? And also just what you’re seeing in the channel like in terms of inventory?
Bart Bender
Sure. I’ll answer that. It’s Bart here. Our best indicator on the repair and remodel side comes through our actual programs that we have with the customer base that services predominantly that end-use sector. So we’ve got weekly indications of the kind of demand that we’re seeing. And I can tell you that they — the consumption that we’re seeing through that portion of our customer base has been steady and it’s been steady for some time actually.
And so we’re not seeing any indication based on actual business done that’s — anything is going to change from where it’s been at. So we’ve been actually encouraged by the amount of business that we’re getting on that side of it.
Moving over to inventory levels. It’s always difficult to put your finger exactly on where the sort of the in-market industry levels are. However, the intelligence that we have through conversations with customers through some reporting that is available suggests that the inventory levels are sort of in that bottom a third of I would say historical norms.
Those are the end market levels. So I can tell you on the inventory levels on our side of the equation we continue to be very diligent in how we manage those. We work very hard to make sure that are in process and finished goods inventories are kept at strategic levels which that is the case for us.
Roshni Luthra
Sorry, go ahead.
Ian Fillinger
No, go ahead.
Roshni Luthra
I was just going to add just on top of that speaking of inventories probably do you have a better sense of what’s going on with the European lumber import? What’s sitting at the U.S. ports or what you’re expecting for the next three months?
Bart Bender
Yes. I mean obviously the year started out a bit differently I think than historical trends. We saw quite a volume come in from the European importers. But I would say, from February on we’ve just seen a steady ratcheting down of those numbers. And I think we’ll end up — in 2023 we’ll end the year at fairly similar to 2022.
However, the pace of the last call it six to eight months has been at a lower level which would suggest that 2024 overall inventories will be coming down to kind of more historical levels of what we saw maybe in I think 2020 is a good indication maybe even 2021. So in and around that high two to low three billion board feet annually.
Roshni Luthra
Thank you. And then just the last question for me Lawrence or Rick. I saw your preliminary CapEx program for next year $140 million I believe. Just where’s the pullback coming from? Is there like a rethink on the multiyear CapEx program? Or just any color you can provide there.
Ian Fillinger
This is Ian. I’ll take that. Yes, our CapEx program as we’ve continually advertised is flexible. We have a CapEx team in place. We’re I think distinctly different than some others in our industry where our capital projects are managed engineered revised and executed on with an internal team largely based out of the South. That gives us the ability at different points in time for a multitude of different reasons, which could be market conditions, could be labor availability. We could be scheduling or moving projects to support start-ups of other projects. So the genesis behind us moving those around has a little bit to do with all of those. And I think that’s a strength of Interfor that we’re not tied to long-term contracts that demand projects to be done at times, where the market doesn’t need any extra wood coming on the market. So, really it’s that more than anything.
The other thing, that also changes when you lay out a plan from 2018 and then lay it out for five or six years is cost. And in some projects, it’s valid and prudent to look at how costs have changed over the last 24, 36 months. So, some of that factors into possibly delaying or pushing out a project to allow the right threshold paybacks to be achieved, et cetera. So, what you’re seeing in our plan going into 2024 is really a combination of all of those factors.
Q – Roshni Luthra
Thanks, Ian. That’s all I had. I’ll it over. Good luck, nice quarter. Thank you.
Ian Fillinger
Okay. Thanks for the question.
Rick Pozzebon
Thanks, Roshini
Operator
Thank you. Your next question comes from Kasia Kopytek from TD. Please go ahead.
Q – Kasia Kopytek
Hi, everyone. It’s Kasia on the line. Just sticking with Roshni’s question. Ian, can you provide some context around the nature of the projects that are being deferred in 2024?
Ian Fillinger
I would say that there’s one project that we’re doing in Thomaston. It’s a large multiyear project. And our goal is to finish that in 2024. Other than that there’s a multitude of smaller projects in 2025 and a couple of mills. Those are not big projects, but have great paybacks. And then there’s one or two in Ontario, that we’re looking at for 2025, 2026. So that’s the high-level again chart of what our projects look like over the next few years.
Q – Kasia Kopytek
Okay. And for the project where you’ve indicated it’s more prudent just from a cost perspective to hold back, what’s the magnitude of the return compression that you’ve been seeing for the expected return compression?
Ian Fillinger
Yes. I mean, we’re always shooting for that hurdle rate 20%. So when they go north of that we take a hard look at it and then decide with an appropriate risk level whether it continue? Or like I said, we have flexibility when prices and equipment prices get too expensive to back off. So as soon as it trips that threshold, it really gets our intention at the senior level and then we talk about it and make the right decision. So, I would kind of leave it at that.
Q – Kasia Kopytek
Great. Okay. Thanks for that. And maybe taking it back to market you gave some context in your prepared remarks around order files. Can you comment maybe on certain areas that are stronger on a relative basis than others? Some preliminary discussions that you’re having for 2024, what that’s looking like? And whether generally things are trending normally from a seasonal perspective?
Bart Bender
Yeah. All good questions. It’s interesting. We’ve got a fairly unique perspective on the markets with the regions that we operate in. And I can tell you that the markets that each region has its own sort of dynamics that are involved. And it’s not always one consistent region that’s showing increased activity versus another it does move around. The market is fairly dynamic that way. The business as we get into 2024 right now is the time that you talk about partnerships and programs, and working with our customers and getting set up for next year.
The interest to partner with Interfor remains high. We’ve got a very strong customer base that’s been — we’ve been servicing them for years. And a lot of them is just a bolt-on from what we acquired in the East. So we feel like we’re in a pretty solid position there. And then we just have to just see how the market goes. I mean, it’s — it really is a bit uncertain right now. And — yeah, we’ll just react to the demand that we see from the market given our sort of network of outreach by region to the different customers.
Ian Fillinger
Yeah. I would just add to Bart’s comments and this is — I’m putting words in Bart’s mouth but he spoke about this. But the advantage that we have — we often get asked around growth and our last acquisition was about a year ago today almost was Chaleur and New Brunswick. But we are seeing significant customers starting to recognize the breadth and depth of our company and customers are now that would be traditionally buying one species in area are now buying from all areas in our company.
And so we are getting great traction with a number of very important customers that are now buying from us in different regions. So I would say that’s a nice synergy that we’re getting. The other one is that, we are the largest producer in the world and very heavy to MSR. So single-family homes start to improve which if you look at FDA forecast and accept that as a trend we should be benefiting from that going forward given that there was some depression in single-family homes over the last 18 months or so. So we do see as Bart’s opening comments medium term some nice trends that we’re expecting.
Kasia Kopytek
Okay. Thank you both for that thoughtful commentary. Last one for me. Maybe just speak to your overall framework for thinking about where share buybacks in your broader capital allocation program?
Rick Pozzebon
Good morning, Kasia it’s Rick. Certainly, we think where we’re trading today represents a significant value opportunity. As we look at our balance sheet we’d like to be back into our target range before we start thinking about share buybacks. It’s certainly high on our priority list in terms of capital allocation so we’ll be keeping a close eye on that going forward.
Kasia Kopytek
Thanks, Rick. Okay. Thanks everyone. That’s all for me, I will get back in the queue.
Ian Fillinger
Thank you.
Rick Pozzebon
Thanks, Kasia.
Operator
Thank you. Your next question comes from Paul Quinn from RBC Capital Markets. Please go ahead.
Paul Quinn
Good morning, guys. Thanks so much. Maybe just a follow up on that targeted range. If you could remind us what that is? And when you expect to get there?
Rick Pozzebon
Sure. Paul, good morning. It’s Rick. Target range for us is 5% to 25%. We’re just slightly above that today at around 29%. And there’s no real time line that I can give you on guidance to get back down to 25%, but we’re certainly comfortable where we’re at. We’ve got some cash flow opportunities in terms of monetizing the cost. That will certainly benefit us over the next 12 months to 24 months. That will help bolster the balance sheet. We still have some additional tax refunds coming in US$25 million that will also help. But certainly the market weakness today is something we’ll keep an eye on and that will be the largest driver of when we’ll be able to recover back down into our target range.
Paul Quinn
Okay. Thanks. And, yes, congratulations on the B.C. Coastal tenure sale. Just wondering if we can — with the time line for the remaining balances and whether we can use those sales metrics as indicator for what your eventual net proceeds will be from there?
Ian Fillinger
Yes, I’ll take for policy. Yes. We’re very pleased to be moving forward on that kind of unencumbered if you will. And the interests we’ve been working on for as you know probably two years now, extremely high advanced conversations with a multitude of people interested in the tenures. We’ve had lots of support from the B.C. government who’s behind the strategy. And so as these things progress which we expect will be on a regular basis yes we’ll keep you and the Street informed but we expect these to be rolling in over the next 24 months.
Rick Pozzebon
And Paul, if I could just add. The economics on the transaction that we announced with our press release yesterday that’s in line with what we would expect to be able to realize on average over the course of the next 24 months or so on the remaining 10-year sales.
Paul Quinn
Okay. Great. And then just lastly if you can give us a high level sort of update as what’s happening on that softwood lumber file? Do you see any movement forward? I mean some of your competitors have talked about an increasing discussion. If we’re talking 24 months of settle the cost. What’s the time line of general softwood lumber?
Ian Fillinger
Yes. Paul, I’ll take a shot at that. I’ve listened to the responses from others. I don’t think I can add much more other than on the Canadian side, the cooperation from coast to coast is extremely high on what a pan-Canadian view would look like. At the end of the day, it’s the two governments have to come together if there’s going to be a negotiated settlement, given the political environment in both countries might be a while. And on the court, really the road block are getting the panel set for the review of the legal case which is probably in 2025 best-case scenarios. If there was a refund through the court system and probably be in that — in and around that range and if there’s a negotiated settlement, it would probably be slightly before that.
Paul Quinn
All right. Thanks helpful. Thanks a lot. Best of luck.
Ian Fillinger
Yes. Paul.
Operator
Thank you. [Operator Instructions] Your next question comes from [Indiscernible] from CIBC Capital Markets. Please go ahead.
Unidentified Analyst
Hello. Good morning. I know you [Indiscernible] at the R&R trends that you’re seeing. But I was wondering, if you could provide some color on your R&R demand expectations for 2024. Do you see volume growth there?
Bart Bender
Yes. Thanks. I think I did mention that, we expect the repair and remodel sector to be fairly steady. We’ve seen that throughout 2023. And as we look at our own results, plus what we’re hearing from our customer base, we’re expecting a similar trend through 2024.
Unidentified Analyst
Okay. Great. Thanks. And then given your ongoing capital projects, what level of production you’re targeting next year?
Rick Pozzebon
Good morning. We don’t provide forward-looking production guidance, but certainly given some of the projects that are ramping up today and over the next quarter or two, we expect some uplift in production from where we are this year at a current pace.
Unidentified Analyst
Okay. Thanks. That’s helpful. That’s all I had for now. I’ll turn it over. Thank you.
Operator
Thank you. There are no further questions at this time. Mr. Fillinger, please proceed with the closing remarks.
Ian Fillinger
Okay. Thank you everyone for your interest in our company. And if you have any further questions, feel free to give us a call or drop us an e-mail at any time. And this concludes our call. Thanks again. Goodbye.
Operator
Ladies and gentlemen, this concludes your conference call for today. We thank you for participating, and ask that you please disconnect your lines. Thank you.
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