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WFP reports Adjusted EBITDA of $15.1M in Q2 2019

Western Forest Products‘ adjusted EBITDA result of $15.1 million in the second quarter of 2019 compared to adjusted EBITDA of $50.2 million in the second quarter of 2018, and $18.1 million reported in the first quarter of 2019. Operating income prior to restructuring and other income was $1.4 million in the second quarter of 2019, compared to $39.7 million in second quarter of 2018, and $5.7 million reported in the first quarter of 2019.

Net loss of $0.7 million ($nil per diluted share) was reported for the second quarter of 2019, as compared to net income of $27.1 million ($0.07 per diluted share) for the second quarter of 2018 and $1.9 million ($nil per diluted share) in the first quarter of 2019.

On June 28, 2019, the United Steelworkers Local 1-1937 (USW), the union representing a majority of the company’s hourly employees and employees working for its timberland contractors in B.C., served seventy-two hours’ notice of strike action. The strike, which commenced July 1, 2019, is ongoing at all USW-certified company manufacturing and timberlands operations. Ladysmith sawmill, value-added remanufacturing facility and both United States divisions (Arlington and Columbia Vista) continue to operate.

“Levering investments in our flexible operating platform allowed us to increase specialty lumber shipments and revenue, partly mitigating the effects of challenging commodity markets and higher coastal B.C. operating costs,” said Don Demens, President and Chief Executive Officer. “Looking ahead, we expect to resolve the ongoing labour strike and move forward with growing our specialty products business.”

The company generated revenue of $310.3 million in the second quarter of 2019, as compared to $327.8 million in the second quarter of 2018, and $275.7 million in the first quarter of 2019. The company partially offset weaker lumber and by-product revenues with increased log revenues, primarily driven by the restart of its export log program.

Summary of second quarter 2019 results

Sales

Lumber revenue of $233.6 million, was 9 per cent lower than the same period last year as the impact of market related curtailments in Western’s Canadian operations more than offset the inclusion of a full quarter of sales from the company’s Columbia Vista division.

Lumber shipment volumes decreased 10 per cent due to weak markets, which led to lower production and sales. Despite declining market pricing, Western’s average realized lumber pricing increased 2 per cent, as the company increased our specialty product mix and benefited from a weaker Canadian dollar (CAD) to United States dollar (USD). Specialty lumber represented 57 per cent of second quarter shipments compared to 48 per cent in the same period last year.

Western Red Cedar (WRC) lumber shipments declined 8 per cent compared to the same period last year, as poor weather impacted market demand. Japan lumber shipments increased 18 per cent. The addition of the Columbia Vista division led to an increase in Douglas fir product sales to Japan, which more than offset weakness in sales of B.C. coastal Hemlock products. Hemlock market share in Japan continues to be challenged by subsidized Japanese domestic species. Niche lumber shipments increased 27 per cent compared to the same period last year through expanded production at our Duke Point sawmill. Commodity lumber shipments declined 26 per cent compared to same period last year as we reduced production due to weaker commodity markets in North America and China. We increased our direct sales of commodity lumber products to China by 31 per cent, which helped mitigate weaker lumber pricing, compared to the same period last year.

Second quarter log revenue was $63.3 million in 2019, an increase of 29 per cent from the same period last year. Log revenue benefited from the resumption of our export log sales program and a stronger domestic log sales mix.

By-product revenue declined $9.8 million compared to the same period last year as a result of lower B.C. coastal production and a 29 per cent reduction in chip price realizations, due to a steep decline in global softwood pulp pricing. In addition, chip purchase-and-resale volume declined by 69 per cent.

Operations

Lumber production of 206 million board feet was 12 per cent lower than the same period last year. Incremental production from Western’s U.S.-based Columbia Vista division acquisition was more than offset by market related sawmill curtailments in the company’s B.C. mills during the quarter. Western responded to challenging economics resulting from weak commodity markets, high stumpage costs driven by export log prices, and the impacts of U.S. softwood lumber duties by redirecting certain logs to the company’s export log sales program and limiting commodity lumber production.

Second quarter per unit manufacturing costs were 14 per cent higher than the same period last year, due to temporary mill curtailments and mix of operations. Manufacturing costs included $1.7 million arising from temporary mill curtailments, and $0.9 million incurred in the operating ramp-up of Western’s Arlington division.

Log production from the company’s B.C. coastal operations was 1,250,000 cubic metres, 7 per cent lower than the same period last year. Decreased log production was primarily due to the curtailment of Englewood operations arising from ongoing harvest permitting challenges.

Western’s B.C. coastal per unit harvest costs increased by 11 per cent from the same period last year, due to a mix of higher cost operations and increased sorting costs related to the resumption of our export log sales program. Per unit stumpage costs were 13 per cent lower primarily due to the mix of species harvested and increased private timberland harvest on which no stumpage fee is incurred.

B.C. coastal saw log purchases were 238,000 cubic metres, a 22 per cent decrease from the same period last year as we managed log purchases to lumber production.

Freight expense increased by $3.3 million from the same period last year, due to the resumption of Western’s export log sales program, an increase in the company’s direct sales to China, and the inclusion of shipments from the company’s Columbia Vista division.

Second quarter adjusted EBITDA and operating income included $9.7 million of countervailing duty (CVD) and anti-dumping duty (AD), as compared to $11.7 million in the same period last year. Duty expense declined as a result of reduced U.S.-destined lumber shipment volumes.

Recent developments – B.C. government forest policies

In 2018, the B.C. provincial government introduced a Coastal Revitalization Initiative and further policy initiatives that will affect the B.C. forest sector.

On April 1, 2019, the province announced the creation of fibre recovery zones, which are intended to increase the supply of residual fibre from primary harvesting for secondary users.

Western estimates that approximately 70 per cent of its timberland operations will be impacted with the creation of fibre recovery zones. The impacts to Western’s business include the potential for higher costs and lower log harvest volumes. The company expects the impacts will start to be realized in 2019. The province has been clear that they do not want to see unintended consequences from the policy implementation. Western continues to collaboratively engage with the province and other stakeholders to ensure that the desired outcome of the policy, less fibre waste and more fibre for domestic manufacturing and pulp production, is met without the unintended consequences of higher costs and less harvest volume for timberland operators.

On May 16, 2019 Bill 21, Forest and Range Practices Amendment Act, 2019, designed to increase opportunities for public input, improve information sharing on forest planning, strengthen the Minister’s ability to manage forest activity, expand the definition of wildlife to help protect at-risk species and improve and streamline range-use planning, was put into force.

On April 11, 2019, the province announced Bill 22, Forest Amendment Act, 2019, which came into force on May 30, 2019. The amendments to the Forest Act will require tenure holders to receive approval from the Minister before disposing or transferring a tenure agreement to a third party. These amendments will enable the Minister to refuse to approve a disposition or transfer if it is deemed not to be in the public interest or detrimental to competition in the buying or selling of timber or residuals, or to place conditions on the approval.

On July 10, 2019, the Province announced the application of a targeted fee-in-lieu of manufacturing for exported logs harvested from BC Timber Sales, as a step towards ensuring that more logs are processed in B.C..

The impact these policy initiatives may have on Western’s operations cannot be determined at this time.

Labour relations update

On July 1, 2019, the United Steelworkers Local 1-1937, the union representing approximately 1,500 of the company’s hourly employees and 1,500 employees working for Western’s timberland contractors in British Columbia, commenced a strike. The strike is ongoing for all of Western’s USW certified manufacturing and timberlands operations. Western continues to operate its Ladysmith sawmill, value-added remanufacturing facility and Arlington and Columbia Vista divisions.

Western has been in negotiations with the USW since April 2019 for a new collective agreement to replace its prior agreement, which expired mid-June 2019. The company applied to the BC Labour Relations Board on June 25, 2019 for the appointment of a mediator to assist in negotiations and have since made multiple requests to meet with the USW and a mediator. The USW served seventy-two hours’ notice of strike action on the company, and some of its contractors, on June 28, 2019.

Western has been working to negotiate a new collective agreement with the USW, as has been achieved in the northern and southern interior of B.C., where the United Steelworkers and the Council on Northern Interior Forest Employment Relations and Interior Forest Labour Relations Association, respectively, have ratified new collective agreements. The actions taken by the USW come at a time when B.C. forestry companies are curtailing production and shutting down mills due to high log costs and poor market conditions.

The company has commenced our work stoppage contingency plan and is working to mitigate the impact of the strike on business partners and customers. Western is committed to reaching a reasonable agreement that respects the contributions of its employees and ensures the company remains globally competitive.

The strike is expected to have a negative impact on Western’s third quarter results compared to the same period last year, but the company is unable to determine the magnitude of that impact at this time.

Sawmill curtailments

The lumber industry continues to face some of the most challenging operating conditions seen in over a decade, including declining lumber and chip prices and high log costs which are challenging the economics of our operations.

Western’s Cowichan Bay sawmill was temporarily curtailed for a two-week period beginning March 25, 2019 and the Alberni Pacific sawmill was temporarily curtailed for a four-week period beginning March 18, 2019, due to market conditions. The company’s Ladysmith sawmill was temporary curtailed for a two-week period beginning May 6, 2019 due constrained log supply.

On June 6, 2019, Western announced temporary production curtailments at three of its sawmills to align production volumes to customer demand. The company curtailed its Duke Point sawmill for two weeks and its Saltair sawmill for one week in June. Western also reduced operating levels at its Chemainus sawmill from 120 hours per week to 80 hours per week.

On July 24, 2019, Western announced a temporary curtailment at its Ladysmith sawmill due to strike action taken by the USW which has impeded log supply to the mill. Subsequent to this announcement, the Labour Relations Board ruled these USW tactics to be illegal and ordered that they refrain from impeding the delivery of logs to the mill. The Ladysmith sawmill will continue to operate as long as there is adequate log supply and market support.

Strategy and outlook

Western’s long-term business objective is to create superior value for shareholders by building a margin-focused log and lumber business of scale to compete successfully in global softwood markets. Western believes this will be achieved by maximizing the sustainable utilization of its forest tenures, operating safe, efficient, low-cost manufacturing facilities and augmenting its sales of targeted high-value specialty products for selected global customers with a lumber wholesale program. Western seeks to manage our business with a focus on operating cash flow and maximizing value through the production and sales cycle.

Market outlook

Western’s long-term view of market fundamentals remains unchanged. In North America, rising lumber consumption will be driven by increased new home construction, a robust repair and renovation sector and growth in the use of mass timber building technologies. In China, a government commitment to housing and economic stimulus should accelerate demand for lumber. Growing demand and the supply implications of North American sawmill curtailments is expected to benefit the industry long-term.

Despite positive long-term growth drivers, lumber markets have been challenged in 2019 as North American weather events and skilled labour constraints have stalled U.S. new home construction and muted growth in repair and renovation spending. Recent lumber market volatility is expected to continue through the rest of 2019. Accordingly, Western will continue to lever its flexible operating platform and specialty product mix to mitigate market conditions.

Western anticipates a normal seasonal slowing of demand in its WRC segment. Pricing is likely to become more volatile moving through the fall season.

In Japan, the company expects demand to remain flat for its Douglas fir products, however increased competition from engineered wood products may pressure pricing. Western expects continued market share erosion for B.C. coastal Hemlock lumber in Japan due to increased competition from Japanese government subsidized domestic species.

The company anticipates demand for appearance quality niche products to moderate due to the trade friction between the U.S. and China. In contrast, Western expects demand to remain steady for timbers and industrial products.

Commodity lumber markets are likely to remain volatile due to high supply chain inventories and stalled demand. The company has had success in limiting commodity price volatility by increasing its direct sales volume to China.

Western expects domestic saw log prices to gradually decline in response to lumber markets. Price declines may be somewhat mitigated by lower market log supply, as recent government initiates that have increased harvest costs are expected to challenge harvest economics. In the U.S. Pacific Northwest, Western expects its Columbia Vista division to continue to benefit from lower Douglas fir saw log prices which have responded to the weaker lumber markets.

Near-term B.C. coastal chip pricing is anticipated to remain weak due to the declining trend in NBSK pulp pricing.

Softwood lumber dispute and US market update

Western’s results for the second quarter of 2019 include $9.7 million of export duty expense, comprised of CVD and AD expense. At June 30, 2019, Western had $82.1 million of cash on deposit with the U.S. Department of Treasury in respect of these softwood lumber duties.

The U.S. application of duties continues a long-standing pattern of U.S. protectionist action against Canadian lumber producers. Western disagrees with the U.S. trade determination and the inclusion of specialty lumber products, particularly WRC and Yellow Cedar products in this commodity lumber focused dispute. As duties paid are determined on the value of lumber exported, and as Western’s shipments to the U.S. market are predominantly high-value, appearance grade lumber, the company is disproportionately impacted by these duties. In May 2018, the company filed a Chapter 19 North American Free Trade Agreement (NAFTA) separate-like-product challenge, which was subsequently presented to a NAFTA hearing panel in May 2019. Western does not expect a ruling until late 2019 or early 2020. If the company is successful in its challenge, the NAFTA panel may instruct the U.S. International Trade Commission to further investigate the company’s like product claim consistent with the panel’s findings.

On April 9, 2019, a World Trade Organization (WTO) panel ruled on certain matters relating to the application of softwood lumber anti-dumping duties, concluding that the U.S. violated international trade rules in the way it calculated anti-dumping duties. Included in the ruling, the WTO panel has allowed the U.S. to use “zeroing” in its calculation of AD, which Canada appealed in June 2019. The practice of zeroing had previously been disallowed by the WTO with regard to softwood lumber. The final determination of AD is subject to additional appeals from both the U.S. and Canada.

U.S. market sales represent less than 25 per cent of Western’s total revenue in 2018. The company’s acquisition of a distribution and processing centre in Arlington, Wash., and the assets of Columbia Vista Corporation and related entities in Vancouver, Wash., are expected to partially mitigate the damaging effects of duties on its products destined for the U.S. market while increasing U.S. market sales. Western intends to leverage its flexible operating platform to continue to partially mitigate any challenges that arise from this trade dispute.