Resolute Forest Products Inc.
Q1 2015 Earnings Call Transcript

Published: 10 May 2015

[Operator:]

Good morning, ladies and gentlemen. Welcome to the Resolute Forest Products First Quarter 2015 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the presentation, we will conduct a question-and-answer session. [Operator Instructions] Please note that this call is being recorded today, Thursday, May 7, 2015 at 9

[Rémi Lalonde:]

Thank you. Good morning, everyone. Welcome to Resolute’s first quarter earnings call. Today, we will hear from Richard Garneau, President and Chief Executive Officer and Jo-Ann Longworth, Senior Vice President and Chief Financial Officer. You can follow along with the slides for today’s presentation by logging on to the webcast, using the link in the Presentations & Webcasts page under the Investor Relations section of our website, where you can download the slides. We also have a backup link to the webcast on our press release. We provide additional financial and statistical information, including a reconciliation of non-GAAP financial measures in our press release and in the slides. As always, certain subjects we will cover involve forward-looking information. Our statements are based on current assumptions, beliefs and expectations, all of which involve a number of business risks and uncertainties and accordingly can change as conditions do. Richard?

[Richard Garneau:]

Good morning and thank you very much for joining us today. So, we generated $50 million of adjusted EBITDA in the quarter and it’s down from $106 million in the fourth quarter of 2014. Compared to the fourth quarter, the change reflects the combination of lower price realizations in market pulp and wood products, together with intensifying challenges in the global newsprint market. We also had the additional burden of a $15 million increase in our pension and OPEB expense, relating to the amortization of the 2014 increase in pension liabilities. This increase does not involve any additional funding. By segment, we generated adjusted EBITDA of $24 million in market pulp, down by $3 million from the fourth quarter, $13 million in wood products, down by $14 million, $10 million in newsprint, down by $22 million, and $18 million in specialty papers, down by $4 million from the previous quarter. Lower selling price for newsprint, market pulp and lumber have explained $33 million of the decline in EBITDA. The decrease in shipments of newsprint and specialty papers accounts for $17 million, which mostly reflects all of our significant recent capacity closures and lower pulp shipments are responsible for $6 million. Even as market prices have retreated that from recent highs for this quarter, we remain bullish on our lumber and pulp businesses. We are confident that we will have significant value with our investment to build capacity, including the two new Ontario sawmills and the Calhoun pulp digester project. We believe in the long-term global pulp market fundamentals, including its underlying growth drivers like tissue production in North America, which has been the growing consumer of our pulp. And our recent newsprint and specialty paper capacity closures on the other hand show our efforts to adapt to changing market dynamics in the paper business, which will continue to evolve. Our clear objective is to generate as much value as we can from these assets by concentrating production to maximize the use of our most cost effective mills, eliminating fixed costs and avoiding costly rotating downtime. Resolute connect is a new grade of uncoated freesheet that we developed and manufacture in Calhoun, Tennessee is a good example of how we generate value by optimizing paper assets. In this case, we are moving up the value chains and generating more attractive margins. We have grown that business to our present run-rate of about 35,000 tons per year and we expect to work up to the machine’s full capacity over time. Let’s review market conditions and segment performance. Through the first quarter, that pulp demand for chemical pulp grew by 6% compared to the same period in 2014, including an increase of 2% in North America, 3% in Western Europe, 11% in China and 12% in Latin America. Demand for Northern softwood was down by 1% and Southern softwood was down by 3%. World demand for hardwood pulp rose by 13% in the quarter with significant increases in China that is up 22%, Western Europe up 7% and North America up 6%. These demand increases were almost entirely for eucalyptus grades, the supply of which has grown with the recent significant expansions of Latin American capacity. Total shipments of Northern and Southern hardwood were up 2% worldwide, but down 5% in North America. Compared to the fourth quarter, our average transaction price for market pulp dropped by $29 per metric ton or 4%, which reflect softer pricing for softwood and fluff grades. Our overall shipments fell by 7% or 23,000 metric tons with all of the drop in softwood grades, offset in part by an additional shipment of fluff pulp delayed from the fourth quarter. Our finished goods inventory rose by 9,000 metric tons. Our shipment fell short of expectation of this quarter, in part due to marketing challenges coming from the pressure of ongoing misinformation campaigns by certain environmental activist groups and also because of unscheduled outage at certain mills. Since peaking in the second quarter of last year, our realized prices for market pulp are down about $60 per metric ton, but we expect that market fundamentals will support better performance in the segment for the balance of the year. The average first quarter of the U.S. housing starts was below 1 million on a seasonally adjusted basis. Actual starts grew by a smaller than expected 4% compared to the same period in 2014. Quarter-over-quarter, our wood product shipments were 1% higher, which includes the first deliveries of Ignace finished lumber. The average transaction price for wood products have fell by $25 per thousand board feet or 7% in the quarter as a result of lower market prices. Our finished goods inventory increased by 14% reflecting the softer market conditions. We expect that the recently restarted Ignace sawmills and the now operating Atikokan planer mill will further contribute to results in the second quarter. The Atikokan sawmill is also advancing well. We expect it to begin to ramp up in the next few weeks. Our near-term outlook for lumber is more uncertain, given lower than expected first quarter of housing starts of under 1 million. The early year about 27% drop in North American exports to Japan and China, the strong U.S. dollars and the reintroduction of export duties and quotas under the Canada-U.S. Softwood Lumber Agreement. With the recently low composite price, we are presently subject to a 2.5% export duty and also quota elimination of 34%. That applies to Central Canada – Central Canadian producers, which could worsen to a 3% export duties and quota of 32% if the composite price continues to fall. Nevertheless, our medium to long-term outlook continued to be positive. North American demand for newsprint dropped by 12% in the quarter, production fell by 16%, supporting operating rate of about 90% for the quarter. Global demand for newsprint decreased by 12% with significant drops in all major regions, including Asia at 11%, Western Europe 12% and Latin America at 16%. The total exports from North America were down by about 21%. And exports are down over 200,000 tons in the last 12 months and almost 100,000 tons in the first quarter alone, which on an annualized basis would represent about two machines of capacity. Reflecting a seasonally lower demand and the impact of our recent capacity rationalization initiatives, our shipments of newsprint were 63,000 metric tons lower this quarter compared to the fourth. And our overall average transaction price fell by $34 per metric ton. To-date, the global newsprint business is particularly challenging for North American producers, who face an accelerating pace of global structural decline, a currency disadvantage in export markets, because of the strong U.S. dollars and a significant oversupply of world market. In late 2014, we responded to these and other challenges by cutting 465,000 metric tons from our annual capacity, with the permanent closure of our three newsprint machines in Canada. Our goal is to optimize assets by concentrating production to maximize the use of our most cost effective mills, eliminate fixed costs and avoid costly rotating downtime. In the end, these closures will make us stronger, because they improve our competitive position. We are confident that our operating platform has the scale, the financial strength and the cost advantage to continue to compete in this – in these very challenging markets. Accordingly, we expect to maintain our share of newsprint volumes, but pricing is likely to remain under pressure given the ongoing challenges for global newsprint, particularly for North American producers. North American demand for all uncoated mechanical paper slipped by 8% year-to-date. Demand for supercalendered grades was down by 4% and SC represents about 20% of our specialty shipments after the recent closure of our Laurentide mill. Shipments of super-brites and hi-brites were down only 2%. The industry shipments to capacity ratio, was 88% for the quarter, down by 1% compared to the same period last year. Coated mechanical demand was down by 3% in the quarter compared to the first quarter of 2014, but the shipment to capacity ratio was 99% in the quarter compared to the much lower operating rates of 2014. Our average transaction price for specialty papers was essentially unchanged in the quarter, but our shipments fell by 61,000 short tons, due mostly to seasonally lower demand as well as the closure of our Laurentide supercalendered mills in October. It’s competitiveness was mainly affected by the restart of the Port Hawkesbury mills at the end of 2012. We expect a moderate uptick in the specialty paper shipments as we move past seasonal lows and also fairly stable overall pricing condition into the second quarter. We have taken the necessary steps, including capacity closures, to optimize our paper asset to adapt to the quickly changing market dynamics. We will use our lower cost advantage, our scales and our financial strength to compete in the paper segment and maximize cash flow to support our growth businesses in – for the long-term, including the continuous digester project at the Calhoun pulp and paper facility and the capacity building initiatives in wood products. What is more? Our financial strength gives us the ability to look at the range of opportunities and also the patience to make sure the valuation is right. I will now ask Jo-Ann to review our financial performance.

[Jo-Ann Longworth:]

Thank you, Richard and good morning everyone. Today, we reported a first quarter net loss of $30 million, or $0.32 per share, excluding special items. GAAP net loss was $33 million, or $0.35 per share. Net special items were $3 million in the quarter. Total sales in the first quarter were $920 million, down by $135 million from the fourth quarter. Overall, pricing slipped as a result of a $34 per metric ton reduction in newsprint pricing, $29 per metric ton in market pulp, and $25 per thousand board feet in wood products, together contributing to a $40 million negative impact on results. This included the unfavorable effect of the weaker Canadian dollar on sales denominated in that currency. Overall volume was affected by a 23,000 metric ton drop in market pulp shipments, 63,000 metric tons of newsprint and 61,000 short tons of specialty papers. The lower volume unfavorably affected results by $23 million. Our manufacturing costs increased slightly this quarter after adjusting for the positive effect of the weaker Canadian dollar and the lower shipment volumes. This reflects the unfavorable impact of a $50 million increase in pension and other post-retirement benefits or OPEB expenses and higher power and steam cost, partly seasonal and partly because of production inefficiencies at certain mills. Offset by lower maintenance costs, particularly in the market pulp segment, higher contribution from cogeneration facilities, lower fixed costs with the newsprint capacity closures and lower natural gas prices. The weaker Canadian dollar favorably affected our results by $16 million compared to the fourth quarter, including a $23 million favorable effect on our costs, net of a $7 million unfavorable effect for sales denominated in that currency. The cogeneration assets that sell power to third parties helped to improve EBITDA by $12 million in the first quarter, a $4 million improvement from the previous quarter. This reflects higher contribution at three facilities following maintenance outages in the fourth quarter. Compared to the fourth quarter, market pulp’s all-in delivered costs fell by 3% to $634 per metric ton, mostly because of lower maintenance cost and higher contribution from the Saint-Félicien cogeneration facility, following the mill’s annual maintenance outage in the fourth quarter, offset in part by higher pension and OPEB expenses. In wood products, the delivered cost was 3% higher at $342 per thousand board feet as a result of the recognition in the fourth quarter of additional tax credits in connection with infrastructure investments, which we did not have in Q1. Newsprint delivered cost was essentially unchanged at $557 per metric ton, reflecting the favorable impact of the weaker Canadian dollar and the lower fixed costs following the capacity closures announced in 2014, offset by higher power and steam costs, mostly due to seasonality and higher pension and OPEB expenses. The delivered cost of specialty papers was $709 per short ton, essentially unchanged, favorably affected by the weaker Canadian dollar and lower natural gas pricing, but offset by seasonally higher power and steam costs, production inefficiencies at certain mills and higher pension and OPEB expenses. We incurred just $6 million of closure-related costs in the quarter compared to $131 million of accelerated depreciation and other closure-related costs in the fourth quarter on the permanent newsprint capacity reductions at Iroquois Falls, Baie-Comeau and Clermont, as well as the Laurentide specialty paper mill. We also recorded a loss of $15 million under corporate and other, which reflects certain expenses that are not allocated to the segment, $7 million of which relates to closed mills, largely impacted again by the higher pension and OPEB expenses associated with those mills. Cash and cash equivalents slipped by $13 million in the quarter to $324 million, maintaining our very low net debt level now at $273 million. Net cash provided by operating activities was $29 million compared to $106 million in the previous quarter. Most of the difference is attributable to changes in working capital and the lower EBITDA. Balance sheet working capital increased by $14 million in the quarter to $693 million, most of which reflects the seasonal build of log inventory. Capital expenditures were $40 million, $11 million less than in the previous quarter. For 2015, we continue to expect approximately $200 million of CapEx, with $130 million on value-creating projects, including our initiatives to build capacity in lumber and pulp. Pension funding was $27 million compared to $29 million in the previous quarter. We expect to make approximately $35 million of pension contributions in the second quarter, which will include $9 million more for U.S. pension plans due to timing. Our balance sheet, net pension, and OPEB liabilities increased by $330 million in 2014, mainly as a result of lower interest rates and the significant impact of longer life expectancy assumptions in both Canada and the U.S. The weaker Canadian dollar largely contributed to the $126 million reduction in the liability as of March 31 to $1.5 billion. As we said last quarter, we face an increase in our pension and OPEB expense of approximately $55 million over the course of the year when compared to 2014. This increase, which does not involve any additional funding, relates to the amortization of the $330 million increase in the balance sheet, net pension and OPEB liability in 2014. Accordingly, in the first quarter, our pension and OPEB expense was $20 million, which is $15 million higher than the expense we recorded in the fourth quarter. For 2015, we continue to expect $145 million of pension contributions and $16 million of OPEB payments versus $81 million of related expense. This compares to 2014’s pension contribution of $164 million and OPEB payments of $19 million versus a combined expense of $26 million. Availability under our ABL credit facility at quarter end was $464 million for total liquidity of $788 million.

[Rémi Lalonde:]

Thank you, Jo-Ann and Richard. Operator, let’s open the call for questions please.

[Operator:]

[Operator Instructions] Your first question comes from Sean Steuart of TD Securities. Your line is now open.

[Sean Steuart:]

Thanks. Good morning, everyone. A couple of questions on price realizations. Richard, it sounds like you are experiencing ongoing newsprint price pressure across several regions into the second quarter. Do you sense any sort of deceleration in the downward trend with currency settling a little bit and with all the capacity you have taken out? Any sense on when prices might start to bottom out?

[Richard Garneau:]

Well, no, at this point, we don’t see any change. The pressure is still there. And I think that when you look at 90% operating rates in North America and it’s about 80% in the – when you look at the stat for the world, I think that we expect to see this pressure to continue. And I also expect to see even additional weaknesses in the price until there is more balance between supply and demand. And I think that it’s as far as I can go.

[Sean Steuart:]

Okay. And on the specialty paper side, I was surprised by the lack of positive momentum into the first quarter given the price increases that were announced for several grades. Is that a function of product mix or is it a function of order file lag with respect to your business this quarter?

[Richard Garneau:]

Well, the first point that I would like to make, the first quarter is always slow. And I think that certainly there was a mix factor here. Certainly like reported, we have some of the grades that we have seen the price increase but – with the closure of a couple of mills. But I think that certainly, with the currency disparity that we have between North America and Europe and the imports, I think that certainly put the kind of brake on implementing the price increase that was announced in November. I think that when you look at the FSC, it’s flat. Well, unfortunately, we lost business, the Best Buy business because of the activist campaigns. And we had to change our product mix. And the mix is less favorable, so we had to replace every piece of the volume with lower value. And I think that when you look at that side also the imports from Europe in FSC are up 10%. So again the same comments I want to make on the currency disparity and the strong U.S. dollar is making it really, really competitive. And when I look at the bottom grade at C, D and [indiscernible] calendar, so we are seeing substitution, obviously, and the demand was quite weak. So we had a reduction of 20% compared to the previous quarter. So I think that, obviously when the demand is not there, you have some pricing pressure. But overall, if you just to – if you to relook at the component, I think that certainly, the currency disparity and the imports are two important factors.

[Sean Steuart:]

Understood. Thanks very much, Richard.

[Operator:]

Your next question comes from Paul Quinn of RBC Capital Markets. Your line is now open.

[Paul Quinn:]

Yes. Thanks very much and good morning. Just following up on Sean’s question on newsprint, it just looks like – I always consider you guys, a low-cost newsprint producer and EBITDA in the quarter, basically is $19, do you think that can fall to zero or do you expect other producers to take downtime as a result of the weak pricing?

[Richard Garneau:]

Well, it’s a tough question to answer and I don’t want to speculate on this one. Yes, I think that we are, I believe, that we are low cost. We have made pretty difficult decision of closing capacity, but the objective was really to avoid this downtime, rotating downtime that are very, very expensive. So I think that what is left now. Our network is competitive. I don’t know what’s going to happen with others, but I think that we have done what’s needed to be done. When I look at our network and our platform and we have to compete with the condition that we knew. And we know it’s not easy, but I said that we expect that we are there to stay and we are going to compete and we are going to face with our financial strength, we are going to face this headwind that’s probably going to sit there for another couple of quarters or three quarters, I don’t know exactly. But there is nothing else in our plan. We are going to run what we have.

[Paul Quinn:]

Okay. And then on the wood product side, you are talking about the duty in place for Q2 here and the quota, can you remind us on how that quota works and does that limit your shipments in Q2?

[Richard Garneau:]

Yes, it will. Because as you are aware, when you are over 3.55 composite price, while it's free trade. And at 3.55, the eliminations so there is 34%, 32% and 30% and the tax goes from 2.5%, 3% and 5%. So for now, we are at the 2.5% level with a quota, not to exceed, and I think that I am just – it’s only Central Canada, because the West has elected to pay higher tax and they continue to have access to – full access to the market. But in our case, we are limited with the quota and we will have to basically sell in Canada or slowdown production. But it is the effect of the sub-27%, 28% lower export. When I look at the volume, export volume from North America to China and Japan in January and February, I didn’t look at March. I didn’t have the data, but I think that there was more wood being exported to the U.S. from Canada. And well, with the A-Pac this adds on pricing.

[Paul Quinn:]

So I understand, La Tuque sawmill is curtailed, any other sawmill curtailments expected in Q2?

[Richard Garneau:]

Well, it’s the – I think that that’s one, again that’s related to wood costs and wood availability. I think that we are probably going to have some issues at two other sawmills where we have some supply issue in the Abitibi region and the other one in the Ottawa region, so at Maniwaki. But I think that besides those three, I think that we have enough supply to run the other sawmills.

[Paul Quinn:]

Okay. And then lastly, despite a difficult quarter, your balance sheet is in great shape and you obviously want to try to grow out of here, can you maybe expand on sort of some of your strategic plans going forward here?

[Richard Garneau:]

Well, certainly, when you look at what we have done, so the Atikokan sawmill is just about now to be completed. And we are going to be able to take advantage of this capacity increase. The other big project that we have is the replacement of the eight batch digesters at Calhoun by a continuous digester. We are going to be able to produce 100,000 tons more hardwood pulp. But I think what is more of a point here, but we have more capacity, but it’s going to reduce our costs quite significantly. So that’s going to provide – and I don’t want to mention how much it’s going to be, but it’s not insignificant and obviously it’s going to help also on the paper side because with the lower-cost pulp, well you have – we are going to see the impact on the margin. So we expect, when I look at the schedule and I visited that a couple of weeks ago, the progress and we are still on track to start up this new equipment in the fourth quarter of this year.

[Paul Quinn:]

Okay, great, that’s all I had. Best of luck.

[Richard Garneau:]

Thank you.

[Operator:]

[Operator Instructions] There are no further questions in queue at this time.

[Rémi Lalonde:]

Okay. Well, we will leave it at that. And thank you everybody for joining us today.

[Jo-Ann Longworth:]

Thank you.

[Operator:]

Ladies and gentlemen, this concludes today’s conference call. You may now disconnect.