Domtar Corporation
Q1 2017 Earnings Call Transcript

Published: 30 Apr 2017

[Operator:]

Good day, ladies and gentlemen, and welcome to the Domtar Corporation's First Quarter 2017 Earnings Financial Results Conference Call. All this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this call is being recorded today, Thursday, April 27, 2017. I would now like to turn the meeting over to Mr. Nicholas Estrela. Please go ahead, sir.

[Nicholas Estrela:]

Thank you. Good morning, and welcome to our first quarter 2017 earnings call. Our speakers today will be John Williams, President and Chief Executive Officer; and Daniel Buron, Senior Vice President and Chief Financial Officer. They will be supported by Michael Garcia from our Pulp and Paper division and Michael Fagan from the Personal Care division. John and Daniel will begin with prepared remarks, after which they will take questions. During the call, references will be made to supporting slides, and you can find this presentation in the Investors section of the website. As a reminder, all statements made during the call that is not based on historical facts are forward-looking statements subject to a number of risks and uncertainties, many of which are outside our control. I invite you to review Domtar's filings to the securities commissions for a listing of those. Finally, certain non-U.S. GAAP financial measures will be presented and discussed. You can find the reconciliation to the closest GAAP measures in the appendix of this morning's release as well as on our website. So with that, I'll turn it over to John.

[John Williams:]

Thank you, Nick, and good morning, everyone. This morning, we reported EBITDA of $122 million on sales of $1.3 billion. Our businesses generated strong operating cash flow, over $90 million, in the quarter. Pulp and Personal Care are providing us with good sales momentum, and we're building on several important initiatives. In Paper, the business is delivering steady results and cash flow as we continue to manage through secular pressures in some of our markets. We're maximizing EBITDA and cash in this business while taking further measures to optimize our assets and improve our manufacturing processes. Our Paper shipments increased as market demand improved seasonally compared to the fourth quarter. As a result, our operations ran at capacity, and we shipped 36,000 tons from inventory. While average paper prices declined when compared to quarter four, our pricing improved through the quarter, mostly due to a favorable mix. Pulp, we had record shipments of softwood and fluff pulp. The A1 line is running well, and demand remained strong in Asia and North America. On the back of this strong demand and balanced global inventory levels, we announced price increases to several pulp grades in the first quarter. The benefits began to flow through in March with further price momentum expected in the second quarter. We remain optimistic for the remainder of the year on the long-term fundamentals for the growers we supply. During the quarter, we successfully completed extensive annual maintenance outages on time and below budget. Some of our raw material costs were higher in quarter 1, which is typically considered to be a seasonally high-cost quarter. Turning to Personal Care, we had a great quarter. Momentum continues to build with 15% year-over-year sales growth and EBITDA increasing 6%. We had record sales in North America, and our European business also had a strong quarter. Our teams are delivering on our cost savings program. We're generating savings from capital projects, manufacturing efficiencies and procurement initiatives. Our sales growth and cost savings initiatives continue to offset price, currency and cost headwinds. We entered 2017 confident of our ability to execute against our strategic objectives, and I'm pleased to report that our businesses are performing well. With that, let me turn the call over to Daniel for the financial review before making further comments on our results and outlook. Daniel?

[Daniel Buron:]

Thank you, John, and good morning, everyone. Let's start by going over the financial highlights of the quarter on Slide 4. We reported this morning net earnings of $0.32 per share for the first quarter compared to net earnings of $0.75 per share for the fourth quarter of 2016. EBITDA amounted to $122 million compared to $159 million in the fourth quarter. Let's turn to the sequential variation in earnings on Slide 5. Consolidated sales were $30 million higher than the fourth quarter, mostly due to better volume in all of our businesses. Cost of sales was $72 million higher than the fourth quarter, mostly due to higher volumes sold and higher maintenance and the raw material costs. Depreciation and amortization were $5 million lower than the fourth quarter. This reduction in G&A is a result of certain assets being fully depreciated. SG&A was $5 million lower than the fourth quarter, due mostly to the positive mark-to-market of stock-based compensation and lower spending in the first quarter. In the first quarter, we recorded an income tax expense of $5 million or an effective tax rate of 20%. Let's now turn to the cash flow statement on Slide 6. Cash flows provided from operating activities amounted to $91 million, while capital expenditures amounted to $34 million. This resulted in a free cash flow of $57 million for the first quarter. Since January 2011, we returned a total of $1.4 billion to our shareholders through dividend and share buybacks, representing 72% of our free cash flow. At the end of the quarter, we had 62.6 million common shares outstanding. Turning to the quarterly waterfall on Slide 7. When compared to the fourth quarter, EBITDA before items decreased by $37 million due to higher maintenance costs for $21 million, higher other costs for $11 million, lower productivity for $8 million, lower prices for $7 million and higher raw material costs for $6 million. These were partially offset by higher volume in mix for $7 million, lower SG&A for $5 million and a favorable foreign exchange impact of $4 million. As you may recall, in January 2017, the largest turbine generator at our Kamloops Mill experienced a mechanical failure. The failure has limited impact on our pulp manufacturing operation but is significantly reducing the amount of electricity we can produce. We still believe that the turbine will be up and running in, early in the third quarter. This event impacted our results in Q1 by $6 million, and a similar financial impact is expected in the second quarter. As this event is covered by our insurance policy, we should recover all costs, except for a $5 million deductible. But you should note that the timing of the insurance reimbursement will lag the expense by a few months. Now the review of our business segment starting on Slide 8. In the Pulp and Paper segment, sales were 3% higher when compared to the fourth quarter and 1% lower when compared to the same period last year. EBITDA before items was $98 million compared to $140 million in the fourth quarter of 2016. Our Paper business on Slide 9. Sales increased 1% versus the last quarter and were 7% lower versus the same quarter last year, while estimated EBITDA before items was $100 million. Manufactured paper shipments were 1% higher when compared to Q4 and 5% lower versus the same period last year. Average transaction prices for all our paper grades were $8 per ton lower than the last quarter. Our Pulp business on Slide 10. Sales increased 8% versus last quarter and 19% versus the same period last year. Estimated EBITDA before item was a negative $7 million -- sorry, $2 million when compared to the fourth quarter. The decline, when compared to the fourth quarter, is in part due to the result of the plant maintenance cost and the financial impact from the turbine failure that happened in Kamloops earlier in the quarter. Pulp shipment was 9% higher versus the fourth quarter and up 23% when compared to the same period last year due to additional volume from the recently converted Ashdown line. Average pulp prices decreased by $5 per metric ton versus the fourth quarter. Our paper inventories decreased by 36,000 tons when compared to last quarter, while pulp inventories decreased by 61,000 metric tons. Our Personal Care business on Slide 12. Sales increased 15% when compared to last year as a result of new customer wins and the addition of HDIS. Our EBITDA before item was $32 billion, in line with the fourth quarter and an increase of $2 million versus last year. Finally, the second quarter will be the busiest maintenance quarter of the year in our Pulp and Paper business. As shown on Slide 13, we expect an increase of $5 million in maintenance costs when compared to the first quarter of 2017. So this concludes my remarks. With that, I'll turn the call back to John.

[John Williams:]

Thank you, Daniel. We've had a good start to the new year, and we're building on several important investments made in 2016. The Ashdown Mill continues to focus on increasing the production of high-quality fluff pulp on the A1 machine. The line is currently running well. Production in quarter 1 was primarily softwood bales, but we are increasing fluff pulp production to customer qualifications. We have qualified at several internal and external customer locations in North America and across the globe, and we're receiving good feedback. We currently have over dozen qualifications in the pipeline. We are on track to ramp up to approximately 50% fluff pulp sales by year-end. As we mentioned previously, the A1 machine is expected to generate approximately $70 million of EBITDA annually at trend price, and when fully ramped up, the fluff pulp. The streamlining at Plymouth also plays a key role in building a world-class pulp business with top tier performance. The timing of Plymouth's optimization is being closely aligned with fluff pulp production at Ashdown, but we expect it to be completed in the second half of the current year. Plymouth will be right sized to an annualized production target of approximately 380,000 metric tons of fluff pulp. Pulp markets in the quarter were strong. Global softwood shipments were 6% higher in the quarter, with good demand from the Chinese and North American tissue markets. Pulp price realizations were impacted by higher sales volumes of softwood bale pulp from Ashdown. We expect prices to improve following the implementation of price increases and a more favorable mix at Ashdown. Our Pulp business is growing significantly and becoming an ever more important part of our portfolio. We shipped nearly 25% more tons than in quarter 1 2016, and current initiatives will continue to support profitable growth in this business. We now have close to 2 million tons of high-quality softwood fluff specialty market pulp capacity that will provide us with a scale business that will add momentum to our growth strategy for years to come. Paper, our shipments trended better than forecast, while our average selling prices were lower when compared to the prior quarter. Operating rates were higher when we ran at capacity while reducing inventory levels by nearly 40,000 tons. Over the last 12 months, we've reduced inventories by more than 100,000 tons in addition to shutting our largest paper machine, which represented over 10% of our capacity or 364,000 tons. Growing our position in specialty grades, where we were off to a good start to the year, shipments were 2% higher with a strong order backlog and good volumes in food packaging. We're developing a strong innovation pipeline in order to bring new products to market while maximizing the flexibility of our assets to be the partner of choice for our customers. Personal Care, we had a good first quarter. We had record sales, higher EBITDA year-over-year, and we're delivering on our cost savings plan. We did well with productivity, which drove better volume and operational efficiencies resulting in lower unit costs. As we ramp up new business and win new volume, our assets are expected to operate more efficiently, resulting in further productivity gains. We continue to grow our base business. Year-over-year, sales volume of both adult incontinence and baby diapers grew 8% and 25%, respectively. Much of the growth was driven by the new customer wins. We also expanded our product line with existing customers and increased our range with some of our larger partner brand customers. We expect to invest further in innovation, marketing and targeted growth initiatives to keep Domtar and our customer brands strong and help us to compete effectively. Our near-term focus is on executing our growth plans, capturing the benefits of our cost savings program and building value for our customers. Our sales pipeline remains active with numerous opportunities to grow in both North America and Europe. We will continue to pursue a balanced approach to the deployment of our capital while maintaining the flexibility to execute on our strategic priorities. Balance sheet is in good shape, and M&A will play an important role in our long-term growth strategy as we also pursue strategic investments that will strengthen our businesses and provide attractive returns. Now to our outlook for the remainder of the year. We anticipate that our paper shipments will be in line with market demand. In Pulp, we expect to benefit from recently announced price increases, while mix will continue to improve as our Ashdown mill produces more fluff pulp. Costs, including freight, labor and chemicals, are expected to marginally increase. In Personal Care, market growth, investments in advertising and promotion in addition to new customer wins should drive higher sales, while raw material costs are expected to slightly increase. Thank you for your time and your support. And I'll turn the call back to Nick for your questions.

[Nicholas Estrela:]

Thank you, John. So both John and Daniel will be available for questions. I'd ask our participants to ask a few questions at a time and then return to the queue for follow-ups as we want to get as many people as possible. Anna, you can open up the lines for questions.

[Operator:]

Thank you. [Operator Instructions] And we will move first to George Staphos with Bank of America Merrill Lynch.

[John Babcock:]

This is actually John Babcock on the line for George. Just wanted to go through a couple of his questions. I guess, first of all, if you could talk about the uncoated freesheet business, and ultimately, your capacity footprint relative to demand trends. And then I was also wondering if you could talk about the sort of trends that you're seeing in imports.

[John Williams:]

Certainly. So -- I mean, as we've talked here, we ran full and actually sold some product from inventory. Obviously, it was a high maintenance quarter, but we're pretty happy with our footprint as we currently speak. We know that in the commodity space, we have very competitive mills. And I think within the specialty space, mills that are both capable of competing and winning business that we can then bring into that commodity network. So if you look at it carefully, take the Appvion deal, for example, we transformed our Marlboro Mill and now have 180,000, 200,000 tons of new business that we hadn't got before, but of course, always remain committed to making sure we balance supply with demand in our own network. Going back to the imports, so they've switched around a bit. So the Portuguese are still importing, even though they're eating the juicing, as are the Brazilians, and some of the Europeans are knocking about looking for bits of business. But nothing like the levels it was, a little bit of growth year-on-year, but nothing too dramatic. That help?

[John Babcock:]

That definitely helps. And then, recently we saw that the Australians decided to move forward with their trade case down there. And I was wondering what impact that might have back to you, particularly since one of those countries wasn't listed in the U.S. trade case?

[John Williams:]

We'll have to see. To be honest, I couldn't speculate. It's very hard to tell.

[John Babcock:]

Fair enough. And then on pulp, I was wondering if you could talk about how the pulp price increases in 1Q and the first half of 2Q here will roll through earnings and how we should kind of think about the timing of that. And then also if you could talk about the sensitivity Domtar to pulp price changes, particularly with the ramp-up of the Ashdown machine?

[John Williams:]

Right. So let me try and give you sort of the full year. So we're going to be operating between sort of 1.8 million to 2 million ton fluff pulp business at full run rate quarter 4 and into 2018. So you do the simple math of what $10 means on that portfolio. I think you can kind of have an idea of how price impacts us. Now undoubtedly, though, the way it works, of course, there is a price increase announcement, we see, really has to move before prices move. So there's always a 30- to 60-day lag between that announcement and that actually turning up in pricing. In addition, there are some customers who have kind of, call it what you will -- they have a slightly different approach to pricing. So I think you're going to begin to see that to feed through with a certain amount of impact into quarter 2, and then obviously, out further into the year. Does that help give you a bit of scale?

[John Babcock:]

Yes, that's great. And then last question, before I turn it over, on Personal Care, if you could. Talk a little bit about kind of growth expectations for the year, given what you've seen so far through the first quarter and into April?

[John Williams:]

Yes, certainly. So we -- I think it was said pretty clearly, we think that market is growing, pick a number, 3% to 4%. It depends whether it's baby or whether it's adult. Adult is obviously growing quite quickly in certain markets. Baby is a little bit flat. We're looking to see double that level of growth. So sort of year-to-year, we're looking for $80 million to $100 million of growth. And quite frankly, at this moment in time, I think we feel pretty good about that for two reasons

[Operator:]

[Operator Instructions] We'll move next to Anthony Pettinari with Citi.

[Randy Toth:]

So this is actually Randy Toth sitting in for Anthony. Just looking at the absolute improvement in year-over-year EBITDA in Personal Care, is any of that from self-supplying from fluff pulp now, or it's more of a second half story? And can you just quantify the savings?

[John Williams:]

I didn't quite catch the beginning of your question, I'm sorry. Could you just repeat it? I don't know why, it got lost in the ether.

[Randy Toth:]

Yes, no problem. Just looking at the absolute improvement in year-over-year EBITDA in Personal Care, is any of that from self-supplying in fluff? Or is that more of a second half story? And can you quantify the savings you expect from Florida integration?

[John Williams:]

Well, let's just be clear. So we sell to ourselves pretty much at the average market price that we generate from other customers. So there's no inherent competitive advantage in pricing to our own Personal Care division. Occasionally, there's a freight savings just because of geography. So for example, the Greenville facility is just around the corner from Plymouth, so they've got a freight saving as any other customer would. So this is really about sales growth, margin improvement, doing a better job with certain customers within the Personal Care business than it is about the integration. Does that help?

[Randy Toth:]

Yes, perfect, perfect. And then just last quarter you mentioned you were in negotiations with a larger customer in Personal Care, that if one would require a couple of more machines. Is there any update on that?

[John Williams:]

We're -- it's still in process.

[Randy Toth:]

Okay, perfect. And then just a quick one. What were sales up in Personal Care without HDIS?

[John Williams:]

They were up 6% without HDIS. Just about where we'd expect it, sort of double the market growth, yes.

[Operator:]

And we'll now move next to Brian Maguire with Goldman Sachs.

[Derrick Laton:]

It's Derrick Laton on for Brian. Just wanted to get your thoughts on the pulp market currently. It seems a little bit tighter than I think most have expected from some delayed capacity coming online and maybe some other geographies. What is your view on supply-demand for BSK and fluff for the remainder of this year and then just looking ahead into 2018?

[John Williams:]

Well, I think, okay. So, I could move on the world hunger on that one, I think. So let's just talk the two separately. NBSK, I see not much capacity growth. I see demand growth, I see tissue growth. I see no reason why that runway doesn't continue. So I'm feeling pretty good about that through to the year end. I don't think that I could speculate on '18, but I can certainly take you that far. Fluff, I think now you've got market consolidation in the supply base, which has been pretty dramatic. You've really got 3 major players, ourselves, obviously, GP and IP. And to my mind, that momentum that we're beginning to see in fluff, I think that carries on certainly till sort of mid to end of year. Where it goes from there, it's too hard to say. I think what you have to remember is, if you look at the underlying growth in the markets fluff pulp is serving, you're seeing 250,000 to 300,000 tons of growth every year. So that's really sort of a decent size machine every year in terms of growth opportunity. And it's a product that has to be qualified. So you can't just kind of make it and they will come actually, because it's so integral technically with the finished product in terms of baby diapers, adult diapers and feminine hygiene product, but the qualification period takes a while as we, I think, are demonstrating to some extent in Ashdown, even though we have our own converting lines in our Personal Care business. So to my mind, this comes into the market relatively slowly, and I think that's why you're seeing what you're seeing. Does that help?

[Derrick Laton:]

Yes, that's really helpful. And maybe just one more switching over to Paper. So you mentioned first quarter was down, call it, maybe $20 per ton sequentially. Is that kind of holding flat so far in April? Kind of what you're seeing so far in the quarter? And then are you expecting to kind of see some...

[John Williams:]

Just trying to remember the numbers. I think the number was 8 quarter-to-quarter actually. Currently, we're seeing, it's flat right now, if that helps.

[Derrick Laton:]

Great, yes. And are you guys expecting any benefits possibly from mix, like you saw in the first quarter as well?

[John Williams:]

Not a great deal. I think it's going to stay pretty stable. I mean, if we sell a little bit more of a higher added value, we'll see a bit, but I don't think it's enough to move the needle sort of dramatically, if that helps.

[Derrick Laton:]

Great, yeah that helps. Thanks for that all the color.

[John Williams:]

Alright thank you.

[Operator:]

[Operator Instructions] And we'll move next to Paul Quinn with RBC Capital Markets.

[Paul C. Quinn:]

Hey thanks very much good morning.

[John Williams:]

Paul good morning.

[Paul C. Quinn:]

Just bouncing around calls here so you might have mentioned something, but I'm just trying to understand the pulp shipments. So it looks like you did 453 in the quarter, but you brought down inventory 61,000 which suggests that production was under 400. And I've got capacity a lot higher than that. So I guess, capacity is ramping up. How should I think of that quarter-to-quarter? Should I go like 400 Q1, 430, 470?

[John Williams:]

Yes, Paul, there was a lot of maintenance in quarter 1. So I think if you took the sales line at about the level we are at today plus a little and thought about that's where the capacity is, you'd be pretty much on the money.

[Paul C. Quinn:]

Okay. Excellent, that's all I had. Hey thanks guys.

[John Williams:]

Alright. Thank you.

[Operator:]

And it appears there are no further telephone questions at this time.

[John Williams:]

Thank you, Anna. So as a reminder, we'll release our second quarter 2017 results on Thursday, July 27, 2017. Thank you for listening, and have a great day.

[Operator:]

And once again, that does conclude today's conference. And we thank you all for your participation. You may now disconnect.