West Fraser(WFG) - 2022 Q1 - Quarterly Report

Management's Discussion & Analysis Introduction, Business, and Strategy West Fraser, a diversified wood products company, pursues strong financial results through cost control and a strong balance sheet, acknowledging industry cyclicality and currency volatility - West Fraser is a diversified wood products company with manufacturing facilities in Canada, the U.S., the U.K., and Europe[5] - The company's core strategy emphasizes cost control, operating responsibly and sustainably, and maintaining a strong, investment-grade balance sheet to navigate market cycles and fund growth[6][10] - Earnings are highly sensitive to cyclical world economic conditions, particularly the U.S. housing market, and are subject to volatility from foreign exchange rate fluctuations[7] Recent Developments Q1 2022 saw North American housing fundamentals tempered by rising rates, significant Canadian transportation challenges leading to production curtailments, a $13 million Hinton mill impairment, and a $1.25 billion share repurchase bid - The U.S. housing market remained supportive with starts at 1.79 million units in March 2022, but rising interest rates and inflation pose risks to demand for new construction and remodeling[11][12] - Logistics and transportation challenges in Canada, including rail service availability and weather issues, negatively impacted the ability to ship products, forcing production reductions at several facilities[13] - The Hinton pulp mill will permanently reduce capacity by shutting one of its two production lines and transitioning to Unbleached Kraft Pulp, leading to a $13 million impairment charge[15] - On April 26, 2022, the company launched a substantial issuer bid (SIB) to purchase up to $1.25 billion of its Common shares via a "modified Dutch auction"[17][18] First Quarter 2022 Results West Fraser reported strong Q1 2022 financial results with sales of $3.11 billion and earnings of $1.09 billion, driven by higher pricing despite transportation issues, resulting in $1.59 billion Adjusted EBITDA Q1 2022 Financial Summary | ($ millions) | Q1-22 | Q4-21 | Q1-21 | | :--- | :--- | :--- | :--- | | Sales | $3,110 | $2,038 | $2,343 | | Operating earnings | $1,427 | $450 | $879 | | Earnings | $1,090 | $334 | $665 | | Adjusted EBITDA | $1,592 | $615 | $1,008 | - The earnings trend improved through Q4-21 and Q1-22 due to strong product pricing, although gains were partially offset by transportation disruptions, particularly impacting rail service in Western Canada[20] Segment Performance Analysis The Lumber and North America EWP segments drove Q1 earnings with higher pricing, while Europe EWP performed strongly, and Pulp & Paper reported a loss due to transportation and cost challenges Lumber Segment The Lumber segment's Adjusted EBITDA surged to $796 million in Q1 2022, driven by higher pricing despite transportation disruptions impacting SPF shipments, with log costs rising and a potential $43 million duty recovery from the Softwood Lumber Dispute Lumber Segment Financials (Q1-22) | ($ millions) | Q1-22 | Q4-21 | Q1-21 | | :--- | :--- | :--- | :--- | | Sales | $1,501 | $888 | $1,300 | | Operating earnings | $750 | $195 | $607 | | Adjusted EBITDA | $796 | $240 | $646 | - Higher lumber pricing was the main driver of increased earnings, contributing a $541 million increase to Adjusted EBITDA compared to Q4-21 and $222 million compared to Q1-21[26] - SPF production and shipments decreased due to transportation disruptions in Western Canada, while SYP production and shipments increased, partly due to the acquisition of the Angelina lumber mill[23][24][29][30] - Preliminary results from the AR3 review of softwood lumber duties for the 2020 calendar year indicate a potential future recovery of $43 million for West Fraser[45] North America Engineered Wood Products (NA EWP) Segment The NA EWP segment achieved $730 million Adjusted EBITDA, driven by higher OSB and plywood pricing despite sequential volume decreases from railcar shortages, with overall costs increasing due to higher input prices NA EWP Segment Financials (Q1-22) | ($ millions) | Q1-22 | Q4-21 | Q1-21 | | :--- | :--- | :--- | :--- | | Sales | $1,217 | $834 | $781 | | Operating earnings | $647 | $270 | $299 | | Adjusted EBITDA | $730 | $343 | $353 | - Higher OSB and plywood pricing drove the segment's performance, contributing a $434 million increase to Adjusted EBITDA compared to Q4-21[56] - OSB shipment volumes decreased from Q4-21 due to limited railcar availability in Western Canada and Ontario but increased from Q1-21 due to the inclusion of an additional month of shipments post-Norbord acquisition[54] - Cost of products sold increased compared to Q1-21 due to higher costs for wood and other inputs like resins, wax, and energy[59] Pulp & Paper Segment The Pulp & Paper segment reported a $38 million loss and negative $15 million Adjusted EBITDA in Q1 2022, impacted by a $13 million Hinton mill impairment, lower shipments due to railcar shortages, and increased fibre and freight costs Pulp & Paper Segment Financials (Q1-22) | ($ millions) | Q1-22 | Q4-21 | Q1-21 | | :--- | :--- | :--- | :--- | | Sales | $171 | $159 | $177 | | Earnings (loss) before tax | $(38) | $(25) | $1 | | Adjusted EBITDA | $(15) | $(14) | $11 | - A $13 million impairment charge was recorded for equipment at the Hinton, Alberta pulp mill as part of its transition to Unbleached Kraft Pulp (UKP)[73] - Pulp shipments were adversely impacted by railcar shortages and port backlogs, leading to production curtailments to manage inventory levels[67][69] - Costs increased due to higher fibre, supplies, and energy costs, as well as higher freight costs from substituting trucking for rail services[70][71] Europe Engineered Wood Products (Europe EWP) Segment The Europe EWP segment achieved strong $78 million Adjusted EBITDA, driven by increased shipment volumes from seasonal demand recovery and normalized production, alongside higher product pricing and an additional month of operations post-Norbord acquisition Europe EWP Segment Financials (Q1-22) | ($ millions) | Q1-22 | Q4-21 | Q1-21 | | :--- | :--- | :--- | :--- | | Sales | $241 | $184 | $112 | | Earnings before tax | $59 | $36 | $(6) | | Adjusted EBITDA | $78 | $61 | $11 | - Shipment and production volumes increased significantly compared to Q4-21, which was impacted by a seasonal slowdown and a major maintenance shutdown at the Genk, Belgium facility[79][81] - Compared to Q1-21, higher product pricing was the primary driver of improved results, contributing a $90 million increase to Adjusted EBITDA[80] - Input costs, particularly for resins, increased year-over-year, driven by availability constraints and rising natural gas costs[83] Non-Operational Items Analysis Non-operational items include an equity-based compensation recovery due to share price decrease, a 23% effective tax rate, and a $94 million actuarial gain on retirement plans from increased discount rates - A recovery was recognized in equity-based compensation in Q1-22 due to a decrease in the company's share price during the quarter[89] - The effective tax rate was 23% in Q1-22, compared to 24% in both Q4-21 and Q1-21[93] - An after-tax actuarial gain of $94 million was recorded on retirement benefit plans, reflecting an increase in the discount rate used to calculate liabilities, partially offset by lower returns on plan assets[98] Outlook and Operations The company anticipates robust wood product demand but faces risks from rising rates and transportation challenges, leading to a reduced SPF lumber shipment forecast, while Norbord integration is on track for $61 million synergies and $500-$600 million capital spending - The 2022 SPF lumber shipment forecast has been reduced from 3.0-3.2 billion board feet to 2.8-3.0 billion board feet due to acute and prolonged transportation challenges in Western Canada[106] - The 2022 OSB shipment outlook is maintained at 6.1-6.4 billion square feet, but input costs for both NA and Europe EWP segments are expected to increase more significantly than anticipated, primarily due to higher energy costs[107][108] - The Norbord integration is progressing well and is on track to achieve targeted annual synergies of $61 million by the end of 2022[112] - The company anticipates investing approximately $500 to $600 million in capital spending in 2022 and increased its quarterly dividend to $0.25 per share[112][114] Liquidity and Capital Resources West Fraser maintained strong liquidity of $2.85 billion and a negative -18% net debt to total capital ratio, with Q1 operating cash flow of $563 million impacted by tax payments and working capital increases, and $210 million returned to shareholders Liquidity and Debt Ratios (as of March 31, 2022) | ($ millions, except as otherwise indicated) | March 31, 2022 | December 31, 2021 | | :--- | :--- | :--- | | Cash and short-term investments | $1,816 | $1,568 | | Available liquidity | $2,851 | $2,593 | | Total debt to total capital | 6% | 7% | | Net debt to total capital | (18%) | (16%) | Q1 2022 Cash Flow Summary | ($ millions) | Q1 2022 | Q1 2021 | | :--- | :--- | :--- | | Cash provided by operating activities | $563 | $462 | | Cash used for financing activities | $(217) | $(109) | | Cash used for investing activities | $(92) | $582 | - Cash from operations was impacted by a $456 million income tax payment (largely a top-up for 2021 earnings) and a combined $587 million increase in receivables and inventories[135][137][138][139] - During Q1 2022, the company returned $210 million to shareholders through $189 million in share repurchases and $21 million in dividends[140][141] Risks and Uncertainties The company's business is subject to various risks and uncertainties detailed in the Annual MD&A and supplemented by new risks identified in this report - The company's business is subject to a number of risks and uncertainties, which are included in the Annual MD&A and this report[144] Controls and Procedures Management confirms responsibility for disclosure controls and internal control over financial reporting, excluding Angelina Forest Products LLC from Q1 2022 scope, with no material changes to ICFR reported - Management has limited the scope of its design of disclosure controls and internal control over financial reporting to exclude Angelina Forest Products LLC, which was acquired on December 1, 2021[146] - Angelina's contribution to consolidated sales was 2.2% and to consolidated earnings was 3.5% for the three months ended March 31, 2022[147] - No changes in internal controls over financial reporting occurred during Q1 2022 that have materially affected, or are reasonably likely to materially affect, the company's internal controls[150] Non-GAAP and Other Specified Financial Measures This section defines and reconciles non-GAAP measures like Adjusted EBITDA and liquidity ratios, used to evaluate performance and provide investors with additional insight into financial condition - The report uses non-GAAP measures including Adjusted EBITDA, available liquidity, total debt to total capital ratio, and net debt to total capital ratio to provide additional performance indicators[152] - Adjusted EBITDA is defined as earnings adding back finance expense, taxes, amortization, equity-based compensation, impairment charges, and other non-recurring items[153] Reconciliation of Earnings to Adjusted EBITDA | ($ millions) | Q1-22 | Q4-21 | Q1-21 | | :--- | :--- | :--- | :--- | | Earnings | $1,090 | $334 | $665 | | Finance expense, net | 7 | 1 | 13 | | Tax provision | 330 | 104 | 205 | | Amortization | 157 | 153 | 122 | | Equity-based compensation | (5) | 12 | 7 | | Impairment charges | 13 | — | — | | Other | — | 11 | (4) | | Adjusted EBITDA | $1,592 | $615 | $1,008 | Forward-Looking Statements This section provides a cautionary note on forward-looking statements within the MD&A, identifying future expectations and listing numerous assumptions, risks, and uncertainties that could cause actual results to differ materially - The MD&A contains forward-looking statements regarding operations, financial condition, performance, and outlook[177] - Key forward-looking statements relate to the impact of interest rates, transportation service timing, completion of share repurchases, demand for products, projected shipments, operating costs, and expected synergies from the Norbord integration[178][179] - A comprehensive list of risk factors that could cause actual results to differ is provided, including economic conditions, product pricing, input costs, transportation disruptions, and government policy changes[180]