Edited Transcript of OSB.TO earnings conference call or presentation 5-Aug-20 3:00pm GMT

Excluding the indefinitely curtailed 100 Mile House mill and Cordele Line 1, we took 143 mill days of downtime in the second quarter compared to just 35 days in the first quarter. And now, I’m especially pleased that we were able to significantly reduce our per unit manufacturing cost versus both comparative quarters, demonstrating the benefits of the flexible operating strategy we adopted to manage through the pandemic and that we will maintain going forward.

You have seen that we are resuming limited production at Line 1 of our Cordele mill, which had been indefinitely curtailed since November last year. The stronger-than-expected rebound in OSB demand has led to extreme tightness in the market and record-high reported benchmark prices. What I would characterize as an emergency restart of Cordele Line 1 is the only option available to us to provide additional volumes to our customers in the near term.

Now going forward, we will incorporate Cordele Line 1 into our new flexible operating strategy, allowing us to adjust our production both up and down on short notice to align with customer demand. In Europe, the effects of COVID-19 in our business were much more acute as many of our U.K. customers were forced to close operations due to government-imposed restrictions. And as a result, U.K. panel demand fell markedly in the second quarter, forcing us to close all of our U.K. mills for between 5 and 8 weeks.

Demand on the continent remained resilient throughout the second quarter, and U.K. demand has recovered in June as government restrictions ease. Our adjusted EBITDA fell from $10 million in Q1 million to $2 million in Q2, given the extent of curtailments we had to take. Despite the pandemic related constraints experienced in the quarter, we continue to make great progress at our Inverness mill. The mill is close to producing at its full Phase 1 capacity, and we remain on track to complete the Phase 2 expansion project before the end of the year. This will help us continue to supply substitution-driven OSB demand growth in Europe for years to come.

And with that, I’ll now pass it over to Robin. Robin?

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Robin E. Lampard, Norbord Inc. – Senior VP & CFO [3]

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Thanks, Peter, and good morning, everyone. As you recalibrate your models for our Q2 results, there are 2 factors I want to draw your attention to.

First, a couple of points on our strong Q2 cost improvement that Peter highlighted. We had a tailwind from both lower raw material costs and the weaker Canadian dollar. And further, we were able to reduce maintenance costs by substituting our own employees for contractors as we limited traffic in our mills during the pandemic.

Second, in light of the recent unprecedented and steep run-up in North American benchmark OSB prices, I’ll remind you of the inherent lag in our realized prices versus the benchmarks during periods of rapidly changing prices. This lag, which cuts both ways, of course, occurs because of the timing impact of our order files for commodity and value-added products. As well as the roughly 25% of our volume that goes into specialty end uses where negotiated prices don’t move up or down with the commodity benchmarks.

Turning to our balance sheet and capital allocation. Our strong Q2 results enabled us to fully repay drawings on our liquidity lines, leaving us with $278 million of liquidity at quarter end and considerable headroom versus our 2 financial covenants.

And as you have seen, after prudently pulling back our variable dividend to $0.05 per share last quarter in the face of significant uncertainty in the early stages of COVID-19, our Board increased dividend to $0.30 per share this quarter reflecting our strong financial results and improving end market demand. This is entirely consistent with our variable dividend policy that gives us the flexibility to adjust the payout level up and down as our operating results, outlook and balance sheet permit and is consistent with our historically balanced approach to capital allocation.

While we are optimistic about the demand strength we’re currently seeing, we recognize there remains considerable uncertainty around the depth and duration of the economic impact of COVID-19. And that the current disconnect between the stronger housing economy and weaker macro economy will ultimately get reconciled one way or another. So we remain vigilant, and we’ll continue to focus on the health and safety of our employees as well as managing our business to be resilient and flexible. One of the silver linings of the pandemic experience is we’ve quickly learned how to be more agile in scaling our production down and up to align with customer demand, while at the same time, managing our costs. And we will maintain this new flexible operating configuration going forward.

I’ll turn things over to our operator, who will open up your lines.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

Our first question will come from Paul Quinn, RBC Capital Markets.

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Paul C. Quinn, RBC Capital Markets, Research Division – Director of Paper and Forest Products & Paper and Forest Products Analyst [2]

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Great. Fantastic job on the cost side, and I realize that input costs are down. And — but maybe you can parse out what the savings on the maintenance side was?

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Robin E. Lampard, Norbord Inc. – Senior VP & CFO [3]

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Well, Paul, difficult to put numbers against that, but I would just point you to the variance table in our earnings presentation that accompanies this call. And we had, I think, it was $19 million — sorry, I don’t have it in front of me. Robert, do you have it? That’s my mistake. Thank you.

Sorry, $15 million year-to-date positive from raw material prices. So that just kind of gives an order — that’s a pretty big movement for 6 months from — primarily from resin and energy prices and also from the weaker Canadian dollar as oil prices and foreign exchange rates, were pretty hugely dislocated in the early stages of the pandemic. So that was a definite tailwind. Then the other big number you see is $19 million in the other operating cost line for first 6 months. And a lot of that would be this labor — the labor savings that we highlighted as we were able to do a lot more maintenance work with our own employees rather than contractors.

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Paul C. Quinn, RBC Capital Markets, Research Division – Director of Paper and Forest Products & Paper and Forest Products Analyst [4]

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Okay. And then I guess maybe just on the OSB — just on the panel side in Europe. Obviously, Q2 was difficult. Do we expect operating rates now back to normal? And do we expect a Q3 similar to Q1 result?

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Peter C. Wijnbergen, Norbord Inc. – President, CEO & Director [5]

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All of our mills now are in full operation, really starting in the second half of May. And our mill in the continent has continued to operate throughout this thing as demand on the continent has been much more resilient than it was in the U.K., as I talked about earlier. So at the moment, we expect much more of a normal quarter based on our current, sort of, operating conditions.

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Paul C. Quinn, RBC Capital Markets, Research Division – Director of Paper and Forest Products & Paper and Forest Products Analyst [6]

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Okay. And then maybe just back on the cost line, what are the specific things that you’re doing in the flexible operating regime that’s able to lower the cost? And could you — and then associated with that, the restart at Cordele Line 1 limited capacity, what does that specifically mean?

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Peter C. Wijnbergen, Norbord Inc. – President, CEO & Director [7]

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All right. Well, on the cost, I think Robin, sort of, tried to explain that already. But in the normal operating conditions, we try to minimize downtime by extensive use of contractors to help us with our weekly or BI weekly maintenance as well as with our annual maintenance. We have taken a completely different posture during the pandemic by scheduling, perhaps a little bit more time to allow us to tackle most of that maintenance with our own people, trading off some time for money if you want to put it that way. And I think that has worked very well for us, and we will continue down that road as
this market progresses.

Thinking about Cordele Line 1, our major constraint, as we have talked about for a long time, is trained labor, and that remains our key constraint. And you may recall that when we had to curtail that mill last year, we had to say goodbye to 45 of our colleagues. We’re now trying to hire up to 25 back. And that explains why we’re on a limited operating schedule. And in the near term, this is all, we believe, we can manage. Longer term, we’re incorporating Cordele Line 1 into our flexible operating configuration, and its production will remain demand-dependent.

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Operator [8]

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Our next question will come from John Babcock, Bank of America.

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John Plimpton Babcock, BofA Merrill Lynch, Research Division – Associate [9]

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Just while we’re on the topic of Cordele. I was wondering if you can talk about, in part, kind of the demand and balancing how good demand is right now and the reacceleration that you’ve seen with how full you’ll have to run Cordele to kind of catch-up on that demand?

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Peter C. Wijnbergen, Norbord Inc. – President, CEO & Director [10]

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Well, our ability to run the Cordele mill, I’ve just described, it’s limited. But the overall demand conditions for OSB, I think are best illustrated if you look at Random Lengths prices and movements over the last 2 or 3 weeks. So we are experiencing extremely tight market conditions. And there is a potential — or I mean, we haven’t even really entered hurricane season yet. And of course, I’m very hopeful that we won’t, but that risk is still out there on top of the strong demand that we’re experiencing across really all areas of demand, whether that’s new home construction, the R&R side, repair and remodeling side or the industrial — our industrial end uses.

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John Plimpton Babcock, BofA Merrill Lynch, Research Division – Associate [11]

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Okay. And where do your order files, I guess, stand right now? And do you have any sense as to how long it might take to catch up on to get those order files to a more normalized level?

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Peter C. Wijnbergen, Norbord Inc. – President, CEO & Director [12]

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Well, I mean, as you’ve heard me talk about in the past, John, we typically would target having about a 2-week order file so that we can schedule our operations as efficiently as possible. We are well in excess of those days. And I think already in the — over the last quarter, we talked about being somewhat uncomfortable with the length of the order file that we were experiencing in December, January and February. It’s very much the same, if not worse at the moment. And typically, what would happen is when demand starts to decline seasonally, that is when we can hope to recover from these tight conditions.

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John Plimpton Babcock, BofA Merrill Lynch, Research Division – Associate [13]

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Okay. Have you had to — with order files where they are now, I assume you have some contract customers that you prefer to serve. And so I mean, have you had to turn away business, given how tight the market is?

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Peter C. Wijnbergen, Norbord Inc. – President, CEO & Director [14]

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We have always focused, John, on our key customer base. And we sell direct — only directly to our key customer retail — or to a retail customer base. So that includes the large repair and remodeling customers as well as the large pro dealers and a number of industrial customers. We are committed to keep them supplied as best as we can. And we will continue to focus on that.

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John Plimpton Babcock, BofA Merrill Lynch, Research Division – Associate [15]

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Okay. Is there — just last question, is there any way you could give us a sense as to how much of the mix those contract customers make up?

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Peter C. Wijnbergen, Norbord Inc. – President, CEO & Director [16]

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Sorry. Can you repeat the question?

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John Plimpton Babcock, BofA Merrill Lynch, Research Division – Associate [17]

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I was just wondering how much of your total sales ultimately come from those contract customers?

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Peter C. Wijnbergen, Norbord Inc. – President, CEO & Director [18]

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Well, we sell those customers both on contract and in the open market or the — what you call a spot market.

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Robin E. Lampard, Norbord Inc. – Senior VP & CFO [19]

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Cash market.

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Peter C. Wijnbergen, Norbord Inc. – President, CEO & Director [20]

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Or cash market, and so really, the majority of our focus is on supplying our key customer base.

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Operator [21]

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Our next question will come from Ketan Mamtora, BMO Capital Markets.

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Ketan Mamtora, BMO Capital Markets Equity Research – Analyst [22]

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Peter, I want to come back to this, the flexible operating approach. And from a system standpoint, not just Cordele, but from a system standpoint, we’ve always thought of OSB mills kind of either running pretty much flat out or not running. But you are on this, sort of, new approach of operating in a more flexible fashion, can you just talk about, kind of, what you’ve learned there? Or what you’re able to do differently that you can have this approach and yet, sort of, keep the unit costs at a manageable level?

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Peter C. Wijnbergen, Norbord Inc. – President, CEO & Director [23]

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Well, Ketan, I mean we have already talked a fair bit about it. But maybe just to explain it in a different way. There is a — we have found that there’s a significant difference between when we have to react at the last moment and schedule in downtime in the last moment as opposed to being able to plan well ahead and use the downtime effectively along the lines of what Robin and I explained earlier to sort of minimize our maintenance cost and reduce the need for outside contractors to help us. And that’s, I think, the thing that we ended up learning during this COVID-related, beginning of this period. And obviously, there’s more lessons to be learned there, but that is what we’re very focused on expanding on.

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Ketan Mamtora, BMO Capital Markets Equity Research – Analyst [24]

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Got it. And Peter, I was curious if there is any way to sort of quantify what pace you’ll be able to run the mill now. You said you all have rehired about 25 employed in mill. So I’m just curious, as it stands today, at what pace you all can run if you all had the demand for that?

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Peter C. Wijnbergen, Norbord Inc. – President, CEO & Director [25]

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Well, I think, as I told you, we are planning to hire up to 25 people. We think that’s the maximum we would be able to find in that basket in terms of trained operators. We’re not there yet. Compared to the 45 people that we had in the mill when it was running flat out. I think that’ll give you a fairly good perspective on what we might be capable of. The other thing you have to remember is that we started this mill up on an emergency basis very quickly. So normally, we would take our time to deal with all the issues beforehand. And obviously, that was much more limited this time around.

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Ketan Mamtora, BMO Capital Markets Equity Research – Analyst [26]

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Got it. That’s helpful. And then just switching to Chambord, Peter. Are there still restrictions with respect in terms of having the people out there, the mill to do the rebuild? Or are those restrictions lifted at this point?

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Peter C. Wijnbergen, Norbord Inc. – President, CEO & Director [27]

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Yes, you’re correct, Ketan. In the second quarter, construction projects were not deemed essential in the province of Québec. And as a result, we had to put our capital spend there on hold. Those restrictions have now been lifted. And so we’re resuming our work very much in line with what we would have told you over the last year. We want to make sure that, that mill is that all of these sort of longer lead time items are complete, so that, that mill can be started up on sort of 6-months’ notice once we make a decision that it is required.

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Operator [28]

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Our next question will come from Mark Weintraub, Seaport Global.

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Mark Adam Weintraub, Seaport Global Securities LLC, Research Division – MD & Senior Research Analyst [29]

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So on pricing, I understand the comments on lags, et cetera, and the specialty mix as well. Could you give us a sense if we were just to hold pricing where it is today in Random Lengths? So taking away the forecasting element of it, order of magnitude, how much higher would your Q3 pricing be than your Q2 pricing?

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Peter C. Wijnbergen, Norbord Inc. – President, CEO & Director [30]

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I don’t know. That sounds like a lot of mental math. I don’t know if I can make it here on the spot, Mark.

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Mark Adam Weintraub, Seaport Global Securities LLC, Research Division – MD & Senior Research Analyst [31]

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I’m sure, you’ve done it already, Peter. But will you share it? That’s the question.

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Peter C. Wijnbergen, Norbord Inc. – President, CEO & Director [32]

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Well, I would say, first of all, at least based on historical precedents, prices are unlikely to stay at, what is now, a record, all-time record high. But typically, we are 2 to 3 weeks or maybe even a little bit more sold in advance. So you can get a bit of a perspective how big the lag could be here when prices have gone up about $200 in the last 3 or 4 weeks. So the average for the quarter will lag significantly to where we are at today. Now whether we will stay at where we are today, I don’t know yet.

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Mark Adam Weintraub, Seaport Global Securities LLC, Research Division – MD & Senior Research Analyst [33]

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Okay. And on the specialty business, how should we think about how that price can move under certain circumstances or not. Is that — I assume they’re annual reopeners or different types of reopeners? And what has been the history in very strong markets and recognizing there’s still uncertainty, and who knows where we are 3, 6 months from now. But if we do have sustained strong markets, what would history tell us what tends to happen in those businesses?

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Peter C. Wijnbergen, Norbord Inc. – President, CEO & Director [34]

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Well, first of all, I want to, sort of, say that we have learned over the last 10 years as we continue to focus on growing our industrial customer base and our volume with those customers that we need to remain consistent in their supply even during periods when commodity prices are significantly higher.

Secondly, the prices are negotiated, although there might be some limited movement up and down related to market in general, the price are negotiated. And we tend to get a premium over the long-term average commodity pricing. In those products because of all the extra services and quality requirements that are — or specific quality requirements for different customers. So that’s sort of, I think, how you need to think of it. Under normal market conditions, there’s always an alternative, right, whether it’s imported plywood or something that customers could revert to and therefore, there’s a need for — during our negotiations to keep pricing or to keep that kind of competition in mind as we price our product. The conditions today are extraordinary. And — but I would expect that as we renegotiate these contracts for next year, we will still sort of come from that same perspective with those customers.

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Mark Adam Weintraub, Seaport Global Securities LLC, Research Division – MD & Senior Research Analyst [35]

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Okay. And then lastly, with the third quarter at a minimum, looking like it’s going to be exceptionally profitable, exceptionally strong from a cash-generating perspective, any help in framing when it’s a relatively short period like this, how you think about the capital allocation question, and in particular, how much might you tend to put towards special dividends? Or any way to help us understand how you process, again, the exceptional state of affairs that we’re in right now?

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Peter C. Wijnbergen, Norbord Inc. – President, CEO & Director [36]

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Well, thanks, Mark. And obviously, dividends is a Board decision, and capital allocation very much is a Board decision. Our next Board meeting is in early November. But first of all, I’ll point to our track record. We have a variable dividend strategy in place. We have a track record of adjusting the variable dividend up and down according to market conditions and including back in 2018 when we had an extraordinary quarter, we had a special increase to the special dividend. I don’t want to foreshadow what may or may not happen at the end of this quarter. But the only other thing that I would put in — that we are certainly actively thinking about is there’s still a lot of uncertainty here in the market. This COVID pandemic is far from run its course. There is a big disconnect between the overall economic performance and the housing, let’s call it, the broader housing market, and whether that disconnect can continue to exist for a long time, we’ve never seen that before. So there’s still a lot of uncertainty, and we’ll certainly — and I think our Board will certainly keep that in mind as they continue to think their way through capital allocation decisions.

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Operator [37]

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Our next question will come from Andrew Kuske, Crédit Suisse.

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Andrew M. Kuske, Crédit Suisse AG, Research Division – MD, Head of Canadian Equity Research and Global Co-ordinator for Infrastructure Research [38]

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The question really relates to the operating model that you’ve now adopted, a bit more dynamic in nature. And just any other color you can provide on the efficiencies you’re seeing rotating through the mills, whether it’s just from a straight out operating basis, shipping to deliver to certain customers in a more reliable fashion and then very fundamentally, just from an employee standpoint, is — you’re clearly a — fairly a large employer in some of the communities where you operate, and is this really reinforcing Norbord as an employer of choice in those communities?

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Peter C. Wijnbergen, Norbord Inc. – President, CEO & Director [39]

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Yes. We certainly like to think of it that way. And you’re right. Most of our mills are in relatively small communities. And it’s not just a direct employment and the fairly good pay and benefits that we provide our employees and their families, but there’s a lot of indirect employment that comes from our operations as well. So the economic footprint in these smaller towns is significant. And we’re very cognizant of that. We have this long-term strategy of aligning our employees’ interest with those of our shareholders through this profit share model. And so as the company does well, so do our employees. And I think that is a very fundamental and important element of how we think of that particular part of — or how we think of our employees.

In terms of the flexibility in the operating schedule, that also plays an important role. And so our first focus is on keeping our employees employed and keeping them with benefits. And that was a very important consideration as we thought around how we would react to this COVID crisis early in March when we started to think about that.

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Andrew M. Kuske, Crédit Suisse AG, Research Division – MD, Head of Canadian Equity Research and Global Co-ordinator for Infrastructure Research [40]

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Okay. That’s helpful. I guess, with that kind of backdrop, that 25 you’re targeting at Cordele, do you think you could exceed that number and get closer to the 45?

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Peter C. Wijnbergen, Norbord Inc. – President, CEO & Director [41]

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Well, at the moment, like the — when we had to part ways with our employees last fall, we did so knowing that all of them would likely find other jobs in very quick order. And that, I think, has been the case. I’m proud of the team to be able to attract a number of those employees back to Norbord. And whether we’ll be able to get to the 25 number — 25 that we are targeting at this moment, we don’t know yet.

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Andrew M. Kuske, Crédit Suisse AG, Research Division – MD, Head of Canadian Equity Research and Global Co-ordinator for Infrastructure Research [42]

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One final question, if I may, and it’s just on the MIP. It looks like it was the mill productivity and just lower costs and overhead. Was there anything else in the MIP that was really notable?

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Robin E. Lampard, Norbord Inc. – Senior VP & CFO [43]

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Yes. I mean, that’s really it. It ties right into what you’ve been seeing in our unit cost. It’s just that it’s measured on a trend price basis. So but otherwise, it’s exactly consistent. It’s productivity. It’s lower raw material usage and pushing down costs across the board, controllable costs.

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Operator [44]

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Our next question will come from Sean Steuart, TD Securities.

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Sean Steuart, TD Securities Equity Research – Research Analyst [45]

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A couple of questions. Chambord, can you give us an update on your thinking of what’s needed in terms of housing starts or regional demand indicators to make the decision to go ahead with that eventual restart?

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Peter C. Wijnbergen, Norbord Inc. – President, CEO & Director [46]

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Well, consistent with what we have been saying in the past about Chambord and very similar to the message we gave prior to its starting decision and Alabama mill. And before that, our Texas, Jefferson mill, we need to see sustained demand for the capacity that, that mill could produce before we’ll make a decision. In that particular mill, we would have to hire 120 or more employees. And we don’t want to do so if the prospect is that we would have to lay them off again in the short term. So that’s not changed. And we’ll continue to evaluate whether that s
ustained demand is indeed there to allow us to make a decision to start that mill up. We have not yet gotten to that place.

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Sean Steuart, TD Securities Equity Research – Research Analyst [47]

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Okay. And Peter, just brighter thoughts on, I guess, risks to the sustainability of this off cycle, Q3, we’ll be looking at North American EBITDA margins, potentially, I guess, north of 50%. Historically, that’s short-lived for this industry. And more broadly speaking, when you’re thinking about what could disrupt this up cycle, are you more concerned with the slowdown in demand growth? Or broader capacity additions coming into the mix? What gives you some concern with respect to sustainability of this up cycle, if anything?

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Peter C. Wijnbergen, Norbord Inc. – President, CEO & Director [48]

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Yes. Let me answer in 2 parts. First of all, we have seen — and we are seeing strong demand within a system where OSB supply can only react so far. And that started off the quarter or the end of the quarter and the beginning of the third quarter with very healthy and strong markets. So the last 2 or 3 weeks, we have seen prices go almost straight up. And I have nothing to go on, but history and historically, we have — at these kind of price levels, we have not seen numbers stay there for a very long period of time. Now that doesn’t mean it won’t happen this time, but that’s at least the precedent that we can point to in the past. But that doesn’t mean that we’re not in a healthy market, right? These sky-high price numbers may not sustain very long, I don’t know. But we don’t need these kind of prices to have a very strong result.

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Operator [49]

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Our next question will come from John Tumazos from John Tumazos Very Independent Research.

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John Charles Tumazos, John Tumazos Very Independent Research, LLC – President and CEO [50]

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Congratulations on the good business environment. Could you just explain maybe to someone less familiar like me the business rationale for only taking orders 2, 3 weeks out. And how much more do you think you could sell today than your current output or I know you’re — by what margin might you be turning away orders?

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Peter C. Wijnbergen, Norbord Inc. – President, CEO & Director [51]

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Yes. So I think if I look at the last bit first, we’re producing as hard as we can at all of our operations that are currently running, including having made this decision to start-up the Cordele Line 1 mill — line on an emergency basis. So even if we would want to sell more, we are physically not capable of doing so. In terms of the first part of your question, our order file is lengthy at the moment. We typically would like to have about a 2-week order file because that’s the right sort of mixture between being able to react to demand surprises as well as being able to plan our operations. Today, we’re significantly beyond that. And that has the advantage, of course, of tying into strong markets. But at the same time, it has the disadvantage that we can — we no longer have any ability to react if anything goes wrong.

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Operator [52]

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Thank you very much. At this time, we have no further questions in the queue. So I would like to turn the conference back over to our speaker.

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Peter C. Wijnbergen, Norbord Inc. – President, CEO & Director [53]

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Well, thank you, Chantel. And as always, Robin, Heather, Robert and I are available to respond to further questions. Thank you all very much for your participation today. Stay safe, and we look forward to reporting on our progress next quarter. Have a good afternoon.

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Operator [54]

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Thank you very much. Ladies and gentlemen, this now concludes today’s conference. You may disconnect your phone lines, and have a great rest of the week. Thank you.