Stella-Jones Q1 2024 Earnings Call Transcript

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May 8, 2024

There are 8 speakers on the call.

Operator

and thank you for standing by. Welcome to Stella Jones' Q1 of 2024 Earnings Call. At this time, all participants are in listen only mode. Following the presentation, we will hold a question and answer session. To queue up for questions by phone, please press star 1 and a moderator will contact you.

Operator

Call is being recorded on Wednesday, May 8, 2024. Please note that comments made on today's call may contain forward looking information and this information, by its nature, is subject to risks and uncertainties. Actual results may differ materially from the views expressed today. For further information on these risks and uncertainties, please consult the company's relevant filings on SEDAR Plus. These documents are also available in the Investor Relations corresponding presentation, which we encourage you to follow along with during this call.

Operator

Corresponding presentation, which we encourage you to follow along with during this call. I'll now hand the call over to Eric Vachon, President and Chief Executive Officer of Stella Jones. Eric?

Speaker 1

Thank you, Matthew. Good afternoon and thank you for joining us today. I'm here with Silvana Traviolini, Senior Vice President and Chief Financial Officer of Stella Jones. Earlier this morning, we issued a press release reporting our results for the Q1 of 2024. Along with our MD and A, it can be found in the Investor Relations section of our website at www.stella jones.com as well as on SEDAR Plus.

Speaker 1

As a reminder, all figures expressed on today's call are in Canadian dollars unless otherwise stated. After a highly successful 2023, 2024 has begun on an equally positive note, with higher sales and record first quarter profitability. We are pleased with the solid momentum of our infrastructure product categories, which has continued into 2024. Our results continue to reaffirm our strategic approach of being future ready. We remain proactive in our pursuit of meeting customer needs, while staying ahead of industry trends and dynamics, anticipating how we'll evolve and being prepared to capitalize on opportunities.

Speaker 1

We have done this through strategically and diligently building out our network through growth investments and acquisitions and investing in inventory levels required to meet demand. And we continue to leverage strategic locations of our operations. We have a largest presence that spans North America and this has allowed us to better cater to customer needs while serving them effectively creating synergies and maximizing economies of scale. These initiatives are supported by the strong long term fundamentals of our business, primarily the steady and growing demand for our products, which I will now discuss in more details. Sales of utility poles were higher year over year, driven by favorable pricing.

Speaker 1

In terms of volume, we noted sequential volume increases compared to Q4 last year, particularly from non contract customers. For our contract business, which represents 70% of our pole sales, we continue to see a shift, whereby certain customers are moving to longer term agreements. We also secured additional multi year commitments from new and existing contract customers, which is indicative of their commitment and need to secure supply on a longer horizon. Our customers' projects are poised to spend several decades and there continues to be growing need to maintain the North American electrical grid. There is also sustained momentum from our utility customers to increase pole purchases to support their broadband access and expansion projects.

Speaker 1

Our goal is to be the supplier of choice and a company our customers can rely on when they proceed with their projects. As always, Stellajones manages its business with an eye on the larger picture, making decisions that are best for the company's long term stability and growth. Sales of railway ties also increased over the same period last year, above the low single digit growth target. With the replenished level of tie inventory, we are now better positioned to service the non Class 1 market. The ability to cater to this market is a significant shift from 2022 when the industry experienced limited availability of untreated wood ties.

Speaker 1

Sales for residential lumber pulled back slightly on account of the lower market price of lumber. We remain Canada's largest manufacturer of treated residential lumber and many customers across North America rely on us for their premium treated lumber, composite decking and accessories. I'll now turn it over to Silvana to provide a more detailed overview of our Q1 financial results.

Speaker 2

Thank you, Eric, and good afternoon, everyone. As Eric indicated, Stella Jones had a robust start to 2024. We generated strong financial results that helped establish a solid foundation for the rest of the year. Sales for the quarter were $775,000,000 up $65,000,000 from Q1 of 2023. The increase was driven by higher infrastructure product sales, which grew organically by $58,000,000 or 10%.

Speaker 2

We benefited from favorable pricing across all our infrastructure product categories, higher railway tie volumes and the contribution of the acquisition of the Baldwin assets. Utility pole sales increased to $402,000,000 compared to $362,000,000 for the same period in 2023 due to higher pricing when compared to Q1 last year. The slower pace of purchases this quarter largely stemmed from contract customers with long term volume commitments. The purchases from customers were deferred and remained lower relative to the Q1 of 2023, we saw a progression in our utility pole volumes over Q4 of last year. Sales of railway ties were $227,000,000 representing an increase of 16% compared to the Q1 of 2023.

Speaker 2

This increase was attributable to both higher pricing and volumes, particularly for non Class 1 customers due to the available supply of railway ties. And residential lumber sales were $87,000,000 compared to $90,000,000 during Q1 2023. While volumes remained relatively stable quarter over quarter, the decrease in sales was attributable to the lower market price of lumber compared to the same period last year. Led by the strong organic sales growth for our infrastructure products, EBITDA increased to a record Q1 of $156,000,000 compared to $120,000,000 in the Q1 of 2020 3. EBITDA grew to 20.1 percent from 16.9% in the Q1 last year.

Speaker 2

Similarly, net income for the Q1 increased relative to the same period last year. We generated net income of $77,000,000 or $1.36 per share. This compares to $60,000,000 or $1.03 per share in the Q1 of 2023. The increase in profitability was attributable to the margin expansion realized across our infrastructure product categories, particularly due to the favorable pricing dynamics compared to Q1 last year for utility poles and railway ties. We ended the quarter with a net debt to EBITDA ratio of 2.7 times, which is within our expectations due to our typical working capital requirements in the Q1 of each year.

Speaker 2

During the quarter, we continued to invest in our inventory position, particularly for the seasonal build of residential lumber ahead of peak demand in the 2nd and third quarters. Inventory levels are however expected to decrease by year end and be in line with levels at the beginning of the year. Inventories are a significant component of working capital and an investment in our ability to provide service to our customers and meet their demand. During the quarter, we also used our liquidity to maintain the quality of assets and expand our production capacity as well as return capital to shareholders. In the Q1 of 2024, we repurchased $15,000,000 of shares and declared a dividend totaling $16,000,000 As a result of our buyback programs, we had 2,000,000 fewer average shares outstanding this quarter compared to last year's Q1.

Speaker 2

As at the end of March, we had returned over $225,000,000 of capital to shareholders out of the $500,000,000 committed for the 2023 to 2025 period. Yesterday, our Board of Directors approved a quarterly dividend of $0.28 per share, reflecting the continued confidence in the long term strength of our business. In summary, our financial performance to begin the year has positioned us well to remain on track to continue to achieve profitable growth and return capital to shareholders. With that, I will pass it back to Eric for his concluding remarks.

Speaker 1

Thank you, Silvana. Our first quarter results helped set the tone for a positive year ahead, and our focus in 2024 will remain on the growth trajectory of our objectives laid out in our 3 year financial plan. We continue to work towards achieving more than SEK3.6 billion in sales by 2025. And despite the impact of short term trends, the underlying fundamentals of our business remain rooted in maintenance and replacement requirements, which play out over the longer term horizon. For utility pool product category, we continue to expect sales to grow at a compounded annual growth rate of 15% for 2024 2025, largely driven by volumes.

Speaker 1

Expected volume growth is based on information shared with us by customers in terms of their needs, as well as additional volume commitments recently secured from new and existing customers. As our customers undertake many of their projects during the 2nd and third quarters, we expect these big volume periods for our business to support the expected volume growth. While our railway type product category had a strong start to begin the year, we are reaffirming our annual sales growth rate in the low single digits. A Class 1 customer has recently modified their 2024 maintenance program, which is expected to reduce overall volume gains for the year. And we maintain our projection of sales between $600,000,000 $650,000,000 for residential lumber, which is expected to comprise less than 20% of our overall sales mix.

Speaker 1

In terms of profitability, considering the strong performance of our EBITDA margin through 2023 and into the Q1 of 2024, we are currently well positioned to exceed our 16% annual margin target. Potential pricing pressures in the second half of the year for utility pole spot market business are expected to impact our current level of EBITDA margin. We look to the future with confidence, thanks to the strengths, resilience and profitability of our business. And we will continue to put in the work every day to keep reaching further and higher while creating value for our shareholders. I would like to conclude the call by acknowledging our employees across North America, many of whom are listening today.

Speaker 1

You are what makes Stella Joles unique. Our customers rely on us for quality products and timely service, and we have the best in class reputation because of our team and the care and attention to our work. Thank you for delivering your best every day. With that, I will now open the line to questions.

Operator

Thank you, Eric. The line is now open for questions. Our first question is from James McGarigle from RBC Capital Markets. Please go ahead.

Speaker 3

And congrats on a congrats on a great quarter. I had a question on the pool pricing outlook. You flagged you expect recent strength to persist early in the year. We clearly saw that in Q1 and then that you expect pricing to fall off in the back half. And given some of the, I guess, the near term demand headwinds, do you see any risk to margins?

Speaker 3

I know you reaffirmed that margin outlook, but demand coming in

Speaker 4

a little bit lower due to some

Speaker 3

of these near term headwinds, pricing comes on, falls off in the back half as new capacity comes on, Any risk to margins in Q3 and Q4? Any color you can provide there would be appreciated.

Speaker 1

So thank you, James. So I guess I'll start by reaffirming our belief in our 15% CAGR growth for 2024 and 2025 supported in better part by volume growth. So to your point, I guess I sort of took away 2 parts to your question. First, obviously, was the pricing. Had strong pricing in the Q1, obviously, for utility poles.

Speaker 1

I believe and I think we stated this before, we believe that the first half of the year we will still see some uplift coming from pricing and we still maintain our assumption of pricing pressures in the second half of this year driven or was supported or justified by the fact that we're seeing new capacity come online. That being said, the volume piece, as I said, we still have strong confidence because we have strong communications with our customers. We have brought on some new customers this year that were not part of our customer list last year, and so we feel pretty strong about our 15% growth for the year.

Speaker 3

Okay, thanks. And just switching gears over to the RailayTies business. You've highlighted in the past some potential catalysts related to funding from the U. S. Infrastructure bill.

Speaker 3

And you've talked about losing that Class 1 customer reducing their volume outlook a little bit. But as we start to look into 2025, do you have any update on if we could see an uptick related to the U. S. Infrastructure bill? And what type of upside that might represent if that those funds start to be start getting to be spent?

Speaker 3

Thanks.

Speaker 1

So we are seeing subsidies for subsidy programs in the U. S. Supported by the U. S. Federal Government's infrastructure plan.

Speaker 1

As recently as you know April 30th there was a deadline to apply for CRISI grants in the US and that budget was around, I want to say around 2,400,000,000 US dollars, which is double the amount that was there in the previous year. So I do believe that, you know, obviously projects will most likely have been applied for and, you know, we would see those funds deployed, in the next 12 to 18 months. CRISI grants are grants that are in place to support rail infrastructure safety. And typically the short line in commercial business would be the targeted market, I guess, for those subsidies. So I do feel that there will continue to be strong dynamics in the non Class 1 business as we go forward into 2025.

Operator

Thank you. Our following question is from Benoit Poirier from Desjardins Securities. Please go ahead.

Speaker 4

Thank you very much and good afternoon. Just to come back on the utility, we've seen some several large utilities like American Electric Power and Dominion that I've mentioned is seeing an uptick in future electricity point of discussion point of discussion with customers in recent months? And how much of a tailwind could this, unfortunately, be on top of the infrastructure and EV backdrop for you guys?

Speaker 1

It's hard to say how much of an impact it would have, but you are correct. It is a topic of conversation that we've been hearing more frequently in the last year, I would say, where energy consumed by data centers is significantly higher, particular I'm assuming you're referring to AI versus your regular Internet use. But I think in the end, it's for our customers it's part of their consideration for overall requirement for electricity. Many utilities in North America are faced with, I would say, maybe a dual challenge. 1 is ensuring you had enough generating assets for the next few decades to support demand.

Speaker 1

And then obviously you need transmission and distribution to be able to support it. So it all fits in the same theme for me. But to your point Benoit, the data centric topic is something that has been coming up more frequently but very hard to quantify that impact.

Speaker 4

Okay. And just looking at your EBITDA margin, obviously, above 20% marks a new record level for you. It's up almost 3 40 bps versus last year. So I don't know if you could maybe provide more color or breakdown the contribution between how much of the increase was driven utility poles versus railway ties? And how confident are you that the margins could be maybe a little bit stronger than initially expected on the back of the start in Q1?

Speaker 1

Well, Benoit, you know very well, we don't disclose margins by product category. But obviously, the as stated in our MD and A, the better pricing for poles and the better pricing for utility sorry for railway ties did contribute to that, you know, favorable uplift in EBITDA margin. You know, very also also very proud on how our team is managing our cost and, you know, leveraging our network to make sure that, you know, we compress costs as best we can. But, you know, going forward, with my comment earlier that pricing would be still strong in the 2nd quarter, so I would still expect some relatively stronger EBITDA for the Q2. Now please I'll remind the listeners that we also usually have a stronger volume for residential lumber in the Q2.

Speaker 1

So the mix would obviously make it different because I guess the mix of residential lumber in the Q1 is obviously lower. But I do believe that our first half of the year will show very strong performance from an EBITDA margin standpoint. And then the second half, we are guiding to softer margins compared to H1, driven by our belief that there will be more competition for utility pole sales.

Speaker 4

Okay, that's great color. And last one for me on the residential lumber side. What are you seeing on the retail side so far in Q2 in your discussion with customers as we enter the summer peak season?

Speaker 1

Obviously, it's a Q2 data point, but it seems that we're our customers are looking for similar volumes year over year Pricing, lumber price of lumber is similar to last year. It ebbs and flows a bit, but in the same range. I don't think pricing would be a big factor necessarily and volumes would be flattish or similar. So thus our conclusion that it would be the same range of $6,000,000 to $650,000,000 in sales annually.

Speaker 4

Perfect. Thank you very much and congrats.

Operator

Our following question is from Jonathan Goldman from Scotia Capital. Please go ahead.

Speaker 5

Thank you for taking my questions. Eric, I appreciate the comments you made on the mix in Q2, but Q2 is typically your strongest EBITDA margin quarter. Wouldn't it be logical to assume margins would be up quarter on quarter?

Speaker 1

Quarter on quarter? No. I think the mix will make it potentially slightly lower. It will still be a strong it will still be a strong EBITDA margin quarter, but it is the peak season for residential lumber. What we saw in April, May June volume wise significantly outweighs the other three quarters of the year.

Speaker 1

But you are right that poles and ties are also have a large presence in the Q2, but I still think that the mix would have it slightly lower.

Speaker 5

Would that mix be different than historically?

Speaker 1

Yes.

Speaker 5

Just perhaps the second one I guess

Speaker 1

Hold on. Sylvia, do you want to add some color?

Speaker 2

Yes, maybe just add some color, Jonathan. Also keep in mind that our pools sales with SYP being a bigger portion of our portfolio, there's a little bit more consistency throughout the year. So we have seen less seasonality, let's call it, currently versus in the past just because of the greater weight that we have of SYP in our portfolio.

Speaker 5

Okay, that's great color. And then I guess the second one would be on pole volume outlook. Eric, you discussed 15% growth in your poles business this year. That would be mostly volume. I think you said how would imply 20% growth in the back 9 months of the year?

Speaker 5

Is that the right way to think about it? And what sort of visibility do you have on growth accelerating to that degree?

Speaker 1

Yeah. So I think your math directionally is correct. And as I mentioned in my remarks, that our capability to or assurance or certainty that which we come forward with our 50% growth comes from discussions we have with our key customers, the projects that they have coming in the next quarters and lapping into actually 25. And as well as I mentioned, we have some new customers that we're ramping up in the Q1 that are now fully supported by us going forward. So I do feel pretty good about it and so does our whole team spend a lot of time looking at our number, making sure that we could come today with a level of comfort in stating or reiterating our 15% growth.

Speaker 5

Okay, perfect. If I could just squeeze one more in. Do you have a sense on the tie to sales growth, the organic growth, how much of that was volume versus price driven this quarter?

Speaker 1

Well, for the it's about half half, about 50%, 50%. You're talking for the entire growth, right?

Speaker 5

The organic growth for Thai, so I guess it's all organic.

Speaker 1

Yeah. For Thai is 5050. Yeah. 50 volume and 50 on price.

Speaker 5

Perfect. Thank you for taking my questions. Thank you.

Operator

Thank you. Our following question is from Michael Tupholme from TD Securities. Please go ahead.

Speaker 6

Thank you. Good afternoon. Maybe a similar question to the one you were asked, Eric. But with respect to the poles product category, if you can provide a breakdown of the 7% year over year organic growth you saw in the quarter, how much of that was volumes versus price?

Speaker 1

Thank you, Michael. So as we explained actually in February in our Q4 call, so our Q4 'twenty three volumes were down 5% year over year and at that point we did take the opportunity to say that we would see a similar trend in the Q1 of this year and that is exactly what we've observed. So no surprises

Speaker 6

there. Okay. And then what are you seeing through the 1st part of the second quarter as far as perhaps the month of April in terms of what you saw on the volume side year over year for pools?

Speaker 1

Well, so Michael, those are that's really a Q2 question. So what really I want to reiterate is that we have confidence in our 50% growth for the year. And obviously, it's a as I mentioned in my comments, it's really a long term view on things. So I really even would say 50% CAGR over 24% 25% as we know that a lot of products from our customers, although there's been a bit of deferral in Q4 and Q1 into the coming quarters. It's a bit of a it is not a bit, it is a long term initiative for all our customers, but still feel comfortable with our 15% CAGR.

Speaker 6

Okay. That's fair. And absolutely took your point that you reiterated the 15% CAGR. And think you were just talking with the prior analyst about what's implied for the remaining 9 months to get you there. I guess, maybe I'll ask the question a little bit differently.

Speaker 6

I guess the question is really then how do we think about the cadence here as you move through the year just to ensure we're not being too aggressive as we think about Q2 for the pools business in terms of organic growth, like how does this ramp as you make your way to that 15% organic growth for the year?

Speaker 1

Yes. So as I mentioned, we've seen better volume in Q1 this year and Q4 next year and it's going to keep growing. And I reiterate that Q2 and Q3 would be our strongest volume quarters. So I guess you could expect us to have a jump, I guess, into volume in the second and third quarters simply because it is the maintenance season in North America granted that in the South US as Saldanha explained, SYP is a year round activity. Canada and the northern part of the US, April to October are the months where installation and maintenance, a lot of it gets done.

Speaker 6

Okay. Fair enough. And then maybe just one other one. You'd previously talked about the prospect to the potential for some pricing pressure. I think you reiterated that risk or potential here on this call as far as the poles business and pricing pressure, particularly in the second half.

Speaker 6

I think previously you talked about those pressures potentially materializing in the spot portion of the coals market. Can you just talk about where do you see potential pricing pressures now? Is it still very much in the spot market? Or do you see anything going on in the contract market? If you can just talk

Speaker 7

about that,

Speaker 1

that'd be helpful. So our views is that it would be entirely in the spot market. Our contract pricing is set and has a mechanism for adjustments that are based on the different cost drivers. So market trends much less or no influence at all. So it's entirely into the spot market.

Speaker 1

Can't say that it's something that we've necessarily seen or measured, but as I explained with the additional capacity in the market and us securing a lot of the long term contracts in the North American market, I feel that a lot of our competitors to move their products will have to take a second look at their pricing. But obviously, that's an assumption that Stella Jones has taken and that's how we've sort of laid out our expectations for our margins for the second half of the year.

Speaker 6

But at this point, you're not yet seeing it in the spot market. This is more of a potential risk still?

Speaker 1

Still a potential risk, yes.

Speaker 6

Got it. Okay. Thank you. I'll leave it there.

Speaker 1

Thank you, Mike.

Operator

Thank you. Our following question is from Maxim Sytchev from National Bank Financial. Please go ahead.

Speaker 7

Hi, good afternoon.

Speaker 1

Hello, Maxim.

Speaker 7

Maybe the first question for Silvana, if I may. So when you talk about normalization of working capital kind of intensity, so Ronald in 2023 there was a drag of $345,000,000 on non cash working capital. Do you mind maybe providing some thoughts around where 2024 might land? Like, will we be able to unwind kind of the vast majority of that? Or how should we think about this?

Speaker 7

Thanks.

Speaker 2

So our expectation for this year, for 2024 is that the inventory level at the end of 2024 will be at a similar level as in 20 at the end of 2023. So it will remain at those higher levels. A part of it is the need to have this higher inventory level to service additional volumes that we are projecting into 2025, particularly for utility poles, but also for railway ties.

Speaker 7

Okay. And then I guess, I mean, I know that 2025 is a bit far, but I'm just trying to think about sort of a normalized perhaps EBITDA to kind of free cash flow conversion. Maybe if you have any thoughts there how we should be approaching this?

Speaker 2

In terms of, I guess, maybe 2 data points that might be useful. The first one is that our expectation is that we our inventory bill is always about 40% of additional revenues. So for every additional dollar of revenue, there's about $0.40 of inventory build. Typically, that is seen throughout the company. And in terms of free cash flow conversion on a normalized basis, I would say probably a 50% to 60% would be probably closer to 50% would be more of a normalized level.

Speaker 7

Okay. That's really useful. Thank you so much, Silvana, for that. And Eric, I mean, I know obviously we're kind of beating the dead horse around pricing dynamic, but how quickly do you think that can clear? Do you think it's really just a back half of 2024 event and then there's sort of like a reset in 2025?

Speaker 7

Or do you think it can have a bit of a longer tail like what are your thoughts from that perspective? Thanks.

Speaker 1

So I mean it's a good point. The obviously it's an assumption. Is it going to happen in Q3 or starting Q4 and lap into early next year? I think it's sort of like we will have the presence of this pressure will once it starts, I'll be there for a couple of quarters. The longer it takes, I would think the better off we are as I think demand will normalize again because I it's short lived.

Speaker 1

We're still expecting to see interest rate drops, maybe not this year at this point, I don't know, later in the year or early next year. But I do think that as soon as we see interest rate moves, we will see more projects come forward in North America and that will most likely help absorb some of that excess capacity.

Operator

We have no further questions in the queue. Thank you.

Speaker 1

Well, thank you everyone for joining us today and look forward to talk to you again next quarter.

Operator

Ladies and gentlemen, this concludes today's call. Thank you for participating. You may now disconnect your lines.

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