PotlatchDeltic Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
July 30, 2024

There are 10 speakers on the call.

Operator

Good morning. My name is Greg and I will be your conference operator today. At this time, I would like to welcome everyone to the PotlatchDeltic Second Quarter 2024 Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker remarks, there will be a question and answer session.

Speaker 1

Thank you. I would now like

Operator

to turn the call over to Mr. Wayne Wacek, Vice President and Chief Financial Officer, for opening remarks. Sir, you may proceed.

Speaker 2

Good morning, and welcome to PotlatchDeltic's Q2 2024 Earnings Conference Call. Joining me on the call is Eric Kremers, PotlatchDeltic's President and Chief Executive Officer. This call will contain forward looking statements. Please review the warning statements in our press release, on the presentation slides and in our filings with the SEC regarding the risks associated with these forward looking statements. Also, please note that a reconciliation of non GAAP measures can be found in the appendix to the presentation slides and on our website at www.potlatchdeltic.com.

Speaker 2

I'll turn the call over to Eric for some comments and then I will review our Q2 results and our outlook.

Speaker 3

Well, thank you and good morning everyone. Thank you for joining us. Yesterday after the market closed, we reported 2nd quarter total adjusted EBITDA of $103,000,000 This is a $73,000,000 increase from the Q1 and was largely driven by strong real estate performance. Overall, we had solid operational execution across each of our business segments despite the current economic environment and languishing lumber markets. Turning to our Q2 results, starting with our Timberlands division.

Speaker 3

This segment generated adjusted EBITDA of $34,000,000 in the 2nd quarter. We harvested 1,900,000 tons exceeding our Q2 harvest plan as better than expected weather conditions in both our northern and our southern regions provided favorable logging and hauling conditions. Saw log prices in Idaho increased due to our indexed agreements coupled with higher cedar prices. For the South, our average Southern log price realizations were comparable to the Q1 despite challenging lumber market conditions. Moving to our Wood Products segment results.

Speaker 3

Adjusted EBITDA was a loss of $7,000,000 in the 2nd quarter compared to breakeven in the Q1. During the Q2, lumber markets remained challenging as seasonal homebuilding activity did not result in tightening lumber markets. While there is weakness across all lumber markets, it has been most notable for our Southern Yellow Pine. Southern Yellow Pine prices are at historically low levels, which stem from pronounced weakness in multifamily construction, declining demand from treaters and ample supply of product. While depressed lumber markets continue to weigh on our wood products results, we continue to focus on the areas we can control, including optimizing our product mix, efficiently running our mills and effectively managing costs.

Speaker 2

As we look towards Q3,

Speaker 3

we believe lumber prices are at or near the bottom as we have seen recent signs of a modest upward trend in lumber prices. Entering the back half of the year, we have reached several significant milestones with our $131,000,000 Waldo, Arkansas sawmill modernization and expansion project. The project continues to progress well with completion in Q3 remaining on track and within budget. In the early part of Q3, the mill will undertake a limited period of downtime to tie in the new equipment. This downtime is expected to reduce our Wood Products division lumber production by approximately 10% or 25,000,000 board feet in the 3rd quarter.

Speaker 3

Following completion, we anticipate a ramp up in production through Q4 and into next year. Based on other brownfield additions in the industry that we have seen, we expect it will take 6 to 12 months to reach the mills new capacity of 275,000,000 board feet per year. As a reminder, the project will increase the mill's annual capacity by 85,000,000 board feet, will improve recovery by approximately 6% and reduce cash processing costs by about 30%. Once the ramp up phase is completed, we expect the mill to generate approximately 25 $1,000,000 of incremental EBITDA annually under mid cycle sales environment with this project. Shifting to our Real Estate segment, this business generated $90,000,000 in adjusted EBITDA in the Q2.

Speaker 3

Our Rural Real Estate side of the business produced very strong financial results as we successfully completed the sale of 43,000 acres at an average of $2,000 per acre during Q2. The highlight of our 2nd quarter rural real estate activity was a closing of the previously announced 34,000 acre Young Timberland transaction for $57,000,000 As discussed on the last call, the Timberland was sold at a significant premium as it was just 4 years old and had no meaningful cash flows for the next 20 years. The quarter also included other value added transactions at significant premiums to Timberland value, including a 2,000 acre conservation land sale in Arkansas $4,700 per acre. Demand for rural real estate continues to remain quite strong. The development side of our real estate business remains steady in this higher interest rate environment.

Speaker 3

During the Q2, we completed a $6,000,000 commercial land sale and sold 13 residential lots at an average price of about $113,000 per lot in our Chenal Valley master plan community in Little Rock. While we fell short of our residential lot sales outlook in the Q2, we remain optimistic about our residential sales the remainder of this year based on strong take up from regional builders on our latest residential lot offerings just this past week. Regarding our emerging natural climate solutions business, it continues to evolve and grow. Starting with solar opportunities, our portfolio of option contracts with solar developers continues to expand with 4 new contracts added since the last quarter ended. Our inventory of solar option contracts now represents 27,000 acres or over 1% of our entire Timberland holdings with an estimated value of approximately $300,000,000 on a net present value basis.

Speaker 3

Given the appetite continues to demonstrate for solar energy, we anticipate further growth of our pipeline. By year's end, we expect our solar option contracts portfolio to include over 30,000 acres with an estimated net present value of roughly $340,000,000 We're also actively pursuing an NCS opportunity focusing on subsurface leases for lithium deposits crucial for battery production. Notably, certain areas of our timberlands in Southern Arkansas feature geological formations that offer promising prospects for lithium. Currently, we are engaged in discussions with selected counterparties regarding the initial leasing of a portion of our subsurface rights. Shifting to forest carbon credit opportunities.

Speaker 3

The voluntary carbon credit market for high quality credits continues to grow. Carbon registries that support voluntary markets continue to evolve in order to ensure high quality credits are being brought to market. In fact, the leading carbon registries are shifting their methodologies to have projects adhere to the relatively new core carbon principles or CCP established by the Integrity Council for the voluntary carbon market. These relatively new core carbon principles are quickly becoming widely recognized as establishing a global benchmark for the highest integrity carbon credits found in the voluntary marketplace. Consequently, we believe that forest carbon credits that are labeled CCP will garner the highest demand and therefore will obtain premium pricing.

Speaker 3

With this in mind, we are shifting our approach and redesigning our 50,000 Acres Southern Timberland Carbon Project to meet these new CCP standards. We believe this will ensure our project or any future projects that we identify will be globally recognized as having real and verifiable climate impact under a transparent methodology using best practices along with creating strong demand and premium pricing. Once we further assess the redesign of our carbon project, which is expected by the end of this year, we will have a clear picture of the type and time horizon of bringing a CCP labeled carbon project to market. We have also identified potentially valuable prospects in carbon capture and storage as well as bioenergy and biofuels. While these ventures are not expected to materialize immediately, they hold the potential for substantial value in the long run.

Speaker 3

We continue to believe that all of these natural climate solutions opportunities will increase demand for our rural land, likely driving timberland values higher due to increasing and diverse cash flows. Moving to capital allocation, we remain committed to our disciplined and opportunistic approach and we constantly evaluate all of our capital allocation opportunities to grow shareholder value over time. In the current economic environment, capital allocation is dynamic and can change from quarter to quarter. Aside from our dividend, share repurchases were very attractive option in Q2 as we were trading considerably below our estimated net asset value. In the Q2, we returned $25,000,000 to shareholders through share repurchase activity.

Speaker 3

Approximately 610,000 shares were repurchased at an average price of $41 per share. We have now utilized half of our current share repurchase authorization with $100,000,000 remaining under the program. Now turning attention to the U. S. Housing market.

Speaker 3

The overall market continues to be weighed down by elevated mortgage rates and affordability challenges. Despite these factors, new single family residential construction continues to demonstrate a fair level of resilience as starts have exceeded 1,000,000 units in 7 out of the last 8 months. This has contributed to some level of stability in the market. This level of activity has been supported by large homebuilders continuing to use incentives such as mortgage rate, mortgage rate buy downs to address affordability. As for the multifamily segment of new residential construction, it has experienced a pullback due to an influx of supply entering the market and the excessive cost of financing construction.

Speaker 3

There are some positive macroeconomic indicators including inflation data showing signs of easing. If this trend in inflation continues, it is anticipated that the Federal Reserve will start to pivot from its restrictive rate policy and begin to lower rates, possibly as early as September. Consequently, we would expect the housing market to see renewed momentum once mortgage rates drop. Not only would new homes become more affordable, but existing home sales would improve as well as existing homeowners are not as locked into a low mortgage rate. Longer term, we remain optimistic on new residential housing fundamentals.

Speaker 3

This is supported by an underlying shortage of housing stock, which some pundits estimated 4,000,000 units and a strong demographic tailwind. Now moving to the repair and remodel segment, which in fact is the largest demand driver for lumber. Demand in this market has softened, especially in the do it yourself segment. The near term headwinds on repair and model appear to be driven by elevated interest rates, thus raising the cost of discretionary projects. Coupled with the low turnover of existing homes, which typically spurs R and R activity.

Speaker 3

Looking forward, favorable longer term fundamentals continue to remain with an aging housing stock at over 40 years on average, continued work from home policies and elevated home equity levels. Back in May, we released our 2023 Corporate Responsibility Report highlighting the continued momentum we are generating around our corporate responsibility goals and initiatives. Looking ahead, we continue to be diligently focused on completing our strategic modernization and expansion project at the Waldo Sawmill on schedule within budget and with the utmost safety for our employees and our contractors. Additionally, we remain committed to enhancing operational and financial performance across all of our business segments and in light of tough market conditions have implemented additional cost controls across all of our mills. Our investment grade balance sheet, ample liquidity capital allocation strategy position us to deliver long term value for our shareholders.

Speaker 3

I will now turn it over to Wayne to discuss our current Q2 results and our outlook.

Speaker 2

Thank you, Eric. Starting with Page 4 of the slides. Adjusted EBITDA was $103,000,000 in the 2nd quarter compared to $30,000,000 in the 1st quarter. The sequential quarter over quarter $73,000,000 increase in EBITDA was driven by strong rural real estate sales. I will now review each of our operating segments and provide more color on our 2nd quarter results.

Speaker 2

Information for our Timberland segment is displayed on Slides 5 through 7. The segment contributed $34,000,000 in EBITDA for 2nd quarter results, which was comparable to the Q1. 2nd quarter EBITDA benefited from higher sawlog prices in Idaho, which were offset by seasonally higher forest management and road costs across our regions. Our Sarlog harvest in Idaho was 365,000 tons in the 2nd quarter compared to 329,000 tons in the 1st quarter. Our team leveraged good hauling conditions coming out of spring breakup, which led to exceeding our plant harvest volume for the 2nd quarter.

Speaker 2

Our Idaho sawlog prices increased from $103 per ton in the first quarter to $113 per ton in the second quarter or 9%. The favorable per tonne increase reflects higher lumber indexed and cedar sawlog prices and the positive effect of a normal seasonal decrease in the densile sawlogs. Turning to the South, we harvested 1,500,000 tonnes in the 2nd quarter compared to 1,600,000 tonnes in the 1st quarter. Slide 7 shows our sawlog prices down 2%, which is on a rounded basis, but actual southern sawlog prices were 1% lower in the Q2 compared to the Q1. The moderate decline can be attributed to a higher mix of smaller diameter pine sawlogs along with the market factors affected by sub log inventories at or nil capacity across the region.

Speaker 2

Moving to Wood Products on Slides 89. Adjusted EBITDA decreased from breakeven in the Q1 to a loss of $7,000,000 in the 2nd quarter. Lower average lumber prices combined with higher per unit cash processing costs primarily associated with our Waldo Arkansas sawmill with its ongoing modernization and expansion project drove the decline. Our average lumber price realizations decreased 2% from $4.30 per 1,000 board feet in the 1st quarter to $4.23 per 1,000 board feet in the 2nd quarter. By comparison, the Random Lengths Framing Lumber Composite price was 5% lower in the 2nd quarter compared to the 1st quarter.

Speaker 2

Note that our regional mix and product mix is not the same as the composite. There's also a timing difference between our sales and the composite. Lumber shipments increased by 15,000,000 board feet from 271,000,000 board feet in the first quarter to 286,000,000 board feet in the 2nd quarter. Shifting to Real Estate on Slides 1011. The segment's adjusted EBITDA was $90,000,000 in the 2nd quarter compared to $6,000,000 in the 1st quarter.

Speaker 2

EBITDA generated by rural sales was considerably higher in the 2nd quarter led by the closing of the previously announced $57,000,000 Southern Timberland transaction. Our rural real estate business remains robust as we closed on a total of 47 transactions aggregating to 43,000 acres. EBITDA generated by our Chennault Valley master plan community increased in the 2nd quarter by nearly $5,000,000 compared to the 1st quarter due to a 12 acre commercial real estate sale for $500,000 per acre. During the Q2, we also closed on the sale of 13 residential lots at a lower average price than in the first quarter due to a different product mix of lots. Turning to capital structure, which is summarized on Slide 12, our total liquidity was just under $500,000,000 This amount includes $200,000,000 of cash on our balance sheet as well as availability on our undrawn revolver.

Speaker 2

We repurchased 610,000 shares at $41 per share for a total of $25,000,000 in the 2nd quarter. We have $100,000,000 remaining on our $200,000,000 repurchase authorization. We intend to refinance $176,000,000 of debt that is due for maturity in October November this year. On our balance sheet, we currently hold notional forward starting swaps of $200,000,000 valued at approximately $38,000,000 Our strategy will be to optimize the use of these swaps either partially or in full to refinance this debt at interest rates below the prevailing market rates. Capital expenditures were $28,000,000 in the 2nd quarter.

Speaker 2

That amount includes real estate development expenditures which are included in cash from operations and our cash flow statement. Our full year capital expenditures remain in the range of $100,000,000 to $110,000,000 not accounting for any possible Timberland acquisitions. This estimate includes approximately $44,000,000 for the final installments on the modernization and expansion project at the Waldo Arkansas sawmill, of which approximately $27,000,000 remains to be spent for the rest of the year. Furthermore, we anticipate that our annual CapEx will drop significantly and return to a more normalized level next year as we do not plan to undertake any major projects comparable to the Waldo initiative. I will now provide some high level outlook comments.

Speaker 2

The details are presented on Slide 13. We expect to harvest 1,900,000 to 2,000,000 tons in our Timberland segment in the 3rd quarter with nearly 80% of the volume in the South. Harvest volumes in the North are planned to be at their seasonal peak as the 3rd quarter typically has the best logging and hauling prices in the Q3 due to lower prices for index sawlogs. In the South, we plan to harvest approximately 1,500,000 tons in the 3rd quarter. We expect our Southern sawlog prices in the 3rd quarter to be comparable to the 2nd quarter.

Speaker 2

We plan to ship 250,000,000 to 260,000,000 board feet of lumber in the 3rd quarter. This forecasted shipment volume takes into account a reduced production level in the Q3 for scheduled downtime at our Waldo, Arkansas sawmill. This pause in operations is necessary to complete the installation of new equipment as part of the expansion and modernization project. Our full year projected shipment volume remains at approximately 1,100,000 board feet. Our average lumber price thus far in the 3rd quarter is 9% lower compared to our 2nd quarter average lumber price.

Speaker 2

This is based on approximately 135,000,000 board feet of lumber. As a reminder, dollars 10 per 1,000 board foot change in lumber price equals approximately $12,000,000 consolidated EBITDA for us on an annual basis. Shifting to real estate, we expect to sell approximately 6,600 acres of rural land in the Q3. Additionally, because of notable strong demand for rural real estate far this year, we anticipate the sale of roughly 55,000 acres of rural land in 2024. For real estate development, we expect to sell approximately 45 Chenow Valley residential lots in the 3rd quarter.

Speaker 2

Additional real estate details are provided on the slide. Overall, we anticipate our total adjusted EBITDA will be lower in the 3rd quarter compared to the Q2. This expectation is based on the decline in rural and real estate activity. That concludes our prepared remarks. Greg, I would like to open the call to Q and A.

Speaker 2

Queue.

Operator

Great. Thanks, Wayne. Okay. It looks like our first question comes from the line of Anthony Pettinari with Citi. Anthony, please go ahead.

Speaker 2

Good morning.

Speaker 3

Your full year lumber shipment

Speaker 4

guidance is unchanged from the beginning of the year, I think at 1,100,000,000 board feet. And some of your competitors are taking curtailments or maybe sharper actions on capacity. And I'm just wondering if you would consider similar actions given profitability has been challenged for maybe longer than we expected or just generally

Operator

how you think about that?

Speaker 3

Yes, Anthony, this is Eric. And I guess as a starter, we mentioned in the prepared remarks that WALDO is going to be down for a portion of Q3, which is going to lower our shipments 25,000,000 to 30,000,000 feet in the quarter. So in some ways we are taking downtime here. But as we do the and everybody's financial situation where their mills sit on the cost curve, everybody's situation is a little bit different from the next competitors. For us, we are more than covering our cash variable costs at all of our mills.

Speaker 3

So for us taking out volume effectively what that does is it hurts the P and L even more. So the math for us is to keep running as hard as we can. Now the math is going to be different for other competitors and that's why you're starting to see others close mills and take out shifts and take out over time and whatnot. So that's kind of our posture in this current market environment.

Speaker 4

Got it. And you referenced, we've seen kind of uptick in lumber, I guess in recent weeks. Is there anything specifically that you did attribute that to? And are you seeing, curtailments or closures by competitors maybe accelerate or maybe start to be felt in the market a little bit more? Do you think the Canadian tariffs could be meaningful?

Speaker 4

Just kind of to the extent you can, how you kind of think about lumber in July August and the trends we're seeing?

Speaker 3

Yes, that's a good question. I think July will be the low point for lumber prices for the year. I mean, I get the forecasting lumber prices a bit of a fool's errand as you know in commodity markets like this. But our sense of it is that July is going to be the low point for the year. In the past couple of weeks in fact, if you go all the way back to the start of the year, we've seen, I don't know, 2,500,000,000 to 3,000,000,000 board feet of capacity come out of the markets.

Speaker 3

We saw a couple of mills, warehouses just announced are closing a mill, Malheur over in John Day, Oregon just announced are closing a mill, Stimpson just down the road here in Plummer, Idaho announced they're closing their mill. If you combine it with curtailments that we're seeing from well West Fraser, Canfor and Weyerhaeuser all announced meaningful capacity cuts in just the past week. In total, that amounts to about 2,500,000,000 to 3,000,000,000 board feet coming out of the market. Meanwhile, I think demand is kind of bottoming here. And as I look out into next year, with interest rates coming down, I can see housing starts being up, I don't know, 150,000 units to maybe 1,500,000 next year.

Speaker 3

I can see R and R markets coming back as we get out into next year with lower financing costs. I can see multifamily coming back as we get out into next year with all this new supply that's come on the market as it gets absorbed. I see European imports rolling over. So I think market is setting up for a decent run-in lumber prices. Now is it going to happen in Q3 or Q4?

Speaker 3

Probably not because we are going into a seasonally slow period of the year with construction activity slowing. But I think as you get out into next year, I think things are looking a lot better.

Speaker 4

Okay. That's very helpful. I'll turn it over.

Speaker 3

Thanks.

Operator

Great. Thanks, Anthony. And our next question comes from the line of Michael Roxlin with Truist Securities. Michael, please go ahead.

Speaker 5

Yes. Thank you, Eric and Wayne for taking my questions. How much of the weakness that we're seeing in housing start do you think relates to smaller builders who don't have the wherewithal of the larger builders to offer meaningful incentives?

Speaker 3

Yes, I think that's a lot of the weakness in the market, Michael. I you look at the big builders with their big balance sheets, they continue to take market share from small builders and I think the public builders now up over 50% of the market and with their ability to buy down rates, I compare and contrast that with what I'm seeing in our own master plan community in Chenal where you've got builders that might do 1 to 5 homes a year more or less that don't have the big balance sheet. It's their own personal equity that's on the line. I think that's driving a lot of the market right now.

Speaker 5

Got you. And so I guess the then really to your point, Eric, it's

Operator

really a matter of rates coming in a

Speaker 5

bit, which will give these regional builders a little bit of breathing room.

Speaker 3

Yes. And I am encouraged. I mean, if you listen, I mean, on our prepared remarks, we talked about a very successful lot draw that we had just last week in Chenal. Now those were higher end homes, golf course lot homes, so to speak, but we had really good uptake in that draw. So demand is there.

Speaker 3

It looks to us like demand appears to be a lot firmer on the high end of the market than it does the low end of the market. But with rates coming off, we've already seen 30 year mortgage rates. I mean last year they peaked at around 7.8 and today they're around 6.7, 6.8. So they've already come down 100 basis points.

Speaker 2

We get a few interest rate cuts from

Speaker 3

the Fed and we get the spread between treasuries and mortgage rates. We get that to compress a little bit, which that spread is pretty wide right now. I think we could see a lot of we could easily see homebuilding get back up to I think 1.5% next year is my base case forecast. And then I think in the 26%, it could be 1.6%, 1.7%. There's just a ton of pent up demand out there.

Speaker 3

It's just that people can't afford it.

Speaker 5

Got it. Makes sense. And just one quick final question in terms of lumber. You mentioned in your opening remarks as well, it's focusing on cost, focusing on things that you're in your control. Given the persistent weakness in the number, can you just provide any color on initiatives that you're pursuing in your mills to improve profitability?

Speaker 3

Well, yes, we've got a strict edict out to the mills now that you need to make sure what you're buying is what you absolutely need to be buying to keep your mill running. Now we're not going to do stupid things like deferred maintenance that's just going to bite us down the road, but it's really making sure that everything that they're buying is something that they need to keep their mill running successfully. But that's not the only thing that we're doing too. We're shifting our product mix. We don't produce a lot of 2x4, but if you've been watching 2x4 Southern Yellow Pine prices, they've been at just rock bottom levels.

Speaker 3

So with some of our mills, we're able to flex our product to capture premium prices, but generally that's somewhat limited.

Speaker 1

Got it. Thank you. Great.

Operator

Thanks, Michael. Thank you. And our next question comes from the line of George Staphos with Bank of America. George, please go ahead.

Speaker 6

Thanks so much, everyone. Good morning.

Speaker 3

Hey, George, we can barely hear you.

Speaker 6

Let's try that. How's that? Is that better?

Operator

Much better.

Speaker 7

Yes, it's much better. Thank you.

Speaker 6

There you go. Appreciate that. So, good performance, tough operating quarter, macro quarter, I should say. Can we go to Slide 8 and look at the waterfall? And just as we sort of think about Q3, recognizing there are no guarantees on pricing, with Waldo going through its last stages, that's going to cost you some volume.

Speaker 6

So volume is probably a negative in 3Q versus 2Q. Can you give us a sense on how that manufacturing cost portion of the waterfall might look sequentially 3Q versus 2Q? Will it be maybe better because 2Q was so tough? Or might it still be a little bit lower just because you're going through those last stages? How should we think about those 2 boxes, if you will, or 2 bars?

Speaker 2

Yes, George, this is Wayne. When we think about I think when we look to move from Q2 into Q3, especially as it relates to Waldo, we believe we absorb most of those costs, higher costs with the modernization project and its effect on manufacturing. So we had that negative impact in Q2, but we think that'll reverse itself over the back half of the year. So that $3,000,000 will kind of roll out in Q3 and Q4 with both improved costs, better fixed cost absorption throughout the remainder of the year. I think we'll be more favorable as we trend the rest of the year.

Speaker 6

Okay. So we should see some green bars on manufacturing costs in the Q3 without getting into the pennies and dollars here, that should be a positive. And are there any other things that might help you in terms of your overall Wood Products EBITDA, again, recognizing your cash cost are better in terms of profitability. What about the cost reduction opportunities that you see? Is there a way to put a dollar amount on that, the things that you're doing right now just given where we are in the cycle?

Speaker 3

Well, yes. So I think George, the way to think of it is that we're pushing both processing costs and fiber costs down at all of the mills. In total, we think our cash processing costs are going to come down maybe 2% full year over full year. We think our fiber costs, especially at St. Mary's and that our Gwynn, Michigan mill are going to come down, who knows, 6% more or less.

Speaker 3

So we think our total cash costs at our mills are going to decline roughly 4% full year over full year. So there will be a benefit here. It's not going to be gargantuan. It's tough to move the needle because we're always theoretically, we're always working as hard as we can to get log costs down and to get operating costs down. But there will be a modest pickup from these efforts.

Speaker 6

Okay. No, I appreciate that, Eric. Appreciate that, Wayne. A couple more questions for me

Speaker 2

and I'll turn it over

Speaker 6

and come back. Can you talk a little bit more about the CCP registry and kind of what's different about how they evaluate credits to what you had been using and ultimately what it can mean in terms of value for a credit? And then just maybe back to Wood, you talked about 2,500,000,000 to 3,000,000,000 board feet of capacity being taken out of the market either permanently or temporarily. To the extent that you have a purview on this, what do you think in the South in particular the amount of remaining excess capacity is, if in fact you think there's any remaining excess capacity? Thank you.

Speaker 3

Yes. I'll let Wayne take the first one and I'll take the second one.

Speaker 2

Yes. So George, on the carbon credits, certainly the project that we're developing, we believe would certainly achieve additionality and produce high quality credits. I think the market the voluntary market though continues to evolve and develop. Certainly buyers continue to demand greater governance and transparency. And I think the market is really searching for greater alignment of standards for these type of projects.

Speaker 2

And as Eric mentioned, this Integrity Council for voluntary credit markets developing these core principles, which are coming globally recognized. I think it establishes a common standard. And we think that these principles will stabilize the carbon trading markets really once they become mainstream. And so we believe that these standards that these labeled projects will attract the highest demand and achieve higher premium pricing. We think potentially upwards of 50% premium pricing.

Speaker 2

And keep in mind, these type of projects, they're not a 1 to 2 year project. These are tend to be multi decade projects. So we're really thinking about the long term value here. And that's why we are pivoting to implement these new standards on a project.

Speaker 3

Yes, George, you may have seen, I mean, there's been a few articles out just in the past couple of weeks about dubious credits being issued and one was in the Wall Street Journal. There was another big article in The Guardian. So we think buyers are getting a little bit suspicious about forestry carbon credits. Now a lot of those dubious credits are coming out of 3rd world countries. But nonetheless, ICBCM has decided that there needs to be a global framework for capturing carbon credits out of forestry.

Speaker 3

So like Wayne said, we expect pricing to be this is going to really clear up the marketplace and we think prices are going to 2 years, whatever it takes to get 50% higher pricing, it's just the right thing to do for our shareholders. So that's kind of how we're thinking about it. Now your second question with regard to how many more mills in the South can close, I honestly I cannot answer that question. All I know is what our mills, what our P and Ls look like. And I'm sure there are a lot of other mills, especially the smaller private ones where people have got to make really tough decisions about do they want to keep running in this kind of an environment.

Speaker 3

It's really hard to know. All I can tell you is I've seen cost curve for the South and at least half of the mills in the South are losing a lot of money right now.

Speaker 6

Yes. Thanks for that, Eric. It was less about cost or more about just overall excess supply recognizing they're somewhat joined at the hip. But if you had a view on excess supply, great. If not, I'll turn it over.

Speaker 2

Okay.

Speaker 8

Thank you.

Operator

Okay. Thanks, George. And our next question comes from the line of Matthew McEller with RBC Capital Markets. Matthew, please go ahead.

Speaker 9

Hi, good morning. Thanks for taking my questions.

Speaker 3

Good morning.

Speaker 9

I called out a potential opportunity around lithium on a couple of the recent calls. Could you provide just a bit more color on the potential size of the opportunity here? And maybe what kind of timeline you're thinking about for something to come to fruition?

Speaker 2

Yes. I think as far as the size of the opportunity, I think we're still working through that potential. It's a little bit early to give any sort of guidance on where we think that could end up. But we certainly think that's an attractive opportunity. On the spectrum of NCS opportunities that's more near term than say for example where we think carbon capture and storage is for us.

Speaker 2

That's a little bit longer tail to that. But lithium we believe has in the next couple of years, we think that opportunity could come to fruition.

Speaker 9

Thanks. That's helpful. And then you called out European lumber imports rolling over as part of how you're thinking about the outlook. Can you give us a sense of what you're seeing on that front today?

Speaker 3

Yes. So year to date, U. S. Offshore imports down 14 percent, most of that is from Europe. And I think the fact of the matter is markets are very weak in Europe right now.

Speaker 3

So European producers have been looking for a home for their lumber. They've been beneficiaries of this spruce bark beetle that has made fiber really cheap for their mills. Fortunately, that's coming to an end here. Drop that 14% number. We think imports are going to continue to roll over as we move forward.

Speaker 3

And I think probably the biggest factor behind that is going to be a European recovery. We're now starting to see Europe lower interest rates. ECB, I think just cut rates 25 basis points a month or so ago. And so we expect more lumber to stay within Europe and less of it to get exported to the U. S.

Speaker 3

So we see a softening in those imports going forward.

Speaker 9

All right. Thanks very much

Speaker 1

for the help. I'll turn it back. Thanks. Thank you, Matthew. And our

Operator

next question comes from the line of Kurt Yinger with D. A. Davidson. Kurt, please go ahead.

Speaker 7

Great. Thanks and good morning everyone.

Speaker 1

Good morning.

Speaker 7

Wayne, I'm sorry if I missed this, but in terms of Northern sawlog pricing, how are you thinking about, I guess, the degree about which those could be lower Q3 versus Q2?

Speaker 2

Yes. For Northern Solid Logs, probably we're looking our estimate is probably kind of mid single digits down from the Q2 assuming around 5%. And I think that there's a mix there. So a couple of things driving that. I believe certainly indexing the index saw logs are down.

Speaker 2

Keep in mind there's a one flag there. So that's pricing from June to August. But on the flip side offsetting some of that weakness is we have more cedar in the mix plus cedar pricing for us is actually quite strong compared to historical averages. And we have pretty tight supply in the Idaho region and that's really driving some strong pricing. So kind of those two factors combined, we're looking to be down around 5%.

Speaker 7

Got it. Okay. That's helpful. And then on the solar side, how are you guys thinking about kind of the timeline in terms of when we could start to see, I guess, a couple or handful or a meaningful total of some of these options really starting to convert to leases?

Speaker 3

Yes, we've talked about this on prior calls, how challenging it is, the backlog of projects that these utilities, these developers have got, waiting to get clearance from regulators and FERC and whatnot. So the timing of these things is really hard to predict. We have actually closed one. We closed one back in Q1 of 2022. It was a sale in CatchMark.

Speaker 3

Of course, we own CatchMark now, but it had one that closed in Q1 of 2018. So 2 have actually already closed. Now that was before the IRA. So now that the IRA is in place, there's been just a tremendous amount of activity. And we think next year there's a potential for 1, maybe 2 of our projects to get executed.

Speaker 3

And so we'll see. We're in discussions now with that partner, but we'll see. But I think starting next year, you'll see some of these options get exercised.

Speaker 6

Okay, that's

Speaker 7

great. And then just last one for me on CapEx levels, makes sense that they would come down next year. I guess if I were to just kind of take the current outlook and then take off kind of the remainder spending related to Waldo this year, Is that a reasonable kind of starting point for thinking about 2025 maybe in that $60,000,000 zip code?

Speaker 2

Yes. I think at this point, we'll see how markets continue to progress the remainder of the year. I mean, we have a number of we're always looking at projects in our Wood Products business that are higher return and have a high RRR. So yes, I think it's a bit early for us to give guidance on CapEx for next year.

Speaker 7

Okay, fair enough. Well, thanks for the color guys and good luck here in Q3.

Operator

Thanks. Thanks, Kurt. And our final question today comes from the line of Mark Weintraub with Seaport Research Partners. Mark, please go ahead.

Speaker 6

Thank you. First of all, just following up

Speaker 8

on the solar coast, as you've highlighted it can be a real dial mover when thinking about the degree of value it can represent of the existing enterprise. But we are, it seems running into maybe delays isn't the right word, but it's been hard to realize these monies start to see them flow through. Is there something you can kind of communicate to give us more confidence, give the market more confidence that it's coming, when it's coming, why it's coming?

Speaker 3

Yes, Mark. So there's been an enormous amount of renewable energy work that's been done in the past year or 2 in the U. S. I think something like 2023 was a record year, it was 32 gigawatts, which was up considerably from prior year. Market is supposed to be up threefold by 2,030 solar power.

Speaker 3

So, there is just a flurry of activity here. And one of the first things the developer has to do to really get their project rolling is identify a piece of property that they can use for their solar farm. And so we happen to be at the very front end of that whole project. I think as we get into next year and we start having more conversations with these developers that have got these projects, By the way, they're paying us all along the way here and they've got no revenue right now from these farms. So it is in their very best interest to accelerate their projects as much as they possibly can.

Speaker 3

But I think as we get out into next year and we perhaps get 1 or 2 of these over the goal line, I think we'll have a lot better feel for what the runway looks like for the ramping up of these projects. But right now, it's most of those option agreements are 4, 5 years in length. A lot of them have been signed just in the last 12 to 24 months. So it's really a bit soon to say when they're going to start hitting that the first option term is coming to an end in the next 2 to 3 years for a lot of these contracts. So hopefully we'll see activity contracts executed over that 2 to 3 year timeframe.

Speaker 8

And is it really not until you get over the goal line where you can have a very high level of confidence on an individual project? Or are there milestones where you can be able to point to why you have a higher degree of confidence today on some of them than you had and which are getting closer than say 3 months ago? Or is it really it's going to be that call at the end of the day whether it goes forward or not?

Speaker 3

Yes, I think as we get closer and closer to when the contract expires, we'll have more conversations with the developer about where they're at with their project. Ironically, we had one, I think it was last year, that did not get executed. We were very happy that the option did not get executed because we turned around and we leased it to another developer at an even higher rate. So sometimes these things falling apart can be a good thing, but I think we won't really get have much visibility into what each and every one of these projects looks like until we get closer to having them come to fruition. Now I do know that for next year, we are having conversations with 1 or 2 of them, and I'm optimistic about those, but we're not there yet either.

Speaker 8

Right. And so if I understand correctly, so the carbon credits, I think you had thought maybe you would have some by the end of this year. And I think that that's now being pushed back as you're going as you change tack. Is there any sort of some of your competitors have kind of put out targets in timelines, in fact both of your Timber Reef competitors. Is there anything maybe not right now, but is that something you'd be ready to share with us at some point soon or if there's color you can give us now?

Speaker 3

Yes, I think Mark, over the next few quarters, I think it's reasonable to assume that we might come up with a forecast. I mean, you can just see, I'm sure you read that greenwashing article in the Wall Street Journal just a couple of weeks ago. There's a lot of crosscurrents in the carbon credit market right now. And we have been a bit reluctant to give guidance knowing that there's all this turbulence. As the dust settles and we get greater clarity, I mean, Wayne talked about our lithium deposits in Arkansas.

Speaker 3

Well, the State of Arkansas hasn't even set the royalty rate yet on what we're going to get paid for our lithium. And so I can't tell you if that's a $1,000,000 opportunity a year or a $20,000,000 opportunity. We just don't know. So I'm reluctant to give detailed guidance, but I think as we move further along the path here and we get more clarity on where these markets are headed, I think we'll be in a good position to give guidance.

Speaker 8

Super. Appreciate it. Thanks guys.

Speaker 2

Thanks Mark.

Speaker 1

Thank you, Mark. And at

Operator

this time, I'm showing there are no more questions. So I will now turn the call back to Wayne Wazcak. Wayne?

Speaker 2

Thank you everyone for joining us this morning and for your continued interest in Potlac Deltic. Have a good day. Thanks.

Operator

And ladies and gentlemen, that concludes today's call. Thank you all for joining and you may now disconnect.

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Earnings Conference Call
PotlatchDeltic Q2 2024
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