PotlatchDeltic Corporation (NASDAQ:PCH) Q4 2022 Earnings Call Transcript

PotlatchDeltic Corporation (NASDAQ:PCH) Q4 2022 Earnings Call Transcript January 31, 2023

Operator: Good morning. My name is Devon, and I will be your conference operator today. At this time, I would like to welcome everyone to the PotlatchDeltic Fourth Quarter 2022 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. I would like to now turn the call over to Mr. Jerry Richards, Vice President and Chief Financial Officer, for opening remarks. Sir, you may proceed.

Jerry Richards: Thank you, Devon. Good morning, and welcome to PotlatchDeltic’s fourth quarter 2022 earnings conference call. Joining me on the call is Eric Cremers, 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 on our website at www.potlatchdeltic.com. I’ll now turn the call over to Eric for some comments, and then I’ll review our fourth quarter results and our 2023 outlook.

Eric Cremers: Well, thank you, Jerry. We reported total adjusted EBITDDA of $574 million for 2022 after the market closed yesterday. That is the company’s second highest EBITDDA on record and it marks our third straight year of strong financial performance. Cumulative EBITDDA generated by our leverage to lumber strategy over that three-year period was $1.6 billion. Our Wood Products segment contributed $291 million of adjusted EBITDDA in 2022 and $861 million over the last three years. We shipped just over 1 billion board feet of lumber in 2022, and we had another strong year in terms of safety performance. As discussed on last quarter’s call, we successfully completed the rebuild of our Ola, Arkansas sawmill, and restarted the large log line on schedule in the third quarter.

While the start-up phase has taken a bit longer than we had hoped relative to our stretch goal, the mill is on track to reach its 150 million board feet annual capacity on a run rate basis by the end of the quarter. As a reminder, Ola’s rebuild also significantly lowers the mill’s cash processing costs and improves its log recovery. In 2022, we also announced a $131 million project to modernize and expand our Waldo, Arkansas sawmill. The project will increase the mill’s annual capacity by 85 million board feet and significantly reduce cash processing costs. Activity will be focused on site prep in 2023, with equipment delivery and installation to come next year. The existing mill will continue to operate during the project with just three weeks of downtime expected in 2024 to tie in the new equipment.

Project completion is expected by the end of 2024. Our Timberland segment generated adjusted EBITDDA of $249 million in 2022, which was just below the record the segment set in 2021. We harvested 6.5 million tons, which exceeded our planned harvest primarily due to the addition of CatchMark’s timberlands in mid-September. Speaking of CatchMark, we had an excellent year on the M&A front. CatchMark added nearly 350,000 acres of high-quality timberlands and some of the strongest log markets in the U.S. South. Separately, we also acquired 46,000 acres of well-stocked timberlands in Mississippi and Arkansas and three bolt-on timberland transactions. Overall, we added nearly 400,000 acres of attractive timberlands in the U.S. South to our portfolio in 2022.

Our Real Estate segment also had a strong year, contributing adjusted EBITDDA of $73 million. On the rural side of the business, we sold 20,000 acres at nearly $2,400 an acre. Those sales included what we believe is the industry’s first solar deal, comprising 1,760 acres for $13 million or $7,500 per acre. Real estate has built a backlog of over $100 million of future potential solar deals. We expect that figure will increase as the team finishes stratifying CatchMark’s acres in 2023. Our team also made good progress on potential carbon credit and carbon capture projects in 2022. While it will take time for these efforts to pay off, we are optimistic about growth tied to providing natural climate solutions, and we believe these efforts will result in higher returns as well as higher timberland values.

On the development side of our real estate business, we sold 181 lots at an average price of $112,000 per lot in our Chenal Valley master-planned community in Little Rock. We also closed commercial sales every quarter in 2022, resulting in over $13 million of revenue at an average price of $290,000 per acre. Turning to housing. U.S. sentiment deteriorated quickly in 2022. While a significant decline in affordability has clearly caused the U.S. housing construction market to slow, we continue to believe that the backdrop is favorable over the long term. This is based on a fundamental shortage of housing stock due largely to the combination of underbuilding after the great financial crisis and favorable demographics in the form of Millennials.

It is also apparent that the Fed’s historic pace of interest rate increases has slowed the economy and is causing inflation rate to decline. Many economists are predicting that the Fed could shift into an easing cycle as soon as the middle of 2023. In fact, markets are pricing in this expectation; the mortgage rates have dropped over 100 basis points recently. Acknowledging it will take time, we continue to expect the U.S. housing starts will return to levels above the long-term average of 1.5 million units per year once homes become more affordable. In the meantime, the number of housing units under construction remains elevated at 1.7 million units in December. We expect that the elevated level of housing units under construction will support lumber demand during the Spring building season.

In addition, home buyers and builders are responding to affordability issues. For example, remote work opened the possibility to move to less costly parts of the country for a lot of people. Builder concessions or a shift in product mix to smaller homes or fewer amenities are other examples that are occurring. Lower mortgage rates and improved consumer confidence are the key remaining ingredients needed to get housing construction back on track. Shifting to repair and remodel, which is the largest market segment for lumber demand, the underlying fundamentals continue to be favorable for a variety of reasons. Existing U.S. housing stock remains the oldest in the history of the statistic at 42 years on average. This is important because older homes are significantly smaller than new homes on average and older homes typically need more repairs.

Higher mortgage rates mean that people are much more likely to stay in their existing homes. Remodeling is a very attractive option for homeowners given strong levels of home equity across the U.S., a job market that remains strong, and the fact that consumer balance sheets remain in good shape. In addition, higher interest rates usually have less of an effect than other factors on repair and remodel demand. Pundits expect repair and remodel spending to continue to grow this year. Harvard’s leading indicator of remodeling activity report forecast R&R spending growth will remain positive and be 2.6% higher year-over-year in the fourth quarter of this year. This sentiment is supported by our home center customer takeaway, which remains strong.

We continue to be optimistic about lumber demand in the R&R market segment. The Random Lengths’ composite lumber price reached a bottom recently and has increased three weeks in a row to $412 per 1,000 board feet. Lumber futures are trading at $100 premium to cash prices. We expect lumber prices will continue to improve from current levels as supply chain stocks up for the spring building season. Moving to capital allocation. We returned $263 million of cash to shareholders in 2022. That amount included a $76 million special dividend, which was driven by our strong results in the first half of the year. We remain committed to growing our regular dividend sustainably. The key to doing so is by increasing our stable cash flows through accretive acquisitions, such as the CatchMark merger and the bolt-on timberland transactions that we completed in 2022.

We increased our regular dividend 2.3% in December. Our regular dividend payout represented 43% of our cash available for distribution in 2022. We also remain committed to repurchasing our shares only when they trade at a significant discount as part of our overall focus on growing shareholder value over time. To that end, our Board approved a new $200 million share repurchase program in August. We bought back $55 million of stock during the year at an average price of $45 per share, which is well below our estimated NAV. Our opportunistic approach also applies to our borrowing costs. In 2022, we utilized interest rate swaps from 2020 to reduce our weighted average borrowing cost by 80 basis points in a year in which the Fed increased interest rates by over 4 percentage points.

Our weighted average borrowing costs are now 2.4%, the lowest of the timber REITs. At the end of the year, we had $344 million of cash on the balance sheet and liquidity of nearly $650 million. Our leverage remains low and our financial strength provides a solid platform to continue growing shareholder value. Shifting gears, our environmental, social and governance reporting team had a very busy year in 2022. We published our third annual ESG report in May, our first carbon and climate report in September, and we launched our ESG website in Q4. We were also named to Newsweek’s list of Most Responsible Companies for the second year in a row. Finally, we announced our commitment to greenhouse gas reduction goals at the end of the year. PotlatchDeltic has a strong ESG story and we are committed to do our part to mitigate climate change and continue our legacy responsibility across the ESG spectrum.

In summary, 2022 was another great year for PotlatchDeltic. That is a real tribute to our employees who had a lot on their plate. Their dedication and hard work allowed us to complete the CatchMark merger, three bolt-on timberland acquisitions and the older rebuild and startup, all while delivering excellent financial results. Our strong balance sheet, liquidity and strategy provide a solid platform to continue increasing shareholder value. I will now turn it over to Jerry to discuss our fourth quarter results and our 2023 outlook.

Jerry Richards: Thank you, Eric. Starting with Page 5 of the slide. Adjusted EBITDDA was $52 million in the fourth quarter compared to $101 million in the third quarter. The quarter-over-quarter decline in EBITDDA was primarily due to lower lumber prices, lower index sawlog prices and seasonally lower harvest volumes. I’ll now review each of our operating segments and provide more color on our fourth quarter results. Information for our Timberlands segment is displayed on Slides 6 through 8. The segment’s adjusted EBITDDA decreased from $65 million in the third quarter to $51 million in the fourth quarter. Our sawlog harvest in the North was 456,000 tons in the fourth quarter, which is flat compared to the third quarter. As we discussed on last quarter’s call, our harvest volume fell short of plan in the third quarter, primarily due to log-and-haul contractor availability issues.

Our Northern team did a good job securing additional contractors and increasing the harvest in the fourth quarter, which reduced the harvest shortfall for the year. Northern sawlog prices were 18% lower on a per ton basis in the fourth quarter compared to the third quarter. The decline in sawlog prices primarily reflects lower prices for index sawlogs. In the South, we harvested 1.4 million tons in the fourth quarter. The fourth quarter was the first full quarter of operations on CatchMark’s timberlands since we closed the merger in September. Solid execution and flexibility by our Southern Timberlands team were key to achieving that result. Our Southern sawlog prices were 3% higher in the fourth quarter compared to the third quarter. The increase was driven by a full quarter of volume in CatchMark’s stronger southern markets, which was more — which more than offset a seasonally lower mix of hardwood sawlogs.

High sawlog prices in our legacy wood baskets were 2% higher in the fourth quarter than in the third quarter. Moving to Wood Products on Slides 9 and 10. Adjusted EBITDDA declined from $31 million in the third quarter to $2 million in the fourth quarter. Our average lumber price realization decreased nearly $100 per 1,000 board feet or 17% in the quarter. By comparison, the Random Lengths Framing Lumber Composite Price was 23% lower in the fourth quarter than the third quarter. As a reminder, the lag we experienced between booking and shipping orders is not captured by the composite, which is closer to a real-time indication of price. Our average lumber price realizations per 1,000 board feet were $487 in October, $480 in November and $450 in December.

Photo by René Schubert on Unsplash

Lumber shipments decreased 7 million board feet from 265 million board feet in the third quarter to 258 million board feet in the fourth quarter. Our planned shipments in the fourth quarter were lower than expected, primarily due to a slower ramp-up at Ola than planned. As Eric mentioned, the team is making good progress at Ola, and we are on track to reach our full production run rate by the end of the first quarter. Shifting to Real Estate on Slides 11 and 12. The segment’s adjusted EBITDDA was $7 million in the fourth quarter compared to $14 million in the third quarter. EBITDDA generated by rural sales declined sequentially due to the sale of fewer acres at a lower average price in the fourth quarter. This was expected as both our and CatchMark’s rural land sales were heavily weighted to the first half of the year in 2022.

EBITDDA generated by our Chenal Valley master-planned community also declined sequentially. We closed the sale of 24 residential lots in the fourth quarter compared to 48 lots in the third quarter. We also sold fewer commercial real estate acres in the fourth quarter. Having said that, we have closed at least one commercial sale every quarter this year for an average price of $290,000 per acre. Turning to financial items, which are summarized on Slide 13. Our total liquidity was $643 million. This amount includes $344 million of cash as well as availability on our undrawn revolver. We refinanced the $40 million of debt that matured in December. We had previously logged the refinance rate, which reduced our interest rate on this debt approximately 100 basis points and lowered our annual interest cost by approximately $400,000.

Overall, we used interest rate swaps to reduce the weighted average borrowing cost on our outstanding debt to 2.4% this year. Including the refinance of CatchMark’s debt in the third quarter, our annual interest cost run rate has declined nearly $9 million. We repurchased $50 million of our shares in the fourth quarter at an average price of $46 per share. We also paid a $76 million special dividend in December. Capital expenditures were $20 million in the fourth quarter. That amount includes real estate development expenditures, which are included in cash from operations in our cash flow statement and it excludes timberland acquisitions. As Eric mentioned, we were the successful bidders on three bolt-on timberland acquisitions in Mississippi and Arkansas earlier this year for $101 million in the aggregate.

We used cash to close all three transactions, including $14 million to close the last of the three transactions early in the fourth quarter. Integration of CatchMark continues to go well, and we have now achieved cash synergies of $19 million on a run rate basis. We remain on track to achieve cash synergies of $21 million versus the $16 million target that we communicated when we announced the transaction at the end of May. I’ll now provide some high-level outlook comments, the details are presented on Slide 14. We plan to harvest approximately 7.7 million tons in our Timberlands segment in 2023. Harvest volumes in the North are planned to be seasonally lower in the first quarter at a level comparable to the first quarter of 2022. We expect Northern sawlog prices to decline about 30% in the first quarter compared to the fourth quarter.

In the South, we plan to harvest approximately 1.5 million tons in the first quarter. We expect our Southern sawlog prices to decrease modestly assuming customer log inventories remain full. We plan to ship 1.1 billion board feet of lumber in 2023. In the first quarter, we plan to ship 255 million to 265 million board feet of lumber. The effect of seasonally lower cut rates in our Northern sawmills and a planned maintenance outage in our Warren, Arkansas sawmill are expected to offset increased production at our Ola, Arkansas sawmill in the first quarter. Our average lumber price thus far in the first quarter is approximately 14% lower than our fourth quarter average lumber price. This is based on approximately 125 million board feet of lumber.

Our lumber prices have been increasing recently and our spot price is currently about 8% lower than our fourth quarter average lumber price. As a reminder, a $10 per 1,000 board foot change in lumber price equals approximately $12 million of consolidated EBITDDA for us on an annual basis. Shifting to Real Estate. We expect to sell approximately 18,000 acres of rural land and 150 Chenal Valley residential lots in 2023. Additional real estate details are provided on the slide. We estimate that interest expense will be approximately $2 million in the first quarter and $9 million to $10 million per quarter for the second, third and fourth quarters of 2023. Interest expense is lower in the first quarter than the other quarters because that is when we receive our annual patronage payments from the Farm Credit banks.

Also, interest income on our balance — cash balance has increased due to higher short-term interest rates. Turning to capital expenditures. We are planning to spend $135 million to $145 million in 2023, excluding any potential acquisitions. That estimate includes $74 million for the Waldo, Arkansas sawmill modernization expansion that we announced last June. Overall, we expect our total adjusted EBITDDA will be lower in the first quarter due to lower lumber and index sawlog prices. Having said that, we believe that lumber prices reached the bottom in January, and we are optimistic the recent improvement will continue. We’re well positioned to continue growing shareholder value over the long term. That concludes our prepared remarks. Devon, now I’d like to open the call to Q&A.

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Q&A Session

Operator: Our first question comes from Mark Weintraub with Seaport Global.

Mark Weintraub: Thank you. In terms of the share repurchase, so you still got $150 million left on the $200 million authorization. How should we think about the type of pace you’d likely execute, recognizing you said that you’re only going to do it when the stock is at the discount, but clearly, it has been? But, at the same time, obviously, your cash generation at least in the first part of the year is going to be a bunch lower. So, kind of how should we think about it? You do have the — you do still have quite a bit of cash on the balance sheet and, obviously, the untapped revolver.

Eric Cremers: Yes. Good question, Mark. Buying back shares opportunistically when our stock trades at a large discount to NAV, like it does today, that remains a very important part of our capital allocation strategy. But needless to say, there is a lot of uncertainty in the markets right now. We continue to believe that share repurchases are an attractive use of our capital, and we’re going to constantly balance that against other capital option — options. But at the end of the day, there really isn’t a price for moving aggressively with share repurchases. And we think our cautious approach to capital allocation has served us very well in the past. Most companies get share repurchases wrong. So, I don’t think I can give you a definitive answer on the pace other than we’re going to be constantly evaluating where our stock is at relative to NAV and other valuation metrics against these other capital allocation alternatives that we have.

And those alternatives, they come and go over time. So, it’s very hard to predict how the pace is going to play out.

Mark Weintraub: And maybe just as a quick follow-up. Is there a certain level of cash that you want to retain on the balance sheet that — can you kind of help us guide on what your thought process might be?

Jerry Richards: Yes. So that’s a good follow-on question, Mark. So, in terms of level of cash, I mean, historically, I thought about $100 million is kind of a base level we like to hold. And then, on top of that, as a reminder, we have $74 million that we’re going to spend on the Waldo project this year. So, something approaching $200 million would be kind of the baseline.

Mark Weintraub: Okay. That’s helpful. I’ll turn it over.

Operator: Our next question comes from Paul Quinn with RBC Capital Markets.

Paul Quinn: Hey, thanks very much. Just a question on — Eric that you mentioned under harvest in the North in 2022. Just wondering how material that is and whether you’re going to make up that volume in ’23?

Jerry Richards: Yes. Actually, I’ll take that one, Paul. This is Jerry. So, in terms of the under harvest, that’s primarily pulpwood and ton wood. So, there’s a couple of things going on. One, we’ve seen pricing for pulpwood for the last few years have been pretty weak in the region. And for us, historically, that’s a low-margin part of our business. So, when it doesn’t pay to hold the wood out, we don’t. And then, the other thing we’ve had, certainly, it was an issue in Q3 is contractor availability. So, our team did a really good job of: one, securing more contract availability in Q4; but they certainly prioritized shipping sawlogs over pulpwood and ton wood. So, at the end of the day, happy to report that 265 million board feet was the plan for the year and they hit that for the year. So, I think going forward, I don’t know if that pulpwood and ton wood gets made up. So, I think it’s — I think that’s in the (ph).

Paul Quinn: Okay. And then, just on the Wood Products side, just knowing that you’ve got the plywood asset, but I’m not sure how well it rained in the quarter, but were your lumber operations breakeven and were they affected by the slower-than-expected ramp-up at Ola?

Eric Cremers: Well, they were definitely affected by the slower ramp-up at Ola. We missed our production and shipment targets at Ola in the quarter, simply because we’re not where we want to be from a cut rate standpoint. From an earnings standpoint, we made money in Wood Products in the fourth quarter, a couple of million dollars. Plywood was definitely under some pressure in Q4, that’s to be expected. But a good chunk of our plywood mix competes with OSB and commodity housing-type applications. And some of it’s more industrial high-end applications. That part of the business is surprisingly is holding up reasonably well. But the other side, the non-repair side of our plywood business was under some pressure in Q4.

Paul Quinn: Okay. And then, thanks for the detail on lumber prices by month. I’m just wondering, we had a big announcement by Canfor up in Canada last week and just wondering how much prices jumped down in Idaho as a result of that announcement. Was that material at all?