July 13, 2020 | Ivan Martin
Conifex: On surviving a competitive market with high production prices
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Conifex (TSX: CFF) is a Canadian company based in BC that is in the business of harvesting timber and manufacturing as well as selling lumber. They primarily operate in Asian and North American markets. Their timberland operations in Canada seek to supply their saw-mills with low-cost fiber to enable the efficient manufacture of lumber.
Jason had an interview with Andrew McLellan, VP of North American Operations for Conifex. Andrew explained to Jason how Conifex started seeing a slowing of their operations after a couple of strong years in 2017 and 2018. Andrew detailed how COVID-19 has affected the company in several ways, starting from their supply chain, passing to a downfall in lumber commodity prices, all the way to the cease of operational activity in some of their sawmills. However, he also delves into how the company has starting to come back up as lockdowns due to the virus have started to unfold.
Jason and Andrew also talked about the ins and outs of the pricing for log costs and how the government could help so that the industry in British Columbia remains competitive. They also discussed the importance and areas of improvement for government programs such as the wage subsidy and stumpage deferrals.
POLICY ACTION RECOMMENDATIONS FOR THE LUMBER SPACE
- Ensure that there is credit line availability for the industry, besides the support from the EDC and BDC
- Extend the stumpage deferral program to adjust with production timelines
- Extend the wage subsidy program while commodity prices for lumber remain down
- Ensure that social distancing is in place so sawmill closures do not repeat
Headquarters: British Columbia
Sector: Basic Materials
Number of employees: 200
Government support programs/grants being used pre-COVID: None
Government support programs/grants being used post-COVID: Wage subsidy program
Core challenges post-COVID: Staying competitive on a low commodity price environment given BC’s higher lumber costs and a nonbeneficial stumpage rate in the jurisdiction.
Jason: Hi Andrew. Nice to meet you. Thanks for taking the time to talk to me today about the impact that COVID-19 has had in Conifex and the forestry industry.
Andrew: Of course. How was your bike ride today?
Jason: Oh, it was fantastic. I had a 30 kilometer an hour tailwind, which seems like it adds about a 30% speed to my normal pace, so yeah. I was biking at some points at around 36 kilometers an hour, it was crazy. So overall, a good day. How about you?
Andrew: Oh wow. That is great! Well, I didn’t have any tailwinds. Mostly tailwinds!
Jason: Right on. With all the economic changes that are happening right now, it is just headwinds that they talk about. And I guess we are going to be talking about that a little bit more today.
The intention of this series is to speak with a variety of business owners, entrepreneurs, and management working in a variety of businesses across Canada. We have a very diverse country and with that, diverse businesses that support our economy. So with that, we are trying to collect information about how things were going pre-COVID, during COVID and how we expect they will evolve past it.
Ultimately, we want to be able to determine what types of policy support programs that have been already rolled out are working well. Also, what else can be done to support the industry in the next few months as it seems that we will most likely be living with the virus for a little while. All of this is with the intention of sharing the information with the press and with policymakers.
Andrew: Awesome, let’s do it
Jason: So maybe you can start off by giving us a little bit of an intro about what it is exactly that you guys do what your business is about.
Andrew: Absolutely. I work as the VP of North American Operations for Conifex. We have a sawmill and a power plant in McKenzie, British Columbia. McKenzie’s is probably one of the most forestry dependent communities in the province of BC. McKenzie is the second largest timber supply area in the province and the third-largest in geographic terms.
So as you can see, it is a fairly expansive area which makes it also a fairly complicated operating environment. We operate on the Williston reservoir, so a large portion of the volume that we harvest is taken down the lake and delivered to our sawmill in McKenzie. All of the residuals from our sawmill go into our biomass power plant, where we are generating enough energy to power 20,000 homes in British Columbia on an annual basis.
Jason: Okay cool. You mentioned energy and forestry, how does that work out as a blend of your business? What percentage is assigned to each?
Andrew: The power plant is a large portion of our revenue relative to our sawmill. Our power plant is based on a locked-in power rate. Something similar to an annuity. Our sawmill is obviously dependent on explosive commodity pricing.
So they are two totally different businesses. But when you integrate them, you get a much stronger business.
Jason: Ok, interesting. I’d love to hear a little bit about yourself, how did you become involved with your company?
Andrew: So I was involved early on in the development of the power project. At that time, I had my own consulting business and we were developing one of the river’s hybrid projects whilst working on a biomass project in British Columbia. One thing led to the other and we ended up helping Conifex to get the required financing to be able to ensure the completion of the project.
It was a non-recourse debt financing so we had to do lots of due diligence upfront to get the financing in place. As we developed and executed the project, I decided to come in and join efforts with Conifex in a management role. Now I have been working for the company for around four years.
Prior to that, I spent some with the oil gas industry in Western Canada. I worked three years overseas as well in Russia. My initial career path kind of came full circle and I found myself working in the forestry and energy sector.
Jason: Okay, excellent. Over the last four years, how have things been going for the business and the forestry industry?
Andrew: So 2017 and 2018 were fairly strong years. We had a run-up in terms of log prices. At the same time, we saw a run-up in our input costs in terms of our logs.
During the tail end of 2018 and 2019, we started to see things soften significantly. In fact, 2019 was a very tough year. Heading into COVID, it seemed like we were turning the corner and expecting commodity prices to come back up in the lumber industry.
Once COVID hit, there was a lot of uncertainty with our supply chain and with overall demand. This is mostly in terms of not really knowing what the US housing situation was going to be and of course, what was going to happen with our international shipments.
As COVID has started to unfold, we’re starting to see commodity prices come back up. We’re a little bit more optimistic. At CONIFEX, we’ve been down for about three months in our sawmill and we’re just going to get started off back again on Mondays. So we’re definitely looking forward to that.
Jason: Oh that’s that’s super exciting. When you say you’ve been down for three months, was that driven by the government requiring shutdowns or was the downtime a result of the decrease in the demand for lumber?
Andrew: Yeah, mostly demanding missing. We managed to keep our business COVID free during the peak and we actually haven’t had any COVID cases within our business. Early on, we put in several measures early to be able to respond to it and since then we have kind of been de-escalating but you know, we were working and we are still working.
I think that in Northern BC, physical distancing is a bit more natural. We have less population density in the north so that certainly played a role in our endurance. When I look at what happened across the rest of Canada, I think that the timing of our spring break was a blessing. Meaning, we didn’t have people traveling all over the place just as COVID was starting to take off.
Jason: I hear that because Montreal and Quebec had their spring break a little bit early, some problems were created so yeah, I understand.
I don’t know lots about the lumber industry but I would like to understand who your customers are and where does the demand come from.
Andrew: We ship about 50% of our product to the US and then the remaining balance of our high-value product goes into Japan. Our low-grade product goes to China.
Jason: And the stuff that goes into the US, that’s mostly used for housing?
Andrew: Yeah, exactly.
Jason: You mentioned lumber prices are improving so I guess that US demand is coming back online now as the economy restarts.
Andrew: Yes, it seems like there order files are getting filled and demand is coming back. The pricing in the futures market is also starting to come back up to the point where most jurisdictions in BC are able to operate, at least at breakeven. McKenzie is one of the highest cost jurisdictions in North America and within British Columbia. During downturns, the community that we operate in is the first to go down in the industry and the last to come back.
It has been challenging but we are working through it and getting to the point where we finally see light at the end of the tunnel.
Jason: For the industry to be healthy in BC, where would the industry would like to see lumber prices at?
Andrew: That’s a difficult question to answer because we need to consider different pricing. BC at the moment is one of the highest cost jurisdictions from a log perspective and in the commodity market, prices are set at a North American or global level. Input cost-wise, we have other jurisdictions in Canada that have been able to keep operating through a global pandemic and through the low cycles in the markets. Those benefit from log costs being in a neighborhood of around $40 to $60 dollars per cubic meter whereas in British Columbia we’re seeing prices from $85 to $90 dollars. That puts us at a significant disadvantage relative to other jurisdictions in Canada.
Jason: Would you be able to expand into what makes a log cost?
Andrew: Absolutely. A large number of it would be part of the rent that the government collects from industry to have access to the timber. Carbon tax is also a big piece of force in BC. The other elements are just our operating costs in terms of logging, infrastructure, and transportation.
Jason: Gotcha. What percentage of that log cost is determined or dictated by the government and are there any changes that you’d like to see there?
Andrew: Yes, certainly we would like to see our stumpage rates trace in line with other jurisdictions in Canada and outside of Canada. In terms of the percentage of our costs, the cost of the log itself is about 50 percent of our costs of doing business. The stumpage cost represents 25 to 30 percent of that 50 percent. So I would say that in total we have 12% to 15% going to government fees.
Jason: Wow, ok. That is pretty significant. Has there been any conversations with the government in terms of them helping out with that fee especially in these challenging times?
Andrew: There’s not a whole lot that’s being done from a pricing perspective. The pricing is set by a market pricing system in British Columbia, which is different than other jurisdictions. 20% of the volume in the province is sold on the open market and that 20% sets the price for the other 80%. The time lag between those prices coming down on the open market and it being reflected in the stumpage rates is around 5 years. They had shortened it recently to reflect prices better.
In Alberta, for example, their stumpage tracks log prices very quickly. A month after a drop in lumber prices, you’ll see a drop in the rates as well. It’s very tightly coupled. Whereas in BC, it has gotten decoupled to a certain extent.
Jason: Gotcha. So when number lumber prices are high it’s okay to charge a higher stumpage fee but if they drop, it’d be nice to see a faster correction.
Jason: Now, during COVID there have been a number of programs that have been put out by the government to try to support businesses. Have you guys been able to use any of those programs?
Andrew: Yes. the wage subsidy has been huge in helping us in terms of managing through the COVID pandemic. I would say it has been very beneficial as it has been able to keep people at work and keep them employed. This has had a good effect on maintaining jobs in these small communities.
From a provincial perspective, there’s been a few initiatives. One of them was stumpage deferral. As far as I know, I think there’s only been one company in BC that has taken advantage of that. The deferrals are interest-bearing so some of them do benefit but not to the extent that we’ve seen federally.
Jason: Is there a reason everyone’s not taking advantage of the stumpage deferral programs? Is there something that they should be doing to improve the structure to make it more attractive for individuals or for businesses?
Andrew: Yeah. So the deferral is interest-bearing but the timing wasn’t also ideal. I mean, it was a two month period where we could defer stumpage but unfortunately the period where this deferral was available was a time when we typically don’t deliver logs. So it had limited benefit and limited uptake. If there was an extension of the deferral it could have made a difference for us but unfortunately at this point it hasn’t .
Jason: I guess in terms of improvement, does the stumpage deferral plan make sense? For example, they extend it out for a year from today. Would that be helpful or not and would you guys take advantage of that? Would others take advantage of it also? Are there other programs or things that you’d like to see the government roll out to help during this period?
Andrew: I think really is an issue about the competitiveness of the industry in BC and really focusing on how we can get into a position where we can have a low cost relative to other jurisdictions so that we are able to compete against. There’s no silver bullet, you know. The stumpage deferral program certainly could help if it was extended but I don’t think on its own it’s not going to make a big difference for us.
Jason: Okay, I see. And I guess, would it be helpful if the wage program was extended out further?
Andrew: I believe it would, yes. It looks like the wage subsidy is going to be available for July and August here so that’s an enormous help. If things kind of get back to more normal conditions and we see commodity prices come back, we’re planning to be up and running and operating our facilities. However, it is also certain that if commodity prices fell off again, the program would be extra beneficial and we would be making good use of it.
Jason: Absolutely. So we keep hearing how this is an unprecedented time and no one could have predicted this. Pandemics are a one in one hundred plus years kind of thing. However, if you could go back and speak to yourself a year ago and convince him that this was coming, what are some of the things that you would have done to prepare differently?
Andrew: Yes, so that’s a good question. Individually, as a business, CONIFEX went through some divestitures of some assets in the US just before COVID. Our timing was in part good luck and part good execution. So we would do the same thing on that front.
Now, in terms of preparing for COVID… Because of the downturn in the industry prior to COVID we were running fairly lean on inventories on both our finished product and our inputs to weather the storm. So I think if we would have had a higher inventory going into COVID, we would have had a tougher time going through it. Overall, I think we were positioned okay going into it.
When we divested our assets at that time, we basically extinguished our debt within our business. Then we got caught in this period, without a credit line to operate the business. There’s always support from EDC and BDC, but if you don’t have a chartered bank committing to you, it is hard to access those funds. So you know, I think one of the learnings would be to make sure that we have a credit facility in place. We would have rather had that.
Jason: In terms of credit facilities, are the banks being accommodative or supportive? Or is there something that the government can do to help on that front?
Andrew: Yes, certainly. If there was some support there from the federal government to access credit facilities that would be a huge help but like I said, if you don’t have a lead charter bank lined up and a facility in place, the EDC and BDC are able to come in and support you.
If there was a way to access those programs without the charter banks taking the lead that would certainly be of help.
Jason: Okay, yeah. I know that in the US, they’re doing their main street lending program and I think the banks have to take five percent of risk in the government back stops. I think in Canada, it’s like 20 percent so it’s a higher threshold. Maybe there’s something that can be done there to make the banks a little bit more willing to take on some risk.
Andrew: Yeah, absolutely.
Jason: Is there anything else you might want to add that you think is important? Maybe some advice to other businesses or other types of requests?
Andrew: You know…the federal programs that have been put in place have been very helpful. I think that if we can continue to access those types of programs as needed, there will be lots of benefits to our business and other businesses. Provincially, as I mentioned earlier, we haven’t seen that same level of support.
I think there’s more that could be done around carbon tax, for example. If we could be getting credits back for carbon taxes and those sorts of things we certainly hope it would help us. This is a massive burden for our business
Jason: So you guys are having to pay a carbon tax?
Andrew: Yeah, because of our gas consumption. If something was changed from that perspective that would be great.
Jason: Ok, interesting. Andrew, I think that concludes our interview today. Thank you so much for taking the time to talk to me today!