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Edited Transcript of CFP.TO earnings conference call or presentation 24-Oct-19 3:00pm GMT

Q3 2019 Canfor Corp and Canfor Pulp Products Inc Earnings Call

VANCOUVER Oct 29, 2019 (Thomson StreetEvents) -- Edited Transcript of Canfor Corp earnings conference call or presentation Thursday, October 24, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Alan R. Nicholl

Canfor Corporation - CFO & Executive VP of Finance

* Brian Yuen

Canfor Pulp Products Inc. - VP of Pulp & Paper Sales and Marketing

* Donald B. Kayne

Canfor Corporation - President, CEO & Director

* Kevin Pankratz

Canfor Corporation - SVP of Sales & Marketing

* Stephen MacKie

Canfor Corporation - SVP of Canadian Operations

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Conference Call Participants

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* Mark William Wilde

BMO Capital Markets Equity Research - Senior Analyst

* Paul C. Quinn

RBC Capital Markets, LLC, Research Division - Analyst

* Sean Steuart

TD Securities Equity Research - Research Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen, and welcome to the Canfor and Canfor Pulp Third Quarter Analyst Call.

A recording and transcript of the call will be available on Canfor's website.

During this call, Canfor and Canfor Pulp's Chief Financial Officer will be referring to a slide presentation that is available in the Investor Relations section of the company's website. Also, the companies would like to point out that this call will include forward-looking statements, so please refer to the press releases for the associated risks of such statements.

And I would like to turn the meeting over to Mr. Don Kayne, Canfor and Canfor Pulp's Chief Executive Officer.

Please go ahead, Mr. Kayne.

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Donald B. Kayne, Canfor Corporation - President, CEO & Director [2]

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Thanks very much, operator. Good morning, everyone, and thank you for joining the Canfor and Canfor Pulp Quarter 3 2019 Results Conference Call.

I'll make a few comments before I turn things over to Alan Nicholl, our Executive Vice President of Canfor Pulp Operations and Chief Financial Officer of Canfor Corporation and Canfor Pulp. Alan will provide a more detailed overview of our performance in quarter 3. Joining Alan and I today are Kevin Pankratz, our Senior Vice President of Sales and Marketing; Stephen MacKie, our Senior Vice President of Canadian Operations; and Brian Yuen, our Vice President of Pulp Sales and Marketing.

As everybody is aware, in August, Great Pacific made a nonbinding proposal to acquire all the outstanding common shares of Canfor. Canfor's Board of Directors has formed a special committee of independent directors to review the offer in consultation with its legal and financial advisers. The decision to proceed or not proceed with the proposal is in the hands of the special committee and ultimately the shareholders if recommended by the special committee. While that process is underway, we continue to focus on operating our business as usual and unfortunately do not have additional information in regard to timing or outcome at this time. As such, we cannot speculate on either the timing or the decision to proceed or not during this call, as I am sure you all will understand.

Moving to our specific Q3 results. The quarter was challenging for both our pulp and lumber businesses, resulting in us having to make very difficult decisions that involved temporary and permanent curtailments in British Columbia.

On the pulp side, we took phased summer curtailments at our Intercon, Northwood and Prince George NBSK mills; as well as at our BCTMP mill in Taylor. While these curtailments are difficult, we believe they will support a quicker market recovery in addition to solidifying our chip inventory over the winter months.

On the lumber side, we made a very difficult decision in July to indefinitely curtail our Mackenzie sawmill. At the same time, we also announced the permanent elimination of one shift at our Isle Pierre mill; and we announced temporary sawmill curtailments, mostly in July and September. We have not taken any of these curtailments decisions lightly. However, they reflect the very challenging lumber market conditions in combination with high fiber costs in British Columbia. On behalf of myself and the entire executive team, I want our employees to know that we deeply regret the very real impacts these decisions have had on them, our contractors and the local communities.

With the exception of Mackenzie, all of our sawmills and pulp mills are currently operating.

Now we'll go into a bit more detail on each of our business lines.

Beginning with our pulp business. We were challenged with weak global pulp market conditions, significant market-related downtime and fiber supply issues in British Columbia. This was a third straight quarter of weak demand combined with excess inventory in the supply chain, most notably in China and Europe, which significantly impacted global pulp prices. On the positive side, energy revenues increased in Q3, largely driven by Northwood's new turbo generator condensing turbine and higher energy prices. Looking forward, it's expected that global pulp pricing will gradually improve in Q4 and into 2020, as global inventories will come back into balance.

Moving to lumber. In June, we announced the permanent closure of our Vavenby mill and subsequent agreement with Interfor to sell them the associated tenure for $60 million. The tenure transfer is subject to approval by the Minister of Forests, and we continue to work through that process. We anticipate the sale will close in Q4.

SPF pricing continued to be challenging in Q3, with excessive inventory impacting overall price levels. While several industry curtailment announcements were made over the last 6 to 9 months, we believe we are just now seeing the impact of these curtailments in the market. U.S. housing starts increased modestly over the quarter, and we anticipate that, that trend will continue through the balance of the year. Lumber prices in Asia, particularly in Japan, are expected to return to more normalized levels in Q4. Our lumber operations in Alberta, the U.S. South and Europe remained strong. Price of Southern Yellow Pine remained steady over the quarter, although our sales were slightly lower than last quarter.

Our European lumber business saw a tempered pricing in the quarter as a result of global market weakness but was somewhat insulated from broader pricing declines due to the relatively higher-value customized products that Vida produces. This pricing pressure is expected to continue through the balance of the year and should stabilize in early '20 as global inventory levels continue to come back into balance.

We remain focused on continuing to reduce our debt levels and continue to strengthen our balance sheet.

I will now turn it over to Alan to provide an overview of our financial results.

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Alan R. Nicholl, Canfor Corporation - CFO & Executive VP of Finance [3]

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Well, thanks, Don. And good morning, everyone.

As Don mentioned, the Canfor and Canfor Pulp quarterly results were released yesterday afternoon. These results come together with their quarterly overview slide presentation in the investor relations section of the respective companies' websites. In my comments this morning, I'll expand a little on a number of Don's points and also speak specifically to several quarterly financial highlights.

Our lumber segment reported an operating loss of $70 million for Q3 compared to a loss of $61 million reported for the previous quarter. Results included a net duty expense of $54 million, restructuring costs of $6 million and a $5 million reversal of a previously recorded inventory write-down provision. After adjusting for these items, the lumber operating loss was $16 million.

Lumber segment results continued to reflect the ongoing weakness in Western SPF lumber prices, high duties and elevated log costs in British Columbia. As Don mentioned, Canfor took significant market-related curtailments and capacity reductions in Q3, and as a result, shipments were down by 16% compared to Q2, while overall sales revenue declined 12%. Average Western SPF sales realizations saw a modest increase from the prior quarter, largely reflecting a small increase in benchmark prices and our sales mix.

For our U.S. South business, average sales realizations were slightly lower than the previous quarter, as the modest improvement in the 2x4 #2 price was more than offset by lower prices for wider-width dimensions. European sales realizations saw a small decrease, with the region's higher-value sales mix partially offsetting a decline in European benchmark prices.

Our pulp and paper business reported an operating loss of $44 million for the third quarter, down $62 million from the $18 million profit reported for the second quarter. The loss reflected the very weak global pulp market conditions that Don mentioned as well as the significant fiber supply disruptions from industry-wide sawmill curtailments in the BC interior over the summer months. Average sales realizations were well down compared to the second quarter, reflecting this backdrop.

Pulp production was down 42% from the previous quarter, principally reflecting the impact of 135,000 tonnes of market-related downtime. Pulp unit manufacturing costs were significantly higher in this current quarter largely due to the curtailments and to a lesser extent the advancing of some planned maintenance work during the downtime. Fiber costs showed a small decrease quarter-over-quarter, with the impact of lower market prices for sawmill and residual chips tied to market pulp prices helping to neutralize the effect of an increased percentage of higher-cost whole-log chips.

Capital spending for the third quarter totaled approximately $76 million and included approximately $50 million in the lumber business and $26 million in Canfor Pulp. For 2019, we are forecasting a total capital spend of $180 million and $80 million for Canfor and Canfor Pulp, respectively. We currently anticipate much lower capital spending in 2020 following the completion of our USD 125 million organic growth program and several other major upgrades by early 2020 and our strong focus on debt reduction.

And during the third quarter, Canfor increased its operating line of credit from $450 million to $550 million, maturing in January 2024. In addition, Canfor Pulp extended its operating line of credit through April 2023 and added a new 3-year $50 million term loan expiring September 2022.

At the end of the third quarter, Canfor, excluding Canfor Pulp, had net debt of approximately $1 billion and available liquidity of just over $300 million. Canfor Pulp ended the third quarter with net debt of approximately $30 million, with available liquidity of just under $100 million.

And lastly, Canfor Pulp's directors approved the continuance of a quarterly dividend of $0.0625 per share for the third quarter.

And with that, Don, I'll turn the call back over to you.

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Donald B. Kayne, Canfor Corporation - President, CEO & Director [4]

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Thanks, Alan.

Operator, we're now ready to take calls from analysts. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And your first question will be from Mark Wilde at BMO.

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Mark William Wilde, BMO Capital Markets Equity Research - Senior Analyst [2]

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Don, I know you can't really say much about this Pattison bid. I'm just curious if it is possible to put any color around the selection of Greenhill as the adviser. I've been doing this -- covering this sector for about 30 years. They have not ever been a real active player, a real knowledgeable player around this sector, so I'm just curious about how that decision might have been made.

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Donald B. Kayne, Canfor Corporation - President, CEO & Director [3]

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Yes. I guess, first of all, I can't say much at all, Mark, as you probably understand, as I mentioned earlier. I just know that they went through a process, the committee. And I wasn't involved in it. And so they chose Greenhill, and that's all I can really say.

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Mark William Wilde, BMO Capital Markets Equity Research - Senior Analyst [4]

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Okay. All right, fair enough. I wasn't sure you're really...

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Donald B. Kayne, Canfor Corporation - President, CEO & Director [5]

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We're just (inaudible).

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Mark William Wilde, BMO Capital Markets Equity Research - Senior Analyst [6]

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Yes, okay. Yes. All right. Well, let's turn to the business then. First of all, I wondered if you could talk about just sort of lumber demand at the moment and how you guys see kind of lumber inventories in the channel.

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Donald B. Kayne, Canfor Corporation - President, CEO & Director [7]

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Yes, okay. I mean I'll talk a bit about that at a high level; and maybe turn it over to Kevin, who's a bit closer to it, a lot closer to it actually, than I am. But I think, like everybody else, we've been over the last few quarters here concerned as to where that was headed, but it does -- and because there's been several false starts over the last probably a couple, 3 quarters. But we are seeing -- and partly because inventory levels, we think, are starting to decline a bit more rapidly now. It's taken some time. Due to these announcements that were made 6 or 9 months ago, it's taken a lot longer to see that in the supply chain that we would have anticipated. And so -- but we do think now we're starting to see the result of that. And so that, combined with pretty decent housing starts and permits in North America, a bit of an improvement in China around inventory levels. And then Japan, we were just over there recently, seems to be pretty good. So between all of those things, demand-wise looks -- it's not a big increase, but it's at least it's -- sort of I think it's started to at least look a little bit more positive. And supply is -- on supply, we're starting to see the inventory starting to have an impact on that. So that's kind of -- so overall right now, going forward, I think we would see things probably looking slightly better over the next couple of quarters. Kevin, you've been over there recently yourself in China in particular.

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Kevin Pankratz, Canfor Corporation - SVP of Sales & Marketing [8]

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Yes. Yes, yes. So we're seeing some good inventory depletion at the major ports. And to your point there, Don, we're starting to see a little bit more tension in the market compared to what we have seen earlier in the year, which I think is disposing for a little bit more of a positive uptick for the balance of the year and into 2020.

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Mark William Wilde, BMO Capital Markets Equity Research - Senior Analyst [9]

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Okay. And then, Don, I wonder if we could just talk for a minute about this European spruce beetle and the impact of that on the Vida business over in Europe and then also sort of any ripples into the Southeast U.S. lumber operations and also potentially into your Chinese export markets.

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Donald B. Kayne, Canfor Corporation - President, CEO & Director [10]

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Yes, for sure. Well, let me just say this at the start, that the beetle issues that's being faced in Europe right now are probably more severe than most people probably had expected them to be. And so in Germany, Austria and certainly all of Czech, it's pretty serious, right? And so as a result of that, there's a lot of log, a lot of the fiber there has been and will be degraded quite significantly, which is resulting in more commodity products being produced. Or some of that is going into North America. Obviously, some of that is going into China and so forth, and it's having some impact. If you look at the North America, though, particularly compared to where it was 10, 15 years ago, when we were importing in the past, nowhere near the same amount of -- we still don't see anywhere near the same amount of volume coming into North America that we saw back then. And we don't -- and neither do we expect that to happen either. There's been a bit more in China too, but it's -- even there it's not really having a significant impact on our business, for sure. In terms of -- good question. How does that look -- how is that going to impact us in Sweden? Actually, I mean, the one thing as we -- and we went through exactly the same thing on when we went -- got into this, the pine beetle in British Columbia. What we just saw is pretty quickly an immediate reduction in the amount of prime percentage and premium products. That's exactly what's going to happen in Europe as well, who in the past has been pretty significant, high-value product producers in Europe. So in Sweden, because we don't have the beetle, [we'll only see a] 1% or less there, mostly probably less. We actually think, with that reduction in high-value products coming out of Austria, Germany and Czech, it's actually going to benefit us up there in Sweden because they don't have to deal with that. And they do mostly make high-value products. So it actually -- it, for us at least, will have, we think, a positive impact on our Swedish returns on a long-term basis.

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Mark William Wilde, BMO Capital Markets Equity Research - Senior Analyst [11]

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Okay. And then just one more for me. I wondered, Alan, when we look at sort of the first 3 quarters with the shoot-out here with Vida, the numbers have been coming down steadily. I wondered if you guys can just address sort of whether this has changed your view of earnings stability at Vida. And also, in the third quarter, if you can just help us understand how much of the decline was kind of price versus the summer outages.

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Alan R. Nicholl, Canfor Corporation - CFO & Executive VP of Finance [12]

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Yes. I -- hopefully, I can help you a little bit there, Mark. In terms of your first point, I think clearly, as Don guided, there is somewhat downward pressure there, but I think we're comforted, I think, with how well those businesses are running. We are seeing log costs respond accordingly, and so that's clearly going to be a mitigating impact. But I think it's probably appropriate to caution for some conservatism in your numbers, but I think we're comforted by some of the mitigating factors there as well. And in terms of the third quarter, as I think we disclosed in our press release that -- Vida did take a month's downtime. And clearly that weighed on the shipments and the costs and so on. So just -- one just has to take that into account, but as I mentioned earlier, our sales mix and some of what Don outlined is clearly helping us mitigate some of the impact from more of the commodity pricing movements in Europe today.

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Operator [13]

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Next question will be from Sean Steuart at TD Securities.

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Sean Steuart, TD Securities Equity Research - Research Analyst [14]

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A few questions. First, on the timber sale to Interfor. You guys indicated you still expect -- or you do expect a Q4 close. This has dragged on a little bit longer than initially thought. Can you give us a little bit more detail on the process with the government approval? And what have been the hangups? And what gives you confidence that this will close in the fourth quarter?

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Donald B. Kayne, Canfor Corporation - President, CEO & Director [15]

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Yes. I think, first of all, we're confident that it will close in the first quarter -- our fourth quarter, sorry. I've seen it run away. I think we expected this thing to maybe close maybe a month or 2 quicker than it has, but clearly, I mean, us being the first ones to really go through this process is, as you go through it, there are some things that you'll learn and things that maybe take a bit longer than you thought perhaps. But we -- really, at the end of the day, so far, it's kind of gone as we expected. I don't think we've had any major surprises at all. In some areas, we've probably had to put a little more work into it and so forth, but for the most part, I think it's kind of -- it's just -- other than taking a bit longer, it's -- we haven't had any real big, material surprises whatsoever. And we -- and as I said at the start, we do expect it to close in Q4.

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Sean Steuart, TD Securities Equity Research - Research Analyst [16]

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Okay. And then a question on the pulp operations. Post the heavy downtime you had in Q3, can you give us an idea what percent of the fiber will be tied to whole-log chipping on a normalized run rate going forward and an update on the cost differential between whole-log chipping and residual chips right now?

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Alan R. Nicholl, Canfor Corporation - CFO & Executive VP of Finance [17]

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Yes. No, it's a good question, Sean. So I think clearly what I would say is that, the actions, as tough as they were, in the third quarter have positioned us well here to run through the winter months. And we're in a much, much better position; and clearly had to take the response that we did. In terms of your question around whole-log chipping, I will say that historically, it's been a lot lower than it is today, but looking forward, I think you could use something like 30% or 1/3. That's what we're kind of anticipating, something like that.

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Sean Steuart, TD Securities Equity Research - Research Analyst [18]

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And the cost differential between that and residual chips right now.

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Alan R. Nicholl, Canfor Corporation - CFO & Executive VP of Finance [19]

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Well, yes. So it really depends on many factors. And clearly, we're motivated to apply a lot of cost discipline there as well, but it's a fair statement to say it comes at a healthy premium to sawmill residuals today.

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Sean Steuart, TD Securities Equity Research - Research Analyst [20]

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No details on that, Alan? Or that's as much as you're prepared to say...

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Alan R. Nicholl, Canfor Corporation - CFO & Executive VP of Finance [21]

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None any more that I can share with you, no. Not on the call, no.

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Operator [22]

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Next question will be from Paul Quinn at RBC.

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Paul C. Quinn, RBC Capital Markets, LLC, Research Division - Analyst [23]

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First question, just maybe just on the log costs side, what you're seeing, whether you're seeing any inflation in the U.S. South. I suspect Vida's costs are coming down slightly, and then Alberta versus BC.

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Donald B. Kayne, Canfor Corporation - President, CEO & Director [24]

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Stephen, why don't you give an update across all the regions?

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Stephen MacKie, Canfor Corporation - SVP of Canadian Operations [25]

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Sure, yes. Paul, so I think, if I start in BC, Paul, and maybe a contrast against Alberta. I mean clearly there's a stumpage differential between BC and Alberta, so we enjoy that benefit in our Alberta operations. You're aware, obviously, that the July 1 stumpage increase was pretty significant in British Columbia, but we're pleased with some of the actions we've taken internally to mitigate those impacts. So relatively speaking, quarter-over-quarter, pretty flat log costs; and starting to see some relief in British Columbia on pressure on purchased wood prices and bid behavior out there in terms of BCTS sales, which we're seeing a little bit of benefit from. So we're expecting relatively flat log costs in BC and similar situation in Alberta. Alberta will be pushed up a little bit as market improves, as Kevin and Don indicated earlier. The guys have touched on Vida. We're seeing corresponding reduction in log costs to reflect market conditions and the downward pricing pressure that Don indicated. So in Europe we're pretty pleased with the responsiveness of the market. And U.S. South is really quite flat. There is an abundance of timber, high-quality fiber available there, so flat. So...

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Paul C. Quinn, RBC Capital Markets, LLC, Research Division - Analyst [26]

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Okay. And just maybe just follow-up on that BC. You're expecting log costs to be flat going forward, but my understanding was you did quite a bit of logging in front of the July 1 stumpage increase. So isn't that going to be that, that increase will be effective on all the stuff that you're logging through the balance of the year and into the first half of next year? Won't that increase your overall cost?

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Stephen MacKie, Canfor Corporation - SVP of Canadian Operations [27]

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Yes. We're expecting there is some upward pressure there, for sure, Paul. And we're in pretty good shape with healthy inventories. Obviously we've taken some pretty significant downtime and capacity reductions across our operations and taken lots of steps to reduce some of the high-cost fiber that we've got in front of our mills, so we're confident we can offset that to a large degree. So I think I would guide to relatively flat quarter-over-quarter log costs.

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Paul C. Quinn, RBC Capital Markets, LLC, Research Division - Analyst [28]

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Okay. And then maybe just flipping over to the pulp side. Pulp costs were up significantly quarter-over-quarter, a lot of it attributed to downtime. I'm just wondering how much -- like how much can we put on that market-related maintenance downtime in terms of the cost increase quarter-over-quarter?

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Alan R. Nicholl, Canfor Corporation - CFO & Executive VP of Finance [29]

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No, a totally fair question, Paul. I mean I think, honestly, the lion's share of that delta was, I think, the maintenance -- the plants -- the advancing of the planned maintenance work was a smaller percentage, just to put that in context, about $7 million or $8 million, but I think the principal reason clearly was tied to the curtailments.

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Paul C. Quinn, RBC Capital Markets, LLC, Research Division - Analyst [30]

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Okay. And then just while I've got you, Alan, just it sounds like you guys are more bullish than most the other people I've seen out there on pulp turnaround here, where you're expecting a gradual increase in pricing in Q4. What gives you that level of confidence?

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Alan R. Nicholl, Canfor Corporation - CFO & Executive VP of Finance [31]

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Yes. So I'll maybe pass it over to Brian to speak to that, but I think in our minds we didn't think we were being extremely positive by talking about a modest recovery, Paul. But I'll maybe just ask Brian to speak a little bit more to what we're seeing in the market and where we're expecting prices to trend here.

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Brian Yuen, Canfor Pulp Products Inc. - VP of Pulp & Paper Sales and Marketing [32]

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Sure, I can speak to that, Alan. Paul, we're actually seeing a stabilization in the market, for sure. With the price corrections over the summer, we've seen an uptick in Chinese demand. Paperboard, tissue producers, these guys are all making solid profits given the lower fiber costs and the relatively stable paperboard, tissue prices. We are in fact actually seeing some modest improvements, going into fourth quarter, in Chinese pricing. What we are keeping a close eye on, however, are the hardwood inventories. For sure, this needs to get in balance before we see any significant improvement in pulp pricing.

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Operator [33]

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Next is a follow-up from Mark Wilde at BMO.

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Mark William Wilde, BMO Capital Markets Equity Research - Senior Analyst [34]

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I just want to go back to these log costs because on Page 3 of the release you talk about the increase in stumpage in BC. And there's a line in here that says this will materially impact BC log costs in the upcoming quarters, so I just wondered if you can kind of square that with what we just heard about stable log costs.

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Donald B. Kayne, Canfor Corporation - President, CEO & Director [35]

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For sure, Mark. I'll get Stephen to comment on that.

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Stephen MacKie, Canfor Corporation - SVP of Canadian Operations [36]

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Yes, sure, Mark. I think that, while we certainly do expect pressure on stumpage -- and again back to the July 1 stumpage update and increase in, and we'll also see some further upward pressure as a result of improving market conditions and [AMB] updates that will push stumpage up, I guess it's a bit of a function of some of the actions that we're taking internally to mitigate those costs and really the great effort by our teams across the BC business to be responsive to the economic times that we're facing and a lot of good work. So I'm probably a little bit more optimistic on what we're able to achieve there to try to mitigate those cost increases.

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Mark William Wilde, BMO Capital Markets Equity Research - Senior Analyst [37]

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Okay, but any examples of things you can do?

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Stephen MacKie, Canfor Corporation - SVP of Canadian Operations [38]

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Not -- probably not a lot of stuff that I'm going to disclose here, Mark, but I think fair to say, obviously, the capacity reductions across BC, our own and others', temporary and permanent, are having impact on the purchased wood market. And we're seeing a change in bidding behavior that is helping offset some of those high-cost fiber.

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Mark William Wilde, BMO Capital Markets Equity Research - Senior Analyst [39]

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Okay, that's helpful. Don, any thoughts on just sort of the potential for some rightsizing in kind of Western Canadian pulp capacity just given the fiber constraints?

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Donald B. Kayne, Canfor Corporation - President, CEO & Director [40]

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Yes. Hard to say at this stage yet, but I mean, just like we've seen happen on the lumber side, I mean, ultimately there's probably going to be some impact down the road yet. And we're certainly looking at that and aware of that and watching that carefully ourselves, but our -- as Alan mentioned, I believe, in his comments, I mean, we think, with the work that we've been doing on our chip supply and our raw material supply for the pulp mills, at least for now, we're -- we can certainly move forward with the production levels that we have today.

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Operator [41]

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Thank you. Ladies and gentlemen, at this time, we have no further questions, so it does conclude your conference call for today. We would like to thank you for attending and ask that you please disconnect your lines. Enjoy the rest of your day.

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Donald B. Kayne, Canfor Corporation - President, CEO & Director [42]

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All right, thanks, operator. And look forward to talking to you all soon.