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Edited Transcript of OSB.TO earnings conference call or presentation 1-Aug-19 3:00pm GMT

Q2 2019 Norbord Inc Earnings Call

TORONTO Aug 5, 2019 (Thomson StreetEvents) -- Edited Transcript of Norbord Inc earnings conference call or presentation Thursday, August 1, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Peter C. Wijnbergen

Norbord Inc. - President, CEO & Director

* Robin E. Lampard

Norbord Inc. - Senior VP & CFO

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Conference Call Participants

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* Hamir Patel

CIBC Capital Markets, Research Division - Director of Institutional Equity Research & Paper and Forest Products Analyst

* John Plimpton Babcock

BofA Merrill Lynch, Research Division - Associate

* Ketan Mamtora

BMO Capital Markets Equity Research - Analyst

* Paul C. Quinn

RBC Capital Markets, LLC, Research Division - Analyst

* Salvator Tiano

Vertical Research Partners, LLC - VP

* Sean Steuart

TD Securities Equity Research - Research Analyst

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Presentation

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Operator [1]

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Good day, everyone, and welcome to Norbord Incorporated Second Quarter Earnings Conference Call. As a reminder, today's call is being recorded and webcast on Norbord's website at www.norbord.com.

Norbord's discussion today may include certain projections and forward-looking statements regarding Norbord's business, future actions and expected results. These statements are subject to known and unknown risks, and future results may differ materially. For further information on known risks, please see the caution regarding forward-looking information statement in Norbord's January 31, 2019, annual information form and the cautionary statement contained in the forward-looking statements section of Norbord's management's discussion and analysis dated July 31, 2019.

And now I'll turn the call over to Peter Wijnbergen, President and Chief Executive Officer. Please go ahead, sir.

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Peter C. Wijnbergen, Norbord Inc. - President, CEO & Director [2]

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Thank you, Jonathan, and good morning, everyone. Welcome to our second quarter 2019 conference call. I'm joined today by Robin Lampard, our CFO; and Heather Colpitts, our Senior Manager of Corporate Affairs. This morning, I'll briefly summarize a few points about our Q2 results and outlook before taking your questions.

Our second quarter results are disappointing, especially when compared to a record second quarter last year. U.S. housing market pullback that began last fall continued into the second quarter. Ongoing affordability concerns and persistent record-breaking wet weather led to poor building conditions in many North American regions. This held back OSB result -- demand, and as a result, benchmark prices were down 11% versus the first quarter.

For the third quarter in a row, we took extensive downtime across our North American mills, another 77 mill days in the second quarter to ensure we only produce what we could sell. This, obviously, negatively impacted our production volumes and manufacturing costs. However, despite taking the same number of mill days down in the second quarter compared to Q1, we were able to lower our unit cost by 6% by operating more efficiently. We also got some help from a modest 5% reductions in resin prices.

As we announced back in June, we will indefinitely curtail our 100 Mile House mill in British Columbia starting later this month. This was a difficult decision, but necessary for our business, as the combination of wood supply shortage and high wood prices do not support the economic operations of the mill. We have a first-class team in 100 Mile House, and this decision was in no way a reflection of the quality of our -- or capability of our employees. They work tirelessly to afford exactly this outcome, and we thank them all for their efforts and commitment. It's a testament to their professionalism and dedication that the mill continues to run well, even as we utilize the remaining wood we have on the site.

We are already in the process of transitioning manufacturing to our 2 lower-cost mills in Alberta. Our capacity at both Grande Prairie and High Level will enable us to meet current and future customer demand, including for the Japanese market.

Looking ahead, we are starting to see signs of improvement in North America. We shared a view of industry analysts that the U.S. housing market will strengthen through the balance of 2019. There are several encouraging indicators. Mortgage rates are down well below 4% again. Homebuilders are pivoting to offer more affordably priced entry-level homes to entice first-time home buyers, and builders are reporting higher levels of buyer interest and net order growth for the first time since last fall of about 5% year-over-year.

As an economist, our forecasting starts this year will be in line with last year, implying a 4% growth in the second half of the year, which would support higher levels of OSB demand than in -- than we saw in the first half.

Market conditions have been slowly firming, and our mills are running well, so we are optimistic that our results are set to improve alongside U.S. housing-related demand through the remainder of the year.

In Europe, our panel business had another good quarter. We delivered $21 million of EBITDA, unchanged versus both comparative quarters, despite the translation headwind of a weaker pound sterling, and representing a strong 16% EBITDA margin.

In Germany, however, the global trade war is starting to negatively impact the macro economy and a particular export activity, which drives about 1/3 of OSB demand in that market, putting downward pressure on European OSB prices. But to put it into context, I'll point out that European OSB prices have been well above average levels for the past 1.5 years. So while we might see continued downward pressure on European panel prices, we expect the ongoing trend of OSB substitution for plywood will continue to drive rapid consumer growth. And as a reminder, the investment we have made and are making at our Inverness, Scotland mill, this is a 4-year pipeline of growth to meet this increasing customer demand.

Finally, I'll highlight that we have completed a new 8-year $350 million bond issuance during the quarter. Given the strength of the U.S. high-yield bond market, we took the opportunity to term out next year's $240 million bond maturity to 2027 at an attractive 5.75% coupon. This gives us a continued balance sheet flexibility and bolsters our liquidity position, leaving us with pro forma liquidity of just over $300 million.

And with that, we'll jump right on to your questions today, so I'll turn things over to the operator, who'll open up your lines.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We'll take our first question from John Babcock of Bank of America.

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John Plimpton Babcock, BofA Merrill Lynch, Research Division - Associate [2]

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I just wanted to start out. We've clearly had seen the OSB market be quite a bit softer than I think most people anticipated through the first half of this year. And I guess that kind of leads to my question and just that, one, where do inventories stand in the channel right now? And ultimately, what do you think it will take for the market to show some more tension from here?

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Peter C. Wijnbergen, Norbord Inc. - President, CEO & Director [3]

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Well, we continue to believe that our customers are, in general, hand to mouth when it comes to inventory. We, of course, don't have a absolute perspective on inventory. But on a calculated basis, we should have seen inventory trending down slightly over the last couple of months. But the reality is that housing demand or demand in general, as a result of housing -- or the poor housing performance, has been disappointing compared to what the general expectations were, and that's been driving this poor performance on the OSB market side.

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John Plimpton Babcock, BofA Merrill Lynch, Research Division - Associate [4]

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Okay. And then just moving to Europe, you talked a little bit about Germany and what you're seeing there. I just want to get a sense. I mean are you feeling any impact of the trade war and Brexit in any of your other European markets at this point?

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Peter C. Wijnbergen, Norbord Inc. - President, CEO & Director [5]

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Well, I'll just remind everyone, 70% of our sales from our European business take place in the U.K. The U.K. is a net importing market for wood products, in particular for panel products. So the impact of Brexit and all the Brexit rumors, so far, has been that the pound has continued to be under pressure, and that's making imported competitive products more expensive. So that's allowed us to continue to gain market share. And we have seen, as a result, increased substitution growth in the U.K. The -- Germany is the largest OSB market in Europe. And so it ultimately is sort of a trendsetter when it comes to market pricing. And because we are seeing the significant slowdown in export orders where our industrial packaging business is impacted, that's why we're starting to see downward pressure on pricing.

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John Plimpton Babcock, BofA Merrill Lynch, Research Division - Associate [6]

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Okay. And then is it possible to quantify the impact of the -- at least, the cost in the next quarter of the closure of the 100 Mile House mill?

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Robin E. Lampard, Norbord Inc. - Senior VP & CFO [7]

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Well, we're not going to give guidance on that, John. But certainly, we will be shutting the mill down later this month. And so it -- we will lose the volume from that mill in part of the quarter. So I wouldn't expect it to be hugely material at this point. And as you saw, we provided for $2 million of costs already in the second quarter.

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Operator [8]

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We'll take our next question from Sean Steuart of TD Securities.

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Sean Steuart, TD Securities Equity Research - Research Analyst [9]

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A few questions. 100 Mile House, can you talk a little bit about the decision to qualify this as indefinite versus permanent? And do you envision -- what would it take for this mill to restart eventually, either in terms of fiber costs normalizing or demand warranting a restart?

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Peter C. Wijnbergen, Norbord Inc. - President, CEO & Director [10]

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Sean, well, we have classified this an indefinite curtailment. There is no immediate plans to start the mill back up, but we will not ballot in such a way that, that option exists in the future. At the moment, it's very difficult to see conditions change dramatically in British Columbia. And remember that the reason why we made this decision was not necessarily market-related. It was really wood supply-related. This beetle kill thing has been plaguing Central British Columbia now for more than a decade. And in order -- as I think the government of BC or the Ministry of -- I can't remember exactly what it's called, but the people who are responsible for forestry over in BC have permanently reduced the annual allowable cut in the region significantly. And so I don't think that those conditions will reverse in the short term.

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Sean Steuart, TD Securities Equity Research - Research Analyst [11]

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Understood. And you mentioned repositioning some of the offshore volume from that mill to your Alberta operations. And correct me if I'm wrong, but it felt like there was excess production capacity at high level, anyway. Will you be able to mitigate some of the volume losses at 100 Mile House by ramping up production rates at High Level?

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Peter C. Wijnbergen, Norbord Inc. - President, CEO & Director [12]

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Yes. I think -- as you know, we restated the capacity of Grande Prairie last year with the investment we made there. And I think we have also talked a little last a little while that the High Level mill still has room to grow given its rated capacity versus where we have been able to operate, as that mill has been through a slow ramp-up. So we believe that there is the capacity in those 2 mills to take the profitable business -- or let's say, the attractive business that we have developed out of 100 Mile House mill over the last decade and transfer those over to those mills.

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Sean Steuart, TD Securities Equity Research - Research Analyst [13]

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Understood. One last one. It looks like your North American specialty volumes have been pretty stable at 25% for a while now. What's -- what does it take for you to grow that share? And I appreciate that a portion of it is tied to the export market, but any initiatives you can speak to, to gradually raise that percentage over the mid- to long term?

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Peter C. Wijnbergen, Norbord Inc. - President, CEO & Director [14]

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Yes. I think the sad thing is that you're right. We have been stuck at this 25% now for a bit. But unfortunately, the biggest impact there was slower export sales, in particular to China this year compared to last year. And so that's been disappointing and that sort of masks the improvements we have seen in our industrial sales. But the other thing to keep in mind on the industrial side is that sort of things like recreational vehicles and those kind of areas of industrial consumption have been very slow this year because of the uncertainty in the economy, I guess, in general. So despite that, we have been able to maintain this volume, including at a higher production level. But making -- these customers take a long time to gain. Some of them, we have been working on for more than 2 years before they finally committed their volume to us. And so look, this is an ongoing process that we believe will take time to play out.

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Robin E. Lampard, Norbord Inc. - Senior VP & CFO [15]

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And I would just add a little bit of context to that. If you go back and put it in a longer-term historical context, since we launched the specialty strategy after the merger at Ainsworth, our North American shipments are up 1 billion feet over that 3-year period. And so yes, the percentages have stayed the same, but we have, in absolute terms, grown our volume into the specialty channel by the equivalent of, I think, a couple of mills. It's quite significant.

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Operator [16]

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We'll take our next question from Hamir Patel of CIBC Capital Markets.

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Hamir Patel, CIBC Capital Markets, Research Division - Director of Institutional Equity Research & Paper and Forest Products Analyst [17]

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Peter, you and one of your competitors have announced indefinite curtailments in BC taking effect in July and August. How long do you think it would take for the inventory at those sites to get worked through and we see some more pricing tension in Western Canada?

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Peter C. Wijnbergen, Norbord Inc. - President, CEO & Director [18]

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Well, I mean I can't speak for our competitors, so I won't. But if I think about our situation, we anticipate running through our log pile by the end of this month or before the end of this month. But we have already -- because that mill was sort of focused on export and some industrial products, as we're transferring that order pile over to our 2 Alberta mills, really, what it has meant is that we are severely limited in our ability to offer commodity products into the North American market for the remainder of this year. So that's the impact we have seen so far on the Norbord side. Obviously, the product -- the volume is not out of the market until our mill -- or our volume isn't really out of the market until the mill actually shuts down.

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Robin E. Lampard, Norbord Inc. - Senior VP & CFO [19]

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Within a couple of [weeks], that is good moving up, right?

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Peter C. Wijnbergen, Norbord Inc. - President, CEO & Director [20]

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Yes. I mean you remember, we don't have warehousing capacity at any of our operations. So...

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Hamir Patel, CIBC Capital Markets, Research Division - Director of Institutional Equity Research & Paper and Forest Products Analyst [21]

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Okay. That's helpful. And just turning to the demand side. Single-family starts off 5% in the first half. Given the weather headwinds that we saw, did you see a decline in your big box volumes as well? And can you quantify the volume change that you've seen there?

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Peter C. Wijnbergen, Norbord Inc. - President, CEO & Director [22]

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No. In fact, the big box volumes are -- have been very strong. They're up significantly over last year. And I think at the consumer level or the small R&R contractors, which are sort of the key customers of the big boxes, they're very price sensitive. And one of the sad, but in this case, good benefits of these really low OSB prices is that OSB is the lowest panel -- lowest cost panel that Home Depot and Lowe's and Menards sell in the store right now. And so we have seen that should translate into a significant increased volume.

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Hamir Patel, CIBC Capital Markets, Research Division - Director of Institutional Equity Research & Paper and Forest Products Analyst [23]

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And can you kind of quantify that increase?

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Peter C. Wijnbergen, Norbord Inc. - President, CEO & Director [24]

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So I think year-over-year, we're up probably by about 1/5.

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Operator [25]

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We'll take our next question from Chip Dillon of Vertical Research Partners.

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Salvator Tiano, Vertical Research Partners, LLC - VP [26]

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This is Salvator Tiano filling in for Chip. So first question is on investment, can you give us an update a little bit on capital expenditures this year and how they're looking for next year, especially since, now, things are not looking as bright? And how are we looking for Chambord? I guess are you delaying any of the CapEx until later? Or is everything, again, on track to bring them to a situation where you can make a short note -- with short note to restart?

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Peter C. Wijnbergen, Norbord Inc. - President, CEO & Director [27]

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Yes. So let me start off with overall CapEx. I mean we have given guidance, I think, for $150 million in the budget. I would anticipate that we won't spend all of that $150 million this year, as we have been gradually pulling back with a decreased outlook for the year. And I would also anticipate that our capital commitment for next year, although we won't give guidance on that, I think, until the fall when we complete our budget cycle, we'll probably be similarly held back as a result of our outlook. We always try to spend within our means.

With regards to Chambord, clearly, there is no immediate urgency to start that mill back up. Of the $70 million that was approved, we have a spend about $40 million. Our intent remains the same. We want to -- and we are more or less complete with the big -- long lead-time items. But obviously, we will pace the remainder of the spend more closely with the decision to eventually start that mill back up once the timing is right.

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Salvator Tiano, Vertical Research Partners, LLC - VP [28]

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Okay. And just if I remember correctly, initially, we're talking more about a higher level of CapEx earlier the year. So I think, closer to $190 million -- sorry, $200 million, perhaps. Can you tell us a little bit about the projects that are being cut out of these things that would have added some of your capacity, debottlenecking projects? Or are you becoming a little bit more efficient with maintenance? And how much is kind of the saving from the curtailment that you had in Mile House with regard to the CapEx budget?

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Robin E. Lampard, Norbord Inc. - Senior VP & CFO [29]

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So Salvator, we have not pulled back at all on the budget guidance. We gave $150 million at the start of the year, and that still remains our guidance. Although, as Peter said, we may end up underspending against that. So nothing has changed there. But other than the 2 big projects with Inverness phase 2 and Chambord rebuild, there is no other single significant project. There's a host of maintenance site project, finishing end to support our specialty strategy kind of project and the like.

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Peter C. Wijnbergen, Norbord Inc. - President, CEO & Director [30]

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That's really to expand capacity at this stage.

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Robin E. Lampard, Norbord Inc. - Senior VP & CFO [31]

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Yes. Nothing to extend capacity there.

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Salvator Tiano, Vertical Research Partners, LLC - VP [32]

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And just the last thing, I guess, on the dividend. Obviously, you're maintaining the dividend at this level, despite a couple of quarters of limited earnings. Is it something that you have visibility you can maintain for 12 to 18 months and as such, at some point, you expect a recovery? Or is it a very quarter-by-quarter decision and we could see a reduction, let's say, next quarter if things don't change?

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Robin E. Lampard, Norbord Inc. - Senior VP & CFO [33]

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It certainly is a quarterly Board decision, but you can see from our track record that we don't adjust the dividend level every quarter. I think the fact that we've held the line on the dividend, it should be viewed as underpinned by our outlook for improvement in the second half of this year, notwithstanding that the last 3 quarters have undershot versus expectations.

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Peter C. Wijnbergen, Norbord Inc. - President, CEO & Director [34]

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And I would add to that, that this -- we see this is very important that we continue to provide a return to our shareholders. And we continue to stay focused on this sort of balanced approach between ensuring that there's long-term growth opportunity for our company with having adequate return for our shareholders' continued interest in our company.

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Operator [35]

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We'll take our next question from Paul Quinn of RBC Capital Markets.

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Paul C. Quinn, RBC Capital Markets, LLC, Research Division - Analyst [36]

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Maybe just to start, you've got this Inverness Phase II project and I'm just wondering if you can sort of remind us where you're at with the project and when it's going to be complete, whether you've slowed down the spending on that baby.

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Peter C. Wijnbergen, Norbord Inc. - President, CEO & Director [37]

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So I would say, all the civil work is completed, so that's most of the unsexy concrete pouring and whatnot or, maybe for some people, that is sexy. But anyway, not much to show for it rather than -- other than an Olympic-sized swimming pool made from concrete. And all the equipment that goes on top of it has been ordered, and the contracts have been signed. Most of that stuff will start to be delivered in the third quarter or towards the end of the third quarter. And the plan is to sort of install it as it comes. We anticipated the 18-month construction phase, so we're into -- I think we have just completed 6 months now or soon, we'll have sort of -- that sort of the range. And so this new capacity should come online towards the end of next year to allow us to continue. That's a gradual ramp-up of that mill, as Robin has pointed out in the past. The plan is to increased -- to make 100 million -- 100,000 cubic meters, I should say, available every year this year, next year and the 2 years after that.

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Paul C. Quinn, RBC Capital Markets, LLC, Research Division - Analyst [38]

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Thanks for the color on Germany, I'm just trying to understand the -- of your European OSB operations. What percentage is going in, in industrial packaging there? Are you just seeing the slowdown in Germany? Or is it elsewhere in Europe as well?

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Peter C. Wijnbergen, Norbord Inc. - President, CEO & Director [39]

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I'd say you're starting -- this -- Germany is sort of the heart of the European economy, right, in many ways. And as you know, the slowdown that's hitting Germany is having an impact on surrounding countries as well. This industrial packaging, I would call that sort of a broad term, but that is really a significant consumer of OSB, in general, in that German market. And that's sort of where we have seen this marginal decrease in demand, which is having an impact on pricing. And Germany sort of functions as sort of the price center market, if you wish, and shoulders sort of a knock-on effect on prices that are available in other markets -- or that we can realize in other markets, including into the U.K.

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Paul C. Quinn, RBC Capital Markets, LLC, Research Division - Analyst [40]

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Okay. And just on resin prices. You noticed that was favorable at 5%. What's the expectation going forward over the next quarter?

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Peter C. Wijnbergen, Norbord Inc. - President, CEO & Director [41]

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I'm a little bit -- but I think there is still some downward trend on resin at the moment.

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Robin E. Lampard, Norbord Inc. - Senior VP & CFO [42]

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But fairly modestly.

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Peter C. Wijnbergen, Norbord Inc. - President, CEO & Director [43]

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But fairly modestly.

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Operator [44]

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We'll take our next question from Ketan Mamtora of BMO Capital Markets.

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Ketan Mamtora, BMO Capital Markets Equity Research - Analyst [45]

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First question, do you think there's kind of a sluggish housing demand? And is the OSB pricing creating any M&A opportunity for you guys in North America?

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Peter C. Wijnbergen, Norbord Inc. - President, CEO & Director [46]

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Yes. I mean you know that we are always interested in growth, and M&A is always are -- is always the most attractive way to grow from our perspective. I don't know yet if people's perspective on pricing is sufficiently depressed that we could see eye to eye on those kind of opportunities at this moment. So I'm not aware of any opportunities that exist at the moment.

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Ketan Mamtora, BMO Capital Markets Equity Research - Analyst [47]

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Okay. That's fair. And then just turning to CapEx, again, and I'm not trying to put too fine line on this, but just trying to get -- so just better color. In terms of Chambord spending, I thought, last quarter, all it said that you expect to spend most of the $71 million in FY '19. Is it fair to say at this point that maybe some of that will spill over into 2020?

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Peter C. Wijnbergen, Norbord Inc. - President, CEO & Director [48]

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I think that's fair to say, yes.

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Operator [49]

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We'll take our next question from Chip Dillon of Vertical Research partners.

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Salvator Tiano, Vertical Research Partners, LLC - VP [50]

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Yes. Salvator Tiano again. Just -- I was wondering a little bit about your realizations. I think I see you have the slides. And obviously, the North Central declined more. Can you let us know a little bit -- your realizations generally deep seems to hold up, perhaps, certainly better than the North Central region, but perhaps a little bit better than other regions as well given that the Western Canada should boost towards the end of the quarter. How much of that -- was it due to your industrial kind of more value-add OSB that's allowing you to keep prices above a certain level? And how should we think about that as prices start going up, hopefully, in the back half of the year?

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Robin E. Lampard, Norbord Inc. - Senior VP & CFO [51]

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Yes. Thanks, Salvator. That is what it is. If you just simply calculate out our realizations versus a regionally weighted random length benchmark price, you'll see our realization increased 3% in Q2 versus Q1. And that is directly linked to our specialty strategy, where the prices and margins are much more stable. And we also didn't have a huge time lag effect in the second quarter because the prices was low, but relatively flat. So that's exactly what it is. It's the -- it illustrates the value of our specialty strategy in a weaker commodity price market.

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Operator [52]

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At this time, there are no further questions in the queue. I would like to turn the call back over to Peter Wijnbergen. Please go ahead, sir.

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Peter C. Wijnbergen, Norbord Inc. - President, CEO & Director [53]

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Thank you, Jonathan. As always, Robin, Heather and I are available to respond to further questions. I want to thank you all for your participation, and I look forward -- or we look forward to reporting on our progress next quarter. Have a good weekend.

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Operator [54]

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Ladies and gentlemen, this concludes today's teleconference. You may now disconnect.