Canfor reported operating income of $201.8 million for the third quarter of 2018, down $80.3 million from reported operating income of $282.1 million for the second quarter of 2018, with the decline reflecting lower operating earnings in both the lumber and pulp and paper segments.
Reported results for the third quarter of 2018 included a net duty expense of $42.6 million, at a current effective countervailing duty (“CVD”) and anti-dumping duty (“ADD”) rate of 14.94%, compared to $51.7 million reported in the second quarter of 2018. After adjusting for duties, operating income was $244.4 million for the third quarter of 2018, down $89.4 million from similarly adjusted operating income in the second quarter of 2018. Adjusted lumber segment earnings primarily reflected steep declines in Western Spruce/Pine/Fir (“Western SPF”) and Southern Yellow Pine (“SYP”) benchmark lumber prices, and to a lesser extent, the disruptive impacts of severe forest fires in Western Canada, and Hurricane Florence in the US South, which contributed to significant cost pressures and temporary operational downtime as a result of limited log deliveries and evacuation alerts. Pulp and paper segment earnings largely reflected a 20% decrease in pulp shipments that was mostly timing-related, and to a lesser extent, higher market-driven fibre costs.
Notwithstanding the downward pressure on pricing through the third quarter of 2018, lumber demand in the North American market remained relatively stable, with US housing starts averaging 1,218,000 units on a seasonally adjusted basis, down 3% from the previous quarter and up 4% from the third quarter of 2017. Offshore lumber consumption remained solid through the third quarter, with demand particularly strong in Japan. While the average benchmark North American Random Lengths Western SPF 2×4 #2 & Btr price at US$482 per Mfbm was down US$116 per Mfbm, or 19%, compared to the second quarter of 2018, Western SPF lumber unit sales realizations benefitted from a strong order file to start the quarter, a higher-value sales mix, and improved offshore pricing.
The average benchmark North American Random Lengths SYP East 2×4 #2 price was US$488 per Mfbm, down US$101 per Mfbm, or 17%, with this decline offset, in part, by a modest increase in 2×10 pricing. The sharp drop in lumber prices from the historical highs seen in the second quarter of 2018, was primarily attributable to higher inventory levels throughout the supply chain, in part from a continued gradual improvement in total lumber production, at 1.28 billion board feet, was 3% lower than the prior quarter as the benefit of improved productivity was more than offset by increased statutory holidays in the current quarter and the aforementioned disruptions.
Total lumber shipments, at 1.29 billion board feet, were down 4% from the previous quarter reflecting reduced production, a drawdown of inventory in the previous quarter following the severe winter weather experienced in the first quarter of 2018, and the impact of flooding and road closures following Hurricane Florence. Unit manufacturing and product costs in the third quarter of 2018 were moderately higher than the previous quarter reflecting higher market-based stumpage and the significant impacts of Hurricane Florence in the US South and severe forest fires in Western Canada, which contributed to lower harvested volumes and increased competition for purchased wood. Log costs in the US South remained stable through the quarter.
Global softwood pulp market conditions remained balanced through the third quarter of 2018, with US-dollar Northern Bleached Softwood Kraft (“NBSK”) pulp list prices, for the most part, reflecting steady global demand. Average NBSK pulp unit sales realizations were in line with the previous quarter as a weaker Canadian dollar and record high US-dollar NBSK pulp list pricing in North America offset a slight decrease in the China US-dollar NBSK pulp list price. Average Bleached Chemi-Thermo Mechanical Pulp (“BCTMP”) unit sales realizations showed a modest decrease quarter-over-quarter as a result of lower US-dollar BCTMP prices. Pulp shipments were down 66,200 tonnes, or 20%, from the previous quarter, reflecting the combination of a drawdown of inventory in the previous quarter as weather related transportation constraints eased, a 10,000 tonne vessel slippage into October, the impact of early fall maintenance and softer market demand from China in the first part of the quarter.
Pulp production was down 11,200 tonnes, or 4%, from the previous quarter for the most part reflecting scheduled maintenance downtime at CPPI’s Northwood NBSK pulp mill in late September (spanning quarter-end), which more than offset increased BCTMP production, following the commissioning of CPPI’s energy reduction project at its Taylor Pulp mill at the end of June. As previously announced, towards the end of the third quarter, Northwood extended its scheduled maintenance outage on one production line. The outage is to enable necessary tube replacements to its No. 5 recovery boiler to rectify damage discovered during routine preventative maintenance inspections. This unscheduled outage is anticipated to result in an additional reduction in NBSK pulp production in the fourth quarter of 60,000-70,000 tonnes.
Pulp unit manufacturing costs were modestly higher than the previous quarter, principally reflecting market-related increases in sawmill and whole log residual chip costs, and an increased proportion of higher-cost whole log chips. Canfor’s collective agreement with the United Steelworkers (“USW”) expired on June 30, 2018. Canfor is a member of both the Council on Northern Interior Forest Employment Relations (“CONIFER”) and the Interior Forest Labour Relations Association (“IFLRA”), which represent a total of seven of Canfor’s operations in the USW negotiations. USW Local 1-2017, who is participating in the CONIFER negotiations, issued a 72-hour strike notice on October 3, 2018 and moved into a legal strike position on October 6, 2018. USW Local 1-2017 represents employees at four of Canfor’s mills. USW Locals 1-405 and 1-417, which are participating in the IFLRA negotiations, recently conducted strike votes at three of Canfor’s mills. Commenting on the Company’s third quarter results, Canfor’s President and Chief Executive Officer, Don Kayne, said, “Despite the significant operational disruptions presented by forest fires and extreme weather, our lumber business generated solid financial results, aided by the dedication and commitment of our employees and contractors who helped to mitigate the impact of the challenging operating conditions.” Kayne added, “Canfor Pulp recorded another financially solid quarter despite significant scheduled maintenance downtime at Northwood, ramp-up efforts at Taylor and several operational challenges. We are very focused on completing our repairs to our No.5 recovery boiler at Northwood and returning to full operating capacity later this quarter”. Looking ahead, the US housing market and repair and remodeling sector is forecast to gradually pick up through the balance of 2018. While North American lumber prices have continued to decline in October, lumber markets are anticipated to modestly improve through the quarter, in part reflecting solid offshore lumber demand and more balanced supply. Results in the fourth quarter are anticipated to reflect lower unit sales realizations due to the current lumber market weakness, as well as continued log cost pressure in Western Canada as a result of increasing market-based stumpage and higher purchased wood costs.
Global softwood kraft pulp markets are projected to be balanced through the fourth quarter of 2018. Results in the fourth quarter of 2018 will include the continuation of the scheduled maintenance outage at CPPI’s Northwood NBSK pulp mill, the aforementioned extended downtime at Northwood, as well as unscheduled downtime taken in early October at all of CPPI’s NBSK pulp facilities as a result of a third-party natural gas pipeline explosion near Prince George. Combined, these scheduled and unscheduled outages are anticipated to result in a total of 85,000-90,000 tonnes of reduced NBSK pulp production, as well as higher associated maintenance costs and lower shipment volumes in the fourth quarter of 2018. Bleached kraft paper demand is anticipated to remain positive through the fourth quarter of 2018.