Reflecting weak global market conditions and a challenging fibre cost environment in British Columbia (“BC”), for the third quarter of 2019, Canfor reported an operating loss of $124.0 million compared to an operating loss of $49.7 million reported for the second quarter of 2019.

The material decline reflected significantly lower operating earnings in both the lumber and pulp and paper segments, and substantial curtailments taken by both businesses during the third quarter.

Reported results for the third quarter of 2019 included a net duty expense of $53.5 million, at a combined countervailing duty (“CVD”) and anti-dumping duty (“ADD”) accrual rate of 29.24%, compared to $45.2 million reported in the second quarter of 2019 at a combined rate of 26.24%. Results in the third quarter of 2019 also included a net $5.3 million recovery in the lumber and log inventory write-down provisions, as well as restructuring costs of $6.4 million related to the previously announced permanent capacity reductions and indefinite curtailments at the Vavenby, Mackenzie and Isle Pierre sawmills.

Lumber segment losses primarily reflected prolonged weakness in Western Spruce/Pine/Fir (“Western SPF”) benchmark lumber prices, continued elevated log costs in BC, and 360 million board feet of production curtailments and capacity reductions in that operating region during the current quarter. Results in the pulp and paper segment reflected weak global pulp market conditions, significant market-related downtime and fibre supply disruptions from BC Interior sawmill curtailments.

Northern Bleached Softwood Kraft (“NBSK”) pulp and Bleached Chemi-Thermo Mechanical Pulp (“BCTMP”) prices saw significant declines through the quarter, driven by weak global softwood pulp demand in combination with elevated global pulp inventory levels. In response to the deteriorating pulp market conditions and fibre supply disruptions, Canfor Pulp Products Inc.

(“CPPI”) took phased summer curtailments at its Intercontinental, Northwood and Prince George NBSK pulp mills in Prince George, BC, as well as at its BCTMP mill in Taylor, BC. Combined, the summer curtailments reduced pulp production in the current quarter by 75,000 tonnes of NSBK pulp and 60,000 tonnes of BCTMP.

Lumber market fundamentals remained relatively unchanged through the third quarter of 2019, with supply continuing to exceed demand. North American home construction showed signs of a recovery late in the third quarter of 2019 while repair and remodeling activity was steady during the quarter and throughout 2019 overall.

US housing starts, on a seasonally adjusted basis, averaged 1,282,000 units, up 2% from the previous quarter; multi-family starts were down 6%, while single-family starts, which consume a higher proportion of lumber, were up 6%. The slower than anticipated recovery of US housing starts year-to-date has in part reflected record high levels of precipitation and severe flooding across the US South, combined with market uncertainty stemming from ongoing trade disputes between the US and China.

In Canada, housing starts averaged 223,000 units on a seasonally adjusted basis, broadly in line with the previous quarter, and reflecting strong demand in Eastern Canadian urban centres. Offshore demand for Western SPF lumber products, particularly in China, weakened in the third quarter. European lumber demand waned during the current quarter, as weaker market conditions spilled over from North America, and this weighed on European benchmark commodity lumber pricing.

The average benchmark North American Random Lengths Western SPF 2×4 #2 & Btr price was up US$23 per Mfbm, or 7%, from the previous quarter, to US$356 per Mfbm. A similar increase was seen in the Company’s Western SPF lumber unit sales realizations driven by benchmark pricing movements across various grades, combined with a modest improvement in the Company’s high-value sales mix.

Southern Yellow Pine (“SYP”) lumber unit sales realizations were slightly lower than the prior quarter as a US$17 per Mfbm, or 4%, increase in the SYP East 2×4 #2 price to US$410 per Mfbm, was more than offset by the impact of price declines for wider-width dimension products. The average European indicative SPF lumber benchmark price (an internally generated benchmark based on delivered price to the largest continental market), at 3,652 Swedish Krona (“SEK”) per Mfbm, was down SEK 351 per Mfbm, or 9%, from the previous quarter, primarily a result of tepid global lumber demand.

The Company’s European SPF lumber unit sales realizations showed a more moderate decrease compared to the previous quarter, as a higher-value sales mix partially offset the aforementioned pricing pressure. Further reducing the unit sales realizations compared to the previous quarter was a 3% strengthening of the Canadian dollar against the SEK.

Total lumber shipments, at 1.23 billion board feet, were 16% lower than the previous quarter principally reflecting the challenging market conditions impacting our Western SPF lumber business and the related market downtime in the current quarter. Total lumber production, at 1.18 billion board feet, was 15% lower than the previous quarter primarily due to the aforementioned BC production curtailments and mill closures, which reduced Western SPF production capacity by approximately 37%, and, to a lesser extent, seasonal production downtime at the Company’s European operations taken for a four-week period in July and August.

Lumber unit manufacturing and product costs declined slightly from the previous quarter, as the impact of reduced market pricing on consumed log costs in both Western Canada and the US South, outweighed the incremental effect of lower production volumes. The timing difference between the delivery and consumption of logs meant that the increase in market-based stumpage in BC, effective July 1, 2019, did not significantly impact log costs in the current quarter; however, this will materially impact BC log costs in upcoming quarters. In Europe, lumber unit manufacturing and product costs were marginally higher than the previous quarter, as the benefit of a market-related decline in log costs offset most of the impact on unit fixed costs from the seasonal production downtime.

Global pulp markets weakened for a third straight quarter with the combination of tepid demand and inventory oversupply, particularly in China and Europe, significantly weighing on global pulp prices. During the current quarter, the US-dollar NBSK pulp list price to China declined to its lowest level in over 10 years, averaging US$585 per tonne, down US$68 per tonne, or 10%, from the previous quarter. Prices to other global regions, including North America and Europe, also experienced similar decreases in the current quarter. As a result of weakening pulp market conditions and pricing, average NBSK pulp and BCTMP unit sales realizations were down significantly compared to the second quarter of 2019.

Energy revenues increased in the current quarter as improved power generation, driven by Northwood’s new Turbo Generator Condensing turbine, and higher energy prices, more than offset the decrease in operating days associated with the aforementioned downtime. Pulp production was 174,000 tonnes, down 126,000 tonnes, or 42%, from the previous quarter, largely reflecting the quarter-over-quarter impact of downtime, which, in the current quarter, principally related to the aforementioned production curtailments at all of CPPI’s pulp mills. The completion of a scheduled maintenance outage at CPPI’s Prince George pulp mill in the current quarter further reduced pulp production by 4,000 tonnes.

In the second quarter of 2019, CPPI completed scheduled maintenance outages at the Intercontinental NBSK pulp and Taylor BCTMP mills which reduced pulp production by 11,000 tonnes and 6,000 tonnes, respectively. Pulp shipments were 213,000 tonnes, down 75,000 tonnes, or 26%, from the previous quarter reflecting the decrease in pulp production, offset in part by a drawdown of inventory in the current quarter. Pulp unit manufacturing costs were significantly higher than the previous quarter, principally reflecting reduced production. Fibre costs showed a modest decline, with lower market-based prices for sawmill residual chips (linked to Canadian dollar NBSK pulp sales realizations) offsetting increased seasonal pricing adjustments and a higher proportion of available higher-cost whole log chips.

“The ongoing tough market conditions made for another extremely challenging quarter for our Western SPF business and all of our employees” said Don Kayne, Canfor’s president and chief executive officer. “However, despite the global lumber market challenges, our SYP and European businesses continued to deliver positive results in the third quarter, and we expect that to continue through the balance of the year. Our pulp business also had a very difficult quarter, as deteriorating pulp market conditions and reduced fibre supply resulted in significant pulp mill curtailments in the third quarter. We expect to see stabilization and a slow recovery in both lumber and pulp prices towards the end of 2019 and into 2020 as demand steadily improves and global inventory levels come back into balance.”

On August 10, 2019, Canfor received an unsolicited and non-binding proposal from Great Pacific Capital Corp. (“Great Pacific”) to acquire all outstanding common shares of Canfor (excluding those already directly or indirectly owned by Great Pacific) at a price of $16.00 per common share (the “Indicative Offer”). The Board has constituted a Special Committee of independent directors to review the Indicative Offer and, in consultation with its legal and financial advisors, consider Canfor’s strategic alternatives, including Canfor’s response, if any, to the Indicative Offer. The Special Committee’s review remains in progress. Looking ahead, for the lumber segment, a gradual recovery in demand in the US housing sector is anticipated, in part reflecting an alleviation of affordability concerns, coupled with solid projected demand in the repair and remodeling sector. Despite the anticipated steady uptick in US lumber demand, increased supply into the North American market is projected to temper North American lumber prices for the balance of 2019, reflecting the combined impacts of incremental European lumber imports into the US, lower shipments from North America to China, and capacity coming online in the US South.

Lumber prices in Asia, particularly in Japan, are anticipated to improve through the balance of 2019, with prices projected to return to more normalized levels. In Europe, the pricing pressure experienced in the current quarter is estimated to continue through the balance of the year, with stabilization anticipated in early 2020, as global inventory levels return to a more balanced range.

It is anticipated that this pricing pressure will be somewhat moderated by lower log costs in Europe. In the pulp and paper segment, global softwood kraft pulp markets are projected to show signs of a modest recovery in the fourth quarter of 2019 with consumers replenishing inventories following the seasonally slower summer months. It is anticipated that global pulp pricing will slowly improve through the balance of 2019 and into 2020 as global inventories move towards a more balanced range.

Given the impacts of recently announced sawmill curtailments and closures in the BC Interior, fibre costs are projected to remain under pressure given the limited supply of incremental pulp logs. Results in the fourth quarter of 2019 will include a one-week curtailment at CPPI’s Prince George NBSK pulp mill and paper machine at the beginning of October, a continuation from the third quarter. Bleached kraft paper demand is anticipated to remain relatively weak through the balance of the year, with prices projected to remain under pressure in the fourth quarter before stabilizing in 2020.