Stella-Jones Inc.’s (STLJF) CEO Eric Vachon on Q3 2020 Results – Earnings Call Transcript


Stella-Jones Inc. (OTC:STLJF) Q3 2020 Results Earnings Conference Call November 5, 2020 10:00 AM ET

Company Participants

Eric Vachon – President and CEO

Silvana Travaglini – Chief Financial Officer

Conference Call Participants

Hamir Patel – CIBC Capital Markets

Walter Spracklin – RBC Capital Markets

Mark Neville – Scotiabank

Mona Nazir – Laurentian Bank

Benoit Poirier – Desjardins Capital Markets

Michael Tupholme – TD Securities

Maxim Sytchev – National Bank Financial

Operator

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to Stella-Jones Third Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. Instructions will be provided at that time for you to queue up for questions. [Operator Instructions]

Before turning the meeting over to management, please be advised that this conference call will contain statements that are forward-looking and subject to a number of risks and uncertainties that could cause actual results to differ materially from those anticipated. I would like to remind everyone that this conference call is being recorded on Thursday, November 5, 2020.

I will now turn the conference over to Eric Vachon, President and CEO. Please go ahead.

Eric Vachon

Good morning, ladies and gentlemen. I’m here with Silvana Travaglini, Chief Financial Officer of Stella-Jones. Thank you for joining us for this discussion of the financial and operating results for Stella Jones’s third quarter ended September 30, 2020. Our press release reporting Q3 results was published earlier this morning. It along with our MD&A can also be found on our website at www.stellajones.com and will be posted on SEDAR today as well.

In addition, I’d like to mention that yesterday we published our 2019 Environmental, Social and Governance report. It has been posted on our website as well. Let me remind you that all figures expressed on today’s call are in Canadian dollars unless otherwise stated.

Let me start by thanking our employees who continue to work diligently every day to service our customers during these challenging times. Their unwavering dedication, combined with the proven resiliency of our business has helped deliver another record performance this quarter with growth in sales, EBITDA and cash from operations.

The continued growth demand across most of our product categories and exceptional rise in the market price of lumber led to an 18% increase in sales, and as a result, EBITDA rose to a quarterly record of $132 million. EBITDA margin also rose to 17.8%, a 2.6% improvement compared to the same period last year.

During the quarter, we generated strong cash from operations, allowing us to continue to invest in our network, return cash to shareholders and reduce our leverage. We ended the quarter in a very solid financial position with ample liquidity in order to continue to drive sustainable growth for our shareholders.

Let me now turn to a brief overview of our third quarter results by product category. Utility pole sales amounted to $252 million, up from $216 million generated in the third quarter of 2019. The increase this quarter is primarily driven by lumber volume, as well as higher pricing.

The pricing improvement stems from upward price adjustments in response to raw material cost increases and better product mix, which includes the impact of greater fire-resistant wrapped poll volumes.

Railway ties sales amounted to $189 million, down from $193 million in the same period last year. Excluding the currency conversion effect, sales decreased $6 million, largely due to lower volumes from Class 1customers, as some of these customers had accelerated their maintenance programs in the second quarter. The decrease in Class 1 volumes was partially offset by continued strong non-Class 1 demand, which is supported this year by the availability of dry railway tie inventory.

Residential lumber sales totaled $220 million, up 39% from $168 million generated last year. The significant increase in sales was driven by the sharp rise in the market price of lumber and the continued strong demand from home improvement products during COVID-19 pandemic.

Industrial product sales amounted to $34 million, down 6% from $36 million recorded into previous year’s quarter primarily due to the timing of shipments of product for rail related bridge projects.

The logs and lumber sales, a product category used to optimize procurement was $49 million, up from $28 million last year. This significant growth is mainly due to the higher market price of lumber throughout the third quarter.

Silvana will now provide further details regarding our results and financial position before I conclude with our outlook. Silvana?

Silvana Travaglini

Thank you, Eric, and good morning, everyone. Turning to profitability, gross profit increased 34% to $147 million, compared to gross profit of $110 million in the third quarter last year. Similarly, operating income and EBITDA increased 45% and 38% to $113 million and $132 million, respectively. The significant increase in profitability was driven by the exceptional sales price increases for residential lumber, which exceeded the higher cost of lumber, given the rising market price of lumber throughout the quarter, coupled with stronger residential lumber demand and improve pricing, product mix and volumes for utility poles. Net income rose 46% for the third quarter $279 million or $1.17 per share, compared to $54 million or $0.78 per share last year.

Turning to liquidity and capital resources, cash flow generated from operating activities totaled $148 million in the third quarter, compared to $124 million generated in the same period last year. The increase is mainly due to improve profitability offset in part by an increase in taxes paid following the deferral of tax installments to the third quarter as permitted by COVID-19 tax relief measures.

We deployed the cash generated to reduce our long-term debt by $102 million, returned $25 million of capital to our shareholders through dividends and share buybacks, and invest $14 million in our network.

In the quarter, as part of our normal course issuer bid, we repurchased 334,653 common shares at an average price of $46.04. Consistent with previous quarters, the Board of Directors of Stella-Jones yesterday declared a quarterly dividend of $0.15 per common share payable on December 17, 2020, to shareholders of record at the close of business on December 1st.

As at September 30, 2020, the net debt to trailing 12 months EBITDA ratio decreased to 1.4 times and we had access to over $300 million in liquidity through a combination of cash on hand, syndicated credit facilities and an undrawn demand loan facility.

I will now turn the call back to Eric for the outlook. Eric?

Eric Vachon

Thank you, Silvana. We revised our earnings guidance for 2020 to reflect our stronger than expected third quarter sales growth in residential lumber and utility poles. We now expect EBITDA for 2020 to be in the range of $365 million to $375 million, up from the previously disclosed guidance of $320 million to $345 million.

We also expect the EBITDA margin in 2020 to be higher compared to 2019. This revised guidance assumes full year exchange rate of 1.35. Capital expenditures are expected to remain in the range of $45 million to $65 million in 2020.

I would also like to add some color for 2021. While the impact of the ongoing COVID-19 pandemic on the demand for the company’s product remains uncertain, based on the company’s current expectation and assuming stable currencies, management is forecasting healthy sales for 2021. Utility pole sales are expected to increase in the mid-to-high single digits compared to 2020, while railway ties sales and industrial product sales are projected to be relatively comparable to those generated in 2020.

The demand for new construction and outdoor renovation project is expected to be strong in 2021, which should continue to benefit sales in the company’s residential lumber product category.

While the current context has created some headwinds, our M&A pipeline is active and we continue to pursue North American acquisition targets that will strengthen our position in our core product categories.

The company’s strategic vision focused on network efficiencies and continental expansion remains intact. We believe that the long-term fundamentals of each product category will stay strong.

We are committed to delivering sustainable long-term value to our shareholders and our healthy financial position allows us to take advantage of internal growth and acquisition opportunities, as well as returning capital to shareholders.

This concludes our prepared remarks. We will now be pleased to answer any questions you may have.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from Hamir Patel of CIBC Capital Markets. Your line is open.

Hamir Patel

Hi. Good morning.

Eric Vachon

Good morning, Hamir.

Hamir Patel

I think, logs and lumber was quite a bit higher than we expected. I know it’s usually a very low margin category. But just given the sharp move in lumber in the quarter, was there a meaningful EBITDA contribution there this quarter?

Eric Vachon

Yeah. It’s a very good question, Hamir. So, yeah, so the price did increase because of the market prices. So you understand that — those dynamics. But we did realize a bit of margin in that product category already this quarter. Nothing, I would say material, but it did help the bottomline.

Hamir Patel

Okay. Great. Thanks, Eric. And your Q4 guide seems to be implying around $50 million to $60 million of EBITDA. I’m just curious what sort of year over year comps that might be building in for res lumber. It doesn’t seem like you’re treated prices have yet come off with your largest retailer. So — and all indications are volumes are likely still going to be up year-over-year. So what assumptions do you have there?

Eric Vachon

Yeah. Great. Well, a few items there to call out. I would say now that we’ve got October behind us, I do have a strong feeling that we will then in the upper part of our guidance at this point. With regards to residential lumber, keep in mind, you’re completely right that our sells prices to our customers in Canada will trend downwards at a slower pace than what we’ve seen in lumber market prices.

However, we also have a good portion of our business in the U.S., which adjusts every week on a regular basis to market prices. So that has a bit of that downturn effect. Also remember that, although, we do expect the stronger volumes into residential lumber for the fourth quarter, it’s not our highest quarter thus far as volume goes.

A couple of other things I’d like to point out is that, although, we’d had strong sales in our utility pole business in the third quarter, as we see in our MD&A it was generated by project related volumes, but also with the sales of more fire-resistant utility poles.

The maintenance piece of it was actually slightly down in the quarter, but it was offset by demand that was driven by West Coast wildfires and storm events. So we’re still seeing a bit of spotty demand on the maintenance front in the third quarter. It has gotten better than what we’ve seen in the second quarter. But the uptick, I guess, in COVID cases that we’ve seen in the last month, have create — still creates a bit of that cautious approach.

And last but not least, I just want to point out that, we do expect higher year-over-year SG&A expenses in 2020 and essentially stemming from the fact that we’re in the midst of our ERP implementation and we are incurring some one-time costs as far as staffing and to be able to properly support the project transition.

Hamir Patel

Yeah. Great. Thanks, Eric. And just a final question for me, for 2021 before any potential M&A, do you think total EBITDA next year could be in line or higher than the ones in the $365 million to $375 million range that you’re guiding for this year?

Eric Vachon

So, I mean, I’d like to point out that, in — actually next week, I’m meeting with the whole team at Stella-Jones CMT [ph] virtually as we’re doing our budget planning for next year. It’s a bit early to come up with that guidance. But I like the fact that you’re thinking it could be similar or a bit higher, but I don’t want to, at this point, jump into it. We will be quantifying that a bit better in our — when we come up with our Q4 results.

Hamir Patel

Yeah. Fair enough. Thanks. Thanks, Eric. That’s all I have.

Eric Vachon

My pleasure, Hamir.

Operator

Your next question comes from Walter Spracklin of RBC Capital Markets. Your line is open.

Walter Spracklin

Thank you very much, Operator. Good morning, everyone.

Eric Vachon

Good morning, Walter.

Walter Spracklin

So I was wondering if you could Eric, perhaps, guide us a little bit on vis — on your visibility into residential lumber? I know you’ve kind of — can you talk a bit about what your — how far out do you see with certain — with a good degree of certainty how sales are coming? The reason I ask obviously is with the big boom that we’ve got in renovations and so forth and construction that, where can you, and at what point, can you start to see that level off or come down on, as we go through the pandemic? Is this a number — is it weeks? Is it months? Just curious to hear your thoughts on how much visibility you have in that segment?

Eric Vachon

Certainly, Walter. So, in talking with our major customers for that product category. They are indicating a strong year for next year volume wise. To be fully transparent, they actually look at it six months at a time and they’re providing guidance that the — that H1 next year would be stronger than H1 of 2020.

So that being said, we’re actually now adjusting our capacity and our workforce to be able to address that demand. But so — our guidance really comes from discussions that we’re having currently right now with our customers.

But we’re also in the process of, I guess, firming up the program for 2021. So there’s lots of discussion going on with current customers and potential customers. I guess I would like to point out that, our ability to service our customers in 2020 has gotten us a lot of credibility in our industry.

And I would say that, although, Q3 was not an easy quarter, we had challenges with procurement, but we were able to supply our customers. And as a result, we have a feeling that with the current inquiries, that we have an opportunity to increase our market presence. So that also would contribute to the volumes into next year.

The pricing piece of it, obviously, as you know, I discussed for the previous caller, will tend to drop compared to what we’re seeing today. But it drops at a much slower rate. So it will enable us to sustain margins.

Walter Spracklin

That’s great color. Moving over to ties, covering the railroads, we’re keenly aware of a lot of congestion now, spiking demand for transportation services in general. Generally, that doesn’t allow for a lot of work to be done on maintenance repair, understanding that this is a vital and important part of safety. I know it can’t be indefinitely deferred. But I’m wondering if in an average year, where you might see some variants year-to-year in the amount of ties replaced in a given year, could we with the recent congestion and significant demand see it at the lower end for your customers given that congestion?

Eric Vachon

So for the Class 1 customers, 2020 would — I would say, would be the low end, as far as what we’ve seen in many of the recent years. A couple of weeks ago, at the Railway Tie Association Conference, most of the Class 1 presented or provided the indication for their 2021 maintenance in terms of volume and it’s pretty flat. It’s comparable year-over-year and that was part of we did our guidance for next year.

That being said, I agree with you. Actually, what is — I agree with you that there seems to be a pickup in traffic, which is typically a good thing, an increase in revenue over the mid-term would indicate most likely a bigger appetite to increase maintenance product — maintenance program. So that’s how we’re viewing it right now.

Walter Spracklin

That makes sense. Last question, Eric, looking at your shareholder return policy, obviously, having a very strong year here this year, looking at another strong year next year, does this change at all your capital allocation, if you look at how you distribute free cash flow after your growth CapEx, when you look at buying back stock, dividend increases and potential M&A. Judging by the pipeline you’re seeing in the M&A side now, how would you expect free cash flow post-CapEx to be divided up as you go into 2021?

Eric Vachon

Well, obviously, top of mind is the M&A. And I know we’ve — it looks like we will not have an M&A in 2020, although, we are working on a project right now and in discussions with a couple of other targets.

That being said, it is top of mind and when we say we want to expand our network and grow our North American presence. There is still opportunities for that and the opportunities are within reach. So that being said, it’s always top of mind.

To answer a bit better your questions, dividend is something that we discuss with the Board. The Board has a commitment of revisiting the dividend and have a continued approach and increasing it. I can’t speak for them. But given the strong cash flows, I think, my recommendation will be to increase it.

I would also like to provide our shareholders a bit of the benefit of the fact that we’re buying back shares. So for the same absolute dollars of dividend, you — we should technically be able to provide a higher dividend per share, since there is less shares. So that’s the way we’re viewing it.

And last but not least, the NCIB, so we’ve — we initiated our program in last August and we do intend to run it as a continuous program. So something that we don’t want to do a fast sprint in the short-term, just to spike it up. I think we want to run it as a regular program and keep deploying capital that way.

Walter Spracklin

That makes sense. Appreciate the time as always. Thank you.

Eric Vachon

My pleasure, Walter.

Operator

Your next question comes from Mark Neville of Scotiabank. Your line is open.

Mark Neville

Hi. Good morning.

Eric Vachon

Good morning, Mark.

Mark Neville

Good quarter. I guess my first question — it’s just around the guidance. I guess I’m just trying to square Q4 to the 2020 outlook. I guess if my math is correct, the implied guidance for Q4 EBITDA is roughly flat year-over-year. Again, I would think residential still up. So I think that would imply poles and ties are down. I mean you can correct me on that if I’m wrong. And then — but then the 2021 outlook for poles suggests sort of mid-to-high single-digit growth. So it just seems a little — again I’m just trying to — it seems a little counterintuitive or little I tried to square that. So if you can help me with that, I would appreciate it.

Eric Vachon

Yeah. Certainly. So for Q4, I mentioned earlier, it is few drivers there. I guess one of the items that could be unexpected is the fact that we will be having higher SG&A expenses, so that just drive the percentage down.

If you compared the percentage to 2019, I would argue that 2019 EBITDA margin as a percentage was much better than previous years. So I know we’ve been increasing pricing on poles and so on over the last three years to get better margins, but we’re still comping against a strong year.

Last but not least, there is a bit of the — in our guidance, as I explained for the maintenance on utility poles, it’s so uncertainty impact of COVID there. So we had a bit of a flattish approach there.

With regards to 2021 guidance for poles, I believe was the last part of your question, we do expect to see more of the fire-resistant pole volumes to increase. So that that would be a good — an additional contribution, if you wanted to our annual volumes. We do expect maintenance to — with our customers to resume for regular maintenance programs and we still see some healthy demand there as we have for the last several years.

And I would also argue that our market reach for utility poles is growing every year. We tend to be very competitive and be able to perform to win new customers over. So that would be a bit of the thought behind the guidance.

Mark Neville

Sure. And the mid-to-high single-digit for poles, that’s volume or that includes pricing?

Eric Vachon

That will be both.

Mark Neville

Okay. Sorry. It’s — yeah. Okay. Okay. And then, I guess, the fire-resistant pole volume. Is that, I mean, to you is that sort of more special project or is that sort of capture a portion of replacements as well? How should we think of that?

Eric Vachon

So, it does — it is part of the replacement, as we are looking at, I guess, the third year of wildfires on the West Coast, this year being the most significant one. It’s not really special project now. It’s part of our customers’ matrix, when they look at what they want to order. When they look at the region, where they got to install new poles, one of the line of questioning is it in area that is subject to wildfires and should we put or not the fire-resistant poles. So that’s where those customers, but we’re also gaining a lot of interest from other customers in North America for the same product.

Mark Neville

Okay. And I don’t know if you can share. But like roughly speaking, like how much higher is the price point on that?

Eric Vachon

No. You’re completely right. We don’t provide some indication. It is a value-added product obviously and since it has — there is — it’s more than the pole, obviously, their domestic goes around it, there is the labor, so it’s obviously a higher priced item.

Mark Neville

Okay. Maybe just one last one, sorry, but the G&A in the Q4…

Eric Vachon

Yeah.

Mark Neville

Is that sort of a one-time thing or is that like a structural increase or is it like catch up on comp and just illustrate what that is?

Eric Vachon

No. Well, there is a bit of catch up on comp, but we’re seeing that in our Q3 year-to-date numbers as well.

Mark Neville

Okay.

Eric Vachon

It’s really more in line with the efforts that we need to put into support our — the implementation of our new ERP system. So…

Mark Neville

Okay.

Eric Vachon

And you are completely right in that, we could see a bit of that, we will see a bit of that into next year and then it will curtail.

Mark Neville

Okay. All right. Thanks for taking the questions. Appreciate it.

Eric Vachon

Thank you.

Operator

Your next question comes from Mona Nazir of Laurentian Bank. Your line is open.

Mona Nazir

Good morning and congratulations on the quarter.

Eric Vachon

Thank you, Mona.

Mona Nazir

I’m just wondering if you could provide some greater insight into the residential strength, which continues to be significantly ahead of large home improvement players. I wish to breakout the 39% growth between volume and pricing. How are those two kind of lever sitting currently — sitting in Q3 and now sitting currently?

Eric Vachon

Yeah. Sure. To be clear, you’re talking year-to-date for the first nine months of 2020?

Mona Nazir

Whatever clarity you could provide?

Eric Vachon

Okay.

Mona Nazir

I was referring only — yeah. I was referring only Q3, but if you want to give me the whole year-to-date, that’s great.

Eric Vachon

I can give you both. So for the quarter, I would say, 75% is pricing and 25% is related to volume. But for the nine months of 2020, I would say, a third of it is related to pricing and two-third is related to volume.

Mona Nazir

Okay. That’s much appreciated. I’m grateful for the insight that you provided into the discussions that you’re having with the customer on the residential side. Because when I’m thinking about residential growth even anecdotally, everyone is putting in new fences every year even if work-from-home continues as there are some longevity to the products. You spoke about increasing your market presence. I’m just wondering does that mean you’re potentially moving more into the U.S. or you’re going to be keeping the kind of same footprint as you’ve had?

Eric Vachon

So the interest in our product offering and remember that in the residential there is treated lumber, as well as accessories, which are like composite decking and stair stringers and rail guards systems.

So the interest in our product offering has significantly increased over — through the year as we’ve been getting a lot of calls from, I would call, a non-current Stella-Jones customer is looking for pressure treated lumber this year.

And obviously, we service the customers that had agreements with us for the 2020 program, but a lot of these potential partners are calling us up now as we are scheduling our 2021 programs and we would like to become a partner with Stella-Jones.

That being said, there are current customers of which we don’t have 100% of the demand, which we service extremely well this year. Our customer satisfaction is very high, and therefore, we’re also potentially looking at increasing our part of the program with them for next year.

Mona Nazir

Okay. Perfect. Thank you. And just lastly for me, we saw significant reduction in leverage on a sequential basis. I know M&A was on slope just given some uncertainty, but we’re now eight months in from initial corporate shutdown. I’m just wondering if you’re — if there is greater comfort surrounding financials of targets, the due diligence process? And I know that you mentioned M&A is the area that you want — is the first area where you want to put some capital towards. I’m just wondering if those targets have changed over the last call it year-to-date?

Eric Vachon

Yeah. So the targets have not changed. And although we were still living with the presence of COVID in North America, daily numbers either stable or tend to increase. We are, I guess, in general terms, I’d like to believe we start learning how to live with that — in that context.

So that’s what’s driving forward the business. It might be at a slower pace. But we’re having regular exchanges with potential targets. So some due diligence is moving forward. It’s — taken it’s on course, but things are progressing. Did I answer the question, Mona?

Mona Nazir

Okay. Perfect. Yeah. That’s perfect. Thank you.

Eric Vachon

Okay.

Operator

Your next question comes from Benoit Poirier of Desjardins Capital Markets. Your line is open.

Benoit Poirier

Good morning, Eric, and good morning, Silvana, and congrats for the good quarter.

Eric Vachon

Good morning, Benoit.

Benoit Poirier

With respect to the previous question, the 75%, 25%, I think, you were referring to the mix between volume and pricing on the residential lumber, right?

Eric Vachon

Yeah. For the — yeah. So it was 25% for the nine months, 25%. No, sorry, it was for the quarter. I apologize. Let me…

Benoit Poirier

Yeah. Yeah. Exactly.

Eric Vachon

Let me take that over again. So for Q3 25% was volume increase, 75% was pricing, but for the nine months of the year, it’s reversed, if you want, it’s 33% on pricing and 66% on volume.

Benoit Poirier

Okay. And now, Eric, I know you’ve been looking at growing your exposure to non-big-box customer, now you have the better network to serve a better value. So, I would just be curious about how the mix between big-box and non-big-box customers has evolved?

Eric Vachon

I like your definition of big-box right, because some bigger retailers consider themselves big-boxes. But if we think about national banners if you want, like significant players in the market, it’s still a very strong mix. We do sell to certain buying groups and to smaller banners. But I would say it’s very heavily weighted towards a select few national banners.

Benoit Poirier

Okay. But did you see the same strength from the non-big-box retailer in the current market condition?

Eric Vachon

Definitely.

Benoit Poirier

Okay.

Eric Vachon

Definitely, Benoit. Look to be honest, we also — we will deal directly like certain independent owners that owns 10 stores, we’ll deal directly because it’s good volume if it’s regionally makes sense…

Benoit Poirier

Okay.

Eric Vachon

…. where our plants are and the strong demand has been across the border.

Benoit Poirier

Okay. And could you talk, Eric, a little bit about the market dynamics in the U.S. residential lumber and whether the strong performance you’ve been able to do in Canada, whether it could help you to better tap the U.S. market eventually?

Eric Vachon

Well, we’re definitely seeing as in Canada, when I look at our U.S. business, we’re definitely seeing increased interest in our product offering. The limitation there, I would say, is that we only have one facility in the U.S. that produces residential lumber in the Northwest.

So — and we’ve actually taken steps this year to increase the capacity at that facility to be able to produce more residential lumber. But to grow it significantly, we would need to add more production assets.

Benoit Poirier

Okay. And with respect to the sourcing of lumber, could you talk a little bit about your ability to secure lumber for next year and also your ability to ramp up production? And maybe, Silvana, how we should be thinking about working capital changes going through Q4 and next year as you rebuild the inventory?

Eric Vachon

All right. Thank you, Benoit. So I’ll take the first part and I’ll let Silvana answer the second part. So, you asked a great question. As procurement has been a key in the last six months and it’s the great relationship with our customers that has enabled us to properly read the market.

We might have paused maybe a week in early April as far as procurement, and question like, is there a market and how is this going to be driven. But we quickly got great market intelligence and we turned around and we never stopped buying lumber, which never got out — got us out of the pecking order at the sawmill.

So we’ve maintained our strong relationships throughout this sort of pandemic with the sawmills as we’ve been consistently buying from them. And that has helped us actually through the third quarter to be able to procure lumber to be able to treat and sell to our customers.

I’ll be honest, if I could have procured more lumber, I would have sold more in the third quarter. But that being said, it’s been a great quarter. And going forward, the relationship we’ve built and being able to sustain in the last month is carrying forward. So on that front I don’t see significant issues to be able to procure sufficient lumber.

Again that goes back to the partnership we have with our customers, because as we are trying to build inventory for 2021, there is a mix there of higher priced lumber and lower priced lumber, so as we’re averaging down our customers are working with us as well, which is greatly appreciated.

With regards to capacity, we’ve increased our ability to treat more at three of our facilities in Ontario, which has been greatly helpful and we’re currently structuring workforce to be well to add some production shifts through the whole of 2021 to ensure supply to our customers. I’ll let Silvana talk about working capital.

Silvana Travaglini

Yeah. For the fourth quarter, Benoit, we’re still expecting an inventory build of about $50 million. This is to support both the growth that we’re expecting in residential lumber and in utility poles.

It might be a little bit more limited depending on how the lumber demand continues to be. We have fairly strong in October. So the build might be a little bit more limited in — for residential lumber but overall we’re still forecasting at about $50 million. This is for the inventory built.

Just always keep in mind that our working capital in Q4 is also highly impacted by the drop in AR. As you know we do collect a lot of the higher sales of Q3 and while we have much lower Q4 sales.

Benoit Poirier

Okay. Okay. That’s great. And when you look at the fire retardantness opportunity, it seems that it’s slowly or gradually ramping up. Could you talk maybe about the overall percentage of revenue related to the fire retardantness technology and where do you see that market or opportunity evolving in the next five years.

Eric Vachon

So, Benoit, it’s — well, it’s — I was going to say it’s hard to quantify, but actually want to say, I don’t want to quantify, because we don’t disclose that level of detail. Needless to say there is interest. It’s a proven product now.

Some of the pools that were installed earlier in 2020 actually were subject to the wildfires. I can report that they actually very well performed in an actual situation, which is unfortunate. But we do have the proof and the testament that the product works.

So it’s — I guess it’s not a gadget that we’re selling and that it’s going to go away in two years. I think it’s here to stay. It’s something that’s proven. It works very well. So it will grow over time. So this quarter we are starting to introduce it in our discussion, because you’ll be hearing more about it.

Perhaps you could ask me that question next quarter. I might be able to quantify a bit better, as right now I have a sense of what we can do with this product next year. But as I said, we have our budget meeting next week and I’ll have — I’ll be able to button down a number of it a bit more tightly.

Benoit Poirier

Okay. That’s great color. Thanks for the time and congrats again.

Eric Vachon

Thank you, Benoit.

Operator

[Operator Instructions] Your next question comes from Michael Tupholme of TD Securities. Your line is open.

Michael Tupholme

Thanks. Good morning.

Eric Vachon

Good morning, Mike

Michael Tupholme

Eric, I don’t know if you’ve covered this already, but the breakdown of utility poles growth in the third quarter between volume and price, was that already provided, and if not, can you provide that?

Eric Vachon

No way. It wasn’t asked and it’s about 50-50, 50% pricing and 50% volume.

Michael Tupholme

Okay. Great. Thank you. And then you had mentioned that the maintenance demand piece has been somewhat sluggish. I gathered this is still sort of due to COVID and a reluctance to have holding back, I guess, a little bit in terms of some of the crews? Is that what’s driving that sluggish demand?

Eric Vachon

Yeah. Exactly. And that was — as I explained earlier was offset by demand. I was prompted by replacement, or should I say now, reconstruction demand for — that was generated after the wildfires and the storms in the Southeast U.S.

Michael Tupholme

Okay. And so the sluggishness on the maintenance side, if I can use that term again, does that create a pent-up demand type of dynamic whereby you think there is some catch up to occur or is it simply once it — once the crews are able to get back out and they ramp back up, it’s just sort of carries on at a more normal pace?

Eric Vachon

Well, first, I think, there is a lot of willingness from our customers to start doing some maintenance, because it’s part of their planning, it’s part of their budget and they need to execute it. So we’re definitely seeing willingness to sustain that activity.

Every year we forecast some growth in volumes. Could that be a bit higher because of pent-up demand or some of our customers wanting to get the work done within their budget or their fiscal year? That could be.

But nonetheless, if our customers’ objective is to reduce the average years — average age of the poles, we’ll get to it eventually. So if it’s not catching up next year, it might catch up over 24 months, but that means we will get done. So I’m not concerned that volume demand is not going away.

Michael Tupholme

Okay. And then similar to my first question, which was about the split between volume and price on the — in the third quarter for poles. When we look at your outlook for 2021 and you’re talking about mid-to-high single-digit type of growth for poles. Can you provide some indication as to how that would be broken down between volume versus price?

Eric Vachon

Yeah. We don’t — I don’t have that detail right now as I had high level guidance for what we believe is going to be our results next year. But it’s really in the next two weeks, where we’re going to do the deeper dive and then have that mix.

But I would tend to say that there is going to be volume in there and there is going to be pricing as we keep seeing fiber cost increases. So that will play in the mix as well, and then, obviously there’ll be a healthier mix, I would say, next year for the fire resistant wrapped poles.

Michael Tupholme

Okay. On the comment about higher SG&A, to be clear, is that being driven exclusively by the ERP costs or is there anything else driving that?

Eric Vachon

Well, year-over-year, it’s largely the ERP. Obviously, we do have a profit share program as this — we’re having a successful year. Those provisions will obviously be — get adjusted. But percentage wise it’s just fit into the historical. So I would say it’s largely driven by the ERP.

Michael Tupholme

Okay. So, and then on that — those ERP costs, is there any way to provide a bit of context around the magnitude of those costs on a quarterly basis? How long they last? And that we already start to see those in the third quarter, such that when we get into next year, we’re looking backwards. They will already be in there for sort of half of the year and it’s just really the other half that we’re comping against a tougher comp or just trying to kind of put all this into perspective?

Eric Vachon

No. No. Certain. So we did start seeing some of that in the third quarter of this year. I would indicate that you’ll be seeing actually something a bit stronger as far as expenses in the fourth quarter. So we will definitely be higher than what we’ve seen in Q3. The Q4 levels, I would say, would hold throughout of next year and then get curtailed at the end of next year, or I would say, early 2022.

So it — and it really comes back to extra headcount that we need to support activities as were freeing up employees to do the project, costs that we cannot capitalize on the project, because for accounting policy do not allow us to do so. So it’s driven by those type of expenses.

Michael Tupholme

Okay. And I have another chance to maybe look through everything in as much detail as I’d like, but is this quantified in your disclosure documents? And if not, can you provide some sense for order of magnitude for — on a quarterly basis?

Eric Vachon

No. We don’t quantify that necessarily, Mike, and I guess, we’d be addressing that when we come out with our quantify guidance for 2021 next quarter.

Michael Tupholme

Okay. Even just how much the ERP is per quarter? I mean the extra cost, you don’t have that or you can’t provide that at this point?

Eric Vachon

Again, it could be, call it, $2 million to $3 million per quarter.

Michael Tupholme

Okay. That’s helpful. Thanks. And I guess just lastly and it relates to all of that higher level though, if you look at — think about the margins for 2021, you’ve — for 2020, you’ve suggested you expect to be able to have comparable margins year-over-year. But if we look at 2021, I guess, you’ve got this — a little bit of this headwind here from these ERP costs. It sounds like you feel confident in your ability to hold the margins in on residential lumber even if pricing comes off. Just any — I don’t know is there any — I know you’re in your budgeting process, but any preliminary thoughts on margin performance next year relative to this year considering these ERP headwinds?

Eric Vachon

Yes. Well, first, Michael, our guidance for margin for this year is to be stronger than 2019. So year-to-date, we’re sitting at 15.6%. I’m sure you’ll be doing the math, but I’m sure you’ll end up, most likely in the high 14% for this year.

I would suspect 2021 to be similar, couple of factors, I do think we’ll be able to sustain margins on residential lumber, as we are dropping, I guess, potentially dropping our pricing next year to step function. It will be in line with our cost.

Although, there will be additional expenses that’s in the SG&A, we will not have those — these expenses we incurred this year related to the diesel hedges, because we don’t adjust for EBITDA. So those will be adjusting. So I do believe that we could end up with similar margins next year.

Michael Tupholme

Okay. I appreciate that. And sorry, Eric, I didn’t realize you had changed your guidance to higher. I was just…

Eric Vachon

That’s okay. Not a problem

Michael Tupholme

I misspoke there. Apologies.

Eric Vachon

Not at all.

Michael Tupholme

That’s all from me. Thanks.

Eric Vachon

Thank you, Michael.

Operator

Your next question comes from Maxim Sytchev of National Bank Financial. Your line is open.

Maxim Sytchev

Hi, Eric and Silvana. Good morning. How are you?

Eric Vachon

Good morning. Yourself?

Maxim Sytchev

Good. Good. Just was wondering if it’s possible to provide a clarification on, if you can quantify the EBITDA impact due to the gains on sale of inventory in the lumber business. I mean obviously there is a lot of volatility from pricing perspective?

Eric Vachon

Yeah. So we don’t detail margins and EBITDA. But I don’t know when you joined the call, but for the quarter, we did guide that it was 25%, our margin gain was 25% related to volume and 75% related to pricing.

Maxim Sytchev

Yeah. Yeah. Yeah. Forgot. Yes. Thank you. That’s very helpful. Thank you very much. And then in terms of circling back to M&A, I was wondering if you could quantify sort of the potential targets that you guys are looking at and maybe protocols of the most interest. I mean, I understand, obviously, it’s a fluid dynamic, but any color you might provide there if it’s possible?

Eric Vachon

Yeah. It’s — the targets we’re looking at, I’ll say, our range between — and it’s a wide range, I would say, between the $30 million and the $90 million kind of range. It — obviously different sizes of the customer of potential targets there, but as long as we haven’t negotiated a transaction, it’s difficult to pinpoint.

Maxim Sytchev

All right. Okay. No. That’s helpful. And any appetite on the resi side or looking at sort of the ties and retail [ph] sort of things?

Silvana Travaglini

Residential.

Eric Vachon

Oh! I’m sorry, residential lumber. I think, as of today as we’re adjusting capacity in Canada, where I think we’re very well served with our network of plants. In the U.S., it’s really a function of — it’s really a function of being able to get customer contracts, if I could for lack of better words in order not multiyear contracts, but their contracts, building new capacity, we’ve just added, I would say, a third player. I think there are two significant players in the U.S. market. If we want to position ourselves as a third player, we’d be creating a lot of pricing pressures in that market. So I think it’s — to your point, it’s most likely related to M&A.

The next question that comes to that is to the U.S. market is, residential lumber business is really a commodity-driven business with a margin profile that is more similar to building materials, I guess on the EBITDA and multiple side, which is not really what we’ve been able to achieve right now with our current residential footprint. So it’s a big question, because there’s lots of thought process that needs to go behind that and understand what the impact would be on our multiples going forward for such a transaction.

Maxim Sytchev

For sure. Okay. Excellent. Just want to double check and great color. Thank you very much.

Eric Vachon

Thank you very much.

Operator

There are no further questions at this time. I will turn the call back over to the presenters.

Operator

Eric Vachon

Thank you for joining us on this call today. We look forward to speaking with you again at next quarterly call.

Operator

Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect.

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