York Timbers – Innovative re-positioning to beat labour, Eskom

Two big issues that many South African companies are grappling were highlighted in this in-depth interview with York Timber’s CEO Pieter van Zyl. Labour costs and the need to mechanise to become globally competitive is one. Rising electricity costs is the other. On the first, York Timber’s problem is that while mechanisation would treble its sawmill productivity, the capital cost is double the company’s total value. In the meantime, the company’s margins are continuously squeezed by labour costs rising much faster than productivity (and inflation). But it is starting on what could be a long road with an initial R300m investment – a third of the current market cap. It is also taking steps to address rising electricity costs by using what is currently waste material to fuel an electricity co-generation plant that will produce more than double the 35 Mw the group consumes. It’s going to be a long haul. But there’s a lot to like about the way York Timbers is tackling its challenges. – AH  

ALEC HOGG: Pieter van Zyl, the Chief Executive of York Timbers is with us in the studio. York Timbers is a forest products enterprise and reported a rise in its revenues but the problem is happening at the bottom-line, earnings per share were down, due to reduced sawmill profitability and margins have been falling for years. I was just having a look, Pieter, at your presentation that you gave to the analysts this morning. It must be very hard to defend. Operating margins, in the last four years were, respectively, 17 percent, 15 percent, 14 percent, and nine percent. Your tangible nett asset value, in the last four years, up only 15 percent. That’s way behind inflation. Tough times for you guys?

PIETER VAN ZYL: I think, Alec, the forestry sector is facing a few challenges. The first one is from organised labour. If you look at the average labour rate increase, above CPI, we didn’t manage to get those cost increases through to the market. Then secondly, the utility cost is really impacting manufacturing business quite substantial. Those two elements had a major impact, on that bottom-line for us.

ALEC HOGG: Just unpack that for us. How much of your costs are labour related?

PIETER VAN ZYL: It is the biggest cost item on our income statement. We are a labour intensive operation. Traditionally, sawmilling in South Africa, the technology we have, depends heavily on your hand labourers, to handle the board and to do the normal, manual activity. We’ve stayed behind the rest of the world, where mechanisation has moved very forward and fast. To give you a comparable. We run at a linear meter speed anything from 60 to 70 meters, per minute.

ALEC HOGG: What does that mean?

PIETER VAN ZYL: A linear meter board speed means the speed at which a sawmill would normally run. The best technology out there today is anywhere between 150 to 180 meters per minute.

ALEC HOGG: So it’s treble.

The slide in the York Timbers share price will now put it onto the value investor's radar
The slide in the York Timbers share price together with its innovative approach on how to beat the labour and electricity challenges will now put it onto the radar of value investors.

PIETER VAN ZYL: Triple and this is the problem. Even people look at us, from a productivity point of view, York is rated at the top level of it, but the technology we’ve just fallen behind.

ALEC HOGG: So why haven’t you invested more in machinery?

PIETER VAN ZYL: I think York is a story of ‘three phases’. Before 2007, I think there was a lot of activity, corporate activity. It was first Mondi and then sold to Global, and then sold to York and the company had to go through a bit of a restructuring and a focus phase then. From 2007, unfortunately we had those bad incidents where the first, in a 100 year event, of the major fires that put the company a bit on the back foot Then we still sat with a one-point-two billion Rand debt package, with 12 consortium banks with high covenant levels. That forced the business to restructure, so we took from, let’s say from 2009…

ALEC HOGG: That didn’t just arrive. That debt package was entered into. That was how the company was put together in the first place.

PIETER VAN ZYL: Yes, but we lost 11 000 hectares of mature timber.

ALEC HOGG: Not insured?

PIETER VAN ZYL: At that stage, it was not insured. Today, all our plantations are insured.

ALEC HOGG: Why would it not have been insured?

PIETER VAN ZYL: I think it is maybe a bit of an oversight. The premiums are very high, at that stage. It’s a premium for a…to insure a forestry asset, like us, is anything in the region of R15m to 25m a year.

ALEC HOGG: But if I go and borrow money against my house, I have to insure it. You borrowed R1.2bn and you didn’t insure your plantations.

PIETER VAN ZYL: I think that was a lesson learnt.

ALEC HOGG: Well, by the banks as well. At least they kept you going though. With my house, they probably would have taken it away.

PIETER VAN ZYL: Let me say this, our shareholders backed us. We did a ‘rights issue’. We reduced the debt package. We refinanced it. We put more acceptable covenant levels into the business, so that’s all par, up to now, where we were. Then we had to find a growth strategy. What are we going to do with this asset? You know, it’s got a beautiful, strong plantation and we’re sitting with a bit of old processing technology, which is actually the opening end of the EBITDA generation. So we’ve worked since, let’s say 2012 on an investment strategy and we are now there to start that phase. The first R300m investment is going in now, to upgrade our existing powered plant.

ALEC HOGG: How much do you need to completely, modernise in the same way, as a North American plant would?

PIETER VAN ZYL: I think we’re looking in the region, a total Capex over a four-year period, anything in the region of R1.2bn to R1.8bn.

ALEC HOGG: How much of that has been approved?

PIETER VAN ZYL: Of this stage, the first R300m phase has been approved by the Board.

ALEC HOGG: So you’ll start with R300m, show what it can deliver and then, possibly continue?

PIETER VAN ZYL: Yes and then go to shareholders with this. Yes, and I think the big thing York needs to prove to shareholders that our returns can be there. Looking at our results, it is moving sideways. One impact on our margin was the wholesale business we did buy but there’s a strategic reason behind it. If you look at the sectors, we are not a dominant but in a stronger position. We obtained the margins and we showed improved EBITDA but it is in the lumber side, where sawmills are struggling because that industry is very fragmented. There’s more buyer power and we are struggling to get our prices up. On our compounded annual growth rate, volumes moved 4.3%, so we’re selling more cubic metres of lumber but the price has only increased by 2.3%.

ALEC HOGG: Way below inflation.

PIETER VAN ZYL: That’s the problem. We could not get that back.

ALEC HOGG: Your strategy sorts out the labour issue clearly, but unfortunately people are going to be retrenched, but you are going to be more efficient through the investment in plant and machinery.

PIETER VAN ZYL: Yes.

ALEC HOGG: What about the utility issue, the electricity prices?

PIETER VAN ZYL: We’ve learnt a lesson; you know the plants were built in the old days, with huge inefficiencies, an over-capacity of machines. The way you start up your electricity, your use of lighting in your plants. We’ve learnt a lot. I think from an energy conservation and efficiency point of view, we cater all, for this in the new upgrade of these plants and we are also going to put up a co-generation facility. This whole Capex that we talk about is not just sawmills. It goes about a co-generation facility and also, to add value to it, there’s the residual product, which we don’t, actually we pay the fibre processing guys to take that product from us, and all of that goes towards, to enhance or to create more value, from your timber resources.

ALEC HOGG: So you are going to use the fibre that, at the moment, you pay people to take away, to generate electricity.

PIETER VAN ZYL: Correct. That’s the one element of it. Then the other one is to potentially put up a medium density fibreboard plant. If you look internationally, solid wood timber is used less and less. They use more of this composite wood, as they refer to it, which is your parquet flooring, interior decorating stuff, and we believe that market has got a huge potential, going forward.

ALEC HOGG: So what’s happened to the value of trees? If I owned a plantation for instance, that was handed down to me over the generations, would that have gone up in value in the last year or gone down, given that lumber prices are rising at less than inflation?

PIETER VAN ZYL: Yes, this is an interesting scenario. On the locked price, as timber, prices of trees went up above inflation but lumber prices did not.

ALEC HOGG: Who is buying it then? Who’s buying the trees?

PIETER VAN ZYL: I think there’s a huge retailer dominance on price. If you look at the mark up that they make on lumber. It is anything in the region from 24 to 56 percent, which these guys mark lumber up. It is much higher than any other building materials. Purely from it’s a fragmented base and they can play with us, against each other. On the lock side, South Africa has this finite resource, and that does not grow. The availability of solid wood/timber for processing guys like us is limited, so we all still fight for that raw material resource but we did not manage to get the price through. On the plywood side, we managed to pull the price back. On the eucalyptus side that we sell out to other users of the product, we managed to pull the price back.

ALEC HOGG: That’s an interesting story, Pieter, and just to close off with, the cogeneration that you’re talking about, how much of your electricity will be provided by that?

PIETER VAN ZYL: We use in the region of 15 megawatts electrical energy as a group. The plant’s scope is for up to 35, so we’ll be a net contributor into the grid.

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