Stella Jones : Q1-2021 MD&A

MANAGEMENT'S DISCUSSION & ANALYSIS

Three-month period ended March 31, 2021 compared with the three-month period ended March 31, 2020

The following is Stella-Jones Inc.'s management discussion and analysis ("MD&A"). Throughout this MD&A, the terms "Company" and "Stella-Jones" shall mean Stella-Jones Inc. with its subsidiaries, either individually or collectively.

This MD&A and the Company's condensed interim unaudited consolidated financial statements were reviewed by the Audit Committee and approved by the Board of Directors on May 2, 2021. The MD&A provides a review of the significant developments, results of operations, financial position and cash flows of the Company during the three-month period ended March 31, 2021 compared with the three-month period ended March 31, 2020. The MD&A should be read in conjunction with the Company's condensed interim unaudited consolidated financial statements for the periods ended March 31, 2021 and 2020 and the notes thereto, as well as the Company's annual audited consolidated financial statements and MD&A for the year ended December 31, 2020.

This MD&A contains statements that are forward-looking in nature. Forward-looking statements include, without limitation, the financial guidance and other statements contained in the "Updated Outlook" section below, which are provided for the purpose of assisting the reader in understanding the Company's results of operations, financial position and cash flows and management's current expectations and plans (and may not be appropriate for other purposes). Such statements are based upon a number of assumptions and involve known and unknown risks and uncertainties that may cause the actual results of the Company to be materially different from those expressed or implied by such forward-looking statements. Such items include, among others: general economic and business conditions (including the impact of the coronavirus [COVID-19] pandemic), evolution in customer demand for the Company's products and services, product selling prices, availability and cost of raw materials, changes in foreign currency rates, the ability of the Company to raise capital and factors and assumptions referenced herein and in the Company's continuous disclosure filings. Unless required to do so under applicable securities legislation, the Company's management does not assume any obligation to update or revise forward-looking statements to reflect new information, future events or other changes after the date hereof.

The Company's condensed interim unaudited consolidated financial statements are reported in Canadian dollars and are prepared in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board ("IFRS") and Chartered Professional Accountants ("CPA Canada") Handbook Accounting - Part I, applicable to the preparation of interim financial statements, including IAS 34, Interim Financials Reporting. All amounts in this MD&A are in Canadian dollars unless otherwise indicated.

This MD&A also contains financial measures which are not prescribed by IFRS and are not likely to be comparable to similar measures presented by other issuers. These measures are as follows:

• Gross profit: Sales less cost of sales
• Gross profit margin: Gross profit divided by sales for the corresponding period
• EBITDA: Operating income before depreciation of property, plant and equipment, depreciation of right- of-use assets and amortization of intangible assets (also referred to as earnings before interest, taxes, depreciation and amortization)
• EBITDA margin: EBITDA divided by sales for the corresponding period
• Operating income margin: Operating income divided by sales for the corresponding period
• Cash flow from operating activities before changes in non-cash working capital components and interest and income taxes paid
• Net debt: Sum of long-term debt and lease liabilities (including the current portion), short-term debt less cash and cash equivalents
• Net debt-to-EBITDA: Net debt divided by the trailing 12-month EBITDA

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Management considers these non-IFRS measures to be useful information to assist knowledgeable investors to understand the Company's operating results, financial position and cash flows as they provide additional measures about its performance.

Additional information, including the Company's Annual Information Form, quarterly and annual reports, and supplementary information is available on the SEDAR web site at www.sedar.com. Press releases and other information are also available in the Investor Relations section of the Company's web site at www.stella-jones.com.

OUR BUSINESS

Stella-Jones Inc. is a leading producer and marketer of pressure-treated wood products. The Company supplies North America's electrical utilities and telecommunication companies with utility poles and the continent's railroad operators with railway ties and timbers. Stella-Jones also manufactures and distributes residential lumber and accessories to retailers for outdoor applications, as well as industrial products which include wood for railway bridges and crossings, marine and foundation pilings, construction timbers, laminated poles and coal tar-based products. The Company's common shares are listed on the Toronto Stock Exchange (TSX: SJ).

As at March 31, 2021, the Company operated forty wood treating plants, twelve pole peeling facilities and a coal tar distillery. These facilities are located in six Canadian provinces and nineteen American states and are complemented by an extensive distribution network across North America. As at March 31, 2021, the Company's workforce numbered approximately 2,260 employees.

Stella-Jones possesses numerous key attributes and competitive strengths which should continue to enhance the Company's strategic positioning in the wood treating industry and enable it to generate maximum value for the Company and its stakeholders:

Resilient business model

• Portfolio of businesses with steady demand
• Leadership position in product categories served
• Decentralized organisational structure with the capability to rapidly adjust to changing environments and meet urgent customer requirements
• Extensive network to service customers from multiple plants across North America
• Solid and sustained customer relationships
• Long-standingstable sources of wood supply and a registration to produce the wood preservative, creosote
• Established track record of delivering solid results

Seasoned management team

• Extensive industry expertise in all divisions throughout North America
• Consistent record of successful acquisition integration and synergy capture
• Entrenched culture of entrepreneurship balanced with a focus on environmentally sound and sustainable practices

Solid financial position

• Strong cash flow generation and low levels of debt
• Financial capacity to stockpile and air-season green wood for major contracts
• Financial strength and flexibility to support growth opportunities.

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OUR MISSION

Stella-Jones' objective is to be the performance leader in the wood preserving industry and a model corporate citizen, exercising environmental and social responsibility and integrity.

Stella-Jones will achieve these goals by focusing on customer satisfaction, core products, key markets, innovative work practices and the optimal use of its resources.

Stella-Jones is committed to providing a safe, respectful, inclusive and productive environment for its employees, where problem solving, initiative and high standards of performance are rewarded.

OUR STRATEGY

Stella-Jones' strategic vision is focused on enhancing the Company's presence in its core product categories, through network efficiencies, innovation and accretive acquisitions, while seeking other strategic opportunities that leverage the Company's footprint, customer base, fibre sourcing and other competitive strengths. As one of the leading providers of industrial treated wood products, Stella-Jones generates consistent value for shareholders, and recognizes the need to integrate environmental, social and governance considerations in key decisions and strategies to enhance its business resilience and contribute to long-term value creation.

Capital Management

The Company's capital allocation strategy leverages its consistent and strong cash flow generation while enhancing its long-term stability and shareholder value creation. To maintain the Company's strong financial position and financial flexibility, capital is deployed in a disciplined manner, balancing growth investments and the return of capital to shareholders. The Company will:

• Invest in capital expenditures in the range of $50 to $60 million annually, to maintain the quality of its assets, the safety of employees and the environment, as well as support organic growth, innovation and productivity;
• Pursue accretive acquisitions that enhance the Company's strategic positioning and drive future earnings growth;
• Maintain a durable dividend payout, targeting dividends equivalent to 20% to 30% of the prior year's reported earnings per share; and
• Return excess free cash flow to shareholders through share repurchases.

As part of its capital allocation approach, Stella-Jones targets a net debt-to-EBITDA ratio between 2.0x and 2.5x. but may deviate from its leverage target to pursue acquisitions and other strategic opportunities, and/or fund its seasonal working capital requirements.

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The Company's capital allocation since 2016 is summarized below:

COVID-19 PANDEMIC

Critical to the integrity of the supply chain for utility, railroad and the construction industries, all of Stella-Jones' North American facilities have remained operational during the COVID-19 pandemic. The Company continues to reinforce measures to mitigate health risks to its employees, business partners and communities where it operates and to prevent disruptions. These measures include rigorous hygiene and cleaning practices, physical distancing policies, health monitoring and testing protocols, business travel restrictions as well as remote working. To date, the Company has not experienced a material disruption to operations, and it has not incurred significant increases in costs as a result of COVID-19. While the Company's first quarter 2021 results were strong, the impact of the ongoing COVID-19 pandemic on the demand for the Company's products, as well as on the Company's operations and those of its suppliers and customers remains uncertain and cannot currently be predicted. The duration and scope of the COVID-19 pandemic and the varying actions taken by government authorities and other businesses to reduce the spread could directly or indirectly disrupt the Company's operations and/or those of its suppliers or customers, which in turn, could adversely impact the business, financial position, results of operations and cash flows of the Company. Please refer to the Updated Outlook section for further details.

HIGHLIGHTS

Overview - First Quarter of 2021

Sales in the first quarter of 2021 were up 23% to $623 million, compared to $508 million in the first quarter last year. Pressure-treated wood sales rose by $79 million and sales of logs and lumber increased by $36 million. The increase in pressure-treated wood sales was primarily driven by the combination of record level market prices of lumber and the continued robust demand for residential lumber products. The upward momentum in the market price of lumber also explains the increase in sales of the logs and lumber product category.

Driven by the strong sales growth, EBITDA increased by 57% to reach $99 million, or a margin of 15.9%, up from $63 million, or a margin of 12.4% in the corresponding period last year. Operating income rose by 82% to $82 million, while net income doubled to $56 million, compared to the first quarter last year.

During the period ended March 31, 2021, Stella-Jones used its liquidity to support higher working capital requirements, invest in its property, plant and equipment and repurchase shares. As at March 31, 2021, the Company maintained a solid financial position with a net debt-to-EBITDA ratio of 2.2x.

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Financial Highlights - First Quarter of 2021

Certain prior period figures were adjusted to recognize customer freight revenues on a gross basis when the Company is the principal with respect to freight services. This change in classification from cost of sales to sales did not affect previously reported operating income and net income in the consolidated statements of income. Please refer to Note 10 in the condensed interim consolidated financial statements for the three-month periods ended March 31, 2021 and 2020.

	Selected Key Indicators
	(in millions of dollars except margins and earnings		Q1-21	Q1-20	Variation ($)	Variation (%)
per share ("EPS"))
Operating results
Sales(1)	623	508	115	23%
Gross profit(2)	112	83	29	35%
EBITDA(2)	99	63	36	57%
EBITDA margin(2)	15.9%	12.4%	n/a	350 bps
Operating income	82	45	37	82%
Net income	56	28	28	100%
EPS - basic & diluted	0.85	0.41	0.44	107%
Cash Flows from (used in)
Operating activities	(141)	(93)	(48)
Financing activities	155	99	56
Investing activities	(14)	(6)	(8)
Financial position	As at	As at	Variation ($)
			March	December
			31, 2021	31, 2020
Inventories	1,166	1,075	91
Short-term debt	137	-	137
Long-term debt(3)	663	606	57
Lease liabilities(3)	135	139	(4)

1. Comparative figures have been adjusted to conform to the current period presentation.
2. This is a non-IFRS financial measure which does not have a standardized meaning prescribed by IFRS and may therefore not be comparable to similar measures presented by other issuers.
3. Including current portion.

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