Earnings Call: Q3 2020

Nov 5, 2020

Morning, ladies and gentlemen, and welcome to the 20 23rd Quarter Results Conference Call for Russell Metals. Today's call will be hosted by Marty Juravsky, Executive Vice President and Chief Financial Officer and John Reed, President and Chief Executive Officer of Russell Metals Inc. Today's presentation will be followed by a question and answer period. I will now turn the meeting over to Marty Jurafsky. Please go ahead. Great. Thanks, Chris. Good morning, everyone. I plan on providing a brief overview of the Q3 highlights to give a context around the key business developments. If you want to follow along, I'll be using the PowerPoint slides that were posted last night to our website. Just go into the Investor Relations section, conference call part of the website. If you go to Page 3, you can read our cautionary statement regarding forward looking information. So let me begin with on Page 5 with a few summary observations. This has been really unprecedented times with the changing business landscape. That being said, we couldn't be more proud of how everyone in the Russell family has worked together during these past several quarters. I think it is a real strong testament to the culture that we have within Russell. In specific relation to Q3, we are really pleased with what our team was able to accomplish and specifically how we adapted to these evolving market conditions. So talking for a few minutes about market conditions. Q3 was a lot different than Q2 as we saw the gradual but continuing improvement across all of our business units. The activity level improved not just in Q3 compared to Q2, but also during the Q3. As a bit of a specific example, our service center volume in September was higher than the Q3 average and that gradual improvement that we saw in activity levels has continued into the early part of Q4. In addition, the underlying steel prices that started to pick up quite nicely towards the tail end of Q3. The effect of that is really bit of a lag element and those prices that were flowing through to our part of the supply chain, we should start to see that effect kicking in, in Q4. 2nd topic is business optimization. We continue to refine our portfolio in a number of ways. We sold some real estate in BC that was part of the rationalization program for that region and we realized $10,000,000 of proceeds. OCTG and line pipe. We talked in the past about a focus to reduce that footprint over a 12 to 18 month period. We have an inventory reduction target of about $100,000,000 In Q3, we are pleased that we achieved $31,000,000 towards that goal and we remain committed to the target. We obviously have a little bit more work to be done on that front. We've also further rationalized some small unprofitable locations. This will reduce costs and further streamline the management of our inventories in other parts of the business. In addition, our focus has always been for the last number of years on value added processing and that continues to be an ongoing initiative. We completed the Trenton project in late in Q3 and we see the business backlog for that operation continuing to grow very nicely. We've got 2 more laser projects in the U. S. Out there being scoped out for 2021. These are the types of projects that allow us to add value for our customers, gain market share, improve margins and generate really nice paybacks. We're generally targeting paybacks of less than 3 years for these type of projects. Liquidity and capital structure. With $81,000,000 of cash from operating activities in Q3, liquidity greater than $500,000,000 and a cash position that was over $120,000,000 We had the opportunity to make some improvements to our debt structure. So over the last little bit, we have completed a number of initiatives. We extended our bank deal under favorable arrangements. The borrowing costs under our bank lines is less than 3% today. We're in the process of redeeming $300,000,000 of our 6% notes that were due in 2022 and this is financed is being financed with cash, bank loan borrowings and a new issuance of longer dated and lower cost notes. The net result is that we will have extended our maturity by several years, improved our credit profile, give us a little bit more flexibility, and equally important, reduce our interest costs by about $8,000,000 per year. So if we go forward now to Page 8 to talk about some of the financial highlights from the quarter, let me start with a few items from an income statement perspective. If we look at Q3 versus Q2 2020, we did see quarter over quarter improvement in sales, EBITDA, EBIT and EPS. Gross margins percentage remained pretty steady at around a 19% level. The one macro observation that I would make in terms of the quarter is that when we look at our expense management philosophy and the flexible business model being core features of our culture, we saw that play out in Q3. Our Q3 employee expenses came down versus Q2 as headcount management and our variable comp model continued to adjust to market conditions. A few other items of note for Q3, some of which were positive, some of which were negative, but we wanted to highlight a number of these items for discussion. 1, wage subsidies were just below $20,000,000 for the quarter, which is a level that was very comparable to Q2. We think this government program was very helpful in creating bit of a buffer time period to adjust to the evolving conditions and allow for markets to recover and internal cost structures to adjust to the circumstances. Property sales of $10,000,000 which I mentioned a little bit earlier, resulted in a gain of $6,000,000 We had some pre existing capital loss carry forwards, so most of that $6,000,000 was shielded from tax. In terms of some incremental costs for the quarter, we're starting down the path of a new ERP project. This is the Q1 where we've discussed magnitude of the cost as the project just started off in July. The cost for the quarter were around $2,000,000 for the quarter, and we expect that order of magnitude to continue through to 2021 with the implementation plan for early 2022. We've always focused on systems as a key factor to managing our information and working capital effectively, and this project is part of that ongoing focus. Lastly, we had a couple of non cash expenses that negatively impacted EBITDA. We provided for a $2,000,000 increase in our energy reserves. And in addition, there was a $2,000,000 expense related to stock based compensation. That's a mark to market adjustment. And in the quarter, our stock price went up by about $2 a share, which resulted in that increased expense for purposes of mark to market. From a cash flow perspective, dollars 41,000,000 reduction in working capital with the biggest shifting from inventory to about $67,000,000 That reduction of inventories was across all of our business segments, but the energy side was the largest as we have a targeted path to reducing that footprint, as I've mentioned earlier. Accounts receivable moved up by $19,000,000 as a function of improved business activity and sales, but our credit metrics continue to track really well and the pace of collections remain strong. CapEx about $6,000,000 is relatively modest. From a balance sheet perspective, net debt declined from $368,000,000 at the end of Q2 to $324,000,000 at the end of Q3, dollars 44,000,000 reduction. As a result, we are sitting on a net cash position of $122,000,000 at the end of Q3. And as I discussed earlier, this provided a really nice opportunity for us to redeem our 6% notes that were due in 2022 and the process reduce our interest expense. For shareholders' equity, there's an accounting adjustment because of the FX shift at the end of Q3 versus the FX at the end of Q2. Final item, we've declared our quarterly dividend of $0.38 per share. Bottom line is that we have made really nice progress in this quarter and in the last quarter as well in undertaking a number of initiatives. Those initiatives are focused around driving free cash flow. Notwithstanding the fact that I believe that we've made really nice progress, I think there's still more on the come. We flip to the next page to Page 7, we include some of our segmented P and L information. The service centers did really well as the market improved. Our revenues increased and our gross margins held in at 21%, and we did generate a higher operating profit in Q3 versus Q2. Hunchip were up 9% versus Q2, which is actually better than the industry data that we have seen, so we continue to make inroads in terms of gaining market share. Price realizations were down 3% in Q3 versus Q2 of this year. As I mentioned earlier, there is a lag effect in terms of steel price increases and we expect that to be realized as we move into Q4. In Energy, the market conditions, revenues, operating profit improved versus Q2, but remain challenged versus historical levels. As I mentioned earlier, the focus is on inventory and cost containment generally with an emphasis on downsizing the line pipe OCTG part of that business. In the quarter, the field stores realized an $8,000,000 profit, whereas the OCTG line pipe loss was $6,000,000 We're starting to see improvements in the pipe pricing part of that business into the early stages of Q4, which is helpful as we use that inventory in a prudent and thoughtful manner. Our distribution had a very comparable results in Q3 versus Q2. If we go to Page 8, we have segmented inventory information to provide a frame of reference for some of our recent capital allocation shifts. If you look at our segmented inventories, it declined from $884,000,000 at the end of the year to $790,000,000 at the end of September or $94,000,000 reduction. The biggest portion of this decline is in the energy, generally in OCTG line pipe in particular. As we continue to adjust our portfolio composition going forward, I expect to continue to shift in the coming quarters. In terms of outlook, let me just give a couple of summary observations. 1, the market is better today than it was 3 months ago with the early signs in Q4 more promising. That said, we often do see some seasonal slowdown as we get to the latter part of the quarter given the Christmas and year end period and fewer operating days at that point in time. But secondly, and perhaps more importantly, we have a lot of flexibility built into our business model as well as the enhanced flexibility on our capital structure. Therefore, we're really well positioned to adapt to the economy as well as take advantage of opportunities. So in closing, on behalf of John and other members of the management team, I'd like to express our appreciation to everyone within the Russell family for their tremendously hard work and nice accomplishments over the course of the past quarter. That concludes my introductory remarks. Chris, if you could open the line now to any questions, that would be great. Your first question comes from Mona Nazir, Laurentian Bank. Mona, please go ahead. Good morning and thank you for taking my questions. Just firstly here, we're seeing some sequential improvement, revenue contraction in kind of the high 20% range versus 37% in the prior period. In your outlook commentary, you stated that you're seeing some improvement, particularly in the latter part of Q3 that may not be fully depicted in quarterly results. I'm just wondering if you could speak about revenue contraction exit rates or where things are sitting currently? Thank you. Sure, Mona. Hey. Yes. So your comment about exit rates, I think that probably the best way to characterize that is particularly on the service center side of it. We saw within the Q3 progression during the quarter. Or said another way, the September activity was actually at higher volume than we saw for the Q3 average. And generally speaking, we saw August was higher than July, September was higher than August and September by definition then was higher than the Q3 average. In fact, when we look at September of this year, our volumes were very, very similar to September of last year. So notwithstanding in a whole bunch of noise and a whole bunch of moving pieces, our exit rate coming out of the quarter using September as a benchmark was quite nice. We are starting to see some of the data points for Q4 continuing on with that same path. So we've never had a view that this is going to be a step function change in terms of economic recovery. But the way we've been characterizing it is a slow and gradual recovery. And we've seen that through Q3 and we're starting to see it in the early signs of Q4 as well. Thank you. Your next question comes from Michael Doumet, Scotiabank. Michael, please go ahead. Hey, good morning, Marty. Good morning, John. Good morning, Mike. Hey, so just starting on the MSC margins. I mean, I guess, we're not for the Qs of $20,000,000 in the quarter. I'm assuming there would have been alternate cost actions. So I'm just trying to get a sense for or maybe a little bit more clarity on the underlying margin performance. And I guess maybe another way to ask, as we go into Q4, steel price is up and volumes improving, could we expect MSC EBITDA margins to fall within the more typical 5% to 6% range, let's say, excluding Houston? So let me give a couple of data points to break that down before I give you the answer. So when we talk about the $20,000,000 a little less than $20,000,000 in the wage subsidies for the quarter, that was across all of our businesses. Probably about $14,000,000 $15,000,000 of that was related to the service center part of the business. So if you want some segmented constructs, that gives you a little bit of magnitude. That being said, there are a bunch of moving pieces, though. So that is a piece that is migrating down, but at the same time that other things are migrating in a different direction, volume is picking up, pricing is picking up, margins are picking up, which is why we cannot look at an individual data point in isolation. We look at it kind of holistically. But directionally, you're right. If you just took that line item out and assumed everything else being equal, the margins would come down. But we're actually looking at it where there's other things that are mitigating effects going the other direction. Got you. No, that's helpful. And then maybe into Q4, just a little bit of a sense just with the moving parts that we have to consider typically when steel prices have moved up as much as they have, the volumes, given your comments around September, Just to push you a little bit harder, should we get margin sort of go back to the normal rate in the next quarter? Or do we have to wait a little bit into 'twenty one to see that happen? So Michael, I think we're moving back to that direction pretty quickly back to normal margins. Actually improved gross margins in the service centers due to our value added process. So I think you'll see that in the quarter. The demand is improving. If you use the steel mill, production rates as a proxy, they went from 60% to 70%. I think that you're seeing a broader industry move in a similar fashion. But we are seeing margin improvement. We are seeing steel prices increase. As Marty said earlier, as we've talked on previous calls, you're aware that Canada is a slower turn inventory just because of the logistical challenges to get product into Canada from the United States or from others. So it's about a 4 turn inventory, so that lag really hit us late September. So we're starting to see those margin improvements now. Again, we turn quicker than our competition in both the U. S. And in Canada. So we'll work through that, but we are definitely seeing those improvements. And I think you can use a normal gross margin percentage and a more similar bottom line margin percentage for Q4. That's great. That's great. Thanks, guys. And I appreciate it. So maybe just turning to the energy business or just the OCTG. I mean, you've done a great job there drawing down capital. And Marty, into your comments, there's more to go. I guess this is a bigger picture question. I mean, do you think you can reinvest the capital back into the business and maintain the company's overall earnings power? I mean, if you look back to the last cycle, call it 2015 to 2018, operating income averaged about $200,000,000 So do you think you can reallocate capital and maintain those profit levels or near those profit levels through the next cycle? Yes, I think so. If you look at this cycle in 2018, OCP, Jim, Lime Pike were a large contributor. Their returns were subpar compared to the rest of our business. I think you looked across the all segments of our business. So we think we can through our value added processing, potential acquisitions. So we think we can reallocate that into a position for us that's going to put us on an improved return for our shareholders. Right. And if I can just Just the related point too that I'd say is, it's also going to reduce the volatility. There's some nice highs, but there's some lows as well. And if we look at the last couple of quarters, that part of the business was generating negative operating profit. So it's reallocating capital in a way that could not only sustain our mid cycle earnings power, but also reduce some of the volatility along the way. That's a great point. And that was the good segue, I guess, to the last question I wanted to sneak in here. But just on the pipeline and the OCTG operating losses in the quarter, any sense whether higher steel prices or maybe reduced industry inventories are starting to alleviate some of the margin pressure into Q4? Like should we expect continued losses the next couple of quarters for that category, at least until you guys have sold down your inventories to a desired level? So there's 2 dynamics going on there. We are getting inventories down. However, the industry as a whole is still overstocked just due to the level of fall that you're seeing. Again, the rig counts at 296 in the U. S. And 86 in Canada as of last Friday. So those are still extremely low numbers for the U. S. They're better in Canada, has been in 2015 in 2009 in the fall. The other is pricing is improving. So as you're seeing flat roll pricing, plate pricing go up, that's the substrate that makes the pipe. And as they're starting to be replacement and replacement from North American mills, that should drive the price up. So we'll work through the inventory, I think, probably through Q4 as an industry maybe lag into Q1 as an industry as a whole industry in OCTG and line type distribution. Optimistic that we're going to see price increases. We're seeing worldwide flat rolling in place increase as well. So that will start to lift the pricing. So I think we should start to come out of that as we continue on our path to exit some of that business. I think it gives us a better path to do that in a more profitable fashion. Got you. All right, guys. Thanks a lot for the answers. Appreciate it. Thanks, Matt. Thank you. Your next question comes from Mark Stebbings, TD Securities. Mark, please go ahead. Hey, good morning. It's Mark on the line here for Michael. You talked about seeing a gradual but uneven recovery across Russell segments, just for the Service Center segment in particular. I was wondering if you can provide some commentary on what sort of trends you're seeing across your different end markets and regions? Yes. So construction has held up relatively well throughout this entire C-nineteen pandemic and continues to hold up well. We're seeing some manufacturing is starting to return gradually. Again, as I mentioned earlier, it's in line with GDP starting to come back as well. So we're seeing gradual improvement. Heavy equipment has shown some signs of life in North America that we weren't anticipating. So that's been helpful. Obviously, wind towers, solar panels have picked up. We do participate in those markets, although on a limited basis just due to geography, but we do participate in some of those markets. But we're starting to see people coming back to work in mid Q3 where we saw just general manufacturing coming back over with us manufacturers, right, manufacturers are coming back to work and getting started. So again, we think that will continue forward barring any other shutdowns or anything out there from the governments that we think will continue to see that this climb forward as people really resurging the work right now. Great. That's great color. Thank you. And then can you talk a little bit about the outlook for steel prices? Obviously, you've seen a pretty strong increase in RO coil and plate has also followed. Are you able to comment at all on your expectations for pricing over the coming months and also into 2021? So again, steel prices jumped significantly. You've seen in the last 6 to 8 weeks, coil prices jumped $200 to $2.50 a ton. You've seen plate increase not as much, but increase. Part of that is due to demand is improving. Again, we're still at 70% mill utilization, which typically you would see pricing power around 80%. And so they are booked well into right now steel mills through December for the most part. You could maybe find a little bit of steel now, but for the most part, they're booked up through the rest of the year. Scrap prices, which again are the input the main input for steel mills continues to be strong. It looks like they'll either be sideways or up for November. Historically, they go down in November. So again, that's going back to demand, kicking back up, so there's more demand for that product. So I think we're good going into Q1. From there, we'll just have to see how things progress. Okay, great. And then just lastly for me. So I continue to make some progress in bringing inventory down in energy products. And you also closed several locations related to the realignment underway. I was just wondering if you could talk about how far you are into this realignment and how much more action we can expect to see over the coming quarters? Yes. So we closed a couple of pipe yards, smaller yards for us. We've also closed a handful of the energy field stores where we just had people shutting wells and they're not working. And that's a nice low risk business. It's got a very small lease, typically 1 to 2 year lease and a 5000 to 10000 square foot facility. So we can just move inventory around. So we've closed some of those wells picked back up and we can move back into the area. I think there'll be continued closures there and we'll see in a limited 3, maybe 3 more stores in the U. S. And maybe 1 or 2 in Canada in Q4. We'll continue though to push on the LCPG and Limelight to bring that inventory down. Our goal is to get that down over 12 to 18 month period, dollars 100,000,000 The initial period, we got it down $31,000,000 and we'll continue on that target to get that down $100,000,000 over the next 12 to 18 months in OCTG and line type inventory. Great. Thanks for your time guys. Thanks, Mohan. Thank you. Your next question comes from Felicia Straderet, Raymond James. Felicia, please go ahead. Good morning. I'm just wondering if you can provide some commentary on how you're viewing M and A in this environment? Yes, we've seen a lot of activity in M and A. We've seen a lot of things come across. Obviously, our focus is service centers, U. S. Being first, Canada being second, Canada with our larger footprint, it would need to be either a niche market that we're not in or a very strategic bolt on type of acquisition that would make a lot of sense for us. We are seeing though a lot of activity there. We have seen activity in the LCTG and line pipe that we've elected to pass as we're trying to shrink our footprint there. So I think again, I think the activity is fairly robust right now. Great. Thank you. That's all I have. Great. Thanks, Jason. Thank you. Your next question comes from Mona Nazir, Laurentian Bank. Mona, please go ahead. Hi. Sorry, just a follow-up in regards to the M and A. I it may be early days as you're starting to see a recovery in the end market and you're progressing with the plan to reduce your energy footprint. But I'm just wondering if you could speak about the pipeline of potential targets and have you seen potential targets come up on the back of current COVID challenges and just potential timing of such? Yes. So we're seeing potential acquisitions, as I was saying to Felicia there, in both service centers and in energy. Our focus is on the service centers. And so some of it may be COVID related, but I think it's more of a timing issue in service centers where there are a lot of private service centers, 3rd, 4th, 5th generation that we're looking to exit. And I think they've been considering this for 2 or 3 years, maybe longer. And so they're just going through that timing. We've seen from small to medium sized service centers out there right now. So again, we're very diligent and disciplined in our process as we go through looking at acquisitions, and we're looking for things that make the right fit for us either geographically, obviously, culturally is number one for us that it fits. And typically, we like well run businesses. We will occasionally go in and try to improve the business, but we typically like to buy well run businesses. Thank you. So just a clarification, the targets really haven't changed much on the back of COVID. Would that be correct? That's right. Okay. And then, just secondly, you received $39,000,000 in government subsidies for the period of March to September. And I appreciate your kind of quarterly breakdown for $20,000,000 for the period. I'm just wondering if you've been able to tally COVID related costs incurred year to date and have it on a quarter by quarter basis or even if it's similar to the amounts that you have received? Thanks. So it's something that's difficult to quantify. We definitely have some COVID related expenses where we can go through with things we've implemented, either via, obviously, the PPE that we've done, the social distancing protocols we're putting in the plastic guards and the things that protect us in the field, the additional staffing that we've had to bring into play just for COVID and to deal with COVID, the expense of medical and the testing that we've done for our employees. So those things that you can be quantified, it's the difficulties that are hard to quantify and what it's done to the business and the effects of where we've had to have multiple people where we would have just had one before, with 141 locations as decentralized as we are, we're running those location by location. So we haven't spent a tremendous amount of time pinning that number down. But again, it's a substantial number to our operation, but we are seeing that wane as well. We've got everything in place. We've got to get our routines down. So there will be some continued protocols that have to stay in place to deal with this. Obviously, they'll be helpful during flu season, at least we hope so. But there'll be some that stay in place. But it's the I think they'll be more in line with the way subsidies move down, but there'll be a natural offset there. Perfect. That's very helpful. Thank you. Thank you. Your next question comes from Anoop Prihar, GMP. Anoop, please go ahead. Good morning. Marty, most of my questions have been answered. So I just have 2 quick ones. Number 1, do you expect to receive wage subsidies in Q4 as well? Yes. We do. It's a bit of a moving target in terms of the revised government program and what that means. Our expectation is it will come down, come down a fair amount, but the exact precision of it is a bit of a mugging game to yes at this point. But if I was to give orders of magnitude, it'd probably be $5,000,000 to $10,000,000 for Q4, somewhere in that zone. Okay, perfect. And then my second and final question, post the quarter on a net basis, you refinanced about 100 sorry, I beg your pardon, you retired $150,000,000 worth of bonds. Can you give me a sense of that $150,000,000 How much of that was funded by cash versus your available lines? Yes. Well, most of it was from cash. And as you can appreciate in this environment, cash is earning virtually zero return. On our September balance sheet, we had about $120,000,000 of cash. And as the actual redemption kicked in, that gives you some order of magnitude. So it was mostly cash, a little bit of revolver and then the balance was basically replacing $150,000,000 worth of notes with a new issue of $150,000,000 of notes at a lower interest rate and a longer maturity. So that's where the $8,000,000 of annualized interest expense savings comes from. Good. Thank you. Thank you. There are no further questions at this time. Please proceed. Well, thank you everybody for paying attention and following us for the quarter. If there's any follow-up questions, feel free to give myself or John a call either this afternoon or any time. Other than that, we look forward to staying in touch and catching up over the course of the next quarter. Thanks very much. Thank you. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.