Earnings Call: Q4 2019

Feb 12, 2020

Good morning, ladies and gentlemen, and welcome to the 2019 Year End and 4th Quarter Results Conference Call. Today's conference call will be hosted by Ms. Marion Britton, Executive Vice President and Chief Financial Officer and Mr. John Reed, President and Chief Executive of Russell Metals Inc. I'd now like to turn the conference over to Ms. Marion Britton. Please go ahead. Good morning, everybody. I'm on the Slide 3 of our deck, which is the cautionary statement. Certain statements made on this conference call constitute forward looking statements or information within the meaning of applicable securities laws, including statements as to our future capital expenditures, our outlook, the availability of our future financing and our ability to pay dividends. Forward looking statements relate to future events or our future performance. All statements other than statements of historical fact are forward looking statements. Forward looking statements are necessarily based on estimates and assumptions that, while considered reasonable by us, inherently involve known and unknown risks, uncertainties and other factors that may cause actual results or events to differ materially from those anticipated in our forward looking statements. Our actual results could differ materially from those anticipated in our forward looking statements, including as a result of risk factors described below in our MD and A and our annual information form. While we believe that the expectations reflected in our forward looking statements are reasonable, no insurance can be given that expectations will prove to be correct and our forward looking statements included in this call should not be unduly relied upon. These statements speak only as of the date of this call and except as required by law, we will not assume any obligation to update our forward looking statements. So before I turn into the deck, I just wanted to make a comment to thank our operations employees who navigated through the steel price reductions and the rough environment that we had during the second half of twenty nineteen, Our metal service center operations and our valve and fittings operations had a solid year and continue to perform as we expect from them. Coming off a year like 2018, we're managing decline. However, Q4 ended with a few more challenges than we then which I will speak to shortly. Turning to Page 5 of the deck, give a few market conditions. During the quarter, we had a selling price decline of 15% compared to Q4 2018 and 6% compared to 2019, our biggest drop during the year. Metal service center tons down 7%, which was slightly higher than our year. Compared to the Q4 2018, we still were stronger than the MSCI reported numbers. Rig count continues down in the U. S. Year over year and in Canada, it's up slightly. Energy Products segment was down 21% compared to Q4, mainly related to lower demand for line pipe and that was because we had a project in Q4 2018 and rig activity. Turning over to Slide 6, 4th quarter results. As people would have noted already, we did report a loss of $7,000,000 or $0.11 per share in the quarter compared to our 2018 Q4 when we reported 0 point 7 $4 For the year, we reported earnings of $77,000,000 or $1.23 and that compares to the $3.53 or stellar year in 2018. We will go into a little more detail as we go through, but there was an inventory reserve of $14,000,000 recorded in Q4 2019 related to U. S. Wine pipe operations and we did have our charges related to the acquisition that was in the quarter. Free cash flow was one of the strong areas For the year, our free cash flow was $220,000,000 compared to $484,000,000 for 2018, particularly strong reduction in working capital during the Q4 of 2019, where we had $133,000,000 reduction in working capital. For the year, it was $144,000,000 Return on equity for the year was 8% and we declared a 0.38 dollars dividend yesterday. The comparative information is on Slide 7. I'm going to skip by that and speak a little more to other pages in the deck. The one thing I'll mention is that we did file all our documents yesterday, so complete sort of statements with no details on the acquisition and other things that people may have interest or have been filed on SEDAR. Turning over to Page 13 in the deck. We've included here a chart, which is a chart which includes non GAAP measures. So I will caution you the fact that the adjusted net earnings is a non GAAP measure, but I think it does help you understand the abnormal entries that we had to record in Q4 and related to the year, the Q4 chart we'll get to shortly. So during the year, our net earnings of $77,000,000 if you consider inventory provisions, which we consider one time, mainly the $14,000,000 related to line pipe and $5,000,000 related to OCTG that was actually recorded in Q3 represent that represented $0.18 or $18,000,000 sorry, or after tax or $0.29 EPS and Citi Price acquisition costs of $4,000,000 and I'll speak to that a little bit later, but that's the fair value accounting of inventory and then the actual costs related to the transaction, which represented $0.07 So that on an adjusted basis brings our EPS to 1.59 Turning over to Page 16, I'll just highlight some of the annual numbers and then we'll go into the quarter numbers. Revenues were down 12%. Revenues in service centers, obviously, off less than our other operations. The gross margins or I mean the operating profits were down more driven by the gross margins. You'll see that our gross margin for Service Center ended up at 18.8%, pretty good considering the conditions we were going through. The Energy Service Products segment was lower due to the reserves that we took and similarly Installed Distribular is lower due to reserves that we took. Going forward to Page 18, the lower selling price was 1% compared to 2018. This is for the annual numbers and tons shipped were was down 6%. You'll note that I had said 15% for the quarter, so it dropped significantly a lot late in the year and the tons held up during the year slightly better than the Q4. We also indicate here that the Canadian and U. S. Service centers MSCI numbers were 7% on an annual basis. Moving on to Page 19. I want to highlight the fact that our oilfield stores and actually, CommScope Pipe ended up with higher revenue and EBIT than they had for 2018. So our valve and fittings side continues to operate strongly. The note under Sezar, there is the Q1 acquisition or I mean, sorry, October 1 acquisition of City Pipe. It resulted in revenues in the quarter of 34,000,000 dollars $2,000,000 of operating earnings. We did have a charge of $6,000,000 of which $4,000,000 of that relates to the fair value of inventory adjustment done as part of the accounting and $2,000,000 related to the actual cost of the transaction. Turning over to Page 20. Steel distributors, revenues were down 13%. You'll note when we get to the Q4 numbers down more due to less demand in that area, and we did take a charge against or an inventory provision of $5,000,000 in our U. S. Operations. Our Canadian operations tend to pre sell their material and continue to operate at strong in 2019 as they were in 2018. I'd like now to flip to Page 28, which has our quarterly numbers. You will see on Page 27, I'll just mention this, I'm not going to go through it in detail, the non GAAP chart again for that brings us from the $0.11 loss to the $0.19 EPS adjusted earnings for the quarter. So if you look at the Page 28, you'll note the revenue decline is down significantly, particularly still the distributors. They had significantly less revenue in the quarter. And you'll note we look at inventories that the revenues are going to be down because they stopped acquiring as much inventory due to price differentials. The good news on this page was the 18.8 percent metal service centers gross margin that they delivered a little stronger than I had indicated when in our last call. So they did perform well and they continued to reduce their inventory to take advantage of the lower cost inventory when they do purchase it. The selling price of 15% lower, which was highlighted on the front slide, looking at the numbers, it looks like we're going to have a similar 15% decline Q1 2020 versus Q1 2019 because if I look at Q4 versus Q1. So there was a significant drop in selling price during the year. So we're a new year over year comp will be hit by that when we get to Q1 2020. The only other comment here is that the drop in revenue and some of the earnings at Energy Products is related to a larger line pipe project that we had going on in Q3, Q4 last year and has not been repeated. Actually line pipe has been an area where demand has been significantly down during 2019. We'll flip back now to Page 21, just make a couple of comments. We did end up spending $35,000,000 on capital expenditures during the year. A significant portion was related to value added processing. This compares to the $41,000,000 we spent in 2018. We have indicated that we expect to spend above depreciation, depreciation being $32,000,000 for the next few years as we continue to add value added processing in our metal service centers. It has helped to keep us our demand better than the average, and we believe it has helped to stabilize our gross margins. Turning over to Page 22, speak to the inventory level charts on this page. You'll note the significant reduction in the inventory at metal service centers is both related to tons and to price. That strong reduction resulted in a turn of 4.5 for the year, which is in line sorry, for the quarter, which is in line where we've been for the last few quarters and significantly better than where we were at the end of 2018 or Q4. The other comment would be the energy products number, although it looks like maybe it hasn't come down as much as you would think, dollars 47,000,000 of that number relates to Citi acquisition in the quarter. So without Citi, it would have been $4.47,000,000 once again the lowest number on this chart that we have. And as I mentioned earlier, Steel Distributors continues to reduce its inventory, which will result in lower revenues on the go forward basis because the pricing environment doesn't pricing environment and demand is not driving activity in our store distributors area. Those are my comments. I'm going to turn it over to the operator. Thank you. Ladies and gentlemen, we will now begin the question and answer session. Your first question comes from Devin Dodge with BMO. Please go ahead. Hi, good morning. Good morning. I just wanted to start with maybe the service center business. It looks like it continues to perform pretty well in a tough environment. Just can you give us a sense for how demand has trended so far in 2020 just across your regions and end markets? 2020 started out with kind of a shot in the arm and it picked up from what was a slow Q4. And so we had it down Q4, so it came out. It's really leveled off now, but with Eastern Canada, it's been pretty strong. Construction seems to be doing very well there. Manufacturing is doing well there. If you move to Western Canada, again, specifically in British Columbia, has been very slow with the issues going on with the lumber and the timber industry that's out there. Oil and gas is obviously slow and in farming, which again is going to affect our ag equipment. So that's kind of a tale of 2 halves for Canada. The U. S. Has been very steady and solid for our business in the service centers. The interesting thing, Devin, I think if you look at and if you start January of 2018 prior to the 232 Marion alluded to it in our opening, we started $6.40 a ton on plate, shoots up to almost $1,000 a ton, dollars 980 by the like Q3, early Q4 of 2018 and then by early to mid Q4 of 2019, we're back down below $640,000,000 So the volatility that we saw in the pricing was not really demand driven, more of a $232,000,000 political arena that was driving all that. And I think our operators and our service centers did an exceptional job of managing and navigating that. To again have a gross margin of 18.8% that Mary had mentioned earlier, I think represents how much of that's been propped up by our value added processing as we continue to grow that when you're looking at a $3.50 a ton drop in about 7 to 8 months. They did not absorbed all of that through. There were no write offs in service centers, so they absorbed all that through margin. So I think they did a tremendous job there. So demand overall, it's okay. It's again, we're not seeing anything that's a catalyst to drive it through the roof like an infrastructure project that would take off or anything like that. But again, it's in a solid place for our service centers right now. That's good color. That's helpful. Thank you. Maybe switching gears, it just it feels like industry conditions in the oil country tubular good distribution is likely to stay challenging. I think there's some mills that are going direct, increased competitive pressures. So just a couple of questions related to this. Does this division earn a return on capital that is consistent with Russell's overall WACC? And have you given much thought or any thought to selling or winding down this business? So when you look at that, it also includes the field stores, energy field stores, Apex, Tomco, now lead supply partners as we merged those 2. So when you look at your OCTG and line pipes, what I think you're referring to in the energy segment, definitely challenged. You now have mills going direct and more mills have started to tiptoe around that fray. So we're seeing as much inventory on the ground at mills as we are in the distribution side of the business. So the supply chain has definitely been disrupted and we think there may be a structural change. So we're looking at several avenues right now, reduction of capital, reduction of inventory, how do we try to get a return. But right now that would be one of our lower performing or the lowest performing group we have would be the OCTG and the line pipe for Russell. Okay. That makes sense. Maybe just one last one. Can you give us an update on the CFO search? We think we're coming to an end sometime maybe early March. Marion was very gracious and gave us a long runway, so it's really let us take our time, vet the process very carefully. Coming through December, January, we've got to put up the brakes on everything with the timing for the year end schedules for both the candidates and for ourselves. But I think we're coming where we'll be winding down to an end for exciting candidate for us sometime in early March. Okay. Thank you. I'll turn it over. Your next question comes from Michael Tupholme, TD. Please go ahead. Thanks. Just building on one of the last questions, John, question about the demand outlook for 2020. Appreciate the comments you provided. In the MD and A, you did talk about demand remaining consistent with early 2019. So I guess just to maybe try to take what you've said so far and maybe put some numbers around it if possible. But when we look at 2020 full year versus 2019, is this a year in which you think you could see sort of modest volume growth? Or where should we be thinking more about a kind of a flatter volume profile for 2020 versus 2019 full year? Are we talking to service centers or overall? Sorry, this is on the service center side and particularly. Yes. Typically, it's going to follow GDP to some extent. So that would lend itself to a relatively flat year. I think when you're modeling, keep in mind the numbers that we mentioned there, you're going into 2019 with just under $1,000 a ton plate. You can look at flat roll. I mean, I'm sure you see the graphs as well and look at where we're going in now. So you're going to see some swings there in top line just if we hold flat on tonnage. Right. Okay. And then just in terms of the can you elaborate a little bit more on your commentary in the MD and A about the oversupply in the energy products operations for the market as a whole. I guess any sense on from your perspective on timing for how long it'll be before we see the market's pipe inventories come back to appropriate levels? And I guess what does that mean for pricing from your perspective? Yes. So you've got I guess 2 real dynamics that are driving that obviously demand the U. S. Down 24% year over year on the rig count. So there is a lack of demand that's there in the U. S. With the rig count hovering around $800,000 $8.50 You've obviously got pricing that's there when you're looking at $50 oil or slightly below, you're looking at $1.80 on natural gas. So those things are impacting demand. But also what we're seeing is, as I mentioned earlier, the mills are now carrying more inventory than they've carried. So they're competing with distribution when there's a downturn that compounds it. End users have been taking longer positions because of the mill programs. So we're competing with end users who are now selling into the market. So that compounds the issue. Q4 was very challenging. We're starting to see certain products now that have bounced back into Q1 that are again selling it, what I would call normalized pricing. There are other products that are still overstock. So you feel your way through your product mix, but we're starting to see the again, I would say 50% to 60% of the product mix now selling at a normalized margin for us. And again, there's still a handful of items that are out there that you're highly competitive on because they're just overstocked in the marketplace. Okay. And I know you took inventory charges, most of the charges in the Q4 were in your Energy Products segment. So presumably, you took what you felt was necessary in the Q4. But given the market dynamics, how do we think about risk of further inventory charges specifically in energy products going forward? Yes. So our approach has always been again when we see that we identify it quickly. We try to plow through it in the quarter and get it behind us so we can move forward. If there's a downturn in pricing, there could be a further risk, but if pricing holds where it is or starts to move back up, then I think we're fine. If oil prices obviously fall, then we could have an issue there if demand changes. But if things stay status quo, I think we're fine. Again, we addressed it very aggressively. We want to plow through this stuff and get it behind us and move on. Also, the charge was more heavily weighted to the U. S. Line pipe area, which not sure that this year is going to see a lot of projects going on with the election in that. And so we're we will be managing that area to make sure that we don't have the same exposure. Okay. And then just maybe lastly, Marion, historically, you've been helpful in providing some gross margin outlook commentary by segment at least sort of over the near term. Is there anything you can say on that front as we look out to Q1 or the first half of the year? How to think about the gross margins for your various segments in terms of any kind of a bounce back to kind of more normal levels or just anything you can provide on that front would be helpful. Well, I would think that service centers is heading back to a number with a 2 in front of it. So 2021. I'm hoping we get there in Q1. We're a little bit wait and see on that, but I would expect it above the $18,800,000 that was the Q4 and annual number. And barring all other changes in pricing, which never seems to happen in 1 year, we should be in that 21% to 22% range before we get to the end of 2020. Energy Products, it's going to be a little bit harder to sort out where we're going to go there, but I would think the Q4, 17.8%. I know last year, we were in the 19s for the year, which I think is too strong for energy. I think it will depend a bit awaiting on our oilfield and valve fitting numbers versus our numbers that we do get from OCTG and that's really be driven a bit more by which area has the larger demand this year. And steel distributors, we're going to get back to a number that is in the range of the 12% to 13%. But once again, the revenues are going to come off in that area. So it will be even less of a factor in our total gross margin. Okay. That's helpful. Thank you. There's no further questions, we can end the call. There's no further questions at this time. Okay. Thanks for your time. Okay. Thanks for your time. I thank everybody for participating and we will talk to you in the spring. Thanks. Bye. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Have a great day.