Earnings Call: Q3 2019

Nov 7, 2019

Morning, ladies and gentlemen, and welcome to the 2019 Third Quarter Results Conference Call for Russell Metals. Today's call will be hosted by Ms. Marion Britton, Executive Vice President and Chief Financial Officer and Mr. John Reed, President and Chief Executive Officer for Russell Metals. Today's presentation will be followed by a question and answer period. I would now like to turn the conference over to Ms. Marion Britton. Please go ahead. Good morning, everyone. I'll start on Page 3, reading 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 made 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 factors that may cause actual results or events to differ materially from those anticipated in such forward looking statements. Our actual results could differ materially from those anticipated in our forward looking statements, including as a result of the risk factors described below in our MD and A and in our annual information form. While we believe that the expectations reflected in our forward looking statements are reasonable, No assurance can be given that these 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 do not assume any obligation to update our forward looking statements. Turning over to Page 5, and I'll speak to our 3rd quarter results. Q3 earnings CAD 18,000,000 or CAD 0.29 of EPS compared to last year, which was a record quarter of $1.10 of EPS. 9 months ended, we have earnings of CAD83 1,000,000 or CAD1.34 During the quarter, we generated significant cash or I mean for the 9 months significant cash of CAD 59,000,000 out of accounts receivable and CAD 80,000,000 from inventory. Free cash flow for the 9 months to September, CAD 134,000,000 or $2.16 compared to $3.86 last year. Return on equity, 13% and we yesterday declared our dividend for the quarter. Turning to Page 6 speaks a little bit to the market conditions. We experienced lower demand in all business segments. Steel prices were down also in the quarter, and we believe steel prices are at or near the bottom. Metal service centers selling price decline was the biggest driver of the metal service decline in earnings. Selling price was down 11% compared to Q3 2018 and was down 7% compared to Q2 2019. The tons were down in the quarter on a same store basis compared to Q3 2018 by 5%. Rig count in both U. S. And Canada are significantly down year over year, which has impacted our demand in our Energy segment. As I said, revenues for Energy were down 17% compared to Q3 2018. Moving forward to the next Page 7. This is our chart that gives you the 4 year look back and our comparison to the 9 months last year, you'll note that our accounts receivable, I mentioned, had generated significant cash in the 9 months, but it is also down very significantly from where we were at this point in Q3 2018 due to the revenue decline. Further down this page, I'll point out the capital expenditures. So part of this year, we spent $24,000,000 on CapEx compared to $31,000,000 last year. We do continue to add value added equipment in a number of our service centers, which we do believe is helping keep our demand and a little hot better than the industry. We don't anticipate spending more than or we anticipate spending this year less than the 2018 number of $40,000,000 We'll expect to be in the low CAD30 1,000,000 for CapEx this year. Turning forward to Page 10. Just point out the cash flow from accounts receivable and inventory. And on that other highlights page, we have the 9 numbers, but you'll note that there was a significant drop in inventory in the quarter. We continue to work on reducing inventories to get rid of higher priced inventories in the segments and to position ourselves, particularly energy where we have lower demand. Turning forward to Page 13. I'll mention here that we completed the acquisition of CityKite October 1. The more specific details on the acquisition are in Note 22 of our completed statements that were filed yesterday on SEDAR. The acquisition price in U. S. Dollars ended up to be $106,000,000 because they had brought down their assets to keep it in line with their revenues. The acquisition price consisted of US56 $1,000,000 of net assets plus US50 $1,000,000 of goodwill. We have not completed the actual allocation of the to fair market value to the assets, but that will be done by year end. Turning forward to Page 14. This is our normal chart, which has our comparison to the prior year, plus shows our gross margin and our EBIT margin. Looking at this, speak to the Metal Services EBIT, our gross margin of 18.5% that compared to the year to date of 18.8 percent. Margins held quite well in the quarter considering the fact that prices came down in the quarter and came down more after the end of quarter. We're expecting that it will be in this range or slightly less in the Q4 period. Energy Products was impacted slightly by some NRVs that we had to take within that segment. I'll speak to that a little bit later and a mix. But mainly the energy decline in margins has to do with the impact of lower rig counts on OCTG product. Steel distributors similarly had pressure on their margins due to the reduction in prices of steel. Moving forward to Page 17. Just to speak to how the year is 9 months compared to the quarterly numbers, the tons for the quarter were down 5%, year to date we're down 6%, which we're anticipating similar numbers for Q4. On the demand side, on the selling price, we actually year to date were up 3% because last year, if you remember, we kind of went up during the year, where this year we have been coming off. But in the quarter, we did have a significant decline at 11%, and we anticipate average selling price over last year's Q4 to be down similar double digit number. Turning forward to Page 18. We did take some NRVs and continue to take some obsolescence reserves in our energy group, NRV related to items that we had received with tariffs on them and relooking at price of steel. So the NRV was around $5,000,000 and we had $2,000,000 of obsolescence taken in our energy segment. There was approximately $1,000,000 each in distributors and service centers also and RVs just to make sure we were in line with current pricing of products. Turning forward to Page 22. We have our normal charts here on our inventory values and turns. You can see the significant drop in inventory in service centers from December, dollars 427 down to $334, both tons and price are have come down. Our service centers have been managing down their inventories very well, trying to get down to a level where they can start purchasing at lower prices. Energy products have not been able to bring their inventory down as much as we would like basically due to demand. We continue to work on trying to get our energy product inventory in line with where we see the demand for the next 6 months. Steel distributors continue to bring those down as they had taken them up during the time when the tariffs were on, but they're now rightsizing them to back, to which would be normal based on revenues we anticipate. Those are my comments for the quarter. We'll open it up for questions. Thank you. Ladies and gentlemen, we will now begin the question and answer session. Your first question comes from Michael Doumet, Scotiabank. Please go ahead. Hey, good morning guys. Good morning. Marion, I caught you providing some margin guidance for Q4 for MSC. Just wondering for the Energy Products segment, I mean, given the declines, demand and pricing wise, what should we expect for Q4? And should that hopefully be the bottom? I would say between 2016 2017 would be my expectation, could be down slightly from where we were this quarter. It really will depend on price and if OCCTG, if we have very little volume, we may have a bit of a mix tick up, but I would say possibly down a bit. Okay. That's helpful. And then aside from OCTG, what categories of products are you seeing the most margin pressure in? And any potential risk of a write down in Q4 or potential magnitude there as well? John will speak to the price of steel issues. Yes. On the service center side, Michael, I think we're in really good shape. Our turns are continuing to move in the right direction. We've done a really good job. We have some exposure on the distribution side, but the write downs would be small. So I don't think there's anything material there that's left. Bigger concern would obviously be energy. It typically lags 45 to 60 days due to it being a substrate of hot rolled product. So as coal pricing looks to have dipped and hit the bottom, we've seen a slight increase now with increase in scrap pricing. You would hope the same is true for OCTG and line pipe, but based on the demand pressure that's out there, I would imagine it will remain pretty aggressive. So if there is anything remaining, we think it would be in that category. Okay. And could you maybe size that up for us just in terms of range or magnitude? I wouldn't think much bigger than what we've had. That would be my expectation, but I assuming prices don't do another mix now. Yes. So when we stay flat in that holes, then I think it would be significantly less than we did in Q3. Okay. Thanks. Your next question comes from Michael Tupholme, TD Securities. Please go ahead. Thanks. Good morning. You provided a little bit of commentary around your thoughts on steel prices, suggesting you think we're at or near a bottom. And as you mentioned, we've seen scrap in November tick up and HRC has come up in the last few weeks. John, wondering if you can talk a little bit about plate prices and what you see happening there? So I think plate prices, if you look at them in relation to historical spreads with coil pricing, I think coil may have overcorrected a little bit. Part of that is due to mills pressing forward with utilization. They may run at a little heavier rate than demand. And so I think we may have overcorrected. So I think plate is getting close to a bottom. We've seen a recent downturn on plate, recent price decrease. I think we're getting close to a bottom there as well. And if scrap pushes forward, then that's going to raise the input cost. Unfortunately, I'm not a big fan of price increases sustaining based on input cost increases because scrap determined again. Demand I get pretty bullish when demand is driving it. So that's I think we're getting to a bottom. Again, scrap drops $30 and we'll all move again. And is there any chatter about price increases on the plate side? Or is it too early for that, you think? I have not heard any on the plate side. I've heard them on the coil side. And again, some of that is appearing to stick on the coil side, but I've not heard on the plate side. Well, obviously, I haven't heard any that I think will stick. Okay. Mary, with respect to service centers, the same store tons shipped down 5% year over year. I apologize if I missed this, but did you provide some sense for how we should be thinking about that in the Q4? Yes. I think we were year to date, we're down 6%. So I would think we're going to be in the 5%, 6% range Q4 also year over year. And how do you think demand and shipments look in that segment as we look a little further out to 2020? I mean, I suspect you're going to face some easier comps. I don't imagine you're going to expect to see those kinds of declines throughout next year. But how do we think about that? Do you see an opportunity for some growth? Or what are you thinking about? As we've historically, when we've entered the down markets, Michael, our people are very adept at managing inventory, managing working capital and taking cost out of the model, but that's when we've typically grown our business. So we've either done it via adding new equipment for value added processing, whether it's lasers, stretcher levelers, whether it was by acquisition or just taking organic market share within markets. So as we look at it, again, we're such a transactional business. We look at down markets as a real opportunity for us to thrive and that we're going to go out and we feel like grow our share regardless of really where the market direction is because again, we think we're built for that. And again, it's we have really professional operators out there in the field who know how to run their business in a down market. We know it's cyclical. They're prepared for it. Our compensation models prepare us well for it as a company. So That's a point, John, regarding share gains and then the value added. Do you think though the overall market how should we think about the overall market so we can sort of overlay your own share gains and growth through value added on top of that? Your guess would be as good as mine. We're not built to predict the market. We're built to react to it better than anyone out there. So Okay. Fair enough. I don't know if it's if you would say the same thing. But with respect to energy products, any thoughts on how we can think about the outlook for next year? I mean, maybe you have a better sense given some of the commentary from some of the industry players on the rig count side, but or I don't know if the visibility there is tough as well. Yes. I mean, the rig count visibility is obviously tough. We think we're getting near a bottom on rig count. It looks like we're seeing some stability in oil pricing now. The change in the model dynamic is obviously the E and P companies having to learn to live within their cash flow budgets and run what I would say like a real business for the first time. So they can't outrun their cash flows and so they're having to live within budget constraints. So I think we've seen that reset this year. I think through our City Pipe acquisition, our Apex, Apex Remington stores, we will see growth out there. It continues to stay at this level. We have to maintain the rigs. But any uptick at all, we'll see the growth. And then through LNG, the project in Canada, we're starting to see some growth there. And also we have one project going in the sands through ComCo that's doing very well. Okay. And actually, that was going to be my last just I was going to ask you about LNG. Is there an actual opportunity that you've been presented with so far? Or is this more sort of perspective as we get further into the year 2020? It's more perspective. We're putting bids together. We're looking at opportunities on how we can do projects where we do the engineering work with the purchasing teams. So it looks like those are real projects. Feel better about that than I do infrastructure. Okay. Thank you very much. Your next question comes from Ryals Stroud, RBC. Please go ahead. Hi, good morning, everyone. This is Ryals Stroud calling on behalf of Derek Spronck at RBC. Thank you for taking my questions today. Thank you. Great. So I guess to start off, with the City Pipe acquisition now fully accounted for, what does the currency deleveraging cadence look like? And is there a number or target leverage range that we should expect for year end 2020? No, we don't have a target leverage. I mean, we will bring throughout cash if the demand is not there. Otherwise, we will move with wherever it is. Our leverage we look at is our debt to equity, which we expect to improve as we throw off cash from working capital, but we'll see what happens. We basically used cash that was on our balance sheet to do the acquisition because we had cash in the U. S. Okay, great. That's helpful. And any color around what the margin profile looks like for City Pipe? And maybe any commentary around what potential synergies might look like as well on a run rate basis? The margin profile of it is similar to our Apex operations that we already own. We did give their 9 month EBIT and revenue number in the commentary, and you can see that it was about 10% above 10% for the 9 month period. So similarly, they run at strong EBIT margins. If you look at them in a general sense, the energy service center business, as we call it, for Citi and Apex looks a lot more like our service center models on inventory turns, margin profiles. They don't have as big a value added component, so it does move around a little bit. But they're much more a service business for distribution It's out there that's a growing model. Again, it's a smaller order size, and so it looks a whole lot more like our service center profile. Okay, great. Great. And just one last one for me and I'll pass the line. So with inventories looking to have been reduced now for about the 3rd straight quarter, is there a target inventory level you're currently comfortable with given the current steel pricing and demand environment? Service centers are getting close to that target. They're not already there. They're continuing to bring down inventory in this quarter. We look at it as a target turn level. We need to improve on energy, and that target turn level needs to improve by at least one full turn is where we would try to get to. To put it in terms in numbers is the declining price. We're chasing a falling knife. So we try to chase it on the term volume. Great. Thanks, guys. Your next question comes from Frederic Bastien, Raymond James. Please go ahead. Hi, good morning guys. Conditions are challenging obviously for you in the sector, but probably even more so for smaller mom and pop operators. So I was wondering if you're finding that potential acquisition targets are more receptive to entering into discussion with you or are you actually seeing the opposite? We really it's been more of a flat market right now in that we've had some opportunities that we've looked at. I think as we go into next year that we will have recalibrated the expectations coming off of 'eighteen. Again, everybody with a record year. I think the people were recalibrated looking at 'nineteen and that there should be some opportunities for acquisitions at a, what we would call, a reasonable level. That's good to hear. Are you as you look forward, are you still contemplating increasing your exposure to U. S. Service centers? Just wondering if your view has changed there with respect to M and A opportunities? Obviously, from a footprint perspective and geography, that's where we make the most sense to grow. Canada gets a little tricky. Color was a nice acquisition because again, it added a product mix that we didn't have, but our footprint in Canada, we're number 1 or 2 in every region we serve there. So obviously, the U. S. Is a much larger footprint for us to grow in, but we won't force it either. So it's it has to be a good fit for us. And we don't like to put people on an island too much where we have a service center out there just by itself where we can't offer any synergies or help. So we're looking to build on our existing footprint or find something that's a larger stand alone operation, 5 or 6 locations. Your next question comes from Anoop Prihar, GMP Securities. Please go ahead. Good morning. Marion, just one quick question. You took a $5,000,000 write down on energy, but then in Note 4, you're showing an $11,000,000 impairment charge. I'm just wondering, can you just connect the dots for me on those two numbers, please? Yes. So the $5,000,000 was an NRV related to price and tariff stuff that we had we felt we needed to right size on energy. We did have another $2,000,000 of obsolescence in the energy area. And then we had $1,000,000 in a bit in service center on NRVs and $1,000,000 in steel distributors. It doesn't quite add up to $10,900,000 I know, but it's kind of where it fell out for less than. All right. And then, John, I'm just curious on the service center side. Are you seeing any material difference in the demand Canada versus the U. S? I mean, the numbers were down obviously across the board. But I'm just curious to see or ask you rather whether or not you're seeing any material difference in demand coming out of Canada versus the U. S? Brendan, I'd say a material difference in demand. Where we are seeing probably a material difference is in competitive pressure. The U. S. Just a lot more aggressive right now than Canada. Both are under pressure. We feel like some of the U. S. Competitors maybe overstock significantly. So we've seen them be a little bit more aggressive on price. Okay. Thank you. Your next question comes from Michael Tupholme, TD Securities. Please go ahead. Thanks. Just a follow-up. Marion, earlier in the call, you had talked about expectations for gross margins in the Service Center segment, I believe, for the Q4. I just wanted to clarify what you had said about that. Yes. We came in at 18.5%, and I think it will be in the that level or slightly down to 18%. It just depends on how pricing holds in plate and everything. So I think we'll stay in the 18% range, but we could be down slightly from Q3. Okay. And then similarly, if I look at the gross margin in Steel Distributors, 10.9%, I don't know if I can find the comment as I'm speaking here, but I think I recall reading that you suggested sort of that was you saw a normalization in the margins within Steel Distributors. I think we were in the 13% range if we go back to Q2. So is this are you now at a level there at around 11% in steel distributors that you think is sort of the sustainable level? Or could that still move around? That margin is pressured a bit by the price moving down, and I anticipate that will be continued in the Q4 also. But we should come back to more of a 12% level, which is more normal in starting in next year. Okay. And then would it be fair to say, I guess, all else being equal at this point, but if we do look out to 2020 for your other segments, it would be reasonable to think about 2020 as sort of going back to the more typical normal type levels, assuming again no further deterioration in price? I would agree, we can make that assumption. Okay. Yes, I mean, I know it's perhaps a bit of a big assumption, but we'll see what happens. Yes. Thank you. Okay. You have no other questions at this time. Please proceed. Okay. Thanks everyone for attending the call and we'll talk to you next quarter. Ladies and gentlemen, this does conclude your conference call for today. We thank you for participating and ask that you please disconnect your lines.