Good morning, ladies and gentlemen, and welcome to the 2019 third quarter results conference call for Russel Metals. Today's call will be hosted by Ms. Marion Britton, Executive Vice President and Chief Financial Officer, and Mr. John Reid, President and Chief Executive Officer for Russel Metals. Today's presentation will be followed by a question and answer period. At that time, if you have a question, please press star one on your telephone keypad. I would now like to turn the conference over to Ms. Marion Britton. Please go ahead.
Morning, everyone. I'll start on page three 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 other 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&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 five, and I'll speak to our third quarter results. Q3 earnings, CAD 18 million or CAD 0.29 of EPS, compared to last year, which was a record quarter of CAD 1.10 of EPS. Nine months ended, we have earnings of CAD 83 million or CAD 1.34. During the quarter, we generated significant cash, or I mean, for the nine months, significant cash of CAD 59 million and out of accounts receivable and CAD 80 million from inventory.
Free cash flow for the nine months to September, CAD 134 million or CAD 2.16 compared to CAD 386 last year. Return on equity, 13%, and we, yesterday, declared our dividend for the quarter. Turning to page six, speak 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 '18 and was down 7% compared to Q2 '19. The tons were down in the quarter on a same store basis compared to Q3 '18 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 of the set revenues.
For energy, we're down 17% compared to Q3 2018. Moving forward to the next page, seven. This is our chart that gives you the four-year look back and our comparison to the nine months last year. You'll note that our accounts receivable, I mentioned, had generated significant cash in the nine months, 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 far this year, we've spent CAD 24 million on CapEx compared to CAD 31 million 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 better than the industry. We anticipate spending this year less than the 2018 number of CAD 40 million.
We'll expect to be in the low CAD 30 million for CapEx this year. Turning forward to page 10, just point out the cash flow from accounts receivable and inventory. On that other highlights page, we have the nine-month numbers. 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 ourself, particularly in energy, where we have lower demand. Turning forward to page 13. I'll mention here that we completed the acquisition of City Pipe October 1st. The more specific details on the acquisition are in note 22 of our complete statements that were filed yesterday on SEDAR. The acquisition price in U.S. dollars ended up to be $106 million because they had brought down their assets to keep it in line with their revenues.
The acquisition price consisted of $56 million U.S. of net assets, plus CAD 50 million of goodwill. We have not completed the actual allocation 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, I'll speak to the metal service EBIT. Our gross margin of 18.5%, that compared to the year-to-date of 18.8%. 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 the quarter. We're expecting that it'll 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. A mix, but mainly the energy decline in margins has to do with the impact of lower rig counts on OCTG products. 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-to-date nine months compare 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 up. 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 a similar double-digit number.
Turning forward to page 18. We did take some NRVs and continued to take some obsolescence reserve in our energy group, the NRV related to items that we had received with tariffs on them and re-looking at price of steel. The NRV was around CAD 5 million, and we had CAD 2 million of obsolescence taken in our energy segment. There was approximately CAD 1 million each in steel distributors and service centers, also NRVs, 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, 427 down to 334. Both tons and price 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 inventories 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 six months. Steel distributors continue to bring theirs down as they had taken them up during the time when the tariffs were on, they're now right-sizing 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. Should you have a question, please press star followed by one on your touch-tone phone. You will hear a three-tone prompt acknowledging your request, and your question will be pulled in the order they are received. Should you wish to decline from the polling process, please press star followed by two. If you're using a speakerphone, please lift your handset before pressing any keys. One moment for your first question. Your first question comes from Michael Doumet, Scotiabank. Please go ahead.
Hey, good morning, guys.
Hi.
Marion, I caught you providing some margin guidance for Q4 for MSC. Just wondering for the energy product segment, given the declines, demand and pricing-wise, what should we expect for Q4, and should that hopefully be the bottom?
I would say between 16 and 17 would be my expectation. Could be down slightly from where we were this quarter. It really will depend on price, and if OCTG, 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. 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.
On the service center side, Michael, I think we're in really good shape. Our turns are continuing to move the right direction, and 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. A bigger concern would obviously be energy. It typically lags 45-60 days due to it being a substrate of a hot-rolled product. As coil pricing looks to have dipped and hit the bottom, we've seen a slight increase now with the 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. If there is anything remaining, we think it would be in that category.
Okay. 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. Assuming prices don't do another write down.
Yeah. Again, assuming we stay flat and that holds, I think it would be significantly less than we did in Q3.
Okay. Well, 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. As you mentioned, we've seen scrap in November tick up, and HRC has come up in the last few weeks. John, wondering though if you can talk a little bit about plate prices and what you see happening there?
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's due to mills pressing forward with utilization. They may run at a little heavier rate than demand. I think we may have overcorrected. I think plate is getting close to a bottom. We've seen a recent downturn on plate, a recent price decrease. I think we're getting close to a bottom there as well. 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 could turn again. I get pretty bullish when demand's driving it. I think we're getting to a bottom. Again, if scrap drops CAD 30, then we'll all move again.
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. Again, some of that is appearing to stick on the coil side, but I've not heard any on the plate side. Well, I'll say I haven't heard any that I think are going to stick.
Okay. Marion, 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 fourth quarter?
Yeah, I think year to date, we're down 6%. I would think we're going to be in the 5%-6% range fourth quarter also year-over-year.
How do you think demand and shipments look in that segment as we look a little further out to 2020? 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?
Historically, when we've entered a down market, Michael, our people are very adept at managing inventory, managing working capital, and taking cost out of the model. That's when we've typically grown our business. We've either done it via adding new equipment, providing value-added processing, whether it was laser or stretcher levelers, whether it was by acquisition or just taking organic market share within markets. 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. Then we're going to go out and we feel like grow our share regardless of really where the market direction is. Again, we think we're built for that. Again, we have really professional operators out there in the field that 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.
That's a massive good 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 will 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.
Okay, no, fair enough. I don't know 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? Maybe you have a better sense given some of the commentary from some of the industry players on the rig count side. I don't know if the visibility there is tough as well.
Yeah, 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&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. They can't outrun their cash flows, they're having to live within budget constraints. I think we've seen that reset this year. I think through our City Pipe acquisition, our Apex Remington stores, we will see growth out there. If it continues to stay at this level, we have to maintain the rigs. Any uptick at all, we'll see the growth. Through LNG is doing very well.
Okay. Actually, that was going to be my last. 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 the projects where we do the engineering work with the purchasing teams. It looks like those are real projects. I feel better about that than I do infrastructure. How's that?
Okay. Thank you very much.
Your next question comes from Ryal Stroud, RBC. Please go ahead.
Hi. Good morning, everyone. This is Ryal Stroud calling in on behalf of Derek Bronk at RBC. Thank you for taking my questions today.
Thank you.
Great. I guess to start off, with the City Pipe acquisition now fully accounted for, what does the current de-leveraging cadence look like? Is there a number or target leverage range that we should expect for year-end 2020?
No, we don't have a target leverage. We will bring off cash if the demand's not there. We'll move with where it ever is. Our leverage we look at is our debt to equity, which we expect to improve as we throw off cash from working capital. 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. 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 nine-month EBIT and revenue number in the commentary, you can see that it was above 10% for the nine-month period. 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 City 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 there. They're much more a service business for distribution that's out there that's a growing model. Again, it's the smaller order size, and so it looks a whole lot more like our service center profile.
Okay, great. Just one last one from me and I'll pass the line. With inventories looking to have been reduced now for about the third straight quarter, is there a target inventory level you're currently comfortable with given the current steel pricing and demand environment?
Service center's getting close to that target, if 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. That target turn level needs to improve by at least one full turn is where we would try to get to. To put it into numbers is with a declining price, we're chasing a falling knife, we try to chase it on the turn volume.
Great. Thanks, guys.
Your next question comes from Frederic Bastien, Raymond James. Please go ahead.
Good morning, guys. Conditions are challenging, obviously for you in the sector, but probably even more so for smaller mom-and-pop operators. 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?
It's been more of a flat market right now in that we've had some opportunities, Frederic, that we've looked at. I think as we go into next year, that we will have recalibrated the expectations coming off of 2018. Again, everybody with a record year. I think the people were recalibrated looking at 2019, and that there should be some opportunities for acquisitions at what we would call a reasonable level.
That's good to hear. 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&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 in our footprint in Canada. We're number 1 or 2 in every region we serve there. Obviously, the U.S. is a much larger broad footprint for us to grow in, but we won't force it either. It has to be a good fit for us. 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. We're looking to build on our existing footprint or find something that's a larger standalone operation, five or six locations.
Okay. That's helpful. Thank you.
Your next question comes from Anup Prehar, GMP Securities. Please go ahead.
Good morning. Marion, just one quick question. You took a CAD 5 million write-down on energy. In note four, you're showing a CAD 11 million impairment charge. I'm just wondering, can you just connect the dots for me on those two numbers, please?
The CAD 5 million was an NRV related to price and tariff stuff that we felt we needed to right size on energy. We did have another CAD 2 million of obsolescence in the energy area. We had a millionA bit in service center on NRVs and CAD 1 million in steel distributors. That doesn't quite add up to 10.9, I know, but kind of where it fell out.
Okay.
Or less.
All right. John, I'm just curious about on the service center side, are you seeing any material difference in the demand Canada versus the U.S.? The numbers were down, obviously, across the board, 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.
We're not seeing a material difference in demand. Where we are seeing probably a material difference is in competitive pressure. The U.S. is just a lot more aggressive right now than Canada. Both are under pressure. We feel like some of the U.S. competitors may be overstocked significantly. We've seen them be a little bit more aggressive on price.
Okay. Thank you.
Ladies and gentlemen, as a reminder, should you have a question, please press star one. 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 fourth quarter. I just wanted to clarify what you had said about that.
Yeah. We came in at 18.5. I think it'll be in that level or slightly down to possibly 18. It just depends on how pricing holds in plate and everything. I think we'll stay in the 18 range, but we could be down slightly from Q3.
Okay. 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 you saw a normalization in the margins within steel distributors. I think we were in the 13% range if we go back to Q2. Are you now at a level there at around 11% in steel distributors that you think is the sustainable level, or could that still move around?
That margin's pressured a bit by the price moving down, and I anticipate that will be continued in the Q4 also. We should come back to more of a 12% level, which is more normal, starting in next year.
Okay. 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, if we can make that assumption.
Okay. Yeah, I know it's perhaps a bit of a big assumption, but we'll see what happens.
Yeah.
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.