Good morning, ladies and gentlemen, welcome to the 2019 second 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 of Russel Metals Inc. 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 will now turn the meeting over to Ms. Marion Britton. Please go ahead, Ms. Britton. Thank you.
Good morning, everyone. Thanks for joining our call. I'm going to begin by reading the cautionary statement that is on page three of our information that we circulated last night. Certain statements made on this conference call constitute forward-looking statements or information within the meaning of applicable securities laws, including statements as of 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 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 will not assume any obligation to update our forward-looking statements. Turning to page five. I'll just summarize a few of the highlights of second quarter. Second quarter earnings 2019 were CAD 31 million, or CAD 0.50 of EPS. You can see there our great results we did having Q2 2018.
I want to remind everybody that Q2 2019 was actually a good result. I am going to speak a little bit to that when we get to the five-year summary. The six months, we produced an EPS of CAD 1.05. Free cash flow was strong at CAD 102 for the six months or CAD 1.65 per share. Also, our return on equity at 15% is a very good result. We declared our dividend of CAD 0.38 per share yesterday. Turning over to page six, a few market comments. Demand is lower and steel price has come down compared to 2018 and earlier in the year. Metal service centers average selling price was 2% higher than Q2 2018. Also, though, the tons were down 7% compared to Q2 2018. The year to date also was down 7%, so volumes are down. To this point in the year, selling price is up.
I'll speak to that in a minute, where we think it's going. Rig counts down in the U.S. and Canada, both year-over-year for the quarter and currently it remains down. Energy product segment revenues decreased 7% compared to Q2 2018, mainly related to the fact that rig counts have been down. Tariffs between the U.S. and Canada were removed in May 20th, 2019. During the quarter, we had our tariffs that were put in place last year removed, and it did have some impact on further pressure downward on steel prices. Turning over to the next page seven. If you look there at our basic earnings, you will see what we produced between 2015 and 2018, and then the Q2 of this year and last year, or I mean, sorry, six months of this year and last year.
You'll note that our results, if you were to annualize them, are second best to our 2018 results produced. We're still having a good year, although in most cases, all our measurables are down because 2018 was a spectacular year. Down below, you'll see the working capital of metal, and we have the fixed assets and everything comparative year-over-year. Net assets employed are down from year-end slightly. We'll get into a little more detail on that in a minute. Turning forward to page 10. This is where I was going to speak to the change in working capital. Accounts receivable did with positive cash flow from accounts receivable, mainly collections in our energy and our decline in revenues as selling price did come off also impacts that. CAD 55 million in the quarter, CAD 31 million year to date.
Inventories provided cash of CAD 17 in the quarter, CAD 32, CAD 33 year to date. Accounts payable in the quarter was CAD 55. That mainly relates to the fact that we've been reducing our inventories, and as we reduce our inventories, we don't have the payments as we start to restock because our inventories, and especially metal service centers, are now at a lower level. We will get the payable. If you look at the accounts payable, it's down CAD 81, or I mean, utilized CAD 81 year to date. Part of that is because we did pay bonuses in February that were accrued at year-end. The non-cash working capital movement has been CAD 22 year to date. Also, you'll note a significant impact from taxes paid year to date, related to some of the amount we were able to pay this year related to 2018 in Canada, and then payment of our 2019 taxes.
Moving forward to page 13. You will note at the bottom, we have updated the information on the tariffs, U.S., Canada, and the Canadian safeguards. What has been happening, we did also give some information on the fact that the Canadian Department of Finance has looked at the structural steel matters and the, or, sorry, that was the U.S. International Trade Commission, sorry, confused the two. Canada was taken out of the preliminary determination, and there will be countervailing duties against China and Mexico. Hopefully, that section recaps everything that happened, starting in 2018, and then some of it has been unwound into 2019. Turning over onto page 14. You will see the decline in total revenues. I have spoken already to the selling price and tons information there. Just wanted to bring your attention to the gross margin. Gross margins for metal service centers down slightly from Q1.
We anticipate some continued pressure on gross margins in metal service centers in Q3, maybe slightly lower than Q2, caused by the fact that plate is still declining, and we will start to buy some of our other inventory at a lower price, but we still need to average that higher price through the system. We'll see some drag on our gross margin in the Q3, and should start improving in Q4, subject to anything else changing. Energy products had consistent margins related to the first quarter, and that is created by the good margins in our oilfield stores and the mix between oilfield and OCTG. Steel distributors are also more consistent with Q1. Similarly, steel prices have come off there, but we continue to be able to sell our product at reasonable margins. The net result of operating profits and revenues is reported down below.
Metal service centers should improve as we go forward, we hope. The next page, 15. I will give you a chart that explains IFRS impact of the capitalization of leases. The assets and liabilities put on the impact of moving some of the EBIT into interest by segment is spoken out there. Moving on to page 16. Just to speak to the selling price. Selling price, I had indicated earlier, was up 2% compared to second quarter 2018. If you were to go backwards, you would see that in Q3, selling price actually went up 6% over Q2 2018, and Q3 2019 is when we are going to drop below where we had been. Just thinking back or taking a view back as to what happened in 2018 versus 2019, tariffs came on in May, June.
Prices started to ramp up, selling price increased significantly for the second half of 2018. Actually, Q3 and Q4 were at similar selling price levels for us. We've now started to drop below those levels, and we expect that Q3 2019 will be approximately 5% lower than Q2 2019. Tons, probably are going to be similar range or maybe a little bit more down than what we have experienced for the first half of the year, which is 7% down. Turning to page 21, just wanted to speak to the inventory levels. You'll note that our inventory levels at June 2019 are very close to our inventory levels at June 2018. The area that we would like to see some improvement is our energy products. We only have turns of 1.9. We had two last year. Yes, second quarter is always challenging with the lower revenues.
We hope that more activity, especially in OCTG in the second half of the year, will help to improve that to some of the levels that we saw at other quarters during 2018 and earlier in 2019. The metal service center turns and levels we're very happy with. As we mentioned, we have been selling off our higher-priced inventory. We will be starting to replace that. That will help our average price and gross margin in the look forward. Steel distributors have brought down their inventory levels as they get to what the new norm is in North America with tariffs. Those are my comments, and I'm going to open it up to questions.
Thank you. Ladies and gentlemen, as a reminder, should you have any questions at this time, please press star followed by one. Our next question is from Devin Dodge of BMO. Please go ahead.
Thanks, and good morning.
Morning.
Obviously lots of moving parts on the pricing side. There was some helpful commentary, Marion, thank you. Just trying to get a sense for maybe for each product line? Obviously, you said plate continues to soften. Has that continued through early Q3? Maybe just from across other pricing commentary for other products that you sell, including maybe some of the energy space?
Listen, Devin, we'll start with flat rolled coil, as you have so many products that are obviously a downstream or byproduct of that. It looks like it bottomed out early July and has started to bounce back now. U.S. numbers hit around $480. We've come back into a currency adjusted situation following the Section 232, we're now U.S. currency adjusted for Canada, which sets back to normal. If you look at the metal margin spreads, it feels like the mills actually over-corrected on coil products. When it got down around that $480, $500 number, there was probably an overcorrection. If you look at the metal margin spread and the spread to the world market, I think that's recovered nicely now, and you're getting it back to a normal metal margin spread, although it'd be on the low end.
It seems to be in a sweet spot to keep imports at bay. Again, I don't see a whole lot of upside potential for it, but it seems to be in a good landing spot. Plate, on the other hand, still has some metal margin room to run. We did see an increase of CAD 20 a ton on scrap this month, with potential for scrap to be flat to up again next month. That would probably take the metal margin back to a reasonable level for plate. It definitely outran and held longer. I think plate through July, early August, is starting to come back in line, maybe CAD 20-CAD 40 a ton more to go, but we're getting to the bottom there. The recovery so far that we've, from the steel mills announcing a CAD 40 increase, we've not seen that take.
Hopefully, they're establishing a floor. As far as tubular products, structural tubing, those products are following similar to flat roll. OCTG and line pipe typically run about 90 days in the rears on pricing, they're continuing to drift south predominantly because a lot of the import timing of the market coming in, versus the flat roll being made in North America and converted. Again, we think we'll see that probably fall throughout the third quarter.
Okay. That's a really good comment. Thank you for that. Can you give us a sense how you're feeling about inventory levels? I think you addressed some of this maybe in the prepared comments, but just, I guess in particular, inventories were up at Energy Products. Just how should we be thinking about that, given the context that OCTG pricing seems like it's set to fall in Q3?
Yes. Start with service centers. We're in a really good position with service centers. Our Canadian service centers will push over 4 this month. U.S. service centers will push over 6 turns this month. We are high on our energy turns for OCTG and line pipe ending the quarter. That will be an emphasis for us in the third quarter, and we could do a better job there getting those in line. We're pulling back on our purchases there dramatically and looking to move material. Again, it will be under margin pressure, though, because of the pullback in price.
Okay, that's helpful. That's it for me. Thank you.
Thank you. Your next question is from Frederic Bastien from Raymond James. Please go ahead.
Hi, good morning. I just want to follow up on that last question. Do you have any concerns around the net realizable value of your inventory across segments?
Service centers, I think we're in good shape. Frederic, I think in the steel distribution that we're in pretty good shape there. There may be a slight adjustment in the U.S. there, but it would not be material. On the energy side, it'll remain to be seen where we bottom out on that. There's a potential for one, but again, I don't think we're looking at anything large materiality. Nothing like we've done in the past.
Okay, cool. I was pleasantly surprised with how pricing held up during the quarter. Based on your comments around the second half, Marion, it looks like the ASPs would settle higher than they were before the imposition of tariffs. Is that a correct assumption?
Yeah, I think so.
Any guess as to how much higher they could settle at, or it is too far out to tell?
Yeah. Too far out to tell at this point. I think we have to let the dust settle a bit more.
Okay. Still a very good environment from a pricing perspective.
Yes.
Okay. I guess, John, I think we ask you that question every quarter, so I'll ask again. On the energy side, the rig counts are trending lower. I guess at the same time, in your comment, you're saying you're seeing continued positive momentum in the Permian Basin. It looks like things are finally moving along with LNG Canada. Given this backdrop, how are you feeling about the outlook for Energy Products into the second half and then into 2020?
Again, we feel like the Permian is obviously one of the hottest spots in North America right now. We're continuing to grow there and really putting an emphasis on future growth there. The LNG has taken off. We're getting some positive momentum. We just landed a nice Suncor project that we've been working on with Comco that will go up through the end of the year, roughly a CAD 50 million project. We're starting to see some positive things happen there in Canada. Again, I think most of the growth that we'll see will be in the U.S., predominantly in the Permian.
Okay. Will the growth of LNG offset some of the weakness you're seeing in Alberta, maybe?
Yeah. We're doing reasonably well in Alberta with energy right now. Again, I think that will offset it some, yes. It's just a matter of how much capital is going to be spent, continuing to be spent in Canada that's non-gas related is a little concern.
Okay. Thanks. That's all I have.
Thank you. Your next question is from Derek Spronck of RBC. Please go ahead.
Good morning. Thanks for taking my questions. Do you feel that you have enough visibility around steel pricing and market demand to maybe look at acquisitions again?
Again, we're always looking at them, Derek, because with the cyclical nature of our business, especially in the downturn, we typically throw off cash. It's a matter of valuation. Again, with the cyclical nature, we really don't try to time the market. It's more of a, when the opportunity's right, and it fits for our organization.
Valuations. Have those conversations, or do you feel more comfortable maybe being a little bit more focused around that, and perhaps valuations are a little bit more attractive now? Is that a fair statement, or?
The volume is slow to what we're seeing. It's out there, the deal volume, that's what we're seeing. As far as valuations, we typically look at a four- to five-year trend. Even in an upmarket, that balances itself out as well. We're looking at the cyclical nature again and trying to put a price tag on that to where we can get a stabilized return that's accretive for us, and accretive to our capital structure, not just our earnings.
How would you characterize your capital allocation priorities over the next 12 months?
Of course, inventory will be one we'll be watching closely, and we'll continue to push through that to see where the market's headed. We'll be looking at equipment and our value-added processing, and then we'll be looking at our computer system. Obviously our dividends, always a top priority.
Okay. Do you expect to see a little bit of a reversal in working capital trends and perhaps a reduction in inventory over the next several quarters, or?
I think that, yeah, the inventory will come down, AAP will actually generate cash conceivably the remainder of the year because we will need to start buying again in our metal service centers. One of the things that happens in the falling market is you wait as long as possible to replace your inventory as you then move out all your high-cost inventory. Also, as you figure out somewhat where the bottom is, at some point, you do have to buy. We will increase our AP. That will have a positive impact on working capital.
Okay. Just one last one from myself before I turn it over. Any color or update around U.S. mill production, following the last, call it eight months of the tariff and geopolitical dynamic?
Yeah, the challenging thing to follow based on historical numbers are the new quotas that are in place with various countries. Some of those are starting to fill up, so there will be some natural replacement in that. You can get a little bit of a false reading there from time to time. You may have more mill capacity coming online in a time when you're actually not shipping as much. We're trying to watch overall shipments and lead times closer. Again, now with Mexico and obviously with Canada being out of that mix with the 232, that will create a shift just comparing it to last year. If you do year-over-year. Again, we watch lead times closer and really watch scrap closer. The sustainability of pricing is the ultimate measure to see how strong demand is.
Okay. You're seeing a bit of a pickup in scrap pricing, right?
Scrap pricing has come up CAD 20. We think it could come up another CAD 20-CAD 40 in Q3. We're definitely seeing an upturn there. We're seeing an upturn in steel pricing with the exception of plate products, as I mentioned before.
Okay. All right. Thanks, John and Marion, for the additional color.
Thanks, Derek.
Thank you. Your next question is from Michael Tupholme from TD Securities. Please go ahead.
Thanks. Good morning. John, just in terms of your comments around plate having more room to run, do you think we're at a bottom here and the next move is upward and following hot rolled coil upward? Is that what you're suggesting?
I think plate's probably getting close to the bottom. Very close, and probably gonna hold. I think we're getting to normal spreads or historical spreads you would see between plate and coil. Coil probably over-corrected. Plate has yet to get there. The metal margin spreads were exceptional on plate for the last year. I think plate's probably getting close to a holding point, we may bounce up or down CAD 20 more if I follow scrap pricing. I think overall, I think it's at a holding point right now.
Okay. Would the same hold true for hot rolled coil? I mean, recognizing we've already seen the bounce, but you think that that sort of played out stable from here?
As stable as the steel business has been, which it hadn't been in my 28 years. Again, I think unless we have a big change in demand up or down, or we have a wild swing, I think it will typically follow scrap right now.
Okay. In the outlook commentary in the MD&A, you talked about overall demand having softened slightly in all of the business segments. Can you just expand on that a little bit? I guess, in service centers, for example, is this across the board or are there certain end markets that have seen greater softness? Just to be clear, is this sort of relative to Q2, is what you're indicating in terms of softening?
Yeah. We've seen softening in Q2. We think it'll carry over into Q3. Again, if you look at Canada being a resource-driven economy, if you look across the resources, oil, natural gas, mining, ag, if we look at the things that are out there, those have all softened across Canada. Construction has softened, but it's holding its head okay. If you look in the greater Toronto area, it's very busy, but across the rest of the country, moving to the eastern side of Canada, though, construction's pretty strong in Quebec, and then shipbuilding for the government vessels out in Atlantic Canada is very strong. Those are kind of what we're seeing across Canada. In the U.S., it's more across the board that we've seen the softening.
Other than probably heavy equipment, which seems to be holding flat to slightly down, the rest seem to have dropped off maybe 3% or 4% more than anticipated.
Okay. Again, this is a further decline relative to Q2, the third quarter being a little bit softer than you saw in Q2. Is that what you mean?
Yeah. I mean, right now it's difficult to tell, but yeah, we would see the third being a little bit softer, but again, you're coming through summer holidays. You got Quebec construction slowdown. There's a lot of variables that's a little cloudy right now to get our head completely around what's seasonality and what's actual slowdown. It feels a little softer overall right now.
Okay. I know it wasn't a big number, the inventory impairment charge in the quarter, Marion, at CAD 2.2 million, was that all in one particular segment, or was that sprinkled across a few segments?
It was sprinkled across. The bigger one was energy, but there was a little bit in service center.
Okay. Just back on your commentary, Marion, about gross margins in the service centers. You could see some further softness or deterioration in Q3 relative to Q2, do you think that at that point we sort of bottomed?
Yes, that's what I think. I mean, the biggest thing is when you see the steel prices coming down, as I mentioned, we wait as long as possible to replace the inventory. You're selling off that high price, which drives your margins down. As we start to replace, our average will come down, and the replacements will start in Q3, but the average will come down even more in Q4 in my mind, which will help expand the gross margin.
Yeah, we won't reach the bottom until sometime in Q3.
Yeah
a lot of reverse calls.
Yeah.
Right. How do you think about a normal margin for that business once you've sort of worked through the higher cost inventory? Where does that sort of stabilize at once you've finished getting through that?
Well, I think we'll go back up into the low 20s, 21, 22.
Okay. As we look out.
Maybe not.
into next year, assuming anything can happen with prices between now and next year. That's how we should be thinking about sort of the margin as we look out to next year, assuming a relatively stable steel price environment.
Yes. That's what I would say. Yeah, we may not get back to the 21 in Q4, but we'll be heading up into the 20s.
Okay. Is there anything going on with margins in energy products as we look out the next few quarters in terms of similar dynamic?
It really depends on what happens on pipe, and I think there is a bit of the price movement, but I think the biggest thing will be does the rig count start to or activity start to happen, particularly OCTG in Western Canada. If it's slow, we will get competitive pressure on top of lower pricing, which could impact prices more than you would hope.
Your energy services business, the Apex-type businesses out there, pretty stable on margins because it's such a highly engineered product. We have very little movement there. That margin's pretty stable. You'll see some pressure, but not as much as you do in OCTG, line pipe, or other product ranges.
Right. Okay. That's all for me. Thank you.
Your next question is from John Vickers, an investor. Please go ahead.
Hi. I keep looking at the dividend here and looking at the payout, about 76% from where I see. Leaves about CAD 7 million in free cash flow. I just don't understand how that can continue to pay out that much dividend and still make acquisitions.
We're a working capital company. It goes up and down. If we make an acquisition, we obviously will take on some more debt, but it would be a working capital type acquisition, which would allow us to borrow more. As a company, we throw off a lot of cash, and we feel the best thing to do with it is to pay a dividend to our shareholders.
Are you guys afraid that if you cut that dividend, the stock will just be reduced big time?
We're not afraid of that. We have, over a number of years, become a dividend yield stock, and we protect the dividend. Any acquisition we do has to be accretive to the dividend, not just accretive to CAD 1 on the bottom line. If it's not going to return enough to continue to pay this level of dividend, then we shouldn't be doing it.
All right. I'm still looking at that long-term debt from where I stand, your finance was like CAD 440 million. That's still a lot considering this quarter, after the dividend was paid, CAD 7 million in earnings.
No, I'm comfortable with it. Our debt equity levels are very low, and that is how we monitor. If we are eroding our equity too much, I would be concerned. As a company, we have very low debt equity levels.
Yeah. I just look at the 18% margin with the 7% dividend out there. That's pretty skinny to me.
I'm comfortable. We've watched this over a number of years. If you were to go back, you would see, I think we said our 70th quarterly dividend.
Right.
We've been a dividend for a long time.
Yeah. I get it. Okay.
I'm comfortable.
Thank you. Thanks.
Thank you. There are no further questions. You may proceed.
Thanks everybody for joining. Enjoy the rest of summer, and we'll talk to you next quarter.
Ladies and gentlemen, this concludes your conference call for today. We thank you for participating, and we ask that you please disconnect your lines.