Earnings Call: Q1 2019

May 8, 2019

Good morning, ladies and gentlemen, and welcome to the 2019 First 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 Reif, President and Chief Executive Officer of Russel Metals. I would now like to turn the meeting over to Ms. Marion Britton. Please go ahead, Ms. Britton. Good morning, everyone. We'll start on Page 3, just running through 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 facts 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 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. So if you can now flip over to Page 5, I'll just highlight the Q1 results. So Q1 2019 earnings of $34,000,000 EPS of $0.55 and that compares to Q1 2018 of 0.62 dollars Free cash flow was strong, dollars 58,000,000 or $0.94 per share compared to $0.97 per share in Q1 2018. Return on equity strong at 16%. We again declared our dividend of $0.38 per share. Flipping forward to Page 6, the market conditions as we see them at this point in time. Q1 2019 selling still selling prices were consistent with the end of 2018, although we do see downward pressure on Q2 pricing. We'll probably get more into that as we go through the questions. Metal service centers average selling price was up 21% compared to Q1 2018 and that is consistent with Q4 of 2018. Metal service centers tons were down 6% on a same store basis. Just to remind you that we bought De Beaux Steel in Q2 2018, and they are up 3% from Q4 2018. Rig count at this point is down 4% in the U. S. And down 18% in Canada. Canada is currently in spring breakup, so the active rigs is fairly low. Energy Products segment revenues decreased 3% in Q1 2019 versus Q1 2018. And we just summarized at the bottom there, and there is more detail in reminder on tariffs. They went in, in mid-twenty 18 U. S. And Canada. Canada did put some safeguards in that were anticipated to end in April 2019 or get updated, maybe I should say not necessarily end. There was safeguards on 7 products, 5 were removed at the end of April. Heavy plate and stainless wire are still on, and we believe that it's going to be quotas and then tariffs, but there's still clarification yet to come. Anticipated that may come in May. Page 7, we have all our metrics. I'm actually at this point, going to flip forward though to Page 9 just to highlight a few items on the balance sheet. We did adopt the new lease standard, along with most other companies, effective January 1, 2019. Just noting on the balance sheet, the lines that are impacted from that. Under the non current assets, you'll see the right to use assets added at $89,600,000 Under liability, short term lease obligations of 15.1 percent and long term lease obligations of 96.2 percent. The difference of $16,000,000 was charged to repaid earnings. Turning forward to Page 10, I'll just make a couple of comments on our working capital changes. Accounts receivable used cash in the quarter, mainly because at year end, our revenue is down in the month of December, much stronger in the month of March. So we have very good collections at year end, although collections are still strong at the end of March. Inventories was a source of cash. Inventories are down slightly. Accounts payable, was the use of cash due to payment of bonuses during the Q1, which related to 2018. Also, you will see that 33,500,000 dollars of income taxes were paid in Q1. It's somewhat consistent last year, but we did have extra payments due to our strong income in 2018 to our catch up payments in Canada. Flipping forward to Page 14, the segment information in the MD and A. The metal service centers revenues up to 18%. I have spoke earlier about the selling price increase and then the tons being down slightly. Steel distributors year over year is up 30%. Strong activity within Canada, in particular, servicing the needs of customers due to the tariff disruption on normal flow of products. In the segment gross margin percent of revenue, you'll note that Metal Service Centers gross margin was at 19.1%, down from last year and down from Q4. Although if you were to look at our gross margin dollars, Q1 2019 compared to Q1 2018, you'll note that it was up $2,000,000 So it was $103,000,000 at Q1 2019 and that's due to the high selling price being consistent or higher than 2018. The change in energy product is mix and you'll notice that it is up from Q4 when we also had a lower margin due to mix in our large line pipe project that was going on at the time. Steel distributors, although it's down from Q1 2018, it is consistent with Q4 2018. On the bottom of that page, you'll notice that we have done a line reconciliation by segment of our impact of the IFRS 16 or the new lease standard as some people might just refer to it. You'll note that our EBIT went up $3,000,000 due to it. Our interest went up $3,000,000 and the net impact on our income was up nil. Looking forward to Page 20, on capital expenditures. Our capital expenditures in the quarter were actually quite low. It was $5,000,000 compared to 11,000,000 dollars last year. That $5,000,000 does exclude our right to use asset additions. We expect to be a low point for the year. We do have a number of items going on related to value added processing. And so we do expect our depreciation this year to be similar to 2018. Down lower on that page, you'll see the breakdown of our inventory. Inventory is up year over year, driven mainly by selling price or cost of inventory. And but you'll note that we have brought it down from the end of the year. Those are my comments. I'm going to turn it over for questions. Thank you. And your first question is from Michael Tupholme from TD Securities. Michael, please go ahead. Thank you. Marion, are you able to talk a little bit about the gross margin and look across the various segments as we go forward? So should I guess specifically is what we saw in service centers, is that sort of where you'd expect to be going forward? And similarly, is Energy? Is this kind of the level we should expect other than some of the seasonal fluctuations that could affect mix? Yes. I would say that some other change related to product, big change in price of product or tariff changes that what we had in the Q1 would be similar to what we would expect for the Q2. Hoping that maybe by second half of the year that metal service centers will come up to a more normal 21 to 22 because the price of our inventory will average equal to current pricing. Michael, there are certain products in the service center that was the industry as a whole over stopped on, plate being one of them as far as the service center industry. So we saw a little bit more intense pressure than we normally see. So I think that will balance out in Q2 and we'll get back to more normalized margins there. Okay. Sorry, John, do you think the oversupply will balance out, but the margin would still, in Q2 stay a little bit lower somewhat what we saw in Q1. Yes. I think we see the pressure yes, it was good continue to see the margin pressure in Q2, but I think by the end of Q2, you'll see it balancing out going into Q3. Right. Okay. And then with respect to Energy Products, can you just any visibility beyond spring breakup in Canada in terms of how you think things will shape up once we get through a breakup? The outlooks are pretty murky on that. I mean, we're being told by several of our key customers that they've got drilling that they plan to go forward, but the overall outlook on the total rig count is a little murky. Obviously, we've got positive momentum with the elections there. It would be favorable. But as of right now, we just don't have any clarity. Okay. And is there anything happening for Russell in terms of opportunity that you've got any kind of line of sight on with respect to LNG Canada and any energy business related to that? We see that the LNG project there are some things starting to move forward working through the Kitimat area in the Northern BC markets and we're starting to participate slightly in that. I think we've said in previous calls that our service centers would likely see some of that work in late 2019 start to develop and we're starting to see some of that now. But really as far as pipeline type work that would affect our OCTG or line pipe operations, that's early 2020. Apex would again be in Q3, Q4, but we're starting to see that work to come in to bid play now. So when you say Apex Q3, Q4, you mean of next year or this year? This year. So Apex will be very similar to the service centers. We'll start to see that come into play in Q3, Q4 of this year. Okay. Was weather a factor at all for you in the quarter in terms of hurting the performance? I mean, I know a lot of companies have talked about how challenging the quarter was. Just wondering if that affected you at all. We definitely have seen delays across Canada and the U. S. On construction. I mean the flooding is obviously well documented. You've seen it in Quebec all the way across into Alberta region. The U. S. Is definitely under pressure, but that should balance out in time. And so again, the weather was definitely a factor. We lost several shipping days. But again, we should see that balance out during Q2. And so I think we'll get a little bit of a pickup from that construction. I'm more interested in watching the architectural building index to see the next posting it was below 50 for the first time in over a year. If that continues to be below 50, then there would be concern going forward on construction, more so than the weather. Again, that's just a delay that there would be pent up demand that will release at some point. Yes. Okay. All right. I'll get back in the queue. Thank you. Thank you. Your next question is from Devin Dodge of BMO. Please go ahead, Devin. Devin, your line is open. You may proceed with your question. Sorry about that. Just want to come back to the service center volume kind of topic. I know you highlighted that construction was a bit weak, maybe weather had an impact there. But have you seen any type of demand recovery in April and maybe the 1st week in May? We're holding about even pace with Q1. And so we may have picked up slightly, but it will be very slightly. So I don't see any big catalyst making a change on that right now. Okay. The MD and A made reference to the U. S. Preliminary determination about Canadian structural steel. Just trying to get a sense whether the Department of Commerce moves ahead with duties. Do you think this will have a material impact on Canadian structural steel prices if the U. S. Effectively gets kind of cut off from Canadian exporters? So it would definitely impact the fabricators coming out of the Quebec region. It would be difficult for them to again to ship across. Right now, again, the two sides of the border both are very bullish on that they think their side will win. We have seen a couple of our larger Canadian fabricators are quoting projects that are beyond the expiry date in August and willing to put in their contract that they'll eat any of those findings that are above and beyond. So they're willing to put the monetary risk there. So that's they're pretty comfortable with that. But if suit on structural steel, it will definitely impact the Canadian fabricators, because it will pin them to their home market. Okay. That's helpful. And I guess can you give us an update on what you're seeing in terms of line pipe opportunities? I just as I recall, I think the comps get pretty tough in the back half of the year. We're actually so the Permian area and Texas right now, there's just such a backup on demand there to get natural gas out because there's a lot of line pipe activity that's going on there With the LNG project again starting to gain traction, we think there's a lot of opportunity potentially in Western Canada in the back half of the year. So we're fairly optimistic on demand for line pipe going forward for the back half. We've actually seen a bit of slowing in the April months, but that started to pick back up in May again. I That was just more timing related to breakup. Okay. Thank you. Your next question is from Tyler Kenyon from Cowen. Just any update you can provide us just on your value added processing initiatives? Marianne, I think you made some comments about having a few of these initiatives underway this year. Wondering what those are and if you can kind of talk about that trajectory over the next couple of years. I still think you're targeting some upside in your value added processing mix, just trying to figure out how to think about it. We've got a project that we're starting forward now in Alberta, where we're thinking going into value added processing with our beam lines and beam yards that will to our capacity there. Across each service center region right now, we've got things that are on the board that they're looking at for approval. I think we'll be adding more 2 laser capacity, more flat laser capacity. So if you think about it from financial modeling, that should continually to incrementally increase as a percentage of our overall sales, which should help stabilize our margin or improve our margin as we go forward. Obviously, with the cyclicality of the price, the steel prices continue to move up and down, but it should help us to get some stabilization in that. So our target for this year is, again, for 2019 is try to approach the 28% to 30% range and beyond, with our goal ultimately being to get closer to that 35% to 40% range of our steel that is sold to be value added processing. Again, that does not count our cut to length. And so when we buy coil, we do not count that as value added processing, so we typically don't sell coil. Okay, great. And then there certainly have been some headlines about some consolidation potentially going just in the E and P side. As you think about your energy business today, I mean, how do you see that impacting things kind of in the intermediate term and longer term? Yes. And we've been here for a few quarters or really for a few years. We still see there's opportunities to grow in the valve fitting flange or if you would, the energy services business that we have primarily in the States. There may be some bolt ons for us that are in Canada. But as we continue to look for growth in the States, we think there's a bigger footprint for that opportunity there as well as in the service centers. We don't see currently adding to our footprint in the OCTG and line pipe. We're comfortable with where we are in those areas. Great. Thank you. Thanks, Tom. Thank you. Your next question is from Frederic Bastian from Raymond James. Please go ahead. Hi, good morning. Marion, I missed your comment, the comment you made about safeguards on plate potentially being removed at the end of the month. Can you please repeat that? So the comment is that there was 7 products and 5 of them were removed at the end of April, but plate is going to or is under review to have quotas and then tariffs. I don't believe it's going to be the 50 day quotas. There's going to be a quota for the year. That is still yet to be determined and the indication was it would be determined in May. Got it. I'll go ahead and answer the clarification. Plate and stainless wire were the 2 that were not removed. All right. And presumably, that would still be quite supportive for healthy prices for plate, correct? Yes, it would definitely support the mill side for plate and anything over 80 inches wide would definitely have legs for the Canadian marketplace. Okay, good. John, turning to you. You commented on the outlook for energy products in Canada being murky and then you provided additional color on line pipe in U. S. How are you feeling about the outlook for the U. S. Field stores? We think it's pretty strong. I mean, again, we just recently trailed below the rig count of 1,000. But again, at the high 900s, the oil price ranging between $60,000 $65,000 we think the drilling will continue. Obviously, the Permian being the hottest area that's down there right now, low cost of production for the field in North America. So we think the anything going on for our outfit and flange or field services stores out in the Oklahoma, Texas area is definitely a strong market for us right now. How are you feeling about skilled distributors with all the moving parts that you have to deal with? We've really come back to more of a normalized margin. We've got some opportunities for margin with the inventory holdings in the United States that took advantage of last year. Our volumes have been up in Canada. Some of the changes that were there, in those were more contractual and longer term, so they were in a more normal margin. But I think we'll be back to a more steady level that we've seen in the past, usually 'fifteen, 'seventeen, those type of time frame. Okay. Last one for me. You hosted a call not that long ago. So I was wondering if your overall outlook for rock soil has changed meaningfully from when you last reported in late February. Is it even better or worse? We still feel about the same. Again, we feel like this is again, I think one of your writings actually said 2018 was a barn burner year and that's exactly right. 2017 was a very good year for Russell. Historically, we think that 2019 again is going to be a very good year, more similar to 2017. We're just again coming off of a record setting year. So we don't think we'll hold that pace, but we feel very good about where we are right now. Great. Thank you, both. Thanks, Brett. Thank you. Your next question is from Anuprija from GMP. Please go ahead. Good morning. Just two quick questions. First, Marion, the IFRS adjustment on EBITDA this quarter was about $7,000,000 Can we assume that that's a decent run rate to use for the quarters over the balance of the year as well? Yes. That's what I would use for now. I mean, if we have additional leases, you'll event that NAFTA isn't ratified, what's your thoughts at this point as to what the default situation could look like in that scenario? Well, if I knew that one, yes, I probably wouldn't be here today. So it will be business as usual. That's where we've been for the last year and a half until something happens. Again, our best opportunity is to continue to turn our inventory and not take long positions. We saw some in the industry do that to put pressure on various products. But we want to just make sure we're there running our business on a day to day and not taking long positions. But we don't see I just don't see a whole lot changing. I'm actually less optimistic than most that the NAFTA will be ratified in the next year and a half, two years. Your next question is a follow-up from Michael Tupholme from TD. Please go ahead, Michael. Thanks. Just with respect to steel distributors, you commented on the margin outlook there. With respect to revenues, is the level you saw this quarter a level you think you can kind of sustain? Or was this benefiting sort of from some of the trade issues and likely a level that kind of comes down as we go forward? I think it will continue to come down. We got a really strong quarter in Canada. I think our U. S. Levels are very similar to what we'll maintain. But I think we'll continue to come down back to a more normalized level. Sort of the kinds of levels we saw during the first part of 2018 before the ramp up in the second half? Is that kind of thing? Yes, that's right. Yes, that's right. 2017, 2018, roughly 10% of our top line revenues where we should be. Okay. And then in terms of the 5 products where the safeguards were lifted, have you seen any change in pricing in the Canadian market as a result of that? I mean, you know it's only been a short period of time, but has anything changed yet? I don't think it's in relation to that. We've seen pricing change, but I think it's more to do with scrap pricing going down, changes the demand right now. So again, I don't think it has anything to do with necessarily those safeguards. As you said, it just hasn't had time to take effect for imports to come in, probably going to take 90 to 120 days to have any effect on that. Would you expect a big influx though or something the market can absorb? I think it's something that can be absorbed. At the level we are now compared to the oil pricing, I just don't see that as an opportunity for imports to come in and the pricing fall and scrap down 30, potentially down again next month. It makes it pretty risky move to be buying an import. Now you'd have to have such a huge spread and I just don't see that coming in a market that potentially could decline further. Okay. And just sort of on that point in terms of the pricing, you've commented on expecting some modest declines in Q2 versus Q1. Looking into the back half, do you think we sort of level off then? Or is there a scenario where you think we maybe see even further declines into the back half relative to Q2? I think we're going to continue to follow scrap, which is what we've done historically. If look at all products really with the exception of plate, you get this traditional scrap spreads are there for the steel mills. You're starting to see it move to scrap moves now. And the less you see a strong catalyst, positive or negative for demand, to change in North America, then I think we'll continue to follow the input cost, which again, the supply restriction, the 232 caused, it's given some spread to plate products from the mill side, that is not historical. But we've actually seen pressure on the service center side because of the people going out and being aggressively inventorying that. So I think that will start to rebalance the service centers mix and some improved margins from the plate as they spin the product out, the other products I think we'll probably see some more pressure from the mill side just depending on what scrap pricing does. Okay. Then just back on energy, understand that the second half outlook for Canada is uncertain. Sounds like things are good in the U. S. Sounds like you see some mine pipe opportunities in, I guess, in both markets, if I understood correctly. You had a strong second half of twenty eighteen in Energy Products. Can you get not necessarily back to those kinds of levels because you had some very large line pipe orders. But with what's going on, I mean, can you get somewhere close to there? Or is it are we looking at a quite a bit low in the second half of this year from a top line perspective? Yes. I think Canada is definitely going to be lower. I just can't give you a good barometer on how much lower that it's going to be. But I think Canada will be lower. Obviously, with the large line pipe project we had last year in the state. We don't have anything in the pipeline recreating that at this point. We think there's opportunities, but we don't have anything that we have firm deals on at this point. So again, I think if you exclude that, I think the states will be very similar to last year, maybe slightly down. Canada has a chance to be down more significantly. Okay. And the LNG does not serve as any kind of an offset to the lower Canadian guidance? There's definitely opportunity there. I just think on the pipe side specifically, it will be early 2020 before we'll see product actually going into it from our product actually going into the project. So this takes off, they'll be doing the infrastructure first in the second half of the year. Okay. Okay. Thank you. That's all I had. Thank you. Your next question is from Derek Spronck from RBC. Please go ahead, Derek. Yes. Good morning. Sorry, I was just jumping from another call. So I'm not sure if these questions have already been addressed. But any color or update around the emergency measures Canada enacted? And what are your thoughts around the recommendations that were recently provided? So the they were removed on 5 products. So the only 2 that are yet to be determined are plate and stainless wire. And there has been nothing firmly announced. We do believe it's probably going to be an annual quota and some type of tariff over that annual quota, but we'll wait and see in May. Okay. And do you feel that the market is roughly balanced at this point now? Or do you still see a little bit of shifting within the inventory supply chains in the steel market? It's a product by product basis. It's placed a little bit over inventory at this point in the service center industry, although it's coming into balance. It's been over inventory for the last 6 to 9 months. So we're seeing that come into balance. Margin pressure starting to subside in that category. Other products seem to be in pretty good balance overall for the industry. We are seeing pricing pressure from up to the drop and scrap prices is pushing through in the drop. And we've seen a little bit of softening in demand. But right now, we think it's a pretty balanced market. Okay. And just lastly, your value add services, any additional investments that you're looking to in order to kind of drive that line item and senior Yes, I know you just joined. As Ryan mentioned earlier, we only did $5,000,000 in Q1, but we see that ramping back up. And we've got projects that we're just about to start in Alberta. We've got several other service center projects for value added on tap for the balance of the year. So we do see that increasing for our CapEx for the rest of the year back to the levels you quoted previously. Okay, great. Thanks for the time. Thank you. Thank you. There are no further questions and you may proceed. Thank you everybody for joining the call. 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.