Good morning, ladies and gentlemen, welcome to the 2018 fourth quarter and year-end results conference call for Russel Metals. Today's call will be hosted by Mr. John G. Reid, President and Chief Operating Officer, and Ms. Marion E. Britton, Executive Vice President and Chief Financial 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 E. Britton. Please go ahead, Ms. Britton.
Okay. Good morning, everyone. John, our CEO, is with us. I guess we had an old intro there, anyways, we're here. I'm going to start on page three, quickly run through our cautionary statement. Certain statements made on this conference call constitute forward-looking statements or information within the meaning of applicable security laws, including statements as to future capital expenditures, our outlook, the availability of our future financing, our ability to pay dividends. Forward-looking statements relate to future events or 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.
Please review the risk factors described below in our MD&A and 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, our forward-looking statements included in this call should not be unduly relied upon. These statements speak only to the date of this call, and except as required by law, we do not assume any obligation to update our forward-looking statements. I'll just reference you on page four, we do give our definitions for Non-GAAP measures that we use periodically throughout this presentation. Page five is where I'm going to start my comments. Comments are highlights for the quarter and year.
We had an EPS of CAD 0.74 to help us mark off a very strong year at CAD 3.53 our EPS, earnings of CAD 219 million, compared to CAD 124 million last year and CAD 2 in EPS. Our CAD 0.74 in the quarter compared to CAD 0.45 produced in the Q4 2017. Had strong free cash flow, CAD 300 million at December 2018, or CAD 4.84 per share, which compares to the prior year of CAD 2.92 per share. Return on equity 22%, very strong for return. We also declared our dividend of CAD 0.38 per share. Flipping over to page six in the deck. Some market conditions that we're seeing at this point in time. Q1 appears to be stable demand for our service centers, although steel prices have peaked in most products. We did see a hot-rolled coil peak in Q4, it has come down since Q4.
Metal service centers average selling price in Q4 was 28% above what it was in Q4 2017, and it was consistent with Q3 2018. That implies selling price had peaked also at some point in Q3. Metal service centers tons shipped were down in Q4 2018 versus Q4 2017 on a same-store basis. Year to date, they are up 2% for the company on a same-store basis. Just to remind people that we would have DuBose and Color Steels acquisitions, DuBose in this year, April 2018, Color Steels added in September 2017, which are year-over-year increases in our service center units. Rig count year-over-year is up in the U.S. The U.S. continues to be strong oil and gas production while Canada is down year-over-year. At the time we put the slide together, it was 33%. It still hasn't improved.
It's improved slightly since then, but not to a number that is very good for 2019 versus 2018. Energy product segment revenue did increase 44% in Q4 versus Q4 2017, mainly driven by the U.S. line pipe projects that were completed or are being completed at this point in Q1 2019, but were in our Q3 and Q4 results for 2018. We also did have strong results in our oilfield stores in the U.S. in the Q4. Tariffs. Just have a comment there reminding people when the steel tariffs were put on, and then during the Q4 was when safeguards were added in Canada for shipments from outside North America. The decision on the safeguards is anticipated in April 2019. Page seven is our chart that shows our five-year numbers.
One of the numbers that is a new milestone, we had revenues for 2018 of CAD 4.2 billion, which is the highest since 2014 or the highest ever, since 2014 when we reported CAD 3.9 billion, so an increase over that. We can see all the numbers there with our EBIT and EBITDA representing high returns in 2018. Going down, you'll note that our accounts receivable were in good shape at the end of the year. Very comparative numbers there. And to 2014, net working capital was up slightly from 2014 with revenues increased. So our numbers are in line with what we would anticipate on our working capital numbers at this point in time. We do have a slight increase in our interest-bearing debt, CAD 447.8 million at the end of the year. Turning forward, I will turn to page 16.
Just before I comment on that page, the one thing that I wanted to mention is that our full set of financial statements with the notes have been filed on SEDAR, so we've included here our quarterly and year-end summary pages, but if you are interested in full set of statements, you can obtain them off of SEDAR. And they will be on our website also. If you turn to page 16, you will see our results for the year compared to 2017. You'll see that all segments had a significant increase in revenues. We've also already talked about the fact that tons weren't up as much as selling price was up in the period. The increased energy, though, does relate to additional demand, the large line pipe order and activity going on.
The segment producing the most improved or increase in operating profit was metal service centers at 112% of prior year. Looking down to the segment gross margin, you will note that the service center is at 23.3% for the year versus last year at 20.7%. Energy is down slightly from last year, driven by the large order, which always carries a lower margin, and there is some mix in there also. Steel distributors, similarly, it is up from last year, driven by rising in steel prices. The company 7.9%, great improvement over 6.3% produced for last year, and the metal service center and steel distributors segment are both up over last year with energy consistent.
I am going to just flip to page 27 at this point so I can make a couple comments on the quarter, and then I will reference a few other pages in the deck. On page 27, you will see the metal service centers is up 25% and energy up 44%, and we have spoken mainly about that, driven mostly by the large line pipe order that was completing in that period. The steel distributors revenue is up 50%. We have had more activity up in Canada, in particular, driven by demand in Canada to source material outside of the U.S. Those shipments will continue into Q1, we will start to taper off as we go through the year as we have brought in less material available for shipment. Segmented operating profits for metal service center, 80%, still continuing to be strong compared to Q4 2017.
Segment gross margin, there was a decline from the year number at the metal service center. We would anticipate somewhere between 21% and 22% in a normal margin, so we were close to that 21%. As I mentioned earlier, we had some products have their pricing under pressure at the end of the year. The segment operating profit as percentage of revenue, 6.4%. Once again, strong quarter number for the company. Go to page 18. I just wanted to make a comment on under metal service center, the middle paragraph there. We talk about our average order size and the transactions handled. Always interesting information when you have that many transactions, 3,274 a day. They are actually less than they were in the prior year. Our average order size went up this year.
The increase to 2,422 for our average order size includes more tons in each order and an increase in selling price. Turning now to page 21, just make a comment on our CapEx for the year. Consistent with comments made throughout the year, our CapEx for this year, CAD 41 million, is higher than our depreciation, is actually higher than last year as we continue to add value-added processing equipment. We expect to exceed depreciation to a number somewhere between the CAD 36-CAD 41 number in 2019 also. The next page, on page 22, we break out our inventory dollars by segment and our inventory turns. You would note that our metal service center number is up quite a bit, but mainly selling price. There is increased tons due to DuBose being added in there, plus availability because demand is feeling fairly good going into 2019.
Steel distributors also increased in relation to the additional activity in Canada selling to the service centers. Those are my comments. I'm going to turn it back for questions.
Thank you. Ladies and gentlemen, as a reminder, should you have any questions, please press *1 on your touch-tone phone. Your first question is from Derek Spronck from RBC. Derek, please go ahead.
Yes, good morning. Thank you for taking my questions. Just on the value-add services, how much of a percent of revenue is now being driven by value-add services, and what sort of the growth rate you're seeing there, and do you have capacity to continue to grow, or will it require additional investments to continue to grow the value-add services that you're offering? Maybe some color around that. That would be great.
Derek, on our service center side, it's roughly 28%-30% of our business right now, if you exclude coil processing. We don't count that number in there. There is some room to continue to grow. We do have some availability on shifts right now with the existing equipment. But I would say that would be a 1%-2% more room there to grow. We will have to spend CapEx, which we have budgeted for this year, similar to last year, in that same range. We'll continue to add equipment there. As we push forward with our goal, we can get to 35%-45% within the next 2-3 years.
The payback on the new equipment that you're purchasing is coming in as expected? Could you quantify the payback period of new equipment?
It's usually two to three years or less.
Okay. Great.
Meeting or exceeding expectations at this point.
Okay. Thanks, John. The margin profile on that, is that margin accretive when you do that as well, or?
Yes. It's changing our margin profile in the service centers as we continue to add that, so we think it will continue to add there. Again, being a parts-based business, it's a little bit more difficult to model because it's not strictly driven off the tons, as you're selling time, so you're selling a lot of labor components to that. I think we've talked before, the part that may weigh the same may have a dramatically different cost in the labor component of that. It can skew that number.
Yep.
It's really a mixed basic issue that you have to go through there.
Yep. Okay, got it. I have a bunch of questions, but I'll ask one more and then see if others ask my other questions. If not, I'll circle back up. I'd be curious to get your thoughts around the emergency measures. Have they been working, and are you concerned at all if they decide to remove those emergency safeguard measures?
Which country are we talking about now?
The Canadians.
I think the Canadian, again, I'm not too concerned if they decide to remove them. I don't think they have a whole lot of option there until the U.S. does something. If they did remove them completely, the U.S. safeguards stay in place, there would be a concern that Canada will become a dumping ground for materials. I don't think that's going to be an issue. I don't think Canada will move without the United States on that. Overall, the impact right now, I think, has been healthy for our service centers and for our energy environment to maintain a pricing level that's good for the mills and good for the service centers, good for energy distribution.
Okay. No, that's great. I'll jump back in the queue. Thank you.
Thank you. Your next question is from Michael Tupholme from TD Securities. Michael, please go ahead.
Thanks. Good morning. Just to follow up on that last question, John. Would it be fair to say your expectation is come the decision in April 2019 by Canada that they would, I guess, make the provisional safeguards more permanent for the time being?
I think they'll try to mirror more permanently what the U.S. is doing. Again, I don't think they can disconnect too much from the safeguards there. They just open up the world market to Canada. Volume out of Canada, you can't handle that all coming into Canada. I think they'll try to mirror or at least maybe even extend the timeframe for review, because they understand fully what the U.S. is doing.
Okay. In the past, in the last few quarters since those provisional safeguards have been put in place, I think there's been some discussion about how, on the whole, it's had sort of a normalizing effect in terms of the prices of steel between Canada and the U.S., although there are some differences, I guess, between hot-rolled coil and plate with, I think, plate being a premium in Canada and hot-rolled coil being at a bit of a discount. Is that still the case?
That gap has narrowed, but they're still there. I think that's more demand driven because now you have both safeguards in place there. Again, they're having a counterbalancing effect. Again, I think it's more demand-driven right now with what's coming in for the hot-rolled coil. It's having a more difficult time getting into the U.S. to be competitive with the U.S. mills, and commercial plates having the opposite effect in Canada.
Okay. Just in terms of the gross margins in the service center segment, just under 21% in the fourth quarter. Marion, I know you said normally that would be sort of a stable pricing environment, something in the 21%-22% range, I wasn't totally sure if you're at 21% in the fourth quarter. What is the outlook going forward, particularly with prices rolling over and sort of having already peaked here?
Yeah, I think it will start to stabilize as we go out of Q1. I don't want to be too comfortable or too confident we're going to be above 21% in Q1, but I think as we go out through the year, the 21%-22% should be a valid number, unless safeguards and all kinds of other things change the environment.
Michael, again, as long as we feel like we're starting to stabilize on flat roll pricing. As long as the pricing stabilizes, we think the 21%-22% becomes a real valid number. Again, if pricing drops or jumps up quickly, then that can change those.
The 2021, what you did in the fourth quarter is a little bit understated relative to what you should be able to do in a normal environment simply because prices came under some pressure?
That's correct.
That's right. We were seeing the decline. That's correct.
There seemed to be a little bit of excess inventory around that seemed to want to be moved somewhere for some reason, and I see people getting concerned about pricing or just preparing for year-end, one or the other.
Okay. Just looking at the outlook comments you had in the MD&A, I just want to clarify a couple of things. When you talk about stable demand in service centers and steel distributors, this is on a sequential basis, like in the early part of 2019 versus the latter part of 2018, you're talking?
Also year-over-year. We were only up 2% year-over-year. Then we're thinking that demand will be somewhat consistent, 2% up, zero, whatever in 2019. We don't see any big up. We don't see any reason for it to go down, though.
Okay. The reason I'm asking, sequential versus year-over-year, because in the fourth quarter, those service centers year-over-year same- stored tons were down about 5%. You actually think there's an opportunity to see some flat to maybe up slightly year-over-year full year 2019 tons in service centers?
I think flat to potentially up. Again, I think Q4, when you look at it specifically, the last two weeks of the year really were just down compared to historic performance for December, especially for the seasonality. I think all service centers, and we're one of the early ones reporting. If you look at the MSCI numbers, you'll see inventory's up and shipments are down for Q4. I think that was really related to December. The world pretty much shut down at Christmas and came back January 6th. We saw shipments taper off more so than normal. I think you'll see a resetting of that in January. Inventory levels will come more back in line in the service center industry as a whole.
I think demand, what we're seeing is demand is picking back up to a level very similar to that of the year for 2018.
Okay. That's helpful. Just two other quick ones here. Can you talk a bit more about the energy products segment outlook and just generally what you're seeing in the energy sector? I know you've had these large line pipe orders benefiting you the last couple of quarters, but the outlook makes it sound like you're only sort of expecting a modest decline. I'm not sure if that's because you still got some line pipe orders coming through in the first quarter, but some of the CapEx budgets from the energy companies on the conventional side seem fairly negative with the pullback in oil in the fourth quarter. Can you just help us frame the outlook for energy a little bit better?
You're really dealing with two sides of the border there. Starting with Canada, we are seeing some pullback on the E&P side as far as their capital budgets. What we're being told from our customer base is somewhere around that 10% range. When the differential was getting up to CAD 40 and we were seeing CAD 10 oil, that was concerning. Now that that's shifted back to more of a normal level and even maybe a little bit lighter than normal level for the differential, the budgets seem to be solid. What we're being told post-breakup going into Q3 is that people, again, are anticipating in Canada being off 10% range for their budget. Overall, we think that's what we'll see as a change. Flipping south of the border to the U.S., they're full speed ahead right now. We're not seeing budgets get cut there.
At the price in the Permian especially that they can extract oil right now, this is a very healthy level. Now, pull the CAD 30 a barrel, that changes. We get up to CAD 75 a barrel, everything changes. As we stand today in the low to mid-50s, I think we're okay.
Just to be clear on the U.S., assuming no dramatic changes in the price of oil, full steam ahead means some actual growth there? I know you've had a bit of a tough comp with the line pipe orders, but can you grow year-over-year in energy in the U.S., or is that more of a flatter?
On our normal business, we can. I think that you're going to have the large line pipe projects that we will bid some others, but there's no certainty that you win those each time as they go through. When I say full steam ahead, I'm talking about on our normal type of business. We do have our normal line pipe business. We don't have any big projects in the hopper right now. Again, that piece will peel off.
Just lastly, in terms of free cash flow with steel prices having plateaued, it doesn't sound like there's no demand growth, maybe get some, but it would seem that you may have a reduction in inventories, I guess, at least with the pricing coming down. Maybe just speak to that, but if that is the case, presumably you're going to have some pretty good cash flow generation in 2019. Just wondering how you think about capital allocation between dividends, buybacks, if the board's considering buybacks and other growth initiatives.
Good. We always look at it every quarter. I think you're right that if all things stay even, the pricing stays where it's at today, that we should start to see cash flow start to increase. We'll review the dividend. I can tell you it was a fulsome discussion this quarter. We'll continue to review it to see where we are. As we reflect back on the dividend, also, we were paying out over 100% there for two years, I think people appreciated that we didn't cut the dividends, and we'll look at it as a long-term approach to what's best for our shareholders. It's still paying a pretty healthy percent over 67%, depending on where our share price is at the moment. We feel like it's in a good position, but we'll look at it again in 90 days.
We also continue to look at the value-added processing growth and at acquisitions.
Is the reason for buybacks part of that discussion as well, John?
Yeah. We've talked about share buybacks in the past. We really only look at those if the stock gets down below book. We don't want to do anything that's not accretive for the shareholder. Again, we don't want to dilute the shareholder and reward the guy for leaving. We'd rather reward the people for staying. We only really look at those typically when we get down below book value.
Got it. Okay. Thank you.
Thank you. Your next question is from Frederic Bastien from Raymond James. Please go ahead.
Hi. Good morning. Are you guys comfortable with the level of inventory that you're currently carrying across segments?
Yeah, we came into the year just a little bit heavy thread on the service center side. We're resetting now the distribution side. That's cleaned up. We had the opportunity last year in Canada that was just created by the safeguard, that's rebalancing now. Our energy inventory is in a very good position. Again, we came in just a little heavy going into Q1 for our service centers than we would've liked to have seen, primarily based on just the last two weeks of December. Basically, the customer base just shut down for the year. We think that'll rebalance very quickly. Overall, I think our returns will be back to normal levels or above very shortly.
Thanks. How would you describe the inventory levels on the industry side in energy? As I recall, a few years back, there was a lot of excess, and it took some time for everything to work through the system. I was wondering what the position is right now across the board.
Our people have done a great job going through, looking at that, continuing to push obsolescences in aged inventory. Push that out. We feel like we're really clean, in a very good position right now.
Okay, cool. A couple more questions on the distribution side. I know it's a smaller business, but it has been contributing nicely to profit. I noticed that there was fairly high level of inventory. It's down from what you had at the end of September, but it's still up significantly. Does that portend a pretty solid Q1 for that business?
What happens, Frederic, is particularly in Canada, we have to bring in when the Great Lakes are open. We do always bulk up at year-end, but we did a lot of purchasing after the announcements, I'll say June 1st, July 1st. Those announcements, shipments arrive. They're gradually being delivered to our customers. No concerns because a lot of the Canadian is pre-sold.
Okay.
There's windows that opened up there, Fred, that we could bring in specific product. Plate being one of them.
Yeah.
that we could bring in that was very advantageous for us in Canada.
We'll move back to the June levels as we move through this first half of the year.
Okay. Separately, you did mention that in your comment that last year's disruptions in trade sources did positively impact that particular business. What's the outlook now that, I guess, those disruptions have gone from short-term to pretty much being ongoing?
The pricing is starting to come back to what I would call a more stable level in that if you look at the North American pricing for coil products, for example, if you take the world market, you add in the tariffs, you add in the freight to come in, we're at those levels and about balance. They had gotten out of balance where the price was well above that. I think the concern for people to import was obviously the instability. That's starting to stabilize now, we're seeing pricing actually move now with input costs, be it scrap or demand, which is more normal for our industry. I think we'll move forward from that, and we'll stay at more normalized levels that you've seen. Coil seems to be balancing out now at an appropriate price.
plate's still a little heavier than the world market, demand's very, very strong in North America. We think we may see plate drift a little bit in pricing. Again, overall, we think that's the strongest product in the market right now. Going forward, I don't think we'll see as much volatility, barring if there's any significant trade changes that are just unforeseen.
Okay. Working capital-wise, I guess with demand stable, at least your outlook for demand to be stable and pricing softening somewhat from what you've experienced in 2018, how should we think about working capital? Are we done now with the investments, and we should expect working capital to start throwing off some cash?
Yeah. The first quarter, we will use cash because AR always goes back up. We had less revenue at the end of the year, we have to pay bonuses and income taxes from last year. As we go through the year, we believe that it should be relatively flat unless there's big changes in prices.
Okay. Thank you.
Thanks, Fred.
Thank you. Your next question is from Anoop Prihar from GMP. Please go ahead.
Good morning. Just curious to ask you, John, over the course of 2018, which of your products experienced the most price distortion, if you can attribute it only to the impact of the tariffs?
Probably the coil, and closely followed by plate.
I'm assuming those were both positive variances?
They were, yes.
Was there any product that was negatively impacted by any of this, actually?
Nothing that was significantly impacted. There was a little bit of pipe product in Canada only. Just it was a timing issue, but that cleaned up pretty quickly. It was about a 60-day window.
I guess, as we look at the price of the stock relative to your financial performance, and the market's obviously a bit confused over all the noise surrounding the tariffs, is there any way we can peg what the EBITDA impact was last year as a consequence of, I guess, it's a positive tailwind from all this?
Your guess is as good as mine. It'd be very difficult to pin that down.
Yeah. No, that's what I figured. It's definitely a tailwind, right?
It was, yes. It definitely helped. It lifted pricing. Again, as we've always said, a higher price, we do better.
Yeah. In selling price, we anticipate not to drop off as much, but in the year, we did get some of the lift in price, which drove the higher gross margins, particularly in service centers, the distributors in the sort of first half to maybe through to Q3 and in service centers.
Yeah.
Thank you.
Okay. Just secondly, Marion, in terms of Q4, the gross margin in steel distribution dropped down a little bit. Is there some definitive reason we can attribute to that, or is that just general business activity?
The volumes that we bring in pre-sold never carry as high a margin as when we take an inventory risk on them. More percentage was driven by Wirth, our Canadian operations than our U.S. operations, and Wirth tends to pre-sell more so than the group as a total. That drove it down a bit.
Okay. Thank you.
Thank you. There are no further questions at this time. You may proceed.
Okay, thanks, everybody, for attending, and we'll talk to you next quarter.
Ladies and gentlemen, this concludes today's conference call. We thank you for participating, and we ask that you please disconnect your lines.