Earnings Call: Q4 2018

Feb 8, 2019

Morning, ladies and gentlemen, and welcome to the 2018 4th Quarter and Year End Results Conference Call for Russel Metals. Today's call will be hosted by Mr. John Reed, President and Chief Operating Officer and Ms. Marion Britton, Executive Vice President and Chief Financial Officer of Russell Metals Inc. Today's presentation will be followed by a question and answer period. I will now turn the meeting over to Ms. Marion Britton. Please go ahead, Ms. Britton. Okay. Good morning, everyone. So John, our CEO, is with us. I guess we had an old intro there, but anyways, we're here. I'm going to start on page 3, quickly run through our cautionary statements. 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 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 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 and 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, and our forward looking statements included in this call should not be unduly relied upon. These statements speak only through 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 4, we do give our definitions for non GAAP measures that we use periodically throughout this presentation. Page 5 is where I'm going to start my comments. Comments are highlights for the quarter year. We had an EPS of $0.74 to help us mark off a very strong year at $3.53 or EPS, earnings of $219,000,000 compared to $124,000,000 last year and $2 in EPS. So our $0.74 in the quarter did compare to $0.45 produced in the Q4 2017. Had strong free cash flow, dollars 300,000,000 at December 2018 or $4.84 per share, which compares to the prior year of $2.92 per share. Return on equity, 22%, very strong for return. We also declared our dividend of $0.38 per share. Flipping over to Page 6 in the deck, some market conditions that we're seeing at this point in time. Q1 appears to be stable demand for our service center, although steel prices have peaked in most products. We did see a hot rolled coil peak in Q4 and has come down since Q4. Metal service centers, average selling price in Q4 was 28%, above what it was in Q4 2017, but and it was consistent with Q3 2018. So that implies selling price had peaked also at some point in Q3. Metal service centers tons shipped were down in Q4 of 2018 versus Q4 of 2017 on a same store basis. Year to date, they're up 2% for the company on a same store basis. Just to remind people that we would have the bows and Color Steel acquisitions, the bows in this year, April 2018. Color Steel 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 Products segment revenue did increase 44% in Q4 versus Q4 2017, mainly driven by the U. S. Lime type projects that were they were completed or 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, I 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 7 is our chart that shows our 5 year numbers. One of the numbers that is a new milestone, we had revenues for 2018 of $4,200,000,000 which is the highest since 2014 or the highest ever, but since 2014 when we reported $3,900,000,000 so an increase over that. Account 3 and 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 then metal and to 2014, netnetworkingcapitalwasup 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 our a slight increase in our interest bearing debt for $47,800,000 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 you 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 the feeder. 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 one type 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'll note that the service center is at 23.3% for the year versus last year at 20.7%. Percent. 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's up from last year, driven by rising in steel prices. Segment operating profit as a percent of revenue, total company 7.9%, grade improvement over 6.3% produced for last year and the Nettle Service Center and Steel Distributors segment are both up over last year with energy consistent. I'm going to just flip to Page 27 at this point, so I can make a couple of comments on the quarter and then I'll reference a few other pages in the deck. On Page 27, you will see the metal service centers is up 25% and energy up 24% and we've spoken mainly about that driven mostly by the large line type order that was complete in that period. The distributor's revenue is up 50%. We've had more activity in Canada, in particular, Those Those shipments will continue into Q1, but then we will start to taper off as we go through the year as we have brought in less materials available for shipment. Segmented operating profits for metal service center 80% does continue to be strong over compared to Q4 2017. Segment gross margin, there was a decline from the year number at the metal service centers. 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 a percentage of revenue, 6.4%, once again strong quarter number for the company. Now go to Page 18. Just wanted to make a comment on on the 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're actually less than they were in the prior year. Our average order size went up this year. So the increase to 2,000 for our average order size includes more tons in each order and additional an increase in selling price. Turning now to Page 21, just to make a comment on our CapEx for the year. Consistent with comments made throughout the year, our CapEx for this year $41,000,000 is higher than our depreciation. It's 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 36.41 number in 2019 also. In 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's increased tons due to depots being added in there, plus availability because demand is feeling fairly good going into 2019. Distributors also increased in doing deal sorry, 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. And 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% to 30% of our business right now if you exclude coil process. And so we don't count that number in there. There is some room to continue to grow. So we do have some availability on shifts right now with the existing equipment, but I would say that would be a 1% to 2% more room there to grow. So we will have to spend CapEx, which we have budgeted for this year, similar to last year in that same arena. So we'll continue to add equipment there as we push forward with our goal being to get the 35% to 45% within the next 2 to 3 years. And the payback on the new equipment that you're purchasing is coming in as expected and what could you quantify the payback period of new equipment? It's usually 2 to 3 years or less. Okay. Okay, great. Meeting or exceeding expectations at this point. Okay. Thanks, John. And that's the margin profile on that, is that a little bit 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. So as we I think we've talked before, the part that may weigh the same may have dramatically different cost in the labor component of that. So you can skew that number. It's really a mix based issue that you have to go through there. Yes. Okay, got it. I have a bunch of questions, but I'll just ask one more and then see if others ask my other questions. If not, I'll circle back up. But 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 remove them. I think 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. State Court stayed in place, there would be a concern that Canada will become the 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 it's 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 a follow-up on that last question, John. So your expectation would it be fair to say your expectation has 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. Volumize, we we can't handle that all coming into Canada. So I think they'll try to mirror or at least maybe even extend the timeframe for review, so they understand fully what the U. S. Is doing. Okay. And 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 any plate being a premium in Canada and hot rolled coil being a different discount. Is that still the case? That gap has narrowed, but they're still there. And I think that's more demand driven because now you have both safeguards in place there again. So they're having a counterbalancing effect. But again, I think it's more demand driven right now with what's coming in for the hot rolled coil just having a more difficult time getting into the U. S. To be competitive with the U. S. Mills and conversion 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 Q4. Marion, I know you said normally that would be sort of a stable pricing environment, something in the 21 percent to 22% range. But I wasn't totally sure if you're 21% in the Q4, but what is the outlook going forward, particularly with prices rolling over and sort of having RDP here? Yes. I think it will start to stabilize as we go out of Q1. I'm not 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 grow through the year, the 2021 to 2022 should be a valid number unless safeguards and all kinds of other things change the environment. And Michael, it's going to be again, as long as we feel like we're starting to stabilize on flat rolled pricing. As long as the pricing stabilizes, we think that 'twenty one to 'twenty two becomes a valid number. But again, if pricing drops or jumps up quickly, then that can change those. So the 'twenty one like what you did in the 4th quarter is a little bit, understood relative to what you should be able to do in a normal environment simply because prices came under some pressure? Correct. That's right. We've seen a decline. That's correct. And there seemed to be a little bit of excess inventory around that seem 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 and 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 'nineteen versus the latter part of 'eighteen you're talking? Well, and also year over year, we were only up 2% year over year and then we're thinking that demand will be somewhat consistent 2% up, 0, whatever in 'nineteen. We don't see any stay up. We don't see any reason for it to go down though. Okay. I guess the reason why I asked me, I guess, sequential versus year over year, because in the Q4, those service centers year over year same store tons were down about 5%. So do you actually think there's an opportunity to see some flat and maybe up slightly year over year full year 2019 tons in service centers? I think it would be a flat to potentially up. I think Q4, when you look at it specifically, the last 2 weeks of the year really were just down compared to historic Q4s and for December especially. So the seasonality, I think all service centers were one of the early ones reporting. But if you look at the MSCI numbers, you'll see inventories up and shipments are down for Q4, but I think that was really related to December. The world pretty much shut down at Christmas and came back January 6. So we thought shipments taper off more so than normal. So 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. And 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 Q1, but some of the CapEx budgets for the energy companies on the conventional side seem fairly negative with the pullback in oil in the Q4. So just help us frame the outlook for energy a little bit better? So you're really dealing with 2 thirds of the border there starting with Canada. We are seeing some pullback on the E and P status 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 to $40 we were saying $10 oil, that was concerning. But now that that shifted back to more of a normal level, even maybe a little bit lighter than normal level the differential. The budget seemed to be solid, but we're being told post breakup going into Q3 is that people again are anticipating in Canada being off 10% range for their budget. So overall, we think that's what we'll see is 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. And at the price in the Permian, especially, that they can extract oil right now, but this is a very healthy level. Now all the $30 a barrel that changes, we get to $75 a barrel that changes. But as we stand today in the low to mid-50s, I think we're okay. And just to be clear on the U. S, assuming no dramatic changes in the price of oil, full steam ahead means like some actual growth there or just I mean, I know you've got a bit of a tough comp with the line pipe orders, but can you maybe grow year over year in energy in the U. S? Or is that more of a flatter? On our normal business, we can. Again, 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. So when I say full steam ahead, I'm talking about our normal type of business, which we do have our normal line pipe business. We don't have any big projects in the hopper right now. And so that piece will be will fill off. And just lastly, in terms of free cash flow with steel prices having plateaued, it doesn't sound like there's tremendous amount of demand growth. Maybe you 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. Wondering how you think about capital allocation between dividends, buybacks, if the Board is considering buybacks and other growth initiatives? We always look at it every quarter. Again, 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. But as we reflect back on the dividend, also we were paying out over 100% there for 2 years. So I think people appreciated that, 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 6% to 7% depending on where our share price is at the moment. So 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. So you bought back part of that discussion as well, John? Yes. We've talked about share buybacks in the past. We really only look at those stock gets down below both. So if we if it's we don't want to do anything that's not accretive for the shareholders. So again, we don't want to dilute the shareholder and reward the guy for leaving. We'd rather reward the people for staying. So 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 Bastian 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? Yes, we came in with you're just a little bit of heavy thread on 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 safeguards. So that's rebalancing now. Our energy inventory is in a very good position. So again, we came in just a little heavy going into Q1 for service centers that we would like to have seen primarily based on just the last 2 weeks of December, Basically, the customer base just shut down for the year. So we think that will rebound very quickly. So overall, I think our turns will be back to normal levels or above very shortly. Thanks. And how would you describe sort of 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. So I was wondering what the position is right now across the board? We feel really clean and people have done a great job going through looking at that, continuing to push obsolescence as an aged inventory, push that out. So we're really clean and in a very good position right now. Okay, cool. A couple more questions on the distribution side. I know it's actually a smaller business, but it has been contributing nicely to the 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 pretend pretty solid Q1 for that business? So what happens, Frederic, is particularly in Canada, we have to bring in when the Great Lakes are open. So we do always bulk up at year end, but we did a lot of purchasing in the after the announcements, I'll say June 1, July 1, those announcements shipments arrived, they're gradually being delivered to our customers, no concerns because a lot of the Canadian is pre sold. There's windows that opened up there for it that we could bring in specific product plate being one of them that we could bring in that was very advantageous for in Canada. So we'll move back to the June level as we move through this first half of the year. Okay. And then separately, I mean, 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. And then if you look at the North American pricing for coil products, for example, if you take the world market, you add in tariffs and then you add in freight to come in, we're at those levels in that balance, they get 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. So we're seeing pricing actually move now with input cost, be it scrap or demand, which is more normal for our industries. I think we'll move forward from that and we'll stay at a more normalized level. So you've seen coil seems to be balancing out now at an appropriate price. So the plate is still a little heavier than the world market, but demand is very, very strong in North America. So we think we may see plate drift a little bit in pricing. But again, overall, we think that's the strongest product in the market right now. So going forward, I don't think we'll see as much volatility. Barn, 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 up some cash? Yes. So the Q1, we will use cash because of AR always goes back up. We had less revenue in them at the end of the year and then we have to pay bonuses and income taxes from last year, which as we go through the year, we believe that it should be relatively flat unless there's no big changes in prices. Okay. Thank you. That's great. Thank you. Your next question is from Anup 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 flake. And I'm assuming those were both positive variances? They were, yes. Was there any product that was negatively impacted by any of this activity? Nothing that was significantly impacted. There was a little bit of pipe product in Canada only. Just it was a timing issue with that clean debt, particularly it was about a 60 day window. I guess as we look at the price of the stock relative to your financial performance, I mean the market 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. Yes. No, that's what I figured. But it's definitely a tailwind, right? We have launched this. It lifted pricing and again, as we've always said, a higher price, we do better. Yes. So in selling price, we anticipate not to drop off as much, but we 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 the Q3 and in service centers. Yes. Thank you. And then just secondly, Marion, in terms of Q4, the gross margin in steel distribution dropped down a little bit. Is there some definitive reason we contribute to that or is that just general business activity? So the volumes that we bring in pre sold don't never carry as higher margin as when we take inventory risk on them and more percentage was driven by worse our Canadian operations than our U. S. Operations and worse tends to pre sell more so than the group as a total. So 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. 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.