Earnings Call: Q3 2018

Nov 8, 2018

Good morning, ladies and gentlemen, and welcome to the 2018 Third Quarter Results Conference Call for Russell Metals. Today's call will be hosted by Mr. John Reed, President and CEO as well as Ms. Marion Burton, Executive Vice President and Chief Financial Officer of Russell Meadows Inc. Today's presentation will be followed by a question and answer period. And I would like to turn the meeting over to Ms. Marion Britton. Please go ahead. Good morning, everyone. We're going to start with the Page 3 of the slide deck that we sent out last night, the cautionary statement. Certain statements made on this conference call constitute forward looking statements or information within the meaning of the flexible 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 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 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 shall 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. If you would turn to Page 5 of the slide deck, I'll highlight some of our 3rd quarter results. Obviously, we're very happy with our operations and the results that we achieved in 2 quarters now back to back. Highest quarterly EPS in a decade was reported this quarter. Our EPS was $1.10 double what we reported for the same quarter in 2017. For the 9 months to September 30, we are now have earnings of CAD 173,000,000 and EPS of CAD 2.79 Free cash flow, CAD 240,000,000 for the 9 month period and were CAD 3.86 per share. Very strong return on equity, 1 more quarter for 23%, and we declared our dividend of $0.38 per share yesterday. Turning over to Page 6. We'll speak to the market conditions as we see them at this point in time. Demand remains stable. Steel prices appear to have peaked in most products. Some products are a little down. Some plate continues to hold and maybe a little higher. Metals Service Centers' average selling price was up 28% compared to Q3 2017, where metal service center tons was consistent Q3 2017 on a same store basis. We did have increased tons related to the 2 acquisitions that were added in the period. Rig count is up in the U. S, and we're calling it flat because it seems to be bouncing up and down quarter or week over week. Energy Products segment revenues increased 38% from Q3 2017. The main reason for the increase is U. S. Line type projects. We had mentioned earlier that we had a number of lime price projects on the go that would get completed in Q3 and Q4. They started earlier this year for ordering. And they have added to this quarter significantly and will continue to add to the revenue in the Q4. And also, our oilfield stores had continued year over year in higher revenue. Tariffs were imposed June 1 by the U. S. And then July 1 by Canada. We were aware of this last quarter. No change there even with the settlement or not settlement, I shouldn't say the speculation on the revised NAFTA agreement. Canadian safeguards were put in effective October 25, and they are based on a quota and tariffs above a quota system. They are in effect for 200 days and are going to be under review. Turning forward to Page 7, which shows our 5 year results information. You'll see our revenue for the 9 months is just over DKK3 1,000,000,000, noting the highest prior revenue of DKK3.9 billion reported in 2014. Expect we will surpass that in the 2018 year. The other numbers to note here are the EBITDA as a percent of revenue, 8.5%, very, very strong number as you can compare it to even 2014 below 6%. EBITDA as a percent of revenue, 9.4%. Looking down at our balance sheet. Net working capital of DKK 1,200,000,000, slightly higher than our 2014 numbers. Steel prices are higher and that is impacting or increasing, I should say, our accounts receivable and our inventory numbers, both of them are in good shape at this point in time. We'll speak to inventories when we go later in the slide deck. Turning forward in the information to Page 13. We did add some additional information or an update on where we think we are on the tariffs and safeguards at this point in time. Obviously, they're causing a lot of uncertainty in the steel industry, the stock market. We continue to watch them, and we feel that we are in good shape for whatever should happen in the future. Turning on to the next page, 14. There is the segment information. Revenues for metal service centers up 35% in the quarter. That does include obviously information. And then revenues for energy products were up 38%. You'll notice that it's over CAD 100,000,000 of increased revenue for Energy in the quarter, and that is driven by the large line type orders. Just want to bring your attention to the impact the large orders had on our segment gross margin at 17.3%. We do receive a large or I mean a lower segment margin on large projects and the mix has driven our margin down. All of our other operations were with in the same consistent with prior quarter Q2. Steel distributors had higher revenue in the quarter compared to last year, Q3. Looking down, you'll note the segment operating profit. Still, Metal Service Centers did the largest contribution to our higher net income, although energy and steel distributors were significant contributors to the good results. Going down to the segment margin, just to speak to Metal Service Centers. For the quarter, we had 24.3% compared to our year to date is 24.1%. We had been up in 25% Q2. There is some pressure on margins related to increase in average cost of inventory and selling price seeming to be flatlining now. Distributors, gross margin did come down and the higher gross margin year to date is because we were selling off inventory that we had at a lower price earlier in the year. We now are replaced most of our inventory with higher priced inventory. As I mentioned before, the segment operating profit for all of our three segments in total is at a very high level. Very happy with how our operations have done to drive that bottom line. Turning over to Page 16. Just point out there the so we have a 28% Europe for the quarter higher selling price, while we have 18% higher selling price for the 9 months ended. Similarly, I had commented that our same store sales in tonnes were consistent with Q3 2017. On a year to date basis, our same store sales are up 5% year over year. And just to remind you that we acquired Color Steel September 2017 and the acquisition of both was April of this year. So they are adding to our revenue and our tons in addition to our same store tonnes being flat. Turning forward to Page 20. Capital expenditures. For the 9 months, we've spent DKK 31,000,000 on capital expenditures. Depreciation expense for the 9 month period is $21,000,000 We've made the comment for the last year that we will continue to spend more than our depreciation expense because we're adding investment in value added processing, which has helped for us to maintain our margins and our segment margins in our metal service centers. We would expect that will be a high $30,000,000 for this year. Turning to Page 21, just point out the inventory levels. So in the metal service centers, our tons are actually down on a same store basis. They are up because of our acquisition, but the turns are very good shape at 4.3%. Like if you look back over the comparative periods, we feel that our inventory is in good shape at our metal service centers. Energy, the inventory dollars are actually down from Q2, but they are up year over year due to the line pipe business. We're doing additional activity and pricing of product in that segment. Similarly, the steel distributors is up significantly due to the fact that they've been able to bring in product, and we'll be selling that throughout the Q4. But we were not concerned about any of the inventory levels at these three segments. Those are my comments. I'm going to turn it over for questions. Thank And your first question will be from Anoop Prihar at GMP. Please go ahead. Good morning. It was a very good quarterly performance and congratulations on that front. Just a couple of questions. First of all, with respect to the strength in the margins in the Service Center business, I know you said that pricing was strong, but I'm just curious to the extent to which the tariffs and all the noise in the marketplace have perhaps created some inefficiencies that you guys have been able to exploit from a pricing perspective and that's adding to some of the mix here as well? Yes. We had you get the 2 countries perform very differently. Canada, again, as we I think we mentioned on our last conference call, there has been a disconnect in the pricing currency adjusted. So the Canadian price didn't go up as far, so it didn't fall as far. So there wasn't the reset, I think, if you will, in the flat roll and the product of flat roll that happened in the U. S. That created some margin pressure for our U. S. Service centers. And then also a very disciplined market in Canada, along with our continued growth in value added processing to help stabilize those margins. How much of the increase in the margin can you attribute to the value added processing? It moves around on a quarterly basis. It also moves around the price of steel, but it's I would say it's 1% to 1.5% right now. Okay. And then the Line Pipe contribution that we had in Q3, has that is that spilling over into Q4 at all? Yes. There's a significant amount that we will have in October, November December. We'll primarily clean the big project up. We have some other projects that will tail out as well. So we'll have a strong Q4, it won't be as big as Q3, but it should be a pretty good Q4 on that as well. And then I recall from our Q2 call, we spoke about pricing potentially stabilizing into Q3. And we see the Q3 numbers on the pricing just seems to keep on going. Yet we're talking about stabilizing again for Q4. I mean, is it really going to stabilize? Do you think we're going to have this pace here for a while? I think we're within a bandwidth. And again, we saw it go up in Q3, but it's come back down to that bandwidth. Again, I think the U. S. Mills may have overshot the markets a little bit, so it's just resetting itself. But we seem to be hovering around that same area. Plate products are obviously very, very strong. Backlogs are very strong. If there's going to be an increase, I think it would be in plate products. If you look at the world spread, market spread to flat roll into plate versus the North American spreads right now, there is room for imports. And I think obviously the tariffs and the quotas in the U. S. And as well as what the Canadians have recently put in, I think we'll keep those at bay. So we'll maintain the 80% to 85% utilization rates at the mills, which should keep price pretty stable. Thank you. Next question is from Derek Sprang at RBC. Please go ahead. Good morning. This is Kyle Brock on behalf of Derek. And first of all, Prior to the emergency measures that were recently enacted by the KT government, were you seeing any signs of increased foreign steel products coming into Canada as a result of U. S. Steel tariffs? Yes. Prior to, we saw a little bit come in. The Canadian government moved pretty quickly. So again, I applaud their efforts to maintain that to keep that from Canada from coming to dump and grow. So I think overall, we saw some. We actually were able to take advantage of some of that through our distribution division in Canada through work. But overall, there should not be a significant impact to the market that should flush itself out within 30 to 60 days. Okay, great. Thank you. And with respect to working capital, how should we be thinking about it in Q4 and into 2019 given the pretty significant draw in 2017 and so far year to date? The receivables typically will go down at year end. We always have a slowdown of our sales in November, December seasonality and in particular in the U. S. Because of the U. S. Thanksgiving and then Christmas driven demand down even more than in Canada. So I expect that inventory will be relatively flat. We're not anticipating any significant price increases, and I think we've sort of our average cost of inventory has started to max on and equal what's out in the market at this point. So I would anticipate in the quarter, we will see some working capital come in. It will go down a little bit. In March quarter, it will go up again for two reasons. First of all, we will have higher revenue in that quarter, which will bring the AR back up. I'm anticipating steel price of inventory is going to stay relatively stable. So inventory won't change that much, but we will do have income tax payments that will be have to be made in Canada because we have higher income in this year. And in addition, we will have bonus payments in the Q1, which will reduce our accounts payable. That's great color. Thanks very much. That's all for me. Thank And your next question will be from Robert Uhra, an investor. Please go ahead. Yes, good morning and congratulations on your fine results. My question is quite simple. As far as the USA tax on steel products, is it inflating our earnings? Or is it would be a boost if those taxes were removed? We may see some margin improvement there, so we'll get some lift on that. But again, I don't see there'd be anything significant either way for us on that. Yes. Steel, the tariffs go out, steel prices will go down slightly, but we don't believe that it's going to have a significant impact one way or the other on steel prices. It may it will vary by products, but are we we're obviously benefiting from higher steel prices and tariffs have raised steel prices, which the mills have raised them also, but it has not significantly driven our margins in our mind. Okay. On that same question, if the tax was removed on Canadian exports only and the United States kept their taxes on 4 other foreign imports. Does that make a difference? That's really probably our best scenario. It could go out of the Canada, U. S. And Mexico, if they were relieved in tariffs, they may go to a quota system, may not, but it would give us reasonable trade in North America and it would benefit the North American pricing compared to the world market for imports. They would be kept at bay to some degree. Obviously, North America needs imports. They don't produce enough to cover all of our demand needs. And I think that would allow us to have a little bit of spread there that would keep the mill manufacturers in North America at a busy operating level, which would obviously keep the pricing at a more stable level for us and a little bit of an inflated level. So again, that to us is probably our best scenario is if we eliminate the tariffs that are in North America right now and we trade freely but maintain them on the rest of the world. The real problem is not in the U. S, it's not in Canada. There's overcapacity in the world market, predominantly driven by China, and that's what's got to maintain they got to maintain addressing them. Thank you very much for your clear answer. I have no further questions. Thank you. Thank you. And at this time, Ms. Burton, it appears that we have no other questions. Okay. I thank everybody for attending the call, and we'll talk to you next quarter. Thank you. Ladies and gentlemen, this does conclude your conference call. Once again, thank you for attending. And at this time, we do ask that you please disconnect your lines. Enjoy the rest of your day.