Earnings Call: Q1 2018

May 2, 2018

Good morning, ladies and gentlemen, and welcome to the 2018 First Quarter Results Conference Call for Russell Metals. Today, we'll be hosted by Mr. John Reid, President and Chief Operating Officer and Ms. Marion Britton, Executive Vice President and Chief Financial Officer of Russell Metals. Today's presentation will be followed by a question and answer period. And I would like to turn the call over to Ms. Marion Britton. Please go ahead. Good morning, everyone. Hopefully, you've been able to get the slide deck, and I'm going to start by reading the cautionary statement on Page 3. 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 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 than 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 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 to 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 will turn forward to Page 6 on or Page 5, sorry, on the slide deck, I'm going to speak to the Q1 results. We had a very strong Q1. It was 0.62 dollars EPS, earnings of 38,000,000 dollars It's our highest quarter that we've had since 2018. And our comparable last year was $0.48 Free cash flow is at $0.97 per share, which is also very high. It's driven off of the earnings. Return on equity at 19% is the strongest over the last 5 years, which shows on our 5 year chart. Net cash was $20,000,000 at the end of the quarter. Also note that in the quarter, we did issue $150,000,000 of 6% senior notes. Thus, we were able to reduce we increased our net cash because of reduction in bank indebtedness to because of the issuance of the $150,000,000 We declared our dividend of $0.38 per share yesterday. And we also I want to note that after the subsequent event after the quarter that we previously announced on April 16, we completed the acquisition of Deboe Steel for US29 $1,000,000 Turning to Slide 6. Demand in steel prices are up in all three segments, which is what drove the positive increase in revenues and in earning EBIT and EPS. Metal service centers, average selling price is up 8%. As you know, steel prices have been rising mainly due to $2.32 but there has been increased demand across certain segments. Metal service center tons were up 7% compared to Q1 2017. In addition, our revenues in that segment were increased 3% due to our acquisition of Color Steel that was completed last September, and there would be no comparable 2017 numbers for that. Rig count is up in the U. S. And it's been basically flat in Canada. We're currently in Canada spring breakup, and we do anticipate that based on seasonality, it may be extended slightly. Energy Products segment revenues increased 13% from Q1 2017. We had positive results in oilfield stores and line pipe, increased sales in both of those operations in the area of our OCTG, our sales were basically flat year over year. Turning to Slide 7, point out the EBIT as a percent of revenue, 6.5%, highest on the chart, and our EBITDA as a percent of revenue of 7.4%. The working capital is currently in our metals operations, 996, which is running similar levels to 2014. It's driven our revenue, if you annualize that, we believe it's going to be higher than our 2014 number. On that page also, you will note that total interest bearing debt for $22,600,000 increased during the quarter based on working capital increases and we'll look at the cash flow shortly. Also going down to the bottom of that other information section, return on capital employed 18% and return on equity, which I previously mentioned at 19%, both very strong for our industry. Turning forward to the cash flow, which is on Page 10 of the slide deck. Cash from operations was $71,000,000 We did utilize cash in the quarter of $49,800,000 for working capital needs. You would see that accounts receivable increased almost 100,000,000 dollars That has to do with significant increase in revenue in the near the end of the quarter, February, March compared to the November, December period and increase the revenue is up obviously year over year also. Inventories have increased in the quarter, and that has been offset by significant increased accounts payable and crude liabilities. The income taxes line, you will note that we did have payments of 31 point $2,000,000 approximately $22,000,000 of that related to installments in Canada for our 2017 payments. So it is higher than our prior Q1, as our earnings in 2017 were significantly higher than 2016. The other line that I will note on here is the purchase of property, plant and equipment of 10.9 percent higher than our 2017 number. And if you were to look at our commentary that comes later in the deck, you'll notice that we anticipate spending more during this year in relation to value added processing equipment. So we would expect our capital expenditure to be approximately $10,000,000 higher than our depreciation that runs around 28,000,000 dollars Turning forward to Slide 14. This is the slide with all the metrics by segment and year over year comparisons for the quarter. As I mentioned before, all of our operations contributed to higher revenues and higher EBIT. The metal service centers quoted the numbers previously, selling price and tons up. Mentioned that in the steel distributors area, there was also steel price increases that drove the 21% increase in revenues as well as higher tons in Canada shipped. Going down to the gross margin as a percent of revenue, 22.1% this quarter compared to 22 0.4% in Q1 2017. The both quarters had rising steel prices. The one thing to note is that the selling price per ton is a lot higher in this quarter compared to 2017, which is what drives the increase of 33% in our operating profits and our metal service center. So the higher price brings more to the bottom line. Energy segment, we were margins were up to 19.3% in the quarter. The reason of the increase mainly is mixed. As I mentioned earlier that our Apex or valves and fitting operation field stores, which is our Apex type operations, had higher results and improved results over the OCTG operations of the same quarter last year. So their higher gross margin would drive the gross margin higher in this quarter. There's also been some increase in selling price in the OCTG area. Steel distributors had comparable to Q1 2017, although steel selling prices were higher than they were in 2017 Q1. Very strong segment operating profits as a percent of revenue. I won't go through them line by line, but you will note also that total operations was 6.5%, which was on the other slide. The other area I'll just comment on is on Page 20, the inventory. You'll note that our inventory is up, up based on all the previous quarters, driven by both additional tons because demand is up and driven by steel prices. For metal service centers, our tons are up approximately 7% higher than Q1 2017. In addition, we would have inventory related to Color Steel in that number that wasn't there last well was there at year end in September, but not Q1 2017. And note the turns are similar to March 31, 2017. Our energy products inventory is up significantly and turns have declined in that area. Lead times have extended for some of the product, and we have fairly strong activity going on in the line pipe area and in the valves area. So we've been required to increase our inventory. We are watching the inventory levels in that area to ensure they're not getting too high. Those are my comments. I'm going to turn it back to the operator to ask for questions. Thank you. And your first question will be from Brett Levi at Selos and Company. Please go ahead. Hey, Mary Anne. Can you talk a little bit about what your strategy is with respect to inventory and how that relates to the various trade cases? Kind of where do you see them going and how will you position yourself based on kind of where you see things going from this point of flower? Hey, Brett, it's John. In regards to inventory, we've obviously pulled a little bit of ahead in anticipation of the 232 as well as extended lead times at the mill manufacturers. So that's reflective in our turns being at 4.2. But again, we pulled ahead maybe half a turn to a turn. As always, again, we will maintain our turns during the inventory and during the cycles. We feel that's the best way to mitigate against risk. So we're not going to take any long positions or any long stretches there in light of what's going on with all the tariffs or the potential quotas. We'll watch closely to see what's happening June 1. We feel like that will probably be quotas that we've seen that with South Korea now. Argentina, Brazil have also apparently agreed to those along with Australia. So we'll continue to watch those closely, but we feel like we're positioned either way, whether it's tariffs or if it's quotas, we're positioned either way to take advantage of that market. And then in terms of M and A, this is kind of the traditional question. You guys have made some, I think, very additive tuck ins in the last little bit here. Are you looking for anything bigger? Is there a particular geography or a product category that seems a little bit more interesting to you as you obviously take advantage of and by the way congratulations a very good quarter? Thank you for the congratulations. I mean, we've said for 5 years, we want to grow the U. S. Footprint in service centers. Thank goodness, we finally did something in the U. S. And service centers after 4 years in Canada, but that's definitely our target market where we see the growth just based on geography and footprint opportunities for us. We are seeing a very active market there as well as we're seeing active M and A opportunities in the fill store businesses in both U. S. And Canada right now. All right. Thanks very much guys. Great quarter. Thank you. Thank you. Next question will be from Michael Tupholme of TD. Please go ahead. Thanks. Good morning. I want to go back to, I think one of points you made, Mary, and I just want to clarify. You've been talking about the working capital and how it was similar to 2014. And did I hear correctly, you suggested that although working capital levels are similar, you expect revenues this year to be higher than they were in 2014? Assuming that we have continued high steel prices, we have done an acquisition in this quarter. I anticipate that we will come in higher than the 2014 number. Okay. And when you say continued high steel prices, I mean, I guess you had in the outlook commentary of the MD and A, there was a suggestion that you do expect steel prices to possibly level off here in the second quarter. Any thoughts on the second half of the year in terms of do you think we kind of sort of trade sideways or is there a thought that we could see actually some change up or down in the second half? Again, for Q2, we think, again, we're going to see stable prices where they are. We think we may be plateauing a little bit given a fairly narrow bandwidth on pricing. Demand seems to be stable, increasing slightly in the U. S. With Canada being very stable. So again, barring any unforeseen changes in demand or unforeseen changes with the 232, which those appear to happen daily. But barring anything there, we think we're in a fairly stable operating environment going out as far as the second half of the year throughout. I don't see anything driving it down at this point. Okay. That's helpful. We think that'd be fairly stable. Got it. Okay. That's helpful. Thanks, John. And back on the 232, you had indicated, I think, that obviously, there's a lot of things, a lot of moving pieces here and things change frequently as you mentioned. But I think you had indicated you think possibly after June 1, we had this Canadian exemption until June 1, but after that point, maybe looking at the possibility of quotas in Canada. But you sort of maybe just elaborate on that a little bit your thoughts there. But secondly, you had indicated that sort of see under either scenario whether there are quotas or tariffs that Russell is well positioned to take advantage. Can you just sort of expand on that? I mean, to the extent that there are quotas or tariffs that do come into effect that affect Canada, What might that mean as far as pricing and how does that relate us to take advantage of the situation? I think part of the extension is obviously in the middle of the NAFTA negotiations. Those appear to be making traction. So I think they've extended it 30 days. It seems to be the preference to move towards quotas, obviously to increase the productivity of the U. S. Steel Mills with the goal the target goal kind of seems to be around 80%. They're slightly under that 75%, 76% capacity today. Without adding the additional tariff and but adding the quota, that should keep manufacturing more competitive as well in the U. S. When you flip to the Canadian side, if we go under the quota, obviously, the Canadian government needs to be prepared to react. They seem to start yesterday with some of that dialogue. So we don't become the dumping ground in Canada for those products. But again, where we are positioned with worth and with our import opportunities as we see those going in. If the U. S. Goes under the quota system, we think there'll be more opportunities to import various products into Canada. Again, as long as the Canadian government moves fairly quickly to avoid being a target for dumping for other countries, I think we'll be in a very good position based on our natural trade lanes and flows that are already out there in the value chain. So and I know this is very complex, but to the extent that we do have quotas come into effect in Canada, I mean, I understand the U. S. Business should be a beneficiary for yourselves. But as far as the Canadian operations, am I hearing correctly that you would see possibly some upside on the steel distributors part of your business. Would that possibly be offset by some downside, I guess, on the service center side if we had quotas here in Canada? I don't think so. Again, I think a lot of the Canadian environment that is there for the manufacturing can still move freely under the current NAFTA agreement unless there's some significant changes there that we're not aware of. Again, as we bring continue to bring in bean drops not made here, heavy plates not made here in Canada. So those become more available. Again, I think we'll continue to use that through Wirth and through metal service centers. There is an opportunity if Canada doesn't move quickly at the government level that the pricing could disconnect from the historical pricing with the U. S. Market, but I don't see that at this time. It looks like Canada is moving very quickly to ensure that this doesn't happen. Okay. That's helpful. Thank you. Just with respect to the strength of margins in the Energy Products segment, Marion, I think you mentioned there are a couple of factors there. I think pricing has helped, but also you talked about mix. Is that favorable mix in terms of what it's doing for the margins? Is that something you expect to continue on really through the balance of the year given what you're seeing in terms of line pipe activity and demand for the valves and fittings? Well, for sure, we'll see it in Q2 because OCTG is down. We do have some larger line type orders that would not be as high gross margin and which will come through stronger in Q3. So the mix will continue to be a factor in that quarter. I can't really see out to Q4, but I suspect based on what where the activity levels are going, it's going to be a factor all year. Okay. On the corporate costs, they're a little bit elevated in the Q1. I think maybe variable comp played a factor there. But should we how should we think about the corporate costs over the remainder of the year? You don't need to quite analyze that because some of the accounting requires that RSUs related to retiring individuals need to be accounted over the period to the retirement and everybody would know who I'm talking about at this point. So they are quite they're going to be stronger in the first half of the year than they are going to be in the second half of the year or higher, I should probably say not stronger, higher. So don't quite annualize it unless the good thing could happen that our stock price does go up and our stock price will drive up the RSU DSUs that are on our statement. So I'll just caveat that at the end with stock price could have impacted stock based comp. Okay. Thanks very much. I'll get back in the queue. Okay, Michael. Thank you. And your next question will be from Phil Gibbs at KeyBanc Capital Markets. Please go ahead. Hey, good morning. Thanks for taking my question. I have my question here is just on the energy side of the equation. How do you see the rest of the year playing out between, call it, downhole applications and line pipe applications? And then maybe talk about whether or not that there's a difference between what you're seeing in the U. S. And Canada right now? Line pipe is very busy in the United States right now. We're seeing a lot of large projects. We're participating in some of those, which will be very active in 3rd Q4 for us. LCTG remains very busy, especially in the Permian Basin in the U. S. Obviously, we're in a breakup in Canada right now, so things are slowing down for the normal seasonal breakup. We should come back out of that late in Q2, early Q3. We've seen a backlog in Canada that is very solid for the OCTG. And line pipe is not as robust as the U. S, but it's healthy in Canada. Okay. Thanks, John. And I know clearly freight's been an issue in the U. S. And can you tell us if you're seeing that in the Canadian markets as well? And then maybe talk about how the freight issues could be impacting sort of the cross border flows right now? The inbound logistics, again, we are seeing some of the pressure from that, but it's not impacting our business dramatically. Again, with the timing and the inventory turns, we should have time there to cover. On anything that we're sending out, we typically control our own trucking. So we do very little where we actually third party truck out. We have our own trucks. It will be at least our own trucks that we manage and maintain on our service center divisions. Our energy divisions and steel distribution have seen some pressure on the outbound trucks that I think would be normal for the industry right now that you're referring to. So I think overall, we're not seeing it as a big impact for us at this time. Okay. Last one for me is just how to think about gross margins for the Q2. Pricing is up to leveling out in Q2, but I would think still up something. And we know costs or inbound steel is going higher. Should we think about the gross margins in the quarter starting to level out as well? Or could there be further upside? Thanks. So in relation to comparison to Q1, we saw the largest increase in gross margins in the March month. So it wasn't predominant over the whole quarter. So we anticipate that service centers at 22.1% could be as high as say 24% or 24% and something in the next quarter. And then after that, it will flatten out or come down in Q3 depending on where steel prices go. So we didn't have a full quarter of ramp up of higher prices. But as you know, once we work through our inventory, it will flatten out. Thanks very much. Thank you. Thank you. Next question is a follow-up from Michael at TD. Please go ahead. Thank you. Just maybe to pick up on that last question there. When we think about the service center gross margins, putting aside the impact that pricing is going to have, which is obviously very important for the Q2. But given the continued expansion of your value added capabilities, do you think there's been some sort of a permanent improvement in the gross margins in Service Centers relative to average historical levels? And if so, what is sort of a more normalized level for the business at present? I think right now there is definitely improvement as we've started this process. Again, as we go across, there's we've got a long way to go as we continue to add value added processing. So we've talked about we're in the 28% to 30% of our volume is being processed if you exclude our cut to length volume. As we continue to add to that, that should stabilize that processing margin. You'll see some upside obviously in operating costs from the timing. But at this point, it would be hard to quantify as an exact number because we're still in the stages of this growth. But I think we will see this continue to grow we continue to add the processing there. We're having good success with those machines being full almost immediately. Okay. And then in terms of the tons growth you've seen in service centers, 7% same store growth in the Q1 year over year. I think, Marion, you said Color Steel's would have added another 300 basis points to that. I guess, starting in Q2, we'll also have the Du Beaus acquisition in there. So when you put that in there as well, what would we be thinking about here in terms of year over year tonnage growth, not just on a same store basis, but with the benefit of all those acquisitions or both of them? So the comment on color was it was 3% of revenue. So there would be a combination of selling price and tons in there. I don't have a good number on that unfortunately. I haven't tracked the tons. Maybe we can give some color on that when we do our Q2 reporting on what they're actually adding in relation to tons. Color is seasonal because they do service the construction industry. So their tons and their addition will be much stronger in Q2. And obviously, we will have the Bose for almost the whole quarter in Q2. So I'll just stop there and say that we'll give some more color about what they're doing to the tons when we do our Q2 reporting. Okay. And then just on working capital, if steel prices level off as you expect they may, how should we be thinking about changes in non cash working capital going forward? Maybe there's still some investment in the 2nd quarter given that prices were still rising through part of the second quarter. But as we get into the back half, how do we think about changes in non cash working capital in that period? I expect that we're going to have similar increase in Q2, but not quite as high as we did Q1. But I do anticipate some increases, due to the activity levels that we're anticipating in line pipe in that during the Q3. So, maybe 50 or slightly more during those two quarters to of additional working capital needs is my estimate at this point in time. Sorry, is that for that amount for each quarter or that's the cumulative? No, that's a cumulative number. Okay. Exclusive of any projects or anything going on, once we get a plateau, we'll bring our turns back to normal levels. So that should flatten out. But again, if you have additional projects that are outside the norm, they obviously have a need for working capital there. Yes. And selling prices will flatten out, but during the quarter, we will be receiving inventory. The quarter being Q2, that's at a higher selling price. So, our inventory and conceivably revenues will or sorry, AR driven by revenues will go up slightly too. So, that's why I do anticipate during the next two quarters, we're having a similar increase, similar to like $50,000,000 Okay. And then just lastly for me, how are you I know you're still interested in acquisitions and you talked about that earlier, but more generally, how are you thinking about capital allocation right now? And I guess I'm thinking about the dividend. I know we've had obviously a very sharp run up in steel prices, but to the extent that you think, if we plateau, but we can kind of hold in at somewhere in around these levels, Demand is good. Based on the earnings you did in the Q1, I mean, if you just annualize that, you're well below that 80% level you've historically talked about in terms of paying out dividends relative to earnings over the course of the cycle. So can you just speak to that, the dividend, I guess, specifically and more broadly capital allocation? So we look at capital allocation across all of our operations on a regular basis such that who's using what for inventory and revenue and where our activity is to make sure that we have proper capital allocation to each of the units and financing for that. In relation to the dividend, we've made this comment before that we still haven't really earned back what we paid out during the period that we were not making money, 'fifteen, 'sixteen. We'll continue to monitor where we are, but we do need to have some improvement and we want to continue to look at acquisitions. So we need to manage our capital in relation to working capital needs, acquisitions, but support our dividend. Okay. That's great. Thanks. That's all for me. Thank you. Thank you. And currently, Ms. Britton, it appears that we have no other questions. Thank you everyone for attending and we'll talk to you next quarter. Thank you. Ladies and gentlemen, this does conclude your conference call for today. Once again, thank you for attending. And at this time, we do ask that you please disconnect your lines. Have yourselves a great day.