Reliance Steel & Aluminum Co

NYSE:RS

Earnings Call Analysis

Challenging Quarter Ahead With Steady Demand

This quarter, pretax income and margins fell to $388 million and 10.7% from $510.9 million and 13.2% previously, primarily due to pricing pressures affecting volumes and margins. EPS stood at $5 on a non-GAAP basis. Despite lower profitability, year-to-date operating cash flow was a robust $1.15 billion, supported by efficient inventory management. The company's solid cash flow facilitated a share buyback, with $146.7 million repurchased in October. Looking to the fourth quarter, end market demand is stable, with tons sold expected to increase by 3.5% to 5.5% year-over-year. However, average selling prices per ton are expected to drop 4% to 6%, with a consequent modest dip in gross profit margins. The company projects Q4 non-GAAP EPS between $3.70 and $3.90.

Resilient Performance Amidst Market Fluctuations

In a nutshell, Reliance has weathered the vicissitudes of the metals market with robust resilience. Their third quarter of 2023 played out as anticipated, marked by a blend of measured growth in tons sold and the navigational prowess to maintain a stable gross margin, even in the face of declining average selling prices. Notably, the company's non-GAAP earnings per share stood strong at $5.

Strategic Capital Allocation and Investment

Reliance has demonstrated unwavering commitment to growth, channeling approximately $125.5 million into capital expenditures within the third quarter alone. This fits neatly into their grand tapestry of a record-breaking $520 million annual capital expenditure budget intended to bolster processing capabilities, upgrade facilities, and penetrate new markets. Despite the absence of new acquisitions, the company's strategy remains aggressive, with a capital outlay expectation of $450 to $475 million for 2023.

Shareholder Returns and Market Advancement

The company continues to shower its shareholders with substantial returns, mixing dividends and share buybacks to the tune of $185.1 million for the quarter. This practice is a consistent thread running through their broader capital allocation strategy, which since 2018 has seen a flowing stream of approximately $3.1 billion returned to shareholders.

Trends in Sales Volume and Pricing

Reliance's sales volume crept up by 1.1% compared to the same quarter of the previous year, and it's up by 3.4% on a year-to-date scale—a testament to the company's solid footing in crucial markets. In contrast, the average selling price dipped by 2.8%, which, while within the expected band, illuminates the downward price volatility pervading the industry.

Net Sales, Margin Pressures, and LIFO Accounting Effects

Net sales retracted by 6.6% against the prior quarter, squarely in line with expected seasonal volume shifts and declining prices. Despite this drawdown and concomitant margin pressures, Reliance's year-over-year growth in tons sold is unshaken, and their maintained gross profit margin remains commendable. Further, the conservative revisions to annual LIFO estimates could seed an income of $140 million for the year, with $35 million anticipated in the fourth quarter alone.

Financial Health and Fourth Quarter 2023 Outlook

While pretax income contracted compared to the second quarter, the company managed a non-GAAP EPS of $4.99, aligning tightly with forecasts. The cash flow narrative is equally robust, with operating cash flows of $1.15 billion so far in 2023. Looking ahead, Reliance is optimistic about demand stability in the fourth quarter, projecting substantial growth in tons sold, albeit with an expected 4% to 6% decrease in average selling prices. As a result, they anticipate a non-GAAP earnings per share ranging from $3.70 to $3.90.

Earnings Call Transcript 2023-Q3

[Operator]

Greetings, and welcome to the Reliance Steel & Aluminum. Third Quarter 2023 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce you to your host, Kim Orlando with Addo Investor Relations. Thank you, Kim. You may begin.

[Kimberly Orlando]

Thank you, operator. Good morning, and thanks to all of you for joining our conference call to discuss Reliance's Third Quarter 2023 financial results. I am joined by Karla Lewis, President and Chief Executive Officer; Steve Koch, Executive Vice President and Chief Operating Officer; and Arthur Ajemyan, Senior Vice President and Chief Financial Officer. A recording of this call will be posted on the Investors section of our website at investor.rsac.com.

Please read the forward-looking statement disclosures included in our earnings release issued this morning, and note that it applies to all statements made during this teleconference. The reconciliations of the adjusted numbers are included in the non-GAAP reconciliation part of our earnings release.

I will now turn the call over to Karla Lewis, President and CEO of Reliance.

[Karla Lewis, executive]

Good morning, everyone, and thank you for joining us today to discuss our third quarter 2023 results. Reliance's business model is designed to provide resilient performance throughout economic cycles, including both pricing and end market demand fluctuations present in the metals industry.

The unique facets of our business model highlighted by strong pricing and inventory management discipline, a highly diversified product mix that is sold into various end markets and geographies, small order sizes, quick delivery value-added processing and increasing collaboration across our family of companies collectively support our ability to deliver consistent profitable results and generate cash flow.

I'd like to commend the entire Reliance team for successfully executing our strategy during challenging times and delivering another quarter of solid financial performance. Our overall financial performance in the third quarter was in line with our expectations. While our tons sold were down slightly more than anticipated, we outperformed broader service center industry trends and delivered year-over-year growth.

As expected, our average selling price declined throughout the quarter across virtually all of our major commodity products, but our pricing discipline and industry-leading value-added processing capabilities provided us with gross margin stability and lessen the impact of falling prices on our gross profit margin.

As a result, we delivered non-GAAP earnings per share of $5 in line with our guidance. Our profitability, coupled with effective working capital management, generated strong operating cash flow of $466 million for the quarter. Investing in growth remains our top capital allocation priority with approximately $125.5 million of capital expenditures.

Our capital expenditure budget for the full year 2023 remains unchanged at a record $520 million, with approximately 2/3 directed towards growth projects to advance our value-added processing capabilities upgrade facilities and expand into new markets. Our total 2023 CapEx cash outlay is expected to be in the range of $450 million to $475 million.

While we did not complete any acquisitions during the third quarter, the pipeline remains robust. We will pursue opportunities that meet our disciplined criteria of well-managed companies that would be complementary to our diversification strategy and immediately accretive to earnings.

Our acquisition strategy is supported by our strong balance sheet and consistent ability to generate cash throughout industry cycles. Along with growth, returning value to our stockholders remains a core element of our capital allocation strategy. During the third quarter, we returned $185.1 million to our stockholders through a combination of dividends and share repurchases and we continue to opportunistically repurchase shares in the fourth quarter.

Since 2018, we have invested over $2.3 billion in organic growth and acquisitions and returned nearly $3.1 billion to our stockholders through dividends and share repurchases, far surpassing our metal service center peers. In summary, we are very pleased with and thankful for the ongoing efforts of our entire Reliance team, all of whom expertly execute Reliance's strategy on a day-to-day basis, operate safely and produce industry-leading results through all operating environments.

We will continue to leverage our strong balance sheet and significant liquidity to fund profitable growth and return value to our stockholders. We are excited about the many growth activities underway and that we anticipate arising under the Infrastructure Bill, the CHIPS Act and the Inflation Reduction Act as well as on-shoring and near-shoring activities in the markets we serve.

Thank you all for your time today. I'll now turn the call over to Steve, who will review our third quarter demand and pricing trends.

[Stephen Koch, executive]

Thanks, Karla, and good morning, everyone. I'd like to echo Karla's comments by thanking the Reliance team for delivering another quarter of profitable results and for the continued focus and effort to ensure the safety of our workforce.

I'm pleased to report that the third quarter was our strongest safety quarter in all of 2023. I will now turn to our third quarter demand and pricing trends. Our tons sold were up 1.1% from the third quarter of 2022 and are up 3.4% on a year-to-date basis, reflecting solid underlying demand in key markets, including nonres construction, aerospace as well as contributions from our organic growth activities.

Our year-to-date 3.4% increase in tons sold outpaces the 1% increase across the broader service center industry. When compared to the second quarter of 2023, our tons sold decreased 4.3% predominantly due to lower carbon flat-rolled shipments at a declining pricing environment led to more cautious customer buying activity, normal seasonality and 1 less shipping day.

Our average selling price per ton sold of $2,552 was down 2.8% from the second quarter of 2023, but in line with our expected range of down 2% to 4%. I will now turn to a high-level overview of the trends we saw within our products and key end markets. Carbon steel tubing, plate and structurals, our 3 largest product groups represented about 1/3 of our third quarter sales -- all of these products experienced higher shipments compared to the third quarter of 2022 and stable or only slight declines in daily shipments compared to the second quarter of 2023.

We continue to believe new public infrastructure projects under various federal state programs in addition to industrial reshoring efforts will continue to support nonres construction and infrastructure demand in the medium to long term. Aluminum and stainless products represented 31% of our total third quarter sales with aluminum stainless aerospace products comprising approximately 9%.

Although common alloy, aluminum and stainless shipments and pricing declined slightly in the third quarter, aerospace product demand and pricing remains strong with shipments up significantly year-over-year. We primarily service the automotive market through our toll processing operations, which as a reminder, are not reflected in our tons sold.

Our tolling business in the third quarter of 2023 was consistent with the second quarter at approximately 4% of our total sales and improved year-over-year on increased processing demand from the automotive market. We did not experience a material impact resulting from the UAW strike during the third quarter. We saw a wide range of products diverse sectors of the general manufacturing market -- shipments declined both sequentially and year-over-year due in part to both seasonality and a pullback in carbon flat-rolled demand as prices decline.

Sales for the semiconductor industry declined both sequentially and year-over-year. However, our long-term outlook for this market remains positive due to the chipset and active reshoring. We continue to make investments to increase Reliance's capacity in semiconductor space support active and anticipated opportunities. Please refer to our earnings release for additional commentary on our end markets and product diversification.

I will now turn the call over to Arthur to review our financial results and outlook.

[Arthur Ajemyan, executive]

Thanks, Steve. Good morning, everyone. Reliance delivered solid performance across all financial metrics this quarter. Our net sales were in line with our expectations, down 6.6% from the second quarter, mainly due to seasonally lower volumes and lower selling prices.

Pricing pressure across our major commodity products, in particular, carbon flat rolled contributed to lower-than-anticipated tons sold. Despite pricing declines in various macro headwinds, we produced year-over-year growth in tons sold and gained market share. While the pricing declines for most of our products resulted in temporary pressure on our margins as our cost on hand exceeded replacement costs we nonetheless maintained a solid gross profit margin of 29.7%, supported by our value-added processing capabilities and generated earnings per share of $4.99 for the quarter.

Higher-than-anticipated declines in carbon steel product prices contributed to a revision of our annual LIFO estimate from $120 million of income to $140 million of income. As a result, we recorded LIFO income of $45 million in the third quarter. Year-to-date, our LIFO income totaled $105 million. Based on our newly updated estimate, we expect $35 million of LIFO income in the fourth quarter.

As of the end of this quarter, like reserve of approximately $639 million in our balance sheet remains available to mitigate the impact of possible further declines in metal prices and benefit future period operating results. Moving on to expenses. Our third quarter same-store non-GAAP SG&A expenses declined by $25.3 million or 3.9% compared to the second quarter due to reduced compensation costs associated with lower FIFO profitability, along with lower variable costs associated with fewer tons sold.

On a year-over-year basis, our same-store non-GAAP SG&A expenses were down $6.1 million or 1% due to lower incentive-based compensation resulting from lower FIFO profitability partially offset by higher compensation expenses associated with increased headcount and wage inflation.

Our third quarter pretax income and margin of $388 million and 10.7% declined from $510.9 million and 13.2% in the second quarter as a result of the aforementioned pricing pressures and their impact on our volumes and gross profit margin. Nevertheless, our EPS of $4.99 or $5 on a non-GAAP basis was within our guidance.

Turning to our balance sheet and cash flow. For the 2023 9-month period, our operating cash flow was $1.15 billion compared to $1.31 billion in the same 9-month period in 2022 as the impact of lower profitability was partially offset by lower working capital needs in 2023. Our inventory turn rate based on tons came in at 4.7x or 2.6 months on hand for the first 9 months of 2023, matching our company-wide goal of 4.7x, and it compared to 4.3x in the comparable period in 2022.

Our healthy inventory turn rate not only contributed to strong cash flow generation, but also helped soften the impact of declining prices on our gross profit margin. As announced in our earnings release, our Board of Directors approved an amendment to our share repurchase plan, replenishing our repurchase authorization to $1.5 billion.

Our share repurchases in the month of October were $146.7 million, bringing the total purchases under our July 2022, $1 billion share repurchase authorization to $705 million.

I'll now turn to our fourth quarter outlook. Overall, we expect that underlying end market demand will remain relatively healthy in the fourth quarter of 2023. We expect 3.5% to 5.5% growth in our tons sold compared to the fourth quarter of 2022 were a sequential decline of 4% to 6%, consistent with seasonal trends.

Although Reliance believes pricing for many products will be near trough levels in the current cycle at some point in the fourth quarter with certain product leveling off or increasing modestly -- we expect our average selling price per ton sold for the fourth quarter to be down 4% to 6% compared to the third quarter.

We also anticipate continued modest temporary downward pressure on our gross profit margin from the declining metal pricing trends. Based on these expectations, we anticipate non-GAAP earnings per diluted share in the range of $3.70 to $3.90 for the fourth quarter of 2023. In closing, we believe we have an industry-leading and a proven business model designed to navigate economic cycles and challenges and a strong balance sheet that collectively give us the confidence to continue pursuing profitable growth and fueling our strong cash flow and capital return activities.

That concludes our comments. Thank you for your attention. We'll now open the call up to questions. Operator?

[Operator]

[Operator Instructions] Our first question is from Martin Englert with Seaport Research. Please proceed with your question.

[Martin Englert, analyst]

I wanted to first touch on SG&A, and you did comment a bit on it in the prepared remarks, $627 million for the quarter, down from $651 million, I believe, sequentially.

Could you briefly touch on your thoughts around SG&A for fourth quarter? Should we expect another step down sequentially here, but kind of still remaining above that $600 million mark.

[Arthur Ajemyan, executive]

Yes, Martin, good question. It should be consistent with seasonal patterns. So I mean, with fewer tons sold, there should be a little bit of a downward trend. But we're not necessarily putting out a specific guidance on SG&A.

[Martin Englert, analyst]

Thank you for that. Looking across the different metals product lines here and your comments more broadly within the guidance on modest gross margin pressure quarter-on-quarter here. But are there any particular products where you feel here's where you're seeing the majority of the pricing pressure or margin pressure rather.

[Karla Lewis, executive]

Martin, it's Karla. That's going to vary a lot based on each of the different products, the markets we're selling into the amount of value-added processing that we're doing. So generally, at a high overall level, when mills are announcing price increases, we're typically able to get a temporary margin expansion on those products.

But when prices are declining and we're selling off our higher cost inventory that's on hand, you can see a little compression. So most products have been declining really for about the last 7 months. We've seen some consistent pricing pressure. So we've been dealing with that for several months. And I think our team has done a great job of being able to manage through that and maintain a very strong gross profit margin, although not at some of the peak levels we had seen recently.

And with the current outlook, although there are price increases on certain products announced, and we anticipate there could be more and on some additional products. Overall, we're anticipating downward pressure at least compared to the average from Q3 into Q4. But we do think in a lot of our products, we'll see some leveling off. But overall, we expect some continued pressure.

[Martin Englert, analyst]

Okay. Understood. I appreciate all the color. If I could 1 last quick one. And again, you just touched on this a little bit in the prepared remarks and no material impact in the tolling business from the UAW strike, but is this something like there might be just a bit of a delayed impact. Or based on what you're seeing for today, well, kind of similar in kind of negligible implications on 4Q.

[Karla Lewis, executive]

Yes, Martin. So in our tolling business, about 60% to 65% of our tolling is automotive related. And then a portion of that is related to the big 3 where the strike activity is occurring. And we've seen very limited impact so far.

However, each time the scope of the strike expands, we could see more impact. So there is some impact based on there being more locations on strike, in particular, the Ford plant in Kentucky. We will see a bit more impact we anticipate in Q4, but we're very hopeful that the strike will be resolved soon, and everyone will be back at work and will be back to normal levels. But even if there's a broad expansion, it will not be material to Reliance as a whole in the fourth quarter.

[Martin Englert, analyst]

All right. I appreciate that. Nice job navigating the down market.

[Operator]

[Operator Instructions] Our next question comes from Phil Gibbs with KeyBanc Capital Markets.

[Philip Gibbs, analyst]

So firstly, I wanted a clarification on the buyback. I had read it as you had about $1.5 billion on a fresh authorization. And then, Arthur, I think you made some comment about almost $150 million purchased in October. Is that part of that $1.5 billion new buyback authorization? Or was that -- is this new one after that one? I'm trying to understand the comments.

[Arthur Ajemyan, executive]

Good question, Phil. No, the $150 million in October going against the previous authorization. The $1.5 billion starts fresh that -- the clock on that starts now.

[Philip Gibbs, analyst]

Okay. Perfect. And secondly, at least in my model, I had $425 million of cash CapEx for this year. I think at the midpoint, you said about $465 million. Did some CapEx get pulled into '23 from '24? Or are you adding new growth and capability projects?

[Karla Lewis, executive]

Yes, Phil. So we do an annual budget that we approved many, many projects for our many different companies. And that 2023 budget has remained consistent at $520 million. However, timing of some of those projects can slip -- the cash outlay can slip into a different year.

We know some of those $520 million projects will extend and some of the cash will go out into 2024. And with the extended lead times we've experienced for equipment, construction, et cetera, over the last couple of years, it has been more pronounced than historically. We've tried to give you guys a better idea of the cash outlay.

So yes, earlier in the year, I think we maybe said $400 million to $450 million, we thought would be the cash outlay this year. We've seen some lead times come in a bit for some of the equipment, some of the projects accelerate a bit. And with that, we upped our cash outlay this year to $450 million to $475 million. Again, it's timing, and we're giving you our best estimate at different points in time on the cash outlay.

[Operator]

Our next question comes from Katja Jancic with BMO Capital Markets.

[Katja Jancic, analyst]

First, can you talk about what percent of orders right now includes value-added processing?

[Arthur Ajemyan, executive]

Yes, this is Arthur. We don't normally update that disclosure throughout the year. But I mean, last time we provided an update, we said it was little over 50% and we expect to kind of be in that range. But we don't normally put out quarterly updates on that.

[Katja Jancic, analyst]

Okay. And is there expectation that with you continuously investing in value-added processing equipment that, that could grow over the next few years?

[Karla Lewis, executive]

Yes, we certainly do anticipate with the investments we're making that will grow. We've been a little over 50%, I think, for the last couple of years, but with certain acquisitions, including an acquisition we made in late 2021, that's more of a wholesale distribution model that does not perform value-added processing that maybe slowed a bit the incremental growth in orders with value-added processing.

But we certainly anticipate that we will continue to grow. We continue to see good opportunity from our customers and even from our suppliers on opportunities to do more and more for them and expand our value-added processing capabilities, and we're very happy invest in those opportunities to help better support our customers.

[Arthur Ajemyan, executive]

And Katja, the only thing I would add to that is our value-added processing capabilities provide tremendous amount of stability to our gross profit margins and especially at times like this, when you have consecutive months of declining prices and when you're providing service, you have orders with value-added processing, those you tend to do much better on those than on the straight distribution orders. Just wanted to highlight that.

[Katja Jancic, analyst]

And then is it fair to assume that CapEx spending will stay elevated over the next few years given that there is a desire to continuously invest in growth.

[Karla Lewis, executive]

Yes, Katja, we're actually in process on our 2024 CapEx budget now, and we'll be giving that number in February on our call. But as I just kind of alluded to, we do see continued opportunity from our customers, especially with a lot of the really positive things in the market right now with the different government stimulus and the activity we expect there as some of the suppliers expand capacity, we're able to work with them to get some opportunities there.

The reshoring, near shoring is real, and that all provides increased opportunity for us. And we're fortunate to have our folks execute the way that they do that we have the strong cash flow and the balance sheet to be able to support our customers and continue to invest. So we don't have a number yet, but -- we do anticipate a healthy budget next year because of the opportunity we see.

[Katja Jancic, analyst]

Okay. If I may, 1 more. Karla, you mentioned the acquisition pipeline is solid. Can you talk a bit more, is there an increase in willingness of these companies to sell? What are the valuations you're seeing?

[Karla Lewis, executive]

Yes. We've seen a flow. I think it's probably increased a bit more with the more traditional types of service center companies over the last 9 months or so. There were some opportunities that came to market in peak periods that it appears deals did not get completed.

So we're seeing a few of those come back around. So we're expecting more reasonable expectations in our view on valuation. Reliance, we were very consistent on how we value companies looking at a normalized pretax income number for the long term going forward, and we value from that. We continue to do that. And do believe that we should be closer in expectations with some of those sellers, but not all sellers were expecting to be paid off of the peak.

The good companies that we acquire have been in this business for a long time. They understand that there are different cycles we go through and look at and understand our approach to the valuation that we expect to continue to be able to acquire more good companies, and we're excited with what we see out there.

[Operator]

There are no further questions at this time. I would like to turn the floor back over to Karla Lewis for closing comments.

[Karla Lewis, executive]

Great. Thanks again, everyone, for joining our call today, and thank you to our big Reliance family out there for all that you do every day. And before we close out the call, I'd like to remind everyone that we'll be in New York City in mid-November, presenting at the Goldman Sachs Metals and Mining Conference, and we hope to see many of you there.

Thank you again to all of you for your continued support of Reliance.

[Operator]

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.