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Good morning, ladies and gentlemen, and welcome to the 2019 First Quarter Results Conference Call for Russel Metals. Today's call will be hosted by Ms. Marion Britton, Executive Vice President and Chief Financial Officer; and Mr. John Reid, President and Chief Executive Officer of Russel Metals. [Operator Instructions] I would now like to turn the meeting over to Ms. Marion Britton. Please go ahead, Ms. Britton.
Good morning, everyone. We'll start on Page 3, just running through the cautionary statements. 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 from those anticipated in our forward-looking statements.Our actual results could differ materially from those anticipated in our forward-looking statements, including as a result of risk factors described below in our MD&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 should 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.So if you can now flip over to Page 5. I'll just highlight the first quarter results. So Q1 '19 earnings of $34 million, EPS of $0.55 and that compares to Q1 '18 of $0.62. Free cash flow was strong, $58 million or $0.94 per share compared to $0.97 per share in Q1 '18.Our return on equity is strong at 16%. We again declared our dividend of $0.38 per share. Flipping forward to Page 6, the market conditions as we see them at this point in time. Q1 '19 steel selling prices were consistent with the end of '18, although we do see downward pressure on Q2 pricing. We'll probably get more into that as we go through the questions. Metals service centers average selling price was up 21% compared to Q1 '18, and that is consistent with Q4 of '18.Metals service centers tons were down 6% on a same-store basis. Just to remind you that we bought DuBose Steel in Q2 2018. And they were up 3% from Q4 2018.Rig count at this point is down 4% in the U.S., and down 18% in Canada. Canada is currently in spring breakup, so the active rigs is fairly low. Energy products segment revenues decreased 3% in Q1 '19 versus Q1 '18.And we just summarized at the bottom there, and there is more detail in reminder on tariffs, they went in, in mid-2018 U.S. and Canada. Canada did put some safeguards in that were anticipated to end in April 2019 or get updated, maybe I should say not necessarily end. There were safeguards on 7 products; 5 were removed at the end of April. Heavy plate and stainless wire are still on, and we believe that it's going to be quotas and then tariffs, but there's still clarification yet to come. Anticipated that may come in May.Page 7, we have all our metrics. I'm actually at this point going to flip forward, though, to Page 9. Just to highlight a few items on the balance sheet. We did adopt the new lease standard, along with most other companies, effective January 1, 2019. Just noting on the balance sheet the lines that are impacted from that. Under the noncurrent assets, you'll see the right to use assets added at $89.6 million. Under liabilities, short-term lease obligations up $15.1 million, and long-term lease obligations of $96.2 million.The difference of $16 million was charged to retained earnings.Turning forward to Page 10. I'll just make a couple comments on our working capital changes. Accounts receivable used cash in the quarter, mainly because that year-end our revenue was down in the month of December, much stronger in the month of March. So we have very good collections at year-end, although collections are still strong at the end of March.Inventories was a source of cash. Inventories are down slightly. Accounts payable was the use of cash due to payment of bonuses during the Q1, which related to 2018. Also, you will see that $33.5 million of income taxes were paid in Q1. It's somewhat consistent last year, but we did have extra payments due to our strong income in 2018 to our direct catch-up payments in Canada.Flipping forward to Page 14. The segment information in the MD&A. The metals service centers' revenues up 18%. I have spoken earlier about the selling price increase and then the tons being down slightly. Steel distributors year-over-year is up 30%. Strong activity within Canada in particular, servicing the needs of customers due to the tariff disruption on normal flow of product.In the segment gross margin percent of revenue, you will note that metals service centers' gross margin was at 19.1%, down from last year and down from Q4. Although if you were to look at our gross margin dollars, Q1 '19 compared to Q1 '18, you'll note that it was up $2 million. So it was $103 million at Q1 '19, and that's due to the high selling price being consistent -- or higher than 2018.The change in energy product is mix. And you'll notice that it is up from Q4 when we also had a lower margin due to mix in our large Line Pipe project that was going on at the time. Steel distributors, although it's down from Q1 '18, it is consistent with Q4 2018.On the bottom of that page, you'll notice that we have done a line reconciliation by segment of our impact of the IFRS 16 or the new lease standard as some people might just refer to it. You'll note that our EBIT went up $3 million due to it. Our interest went up $3 million, and the net impact on our income was nil.Flipping forward to Page 20, on capital expenditures. Our capital expenditures in the quarter were actually quite low. It was $5 million compared to $11 million last year. That $5 million does exclude our right-to-use asset addition. We expect that to be a low point for the year. We do have a number of items going on related to value-added processing. And so we do expect our depreciation this year to be similar to 2018.Down lower on that page, you'll see the breakdown of our inventory. Inventory is up year-over-year, driven mainly by selling price -- or cost of inventory. And -- but you'll note that we have brought it down from the end of the year.Those are my comments. I'm going to turn it over for questions.
[Operator Instructions] And your first question is from Michael Tupholme from TD Securities.
Marion, are you able to talk a little bit about the gross margin outlook across the various segments as we go forward? So I guess specifically, is what we saw in service centers, is that sort of where you'd expect to be going forward? And similarly, is energy, is this kind of the level we should expect other than some of the seasonal fluctuations that could affect mix?
Yes, I would say that subject to some other change related to product -- big change in price of product or tariff changes that what we had in the first quarter would be similar to what we would expect for the second quarter, hoping that maybe at -- by second half of the year that metal service centers will come up to a more normal 21 to 22 because the price of our inventory will average equal to current pricing.
Michael, there are certain products in the service center that the industry as a whole is overstocked on, plate being one of them, as far as the service center industry. So we saw a little bit more intense pressure than we normally see. So I think that'll balance out in Q2, and we'll get back to more normalized margins there.
Okay. Sorry, John, you think the oversupply will balance out, but the margin would still in Q2 stay a little bit lower, similar to what we saw in Q1?
Yes, I think we'll see the pressure -- yes, yes, we'll still continue to see the margin pressure in Q2, but I think by the end Q2, you'll see it balancing out going into Q3.
Right, okay. And then with respect to energy products, can you just -- any visibility beyond spring breakup in Canada in terms of how you think things will shape up once we get through breakup?
The outlooks are pretty murky on that. I mean, we're being told by several of our key customers that they've got drilling that they plan to go forward. But the overall outlook on the total rig count is a little murky. Obviously, we've got positive momentum with the elections there, it would be favorable. But as of right now, we just don't have any clarity.
Okay. And is there anything happening for Russel in terms of opportunity that you've got any kind of line of sight on with respect to LNG Canada and any energy business related to that?
Yes, we see that the LNG product, there are some things starting to move forward, working through the Kitimat area and the Northern BC markets. And we're starting to participate slightly in that. I think we've said in previous calls that our service centers would likely see some of that work in late 2019 start to develop. And we're starting to see some of that now, but really as far as pipeline-type work that would affect our OCTG or Line Pipe operations, that's early 2020. Apex would again be Q3, Q4, but we're starting to see that work to come in to bid play now.
Sorry, and when you say Apex Q3, Q4, you mean of next year or this year?
This year. So Apex would be very similar to the service centers. We'll start to see that come into play in Q3, Q4 this year.
Okay. Was weather a factor at all for you in the quarter in terms of hurting the performance? I mean a lot of companies have talked about how challenging the quarter was. Just wondering if that affected you at all?
It -- we definitely have seen delays across Canada and the U.S. on construction. I mean the flooding is obviously well documented. You've seen it in Quebec, all the way across into Alberta region. The U.S. is definitely under pressure, but that should balance out in time. And so again, weather was definitely a factor. We lost several shipping days. But again, we should see that balance out during Q2. And so I think we'll get a little bit of a pickup from that construction. I'm more interested in watching the Architectural Building Index (sic) [ Architectural Billings Index ] to see the next posting. It was below 50 for the first time in over a year. If that continues to be below 50, then there would be concern going forward on construction, more so than the weather. Again that's just a delay, but there would pent-up demand that'll release at some point.
Your next question is from Devin Dodge of BMO.
Just wanted to come back to the service center volume kind of topic. I know you highlighted that construction was a bit weak, maybe weather had an impact there. But have you seen any type of demand recovery in April, and maybe the first week in May?
We're holding about even pace with Q1. And so we may have picked up slightly, but it would be very slightly. So again, I don't see any big catalyst making a change on that right now.
Yes, okay. The MD&A made reference to the U.S.' preliminary determination about Canadian structural steel. Just trying to get a sense whether the Department of Commerce moves ahead with duties, do you think this will have a material impact on Canadian structural steel prices, if the U.S. effectively gets kind of cut off from Canadian exporters?
So it would definitely impact the fabricators coming out of the Québec region. It would be difficult for them to, again to ship across. Right now, again, the 2 sides of the border both are very bullish on that they think their side will win. We have seen a couple of our larger Canadian fabricators are quoting projects that are beyond expiry date in August and willing to put in their contracts, that they'll eat any of those findings that are above and beyond. So they're willing to put the monetary risk there. So that's -- they're pretty comfortable with that. But if there is a suit on structural steel, it would definitely impact the Canadian fabricators because again, it'll pin them to their home market.
Okay. That's helpful. And I guess can you give us an update on what you're seeing in terms of Line Pipe opportunities? I just -- as I recall, I think the comps get pretty tough in the back half of the year.
We're actually -- so the Permian area and Texas right now, there's just such a backup on demand there to get natural gas out. So there's a lot of Line Pipe activity that's going on there. With the LNG project again starting to gain traction, we think there's a lot of opportunity potentially in Western Canada in the back half of the year. So we're fairly optimistic on demand for Line Pipe going forward for the back half. We've actually seen a bit of slowing in the April month, but that's started to pick back up in May again. I think that was just more timing related to breakup.
Your next question is from Tyler Kenyon from Cowen.
Just any update you can provide us just on your value-added processing initiatives? Marion, I think you made some comments about having a few of these initiatives underway this year. Wondering what those are, and if you can kind of talk about that trajectory over the next couple years. I still think you're targeting some upside in your value-added processing mix. Just trying to figure out how to think about it.
We've got a project that we're starting forward now in Alberta, where we again, going into value-added processing with our beam lines and beam yards that will add to our capacity there. Across each service center region, right now, we've got things that are on the board that they're looking at for approval. I think we'll be adding more tube laser capacity, more flat laser capacity. So as you think about it from financial modeling, that should continually to incrementally increase as a percentage of our overall sales, which should help stabilize our margin, or improve our margin as we go forward. Obviously, with the cyclicality of the price, the steel price is going to continue to move up and down, but it should help us to get some stabilization in that.So our target for this year is to, again, for 2019 is to kind of broach the 28% to 30% range and beyond, with our goal ultimately being to get closer to that 35% to 40% range of our steel that is sold to be value-added processing. Again, that does not count our cut-to-length. And so when we buy coil, we do not count that as value-added processing, because we typically don't just sell coil.
Okay, great. And then there certainly have been some headlines about some consolidation potentially going on just in the E&P side. As you think about your Energy business today, I mean how do you see that impacting things kind of in the intermediate term and longer term?
Yes, and we've been here for a few quarters, or really for few years, we still see there's opportunities to grow in the valve fitting and flange or if you would, the energy services business that we have primarily in the States. There might be some bolt-ons for us that are in Canada. But we continue to look for growth in the States. We think there's a bigger footprint for that opportunity there as well as in the service centers. We don't see currently adding to our footprint in the OCTG and Line Pipe. We're comfortable with where we are in those areas.
Your next question is from Frederic Bastien from Raymond James.
Marion, I missed your comment, the comment you made about safeguards on plate potentially being removed at the end of the month. Can you please repeat that?
So the comment is that there were 7 products and 5 of them were removed at the end of April, but plate is going to -- or is under review to have quotas and then tariffs. I don't believe it's going to be the 50-day quotas. It's going to be a quota for the year. That is still yet to be determined, and the indication was it would be determined in May. Plate and stainless wire were the 2 that were not removed.
All right. And presumably, that would still be quite supportive for healthy prices for plate, correct?
Yes. It would definitely support the mill side for plate and anything over 80-inch would definitely have legs for the Canadian marketplace.
Okay, good. John, turning to you. You commented on the outlook for energy products in Canada being murky and then you provided additional color on Line Pipe in the U.S. How are you feeling about the outlook for the U.S. field stores?
We think it's pretty strong. I mean, again, we just recently fell below the rig count of 1,000. But again at the high 900s, the oil price ranging between $60 and $65, we think the drilling will continue. Obviously, the Permian being the hottest area that's down there right now, low cost of production for any field in North America. So we think the -- anything going on for our valve fitting and flange or field services stores out in the Oklahoma, Texas area is definitely a strong market for us right now.
How are you feeling about steel distributors with all the moving parts that you had to deal with?
We've really come back to more of a normalized margin with some opportunities for margin with the inventory holdings in the United States, they took advantage of last year. Our volumes have been up in Canada, some of the changes that were there. And those were more contractual and longer term. So they were in a more normal margin. But I think we'll be back to a more steady level that we've seen in the past vis-Ă -vis '16, '17, those type of time frames.
Last one for me. You hosted a call not that long ago. So I was wondering if your overall outlook for Russel has changed meaningfully from when you last reported in late February.
No, we still think...
Are you feeling better or worse than...
We still feel about the same. Again, we feel like this is -- again, I think one of your writings actually said '18 was a barn burner year, and that's exactly right. '17 was a very good year for Russel, historically. We think that '19, again, is going to be a very good year, more similar to '17. We're just again coming off of a record-setting year. So we don't think we'll hold that pace, but we feel very good about where we are right now.
Your next question is from Anoop Prihar from GMP.
Just 2 quick questions. First, Marion, the IFRS adjustment on EBITDA this quarter was about $7 million. Can we assume that that's a decent run rate to use for the quarters over the balance of the year as well?
Yes, that's what I would use for now. I mean if we have an additional leases, you'll be able to see as we capitalize them through the year, which could impact it. But for now, that would be a good rate. I don't...
Okay. And then, John, just in terms of the legislation, I mean this -- we've been dealing with this issue now for a while, but in the event that NAFTA isn't ratified, like what's your thoughts at this point as to what the default situation could look like in that scenario?
Well, if I knew that one, yes, I probably wouldn't be here today. So it's -- it will be business as usual, that's where we've been for the last 1.5 years until something happens. Again, our best opportunity is to sit there and continue to turn our inventory, not take long positions. We saw some in the industry do that, it put pressure on various products. But we want to just make sure we're there running our business on a day-to-day and not taking long positions. But we don't see -- I just don't see a whole lot changing. I'm actually less optimistic than most that the NAFTA will be ratified in the next 1.5 years, 2 years.
Your next question is a follow-up from Michael Tupholme from TD.
Just with respect to steel distributors, you commented on the margin outlook there. With respect to revenues, is the level you saw this quarter a level you think you can kind of sustain? Or was this benefiting sort of from some of the trade issues and likely a level that kind of comes down as we go forward?
I think it'll continue to come down. We got a really strong quarter in Canada. I think our U.S. levels are very similar to where they will maintain. But I think we'll continue to come down back to a more normalized level.
Sort of the kinds of levels we saw during the first part of 2018 before the ramp up in the second half, is that how to think about it?
Yes, that's right. Yes, that's right. 2017, 2018, roughly 10% of our top line revenue is where we should be.
Okay. And then in terms of the 5 products where the safeguards were lifted, have you seen any change in pricing in the Canadian market as a result of that? I mean, I know it's only been a short period of time, but has anything changed yet?
I don't think it's in relation to that. We've seen pricing change, but I think it's more to do with scrap pricing going down, changes of demand right now. So again, I don't think it has anything to do with necessarily those safeguards. But as you said, it just hasn't had time to take effect for imports to come in. It's probably going to take 90 to 120 days to have any effect on that.
We should expect a big influx though or something the market can absorb?
I think it's something that can be absorbed, but at the level we are now compared to the world pricing, I just don't see that as an opportunistic opportunity for imports to come in. Again with pricing falling, scrap down 30, potentially down again next month, but it makes it a pretty risky move to be buying import now. You'd have to have such a huge spread that I just don't see that coming in, in a market that potentially could decline further.
Okay. And just sort of on that point in terms of the pricing, you've commented on expecting some modest declines in Q2 versus Q1. Looking into the back half, do you think we sort of level off then? Or is there a scenario where you think we maybe see even further declines into the back half relative to Q2?
So I think we're going to continue to follow scrap, which is what we've done historically. If you look at all products really with the exception of plate, you get this traditional scrap spreads are there for the steel mills, you're starting to see it moves, the scrap moves. Now unless you see a strong catalyst, positive or negative for demand to change in North America, then I think we'll continue to follow the input cost, which again, with the supply restriction the 232 caused, it's given some spread to plate products on the mill side that are not historical. But we've actually seen pressure on the service center side because of the people going out and being aggressively inventorying that. So I think that will start to rebalance. The service centers may actually see some improved margins from the plate as they thin the product out. The other products, I think, will probably see some more pressure from the mill side just depending on what scrap pricing does.
Okay. And then just back on energy. I understand that the second half outlook for Canada is uncertain. Sounds like things are good in the U.S. Sounds like you see some Line Pipe opportunities in, I guess in both markets, if I understood correctly. You had a strong second half of 2018 in energy products. Is -- can you get, not necessarily back to those kinds of levels because, I think, you had some very large line pipe orders, but with what's going on, I mean, can you get somewhere close to there? Or are we looking at quite a bit low in the second half of this year from a top line perspective?
Yes, I think Canada is definitely going to be lower. I just can't give you a good barometer on how much lower that it's going to be. But I think Canada will be lower. Obviously, with the large Line Pipe project we had last year in the States, we don't have anything in the pipeline recreating that at this point. We think there's opportunities, but we don't just have anything that we have firm views on at this point. So again, I think if you exclude that, I think the States will be very similar to last year, maybe slightly down. Canada has the chance to be down more significantly.
Okay. And the LNG does not serve as any kind of an offset to the lower Canadian dynamic?
There's definitely opportunity there. I just think on the pipe side specifically, it will be early 2020 before we'll see product actually going into it -- our product actually going into the project. So as it takes off, they'll be doing the infrastructure first in the second half of the year.
Your next question is from Derek Spronck from RBC.
Sorry, I was just jumping from another call, so not sure if these questions have already been addressed. But any color or update around the emergency measures Canada enacted? And what are your thoughts around the recommendations that were recently provided?
So the -- they were removed on 5 products. So the only 2 that are yet to be determined are plates and stainless wire. And there has been nothing firmly announced. We do believe it's probably going to be an annual quota and some type of tariff over that annual quota, but we'll wait and see in May.
Okay. And do you feel that the market is roughly balanced at this point now? Or do you still see a little bit of shifting within the inventory supply chain in the steel market?
It's a product-by-product basis. Plate's a little bit over-inventoried at this point in the service center industry, although it's coming into balance. It's been over-inventoried for the last 6 to 9 months. So we're seeing that come into balance. Margin pressure is starting to subside in that category. Other products seem to be in pretty good balance overall for the industry. We are seeing pricing pressure from outside to drop -- in scrap prices is pushing through in the drop. And we've seen a little bit of softening in demand. But right now we think it's a pretty balanced market.
Okay. And just lastly, your value-added services, any additional investments that you're looking to in order to kind of drive that line item in the overall...
Marion mentioned -- yes, I know you just joined, as Marion mentioned earlier, we only did $5 million in Q1. But we see that ramping back up, and we've got projects that we're just about start in Alberta, we got several other service center projects for value-added on tap for the balance of the year. So we do see that increasing for our CapEx for the rest of the year, back to the levels she quoted previously.
There are no further questions, and you may proceed.
Thank you, everybody, for joining the call. We'll talk to you next quarter.
Ladies and gentlemen, this concludes your conference call for today. We thank you for participating, and we ask that you please disconnect your lines.