Russel Metals Inc

TSX:RUS

Earnings Call Transcript 2020-Q1

[Operator]

Good morning, ladies and gentlemen, and welcome to the 2020 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 Inc. [Operator Instructions]I will now turn the meeting over to Ms. Marion Britton. Please go ahead, Ms. Britton.

[Marion E. Britton;Executive Vice President and CFO]

Good morning, everyone. Thanks for joining us. I'll start off by reading the cautionary statement on Page 3 of the deck that was sent out last night. 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&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 as except required by law, we do not assume any obligation or an update -- to update our forward-looking statements.We're going to start off today's call with an update on COVID-19 and where we are -- where -- situations there, and John Reid is going to give you that update.

[John Gregory Reid, CEO, President & Director]

Good morning. If you'll refer to Page 5 on COVID-19 and our market update. Again, I want to commend our operators, our employees and our safety professionals as everyone's selfless and tireless efforts to effectively and efficiently address this pandemic as it has evolved. We initiated a safety committee very quickly and disseminated information to each of our operating units, as they established the -- and implemented the safety protocols expediently to address the evolving environment, ensuring the safety of the RMI family, our customers and our suppliers. This group just did an absolute tremendous job being out in front of this, and they really need to be commended.We were deemed an essential service at all of our operations. And so we are operating and delivering product to our customers. Also, we deliver products to manufacturers of masks and hospital beds, ventilators, hand sanitizers, mobile lab, various government projects and other equipment. We worked really closely and safely with our customers to assist them being part of the solution in Canada and in the U.S. as we battle this situation. Due to the customer closures that were mandated or self elected, obviously, that's impacted demand for Russel across all of our divisions. We reduced our staff. We've reduced our inventory, our on-order positions. We initiated work sharing programs, and we've accessed other government initiatives that are available out there to assist both our employees and the company.Our model is working in relation to liquidity. Our business model continues to throw off cash as our working capital needs have declined. We are completing CapEx projects that are underway. We're maintaining our required maintenance projects, but we have delayed some of our new projects.Our credit teams are working very closely with our customers, specifically in energy as we navigate this environment. The oil prices and the rig counts, again, a challenge impacting short-term demand on energy. Oil prices obviously collapsed, driven by the oversupply on the oil market, coupled with the pandemic, continues to impact the energy business for Russel. Our Comco division, however, recently secured a significant volume of work through the Trans Mountain project, both Phase 1 and Phase 2, and it will last throughout the balance of 2020.Our decentralized model really allowed our managers to quickly implement safety protocols across all 146 locations, while they simultaneously address the change in demand. We moved over 500 people working remotely very early in this process, and I really want to recognize the outstanding work of Maureen Kelly and her IT team as they were able to have us up and running seamlessly within a matter of hours, as they are and my family members were able to safely function from home offices.I also want to thank the RMI family members who continue to come in every day and service -- in essential service to our customers and our communities. Their supportive and expeditious adoption of the new safety protocols, it's really remarkable. And the collective efforts made this possible for Russel to safely serve our customers every day during this time. So I'll turn it back over to Marion.

[Marion E. Britton;Executive Vice President and CFO]

Yes, I'm going to give a high-level review of our Q1, obviously, some of the factors are less significant in this environment that we're in. But I think there are important points that I'm going to cover off. So we did end up with an earnings of $0.17. There is some adjustments to that, and I'll point to that on a later page when we get to that page on the report.Our free cash flow, which is an important part of our model, was strong, $26 million in Q1, $41 million -- sorry, $0.41 per share for the quarter. We do anticipate as revenues come down throughout Q2, we will throw off additional free cash flow.Cash from working capital was $36 million. And this is the area actually where we will throw off the cash, mainly from AR and reducing our inventories in relation to demand. And that represented $0.58 per share in Q1, and it will come down again in Q2.We did have a return on equity of 6% for the quarter. Our year last year was 8%. So even though it wasn't a great quarter, we did have a fairly strong return on equity. And we did declare our full dividend of $0.38 per share yesterday. And that's based on the fact that we do have the cash flow to support it at this point in time. So on Page 7, I'm not really going to highlight too many numbers, but you'll see our comparative, all the additional information there. I do want to skip forward to Page 13 of the deck. On that page, in the -- under overview, the last paragraph, you'll see our comments about adjustments that were needed to be put through our first quarter. We decided we needed to add $5 million to our OCTG, and Line Pipe net realizable value of inventory, the demand for those products is very low at this point in time, and we felt there was an additional reserve required.Also, the triggering event of the pandemic and the excess oil supply required us to do a review of all our long lived assets. During that review, we realized that our U.S. Line Pipe operations, right-of-use assets, which is the leases that we capitalized at January 1, 2019, were not supported by the ongoing operations, and we took an impairment loss of CAD 4 million.The reduction in share price did impact the stock-based comp by $5 million, which was a positive to the numbers. But also additional positive which will be additional cash flow at some point later this year. We were able to take advantage of the carryback of our 2019 tax losses we had in the U.S. to an earlier year and took an additional income reduction -- income tax reduction of $3 million.Turning to Page 14. This shows you the revenue change, which was by unit, and I'll speak to that as we get to the units, but one of the things I wanted to highlight on this page was the metals service centers. Gross margin was -- for the quarter at 21.3%. We were expecting it to come in that range, 21% to 22%, which is a more normalized margin, but I don't know what normal is anymore. It is up from Q1 2019 and also from Q4 of 18.8%. It appears that pricing has been moved around in our products, but it's been relatively stable through most of the first part of 2020. And so our margins are in a level that we would expect them to be at 21.3%.The energy products margin is -- includes the $5 million write-down. But they were relatively strong, driven by our oilfield stores and Comco operations.Steel distributors had low revenues, but their margins were comparable to first half of 2019 and other years. You'll also note that our operating profit as a percentage of revenue for metals service centers at 4% was strong, based on the situation as the fact that the impact -- pandemic did impact the last part of March.Moving forward to Page 16 of the deck, just point out the reduction in revenue of 19% represents a reduction in tons shipped of 3%, which is much stronger than the MSCI numbers put out and our competitors. So we're quite happy with the market share in -- pickup there. And the average selling price was the area that represented most of the decline in the revenue. So it was down 16% for the quarter, but it was down only -- sorry, it was 1% lower than the 2019 fourth quarter.So the -- if you -- just to give you a little bit of color on last year, tariffs didn't come off until May 2019. Product started to come down in price as we went through the year and by the end of the year, had got to levels that we are at this point in time, and we were able to get our average inventory similarly down by the end of the year, our pricing on it.Turning forward to Page 17. Revenue for our energy products segment was down 15%. But if you look at it on a same-store basis, it's actually down 24%. We acquired City Pipe in October 1 of last year. The City Pipe being in the oilfield stores area, that area has seen a modest decrease, but the bigger decrease was in the area of the OCTG and drilling rig activity during Q1.As I previously mentioned, we took a $5 million additional reserve for OCTG and Line Pipe, which is the area that was most significantly down in Q1. There was no NRV adjustments for oilfield stores. And typically, we don't see NRVs there because it's more of a manufactured product, and we don't anticipate ones in the future in that area.Turning to Page 18. Steel distributors was down 49% in revenue. Most of that was demand estimated at 42%. Then also selling price was down 16%, similar to service centers. Once again, driven mainly by high demand we had from the tariffs being in effect until May 2019. So the first half of 2019, we had strong revenue demand in our steel distributor segment.Turning forward to Page 20. Just want to point out the CapEx comment, and we did spend more than our Q1 2019. But as John mentioned, we expect activity to be lesser as we complete projects that are ongoing at this point in time. And then inventory numbers are at the bottom of that page. The $320 million value for service -- metals service centers is up from year-end, but that's more FX driven, the tons are actually down. And you'll note, it's down significantly from March a year ago.Energy products is down slightly from the end of the year, obviously up from Q1 because of the addition of City into the numbers, they were added as of December 31 into our numbers.Steel distributors inventory is somewhat consistent with the end of the year. Some of that -- that increase is actually FX there. They will be continuing to bring their inventories down in line with demand.So those are the comments that I want to make about the quarter. I'm going to open it up for questions.

[Operator]

[Operator Instructions] First question comes from Michael Doumet from Scotiabank.

[Michael Doumet, Analyst]

So I assume demand for steel products and service centers began to decline mid-March, like you talked about that accelerated through April. Could you give us a sense for those declines? What they were in terms of tons shipped in April? And if you've seen activity levels pick up from those low levels yet?

[Marion E. Britton;Executive Vice President and CFO]

John, do you want to...

[John Gregory Reid, CEO, President & Director]

Michael, thanks for the question. Yes, you're exactly right. We really saw at the back half of March that we saw the decline start in the service center and distributor segment moved pretty rapidly as we moved into the current environment we're working in. So we continued to see that fall in April as it ramped up. We adjusted, obviously, we had to adjust the workforce for that. But really, that was driven by the closures and the shutdowns that were being mandated by various provinces and states that were out there. So the magnitude of the drop, to try and put it in percentage is, we're down about 30% for April. And again, overall for our service centers.

[Michael Doumet, Analyst]

Okay. Have you seen -- I mean, this would be a week-to-week question, but have you seen a pickup from the low point in April as activity has sort of resumed from -- in certain provinces?

[John Gregory Reid, CEO, President & Director]

Yes. I'm sorry, I didn't answer that for the first part of your question. The -- yes, we have. And the nice thing we're seeing now in our service centers initially picked up in Canada first, and now we're seeing it in the U.S. as well in the recent days, where our billing is starting to be outpaced by our bookings, so our bookings are higher. And so that's a very positive sign for us. So we feel like that we've seen the bottoming. And as we have the restrictions on working lifted and people are starting to return to work, we think that obviously will be a positive impact for demand.

[Michael Doumet, Analyst]

Okay. And just turning to the operating expenses. I mean, those were largely flat in your service centers and energy products year-over-year. So did the cost reduction efforts you talked about have much of an impact at all in Q1 results? Or is that mostly in Q2? And can you give us a sense of the magnitude?

[John Gregory Reid, CEO, President & Director]

So in the service centers and the energy field stores is demand held fairly well going into March, and we really started to see the dive in late March as we started to make those changes and adjustments, they really are going to affect April. More so, it was really the last of March that we started to make changes or give notices. And so we think that impact will be, again, be recognized in April more fully.

[Michael Doumet, Analyst]

Okay. And should they match activity levels somewhat?

[John Gregory Reid, CEO, President & Director]

I think so. Again, the drop is so dramatic so quickly. We'll be chasing that for a little while. So we continue to -- the layoffs continue to grow each week during April. So we may get caught a little bit there as we're chasing that down and making the adjustments, so we can still continue to ship product effectively to customers, but it should match out over time then.

[Operator]

The next question comes from Frederic Bastien from Raymond James.

[Frederic Bastien, MD & Equity Research Analyst]

I appreciate that the visibility is as clear as mud right now on the energy side, but -- any way you can provide us some goalpost that you can, I guess, point us towards for Q2 and potentially beyond?

[John Gregory Reid, CEO, President & Director]

From the Canadian side, Frederic, I never thought I would say this, but actually, breakup is coming at a really good time. It's going to allow us that 8-week -- 6 to 8 weeks during breakup to get some clarity on what is going on out there with the oil price and with the pandemic and the demand tailwind. So we'll get more clarity as we go along in Canada. And again, we've seen the -- as you've seen as well, we've seen the capital project be pulled back. We are hearing some positive signs from customers on both sides of the border, things starting to spend money and starting to spend capital. But it's very limited right now. So energy is really an unknown for us going forward as to what demand is going to do overall, but I think we're hitting a low point. I just don't know how long we're going to stay at this point.

[Frederic Bastien, MD & Equity Research Analyst]

Okay. And just to clarify an earlier answer you gave. You mentioned that billings were starting to be outpaced by bookings. Is that on the service center side only?

[John Gregory Reid, CEO, President & Director]

Yes, on the service center side, they are. That's correct.

[Marion E. Britton;Executive Vice President and CFO]

So actually, bookings are outpacing billings, which means we will have future billings. It was got to -- sorry, John, you kind of confused it a bit. So -- I think that's what you're trying to say, where bookings are getting stronger, which will mean as throughout May and into June, we're going to have more billings.

[Frederic Bastien, MD & Equity Research Analyst]

Great. But -- okay. Perfect. And then Marion, maybe the next one for you. With respect to your liquidity, just shy of $400 million right now. If we get -- I mean, I'm sure you have a number of scenarios you're looking at for this year. But if you assume one that's pretty dire, where do you think that liquidity ends up at the end of the year?

[Marion E. Britton;Executive Vice President and CFO]

If it's a very dire situation, we're going to throw off all kinds of cash because the revenue will go down, move through receivables. Obviously, it will be tougher to bring down the inventory if revenue declines quickly. I don't really see that being a factor, but I do expect that we could throw off $50 million to $100 million of cash over the next couple of quarters as we go through. The question will be is whether Q4 picks up. And then if it does, we'll start to use some capital to replace inventory.

[Frederic Bastien, MD & Equity Research Analyst]

Okay. And what would you be -- what would be your best guess as to where you're going to end up the year in terms of liquidity?

[Marion E. Britton;Executive Vice President and CFO]

I'm not very good at guess on where the revenue is going to get. So that makes it tough, but let's say, $100 million positive.

[Operator]

[Operator Instructions] The next question comes from Michael Tupholme from TD Securities.

[Michael Tupholme, Research Analyst]

Marion, can you talk about whether or not you've seen any collection issues anywhere in the business, but I guess I'm particularly wondering about the energy side?

[Marion E. Britton;Executive Vice President and CFO]

So at this point, I am very happy with my credit team. The month of April ended with our collections as a percent, and that's how we look of our previous AR being up slightly from where we end in March. They've been doing a great job dealing with customers. I mean, certain areas, the collections were a little lighter, in particular, say, Québec, where we had the -- certain businesses shut down, so I'm sure that was part of the challenges. Within energy, we've been continuing to collect from our customers. We're managing the situation very good at this point in time. Obviously, we have concerns as we go through this quarter of what customers are going to be struggling for cash flow as they meet their payrolls and come back to work.

[Michael Tupholme, Research Analyst]

Okay. So at this point, bad debt expense, has that changed at all? Or do you expect that to change at all relative to what it's been running at?

[Marion E. Britton;Executive Vice President and CFO]

Based on everything I know today, bad debt expense hasn't changed. But it's obviously an area that is a higher risk. As we continue to sell through this quarter, we will be working closely with our customers to make sure we don't have any -- take a risk that we don't feel is appropriate.

[Michael Tupholme, Research Analyst]

Okay. And then I guess 2 questions related to inventory, sort of different questions. First of all, on the provisions you took in the quarter, there were -- I mean, they were primarily concentrated in the energy products segment. In the table, talks about $6.6 million of inventory provisions, but you called out $5 million specifically in OCTG and Line Pipe. I think I heard you say earlier there wasn't anything in oilfield stores. I'm just trying to understand what the delta between that $5 million in OCTG Line Pipe and $6.6 million, you talked about in Note 4, the additional $1.6 million. Where was that?

[Marion E. Britton;Executive Vice President and CFO]

That would be our normal obsolescence reserves that we've taken, and we don't normally call that out. We do have our inventory aging reserves that we take on a regular basis. And it's anything -- starts at anything over 18 months. So we continue to include that, which is our normal reserve. And that's why we didn't call it out. And we only usually speak to the NRVs.

[Michael Tupholme, Research Analyst]

Okay. And then the other question on inventories. Just -- can you comment on how you feel about the inventory position now? And any areas where there is any concern just about the level of inventories and whether or not that's going to come down as quickly as you'd like it to?

[Marion E. Britton;Executive Vice President and CFO]

So within service centers, I have no concerns at all. And we did -- we ask all of our units to consider their local branches before they start ordering anything through the cycle and really watch this -- what they do order because demand is uncertain for this quarter, in particular, and we don't really know what Q3 will look like.Our biggest concern is energy. Our inventories are in fairly good shape, but they can always be better. And if really there isn't drilling activity going on in Q2 and Q3, it's going to be tough to bring those inventories down so we may be carrying that inventory longer than on our books, like turns may get very low before through those 2 quarters.I'm not that concerned in our oilfield stores. I think demand is down, but there's nothing there that we need to have the inventory at the, whatever, 80 stores we have. So it's kind of spread out and it does maintain its value.

[Michael Tupholme, Research Analyst]

Okay. And then just a question on, I mean, on steel prices. We have seen steel prices weaken since sort of the early to middle of March. We've seen some recent announcements from mills of increases in prices. Just maybe a question for John. Any -- I know it's a very uncertain environment, obviously, but any commentary around the pricing outlook? Do you think the increases that have recently been announced, are those likely to be accepted? Or any sense on that? And maybe if you can also talk about mill lead times.

[John Gregory Reid, CEO, President & Director]

So the pricing right now, as we look at it, I'll start with scrap. And so we're starting to see scrap come out right now as we look at next month, and it's showing an increase. And I've heard everything from $10 to $30. Right now, it's a little preliminary, but it looks like scrap will go up, which will help solidify the increased announcements that have recently come up. I think the -- again, the low points in this week fell in hot-rolled coil and in plate; I think we've hit low points. We're starting to come off of those slightly. The full increase has not been absorbed yet. But again, I think, we're starting to see very positive momentum in those corrections. So we're coming off of the bottom. It will be a slow climb back out as demand improves. With the mill shutdowns that you mentioned, they're taking out enough capacity. We're not balanced to the demand level of where we are today with automotive being closed and with energy being so slow, but it is helping solidify some of those -- some increased opportunities that are out there.

[Michael Tupholme, Research Analyst]

Okay. That's helpful. And then just lastly, related to that, any commentary on what that means for OCTG and Line Pipe pricing? Obviously, different dynamics in that market, given that it's not all just COVID-19 related, the demand weakness there. But what do you see happening with prices in that area?

[John Gregory Reid, CEO, President & Director]

Typically or historically, they have lagged 60 to 90 days when you look at coil pricing and plate pricing, just for the time for it to work through the system to become a pipe or OCTG or Line Pipe. This latest dip because of the downturn with a lot of the mill closures in Pipe from various pipe mills, I think, they may actually miss the bottom. And so we may see it help stabilize the number. It has drifted further in April from where it was in March, but we may not go all the way down to where flat roll was because, again, they're just not producing right now. So assuming their raw material that they're not oversupplied in raw material, most of it was in finished goods, which is what we're being told from most of the pipe mills that they may actually solidify their pricing a little earlier than they have historically.

[Operator]

At this time, there are no further questions. You may proceed.

[Marion E. Britton;Executive Vice President and CFO]

Okay. Thank you, everybody attending. Everybody stay safe and talk to you next quarter.

[Operator]

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and we ask that you please disconnect your lines.