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Good morning, ladies and gentlemen, and welcome to the 2019 Third 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 for Russel Metals. [Operator Instructions]I would now like to turn the conference over to Ms. Marion Britton. Please go ahead.
Good morning, everyone. I'll start on Page 3, reading the cautionary statement. 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 made of historical facts are forward-looking statements. Forward-looking statements are necessarily based on estimates and assumptions that while considered reasonable by us inherently involve known and unknown risks, uncertainties and other factors that may cause actual results or events to differ materially from those anticipated in such forward-looking statements.Our actual results could differ materially from those anticipated in our forward-looking statements, including as a result of the risk factors described below in our MD&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.Turning over to Page 5, and I'll speak to our third quarter results. Q3 earnings, $18 million or $0.29 of EPS compared to last year, which was a record quarter of $1.10 of EPS. 9 months ended, we have earnings of $83 million or $1.34.During the quarter, we generated significant cash -- or I mean, for the 9 months significant cash of $59 million from accounts receivable and $80 million from inventory. Free cash flow for the 9 months to September, $134 million or $2.16 compared to $3.86 last year. Return on equity, 13%. And we, yesterday, declared our dividend for the quarter.Turning to Page 6. Speak a little bit to the market condition. We experienced lower demand in all business segments. Steel prices were down also in the quarter, and we believe steel prices are at or near the bottom.Metals service centers selling price decline was the biggest driver of the metal service decline in earnings. Selling price was down 11% compared to Q3 '18 and was down 7% compared to Q2 '19. The tons were down in the quarter on a same-store basis compared to Q3 '18 by 5%. Rig count in both U.S. and Canada are significantly down year-over-year, which has impacted our demand in our energy segment. Product segment revenue for energy were down 17% compared to Q3, 2018.Moving forward to the next, Page 7. This is our chart that gives you the 4-year look back and our comparison to the 9 months last year. You'll note that our accounts receivable, I mentioned, had generated significant cash for the 9 months, but it is also down very significantly from where we were at this point in Q3 2018 due to the revenue decline. Further down this page, I'll point out the capital expenditures. So far this year, we spent $24 million on CapEx compared to $31 million last year. We do continue to add value-added equipment in a number of our service centers, which we do believe is helping keep our demand and a little hot better than the industry. We don't anticipate expending more than -- or we anticipate spending this year less than the 2018 number of $40 million, we'll expect to be in the low $30 million for CapEx this year.Turning forward to Page 10. Just point out the cash flow from accounts receivable and inventory. And on that other highlights page, we have the 9-month numbers. But you'll note that there was a significant drop in inventory in the quarter. We continue to work on reducing inventories to get rid of higher-priced inventories in the segments and to position ourselves, particularly in energy, where we have lower demand. Turning forward to Page 13. I'll mention here that we completed the acquisition of City Pipe, October 1. The more specific details on the acquisition are in Note 22 of our complete statements that were filed yesterday on SEDAR. The acquisition price in U.S. dollars ended up to be $106 million because they have brought down their assets to keep it in line with their revenues. The acquisition price consisted of USD 56 million of net assets, plus $50 million of goodwill. We have not completed the actual allocation of the -- to fair market value to the assets, but that will be done by year-end.Turning forward to Page 14. This is our normal chart, which has our comparison to the prior year, plus shows the gross margin and our EBIT margin. Looking at this, we'll speak to the metal service EBIT. Our gross margin of 18.5%, that compared to the year-to-date of 18.8%. Margins held quite well in the quarter, considering the fact that prices came down in the quarter and came down more after the end of the quarter. We're expecting that it will be in this range or slightly less in the Q4 period. Energy products was impacted slightly by some NRVs that we had to take with in that segment. I'll speak to that a little bit later, and mix. But mainly the energy decline in margins has to do with the impact of lower rig counts on OCTG product. Steel distributors similarly had pressure on their margins due to the reduction in their prices of steel.Moving forward to Page 17. Just to speak to how the year is -- 9 months compared to the quarterly numbers. The tons for the quarter were down 5%. Year-to-date, were down 6%, which we're anticipating similar numbers for Q4 on the demand side.On the selling price, we actually -- year-to-date, we're up 3%, because last year, if you remember, we kind of went up during the year, where this year, we've been coming off. But in the quarter, we did have a significant decline at 11%, and we anticipate average selling price over last year's Q4 to be down a similar double-digit number.Turning forward to Page 18. We did take some NRVs and continue to shake some obsolescence reserves in our energy group NRV related to items that we have received with tariff on them and relooking at price of steel. So the NRV was around $5 million, and we had $2 million of obsolescence taken in our energy segment. There was approximately $1 million each in steel distributors and service centers also NRVs, just to make sure we were in line with current pricing of products.Turning forward to Page 22. We have our normal charts here on our inventory values and turns. You can see the significant drop in inventory in service centers from December, $427 million down to $334 million. Both tons and price are -- have come down. Our service centers have been managing down their inventories very well, trying to get down to a level where they can start purchasing at lower prices. Energy products have not been able to bring their inventories down as much as we would like, basically due to demand. We continue to work on trying to get our energy product inventory in line with where we see the demand for the next 6 months.Steel distributors continue to bring theirs down as they have taken them up during the time when the tariffs were on, but they're now rightsizing them to that, to which would be normal based on revenues we anticipate.Those are my comments for the quarter. We'll open it up for questions.
[Operator Instructions] Your first question comes from Michael Doumet, Scotiabank.
Marion, I caught you providing some margin guidance for Q4 for MSC. Just wondering for the energy products segment, I mean, given the declines demand and pricing-wise, what should we expect for Q4? And should that hopefully be the bottom?
I would say between $16 million and $17 million would be my expectation, could be down slightly from where we were this quarter. It really will depend on price and it -- OCTG, if we have very little volume, we may have a bit of a mix pickup, but I would say it possibly down a bit.
Okay, that's helpful. And then aside from OCTG, what categories of products are you seeing the most margin pressure? And any potential risk of a write-down in Q4 or potential magnitude there as well?
Sure. John will speak to the price of steel issues.
Yes. On the service center side, Michael, we're in really good shape. Returns are -- we're continuing to move in the right direction. And we've done a really good job. We have some exposure on the distribution side, but the write-downs would be small. So I don't think there's anything material there that's left.A bigger concern would, obviously, be energy. It typically lags 45 to 60 days due to it being a substrate of hot-rolled product. So as coal pricing looks to have dipped and hit the bottom, we've seen a slight increase now with increase in scrap pricing. You would hope the same is true for OCTG and Line Pipe, but based on the demand pressure that's out there, I would imagine that we'll remain pretty aggressive. So if there is anything remaining, we think it would be in that category.
Okay. And could you maybe size that up for us, just in terms of range or magnitude?
I wouldn't say much bigger than what we've had, like, that would be my expectation. But -- so if prices don't do another breakdown.
Yes. Some of which stay flat and that holds, then I think it would be significantly less than we did in Q3.
Your next question comes from Michael Tupholme, TD Securities.
You provided a little bit of commentary around your thoughts on steel prices, suggesting you think we're at or near a bottom. And as you mentioned, we've seen scrap in November tick up and HRC has come up in the last few weeks. John, wondering if you can talk a little bit about plate prices and what you see happening there?
So I think plate prices, if you look at them in relation to historical spreads with coil pricing each, I think coil may have overcorrected a little bit. Part of that's due to mills pressing forward with utilization. They may run a little heavier rate than demand. And so I think we may have overcorrected. So I think plate is getting close to a bottom.Well, we've seen a recent downturn on plate, a recent price decrease. So I think we're getting close to a bottom there as well. If scrap pushes forward, then that's going to raise the input costs. Unfortunately, I'm not a big fan of price increases sustaining based on input cost increases because scrap can turn again. Demand, I get pretty bullish when demand is driving it, so that's -- I think we're getting to a bottom. Again, if scrap drops $30, then we'll all move again.
And is there any chatter about price increases on the plate side? Or is it too early for that, you think?
I have not heard any on the plate side, I've heard them on the coil side. Again, some of that is appearing to stick on the coil side, but I've not heard any on the plate side. Well, I haven't heard anything. I think we're going to stick.
Okay. Marion, with respect to service centers, the same-store tons shipped, down 5% year-over-year. I apologize if I missed this, but did you provide some sense for how we should be thinking about that in the fourth quarter?
Yes, I think we were -- year-to-date, we're down 6%. So I would think we're going to be in the 5%, 6% range fourth quarter also year-over-year.
And how do you think demand and shipments look in that segment as we look a little further out to 2020? I mean, I suspect you're going to face some easier comps, so I don't imagine you're going to expect to see those kinds of declines throughout next year. But how do we think about that? Do you see an opportunity for some growth? Or what are you thinking about?
As we've -- historically, when we've entered the down markets, Michael, our people are very adept at managing inventory, managing working capital and taking cost out of the model, but that's when we've typically grown our business. So we've either done it via adding new equipment for value added processing, whether it's lasers, stretcher levelers, whether it was by acquisition or just taking organic market share within markets. So as we look at it, again, we're such a transactional business. We look at down markets as a real opportunity for us to thrive. And then we're going to go out and we feel like, grow our share regardless of really where the market direction is. Because, again, we think we're built for that. And again, we have really professional operators out there in the field who know how to run their business in a down market. We know it's cyclical. They're prepared for it. Our compensation models prepare us well for it as a company. So...
No, that's a good point, John. Regarding share gains and then the value added, do you think, though, the overall market, how should we think about the overall market, so we can sort of overlay your own share gains and growth through value-added on top of that?
Your guess would be as good as mine. We're not built to predict the market. We're built to react to it better than anyone out there. So...
Okay. Fair enough. I don't know if it's -- if you would say the same thing. But with respect to energy products, any thoughts on how we can think about the outlook for next year? I mean, maybe you have a better sense, given some of the commentary from some of the industry players on the rig count side, but I don't know if the visibility there is tough as well?
I mean, the rig count visibility is obviously tough. We think we're getting near a bottom on rig count. It looks like we're seeing some stability in oil pricing now. The change in the model dynamic is obviously the E&P companies having to learn to live within their cash flow budgets and run, what I would say, like a real business for the first time. So they can't outrun their cash flows, and so they're having to live within budget constraints. So I think we've seen that reset this year. I think through our City Pipe acquisition, our Apex, Apex Remington stores, we will see growth out there. If it continues to stay at this level, we have to maintain the rigs. But any uptick at all, we'll see the growth. And then through LNG, the project in Canada, we're starting to see some growth there. And also we have 1 project, one in the sands through Comco that's doing very well.
Okay. And actually, that was going to be my last -- just I was going to ask you about LNG. Is there an actual opportunity that you've been presented with so far? Or is this more sort of prospective as we get further into the year and 2020?
It's more prospective. We're putting bits together. We're looking at opportunities on how we can do the projects where we do the engineering work with the purchasing teams. So it looks like those are real projects. I feel better about that than I do infrastructure. How's that?
Your next question comes from Ryall Stroud, RBC.
Good morning, everyone. This is Ryall Stroud calling in on behalf of Derek Spronck, RBC. Great. So I guess to start off. With the City Pipe acquisition now fully accounted for, what does the currency deleveraging cadence look like? And is there a number or a target leverage range that we should expect for year-end 2020?
No, we don't have a target leverage. I mean, we will bring -- throw off cash if the demand's not there. Otherwise, we will -- we'll move with wherever it is. Our leverage, we look at is our debt to equity, which we expect to improve as we throw off cash from working capital. But we'll see what happens.We basically use cash that was on our balance sheet to do the acquisition because we have cash in the U.S.
Okay, great. That's helpful. And any color around what the margin profile looks like for City Pipe? And maybe any commentary around what potential synergies might look like as well on a run rate basis?
The margin profile of it is similar to our Apex operations that we already own. We did give their 9-month EBIT and revenue number in the commentary, and you can see, that it was about -- above 10% for the 9-month period. So similarly, they run at strong EBIT margins.
If you look at them in a general sense, the energy service center business, as we call it for City and Apex, it looks a lot more like our service center models on inventory turns, margin profile, they don't have as big a value-added component, so it does move around a little bit. But they're much more a service business for distribution that's out there that's a growing model. Again, it's the smaller order size. And so it looks a whole lot more like our service center profile.
Okay, great. Great. And just one last one for me, and I'll pass the line. So with inventories looking to have been reduced now for about the third straight quarter, is there a target inventory level you're currently comfortable with, given the current steel pricing and demand environment?
Service center is getting close to that target, if they're not already there. They're continuing to bring down inventory in this quarter. We look at it as a target turn level. We need to improve on energy, and that target turn level needs to improve by at least one full turn is where we would try to get to. To put it in turn -- in numbers is, with the decline in price, we're chasing a fall in [ mix ]. So we try to chase it on a turn volume.
Your next question comes from Frederic Bastien, Raymond James.
Conditions are challenging, obviously, for you in the sector, but probably even more so for smaller mom-and-pop operators. So I was wondering if you're finding that potential acquisition targets are more receptive to entering into discussion with you? Or are you actually seeing the opposite?
But we really -- it's been more of a flat market right now, and that we've had some opportunities that we've looked at. I think as we go into next year, that we will have recalibrated the expectations coming of off '18. Again, everybody was a record year. I think the people would've recalibrated looking at '19, and there should be some opportunities for acquisitions or -- what we would call at a reasonable level.
That's good to hear. Are you -- as you look forward, are you still contemplating increasing your exposure to U.S. service centers? Just wondering if your view has changed there with respect to M&A opportunities?
Obviously, from a footprint perspective and geography, that's where we make the most sense to grow. Canada gets a little tricky. Color was a nice acquisition because, again, it added a product mix that we didn't have in our footprint in Canada. We're #1 or 2 in every region we serve there. So obviously, the U.S. is a much larger footprint for us to grow in. But we won't force it either. So it's -- it has to be a good fit for us, and we don't like to put people on an island too much where we have a service center out there just by itself and we can't offer any synergies or help. So we're looking to build on our existing footprint or find something that's a larger standalone operation, 5 or 6 locations.
Your next question comes from Anoop Prihar, GMP Securities.
Marion, just one quick question. You took a $5 million write-down on energy. But then in Note 4, you're showing an $11 million impairment charge. I'm just wondering, can you just connect the dots for me on those 2 numbers, please?
Yes. So the $5 million was an NRV related to price and tariff stuff that we felt we needed to rightsize on energy. We did have another $2 million of obsolescence in the energy area. And then we had $1 million EBIT in Service Center on NRVs and $1 million in steel distributors. It doesn't quite add up to 10.9, I know, but kind of where it fell out, a little bit less.
All right. And then John, I'm just curious, on the service center side, are you seeing any material difference in the demand, Canada versus the U.S.? I mean, the numbers were down, obviously, across the board, but I'm just curious to see or ask you rather whether or not you're seeing any material difference in demand coming out of Canada versus the U.S.?
We're not seeing a material difference in demand. What we are seeing is probably a material difference is in competitive pressure. The U.S. is just a lot more aggressive right now than Canada. Both are under pressure. We collect some of the U.S. -- competitors may be overstocked significantly. So we've seen them be a little bit more aggressive on price.
[Operator Instructions] Your next question comes from Michael Tupholme, TD Securities.
Just a follow-up. Marion, earlier in the call, you had talked about expectations for gross margins in the service center segment, I believe, for the fourth quarter. I just wanted to clarify what you had said about that?
Yes. We came in at 18.5%. And I think it will be in the -- that level or slightly down to possibly 18%. It depends on how pricing holds in plate and everything. So I think we'll stay in the 18% range, but we could be down slightly from Q3.
Okay. And then, similarly, if I look at the gross margin in steel distributors, 10.9%. I don't know if I can find the comment as I'm speaking here, but I think I recall reading that you suggested sort of that was -- you saw a normalization in the margins within steel distributors. I think we were in the 13% range if we go back to Q2. So is this -- are you now at a level there at around 11% in steel distributors that you think is sort of the sustainable level? Or could that still move around?
That margin is pressured a bit by the price moving down. And I anticipate that will be continued in the Q4 also, but we should come back to more of a 12% level, which is more normal in -- starting in next year.
Okay. And then would it be fair to say, I guess, all else being equal at this point, but if we do look out to 2020 for your other segments, it would be reasonable to think about 2020 as sort of going back to the more typical normal type levels, assuming, again, no further deterioration in price?
I would agree that if we can make that assumption.
Okay. Yes, I mean, I know it's perhaps a bit of a big assumption, but we'll see what happens.
You have no other questions at this time. Please proceed.
Okay. Thanks, everyone, for attending the call, and we'll talk to you next quarter.
Ladies and gentlemen, this does conclude your conference call for today. We thank you for participating, and ask that you please disconnect your lines.