Russel Metals Inc

TSX:RUS

Earnings Call Transcript 2018-Q4

[Operator]

Good morning, ladies and gentlemen, and welcome to the 2018 Fourth Quarter and Year-End Results Conference Call for Russel Metals. Today's call will be hosted by Mr. John Reid, President and Chief Operating Officer; and Ms. Marion Britton, Executive Vice President and Chief Financial Officer of Russel Metals Inc. [Operator Instructions]I'll now turn the meeting over to Ms. Marion Britton. Please go ahead, Ms. Britton.

[Marion E. Britton, Executive VP, CFO & Secretary]

Okay, good morning, everyone. So John, our CEO, is with us. I guess, we have an older intro there. But anyways, we're here. I'm going to start on Page 3, quickly run through our 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 dividend. Forward-looking statements relate to future events or 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 such forward-looking statements. Our actual results could differ materially from those anticipated in our forward-looking statements. Please review the risk factors described below in our MD&A and our Annual Information Form.While we believe that the expectations reflected in our forward-looking statements are reasonable, no assurance can be given that these expectations will prove to be correct, and our forward-looking statements included in this call should not be unduly relied upon. These statements speak only to the date of this call and, except as required by law, we do not assume any obligation to update our forward-looking statements.I'll just reference you on Page 4. We do give our definitions for non-GAAP measures that we used periodically throughout this presentation.Page 5 is where I'm going to start my comments. Comments are highlights for the quarter and year. We had an EPS of $0.74 to help us mark off a very strong year at $3.53 our EPS, earnings of $219 million compared to $124 million last year and $2 in EPS. So our $0.74 in the quarter did compare to $0.45 produced in the Q4 '17. We had strong free cash flow $300 million at December 2018 or $4.84 per share, which compares to the prior year of $2.92 per share. Return on equity 22%, very strong for return. We also declared our dividend of $0.38 per share.Flipping over to Page 6 in the deck. Some market conditions that we're seeing at this point in time. Q1 appears to be stable demand for our service center. Although steel prices have peaked in most products, we did see our hot rolled coil peak in Q4. It has come down since Q4. Metals service centers average selling price in Q4 was 28%, above what it was in Q4 '17, but -- and it was consistent with Q3 '18. So that implies selling price had peaked, also, at some point in Q3. Metal service centers tons shipped were down in Q4 '18 versus Q4 '17 on a same-store basis. Year-to-date, they are up 2% for the company on a same-store basis. Just to remind people that we would have DuBose and Color Steels acquisitions. DuBose in this year April '18, Color Steels added in September 2017, which are year-over-year increases in our service center units.Rig count year-over-year is up in the U.S. The U.S. continues to be strong in oil and gas production while Canada is down year-over-year. At the time we put the slide together, it was 33%. It still hasn't improved. It's improved slightly since then, but not to a number that is very good for 2019 versus 2018.Energy products segment revenue did increase 44% in Q4 versus Q4 '17, mainly driven by the U.S. line pipe projects that were -- they were not -- they were completed or being completed at this point in Q1 '19, but were in our Q3 and Q4 results for '18. We also did have strong results in our oil field stores in the U.S. in the Q4. Tariffs, I just have a comment there, reminding people when the steel tariffs were put on, and then during the Q4 was when safeguards were added in Canada for shipments from outside North America. The decision on the safeguards is anticipated in April 2019.Page 7 is our chart that shows our 5-year numbers. One of the numbers that is a new milestone. We had revenues for 2018 of $4.2 billion, which is the highest since 2014 or the highest ever, but since 2014 when we reported $3.9 billion. So an increase over that. Accounts -- and you can see all the numbers there with our EBIT and EBITDA representing high returns in 2018. Going down, you'll note that our accounts receivable were in good shape at the end of the year, very comparative numbers there. And then metals -- and 2014 -- net working capital was up slightly from 2014 with revenues increased. So our numbers are in line with what we would anticipate on our working capital numbers at this point in time. We do have a slight increase in our interest-bearing debt $447.8 million at the end of the year.Turning forward, I will turn to Page 16. Just before I comment on that page, the one thing that you'll -- wanted to mention is that our full set of financial statements with the notes have been filed on SEDAR. So we've included here our quarterly and year-end summary pages. But if you are interested in full set of statements, you can obtain them off on SEDAR. The -- and they will be on our website also, sorry.If you turn to Page 16, you will see our results for the year compared to 2017. You'll see that all segments had a significant increase in revenues. We've also already talked about the fact that tons weren't up as much as selling price was up in the period. The increased energy, though, does relate to additional demand in the large line pipe order and activity going on.The segment producing the most improved increase in operating profit was metals service centers at 112% of prior year. Looking down to the segment gross margin, you'll note that the service centers at 23.3% for the year versus last year 20.7%. Energy is down slightly from last year, driven by the large order, which always carries a lower margin, and there is some mix in there also. Steel distributors similarly is up from last year, driven by rising steel prices.Segment operating profit as a percent of revenues for the company 7.9%, great improvement over 6.3% produced for last year. And the metals service center and steel distributors segment are both up over last year with energy consistent.I'm going to just flip to Page 27 at this point, so I can make a couple of comments on the quarter, and then I'll reference a few other pages in the deck. On Page 27, you will see the metals service centers is up 25% and energy up 44%, and we have spoken mainly about that, driven mostly by the large line pipe order that was completing in that period.The steel distributors revenue is up 50%. We've had more activity in Canada, in particular, driven by demand in Canada to source material outside of the U.S. Those shipments will continue into Q1, but then we will start to taper off as we go through the year as we have brought in less materials available for shipment.Segmented operating profits for metals service center 80%, does continue to be strong over -- compared to Q4 2017. Segment gross margin, there was a decline from the year number at the metals service centers. The -- we would anticipate somewhere between 21% and 22% in the normal margins, so we were close to that 21%. As I mentioned earlier, we had some products have their pricing under pressure at the end of the year. The segment operating profit as a percentage of revenue 6.4%, once again strong quarter number for the company.Now I'll go to Page 18. I just wanted to make a comment on the metals service centers. The middle paragraph there, we talk about our average order size and the transactions handled, always interesting information when you have that many transactions, 3,274 a day. They are actually less than they were in the prior year. Our average order size went up this year. So the increase to $2,422 for our average order size includes more tons in each order and additional increase in selling price.Turning now to Page 21. Just make a comment on our CapEx for the year. Consistent with comments made throughout the year, our CapEx for this year $41 million is higher than our depreciation, and it's actually higher than last year as we continue to add value-added processing equipment. We expect to exceed depreciation to a number somewhere between the $36 million, $41 million number in 2019 also.In the next page, on Page 22, we break out our inventory dollars by segment and our inventory turn. You would note that our metals service centers number is up quite a bit, but mainly selling price, there's increased tons due to DuBose being added in there plus availability because demand is feeling fairly good going into 2019. Steel distributors also increased in doing deals -- sorry, in relation to the additional activity in Canada, selling to the service centers.Those are my comments. I'm going to turn it back for questions.

[Operator]

[Operator Instructions] And your first question is from Derek Spronck from RBC.

[Derek Spronck, Analyst]

Just on the value-add services, how much a percent of revenue is now being driven by value-add services? And what sort of the growth rate you are seeing there? And do you have capacity to continue to grow, or will it require additional investments to continue to grow the value-add services that you are offering? Maybe some color around that, that would be great.

[John Gregory Reid, CEO, President & Director]

Derek, on our service centers side, it's roughly 28% to 30% of our business right now, if you exclude coil prices. So we don't count that number in there. There is some room to continue to grow, so we do have some availability on shifts right now with the existing equipment. But I would say there will be a 1% to 2% more room there to grow. So we will have to spend CapEx, which we have budgeted for this year similar to last year in that same range. So we'll continue to add equipment there as we push forward with our goal maybe to get to 35% to 45% within the next 2 to 3 years.

[Derek Spronck, Analyst]

And the payback on the new equipment that you're purchasing and is coming in as expected. What -- could you quantify the payback period of new equipment?

[John Gregory Reid, CEO, President & Director]

It's usually 2 to 3 years or less.

[Derek Spronck, Analyst]

Okay, great.

[John Gregory Reid, CEO, President & Director]

Maybe they're exceeding the expectations at this point.

[Derek Spronck, Analyst]

Okay. John, and that -- the margin profile on that, is that a little bit -- is that margin-accretive when you do that as well or...

[John Gregory Reid, CEO, President & Director]

Yes, and it's changing our margin profile in the service centers if we continue to add that. So we think it'll continue to add there. Again, being a parts-based business, it's a little bit more difficult to model because it's not strictly driven off of tons as you're selling time, so you're selling a lot of labor components to that. So as we -- I think we've talked before the parts that may weigh the same may have dramatically different cost and the labor component of that. So it can skew that number. It's really a mix -- it's a mix-based issue that you have to go through there.

[Derek Spronck, Analyst]

Yes, okay, got it. I have a bunch of questions. But I'll just hop on -- I'll ask one more and then see if others ask my other questions. If not, I'll circle back up. But I'd be curious to get your thoughts around the emergency measures. Have they been working? And are you concerned at all if they decide to remove those emergency safeguard measures?

[John Gregory Reid, CEO, President & Director]

Which country are we talking about now?

[Derek Spronck, Analyst]

The Canadian.

[John Gregory Reid, CEO, President & Director]

I think the Canadian -- again, I'm not too concerned if they decide to remove them. I think -- I don't think they have a whole lot of options until the U.S. does something. If they just -- if they do remove them completely, the U.S. safeguards stay in place. There would be a concern if Canada would become a dumping ground for materials. I don't think that's going to be an issue. I don't think Canada will move without the United States on that. Overall, the impact right now, I think, has been healthy for our service centers and for our energy environment to maintain a pricing level that's good for the mills and good for the service centers and good for energy distribution.

[Operator]

Your next question is from Michael Tupholme from TD Securities.

[Michael Tupholme, Research Analyst]

Just a follow-up on that last question, John. So your expectation -- will it be fair to say your expectation has come with the decision in April 2019 by Canada that they would, I guess, make the provisional safeguards more permanent for the time being?

[John Gregory Reid, CEO, President & Director]

I think they try to mirror more permanently what the U.S. is doing. Again, I don't think they can disconnect too much on the safeguards there. They just opened up the world market through Canada, with volume -- we can't handle that all coming into Canada. So I think they are trying to mirror or at least maybe even extend the time frame for review, so they understand fully what the U.S. is doing.

[Michael Tupholme, Research Analyst]

Okay. And in the past, in the last few quarters, since those provisional safeguards have been put in place, I think there has been some discussion about how, on the whole, it has sort of a normalizing effect in terms of the prices of steel between Canada and the U.S. Although there are some differences, I guess, between hot rolled coil and plates with I think plate being at a premium in Canada and hot rolled coil being at a bit discount. Is that still the case?

[John Gregory Reid, CEO, President & Director]

Yes, the gap has narrowed, but they're still there. And I think that's more demand driven because now you have both safeguards in place. So they're having a counterbalancing effect. But again, I think it's more demand driven right now with what's coming in for the hot rolled coil. It's having a more difficult time getting into the U.S. to be competitive with the U.S. mills and conversely plates having the opposite effect in Canada.

[Michael Tupholme, Research Analyst]

Okay. Just in terms of the gross margins in the service centers segment, just under 21% in the fourth quarter. Marion, I know you said normally that would be in a sort of stable pricing environment, something in the 21% to 22% range. But I wasn't totally sure if you're 21% in the fourth quarter, but what is the outlook going forward, particularly with prices rolling over and sort of having already peaked here?

[Marion E. Britton, Executive VP, CFO & Secretary]

Yes, I think it will start to stabilize as we go out of Q1. I'm not -- I don't want to be too comfortable or too confident we're going to be above 21% in Q1. But I think as we go through the year, the 21%, 22% should be a valid number unless safeguards and all kinds of other things change the environment.

[John Gregory Reid, CEO, President & Director]

Michael, it's going -- again, as long as we feel like we're starting to stabilize on flat-rolled pricing. As long as the pricing stabilizes, we think that 21% to 22% becomes a valid number. But again, if pricing drops or jumps up quickly, then that can change those.

[Michael Tupholme, Research Analyst]

So the 21% -- like, what you did in the fourth quarter is a little bit understated relative to what you should be able to do in a normal environment simply because prices came under some pressure?

[Marion E. Britton, Executive VP, CFO & Secretary]

Correct.

[John Gregory Reid, CEO, President & Director]

That's right. We have seen the decline, and that's correct.

[Marion E. Britton, Executive VP, CFO & Secretary]

And there seem to be a little bit of excess inventory around that seem to want to be moved somewhere for some reason, and I think people getting concerned about pricing are just preparing for year-end one or the other.

[Michael Tupholme, Research Analyst]

Just looking at the earlier comments you had in the MD&A, I just want to clarify a couple of things. When you talk about stable demand in service centers and steel distributors, this is on a sequential basis, like, in the early part of '19 versus the latter part of '18 you're talking?

[Marion E. Britton, Executive VP, CFO & Secretary]

Well, and also year-over-year. We're rolling up 2% year-over-year, and we are thinking that demand will be somewhat consistent 2% up, 0, whatever in '19. We don't see any big up. We don't see any reason for it to go down, though.

[Michael Tupholme, Research Analyst]

Okay. I guess -- I'm asking, I guess, sequential versus year-over-year because in the fourth quarter, those service centers year-over-year same-store tons were down about 5%. So -- but you actually think there's an opportunity to see some flat to maybe up slightly year-over-year full year '19 tons in service centers?

[John Gregory Reid, CEO, President & Director]

Yes. Flat to potentially up. I mean, I think Q4, when you look at specifically the last 2 weeks of the year, really were just down compared to historic Q4, for December especially with the seasonality. So I think, all service centers were the early ones reporting. So -- but if you look at the MSCI numbers, you'll see inventories up and shipments were down for Q4, but I think that was really related to December, the world pretty much shipped down at Christmas and came back January 6. So we thought shipments pay for all more so than normal. So I think you'll see a resetting of that in January. Inventory levels will come more back in line in the service center industry as a whole. And I think demand -- we're seeing this demand picking back up to a level very similar to that of the year for 2018.

[Michael Tupholme, Research Analyst]

Okay. That's helpful. Just 2 other quick ones here. Can you talk a bit more about the energy products segment outlook and just generally what you're seeing in the energy sector? I know you had these large line pipe orders benefiting you in the last couple of quarters. But the outlook makes it sounds like you're only sort of expecting a modest decline. I'm not sure if that's because you still got some line pipe orders coming sort of in the first quarter. But some of the CapEx budgets from the energy companies on a conventional side seem fairly negative with the pullback in oil in the fourth quarter. So maybe just help us frame the outlook for energy a little bit better.

[John Gregory Reid, CEO, President & Director]

So you're really dealing with 2 sides of the border there. Starting with Canada, we are seeing some pullback on the E&P side as far as their capital budgets. What we are being told from our customer base is somewhere on a 10% range. When the differential was getting up to $40 and we were saying $10 all, that was concerning, but now that, that has shifted back to more of a normal level and even maybe a little bit lighter-than-normal level for the differential. The budget seemed to be solid, but we're being told of breakup going into Q3 as the people are anticipating in Canada being of 10% range for their budget. So overall, we think that's what we'll see as a change. Flipping south of the border in the U.S., they're full speed ahead right now. We're not seeing budgets get cut there. And the price in the Permian, especially if they can extract oil right now, but this is a very healthy level. Now although $30 a barrel that changes, we guess $75 a barrel, everything changes. But as we stand today in the low to mid $50s, I think we're okay.

[Michael Tupholme, Research Analyst]

And just to be clear on the U.S., assuming no dramatic changes in the price of oil full steam ahead means, like it's natural growth there or just -- I mean, I know you had a bit of a tough comp with the line pipe orders, but -- like, can you even grow year-over-year in energy in the U.S.? Or is that more of a flat...

[John Gregory Reid, CEO, President & Director]

On our normal business, we can. Again, I think you're going to have the large line pipe projects that we will bid some others, but there is no certainty that you win those, each time as they go through. So when I say full steam ahead, I'm talking about our normal type of business. We do have our normal line pipe business. We don't have any big projects in the hopper right now. And so that piece will be -- we feel well.

[Michael Tupholme, Research Analyst]

And then just lastly. In terms of free cash flow, with steel prices having plateaued, it sounds like there's tremendous amount of demand growth. You'll get some, but it would seem that you may have a reduction in inventories, I guess, at least with the pricing coming down. Maybe just speak to that, but if that is the case, presumably you're going to have some pretty good cash flow generation in 2019. Just wanted to know how you think about capital allocation between dividends, buybacks, if the board is considering buybacks and other growth initiatives.

[John Gregory Reid, CEO, President & Director]

We always look at it every quarter. Again, I think you're right. If all things stay even, the pricing stays where it's at today that we should start to see -- cash flow start to increase. We'll review the dividend. I can tell you it was a fulsome discussion in this quarter. We'll continue to review it to see where we are, but as we reflect back on the dividend, also what we were paying out over 100% there for 2 years. So I think people appreciated that, and we didn't cut the dividend. So we'll look at it as a long-term approach to know what's best for our shareholders is still paying a pretty healthy percent, over 6% to 7%, depending on where share price is at the moment. So we feel like it's in a good position, but we'll look at it again in 90 days. We'll also continue to look at the value-added processing growth and at acquisitions.

[Michael Tupholme, Research Analyst]

Okay. Is buybacks part of that discussion as well, John?

[John Gregory Reid, CEO, President & Director]

We've talked about share buybacks in the past. We really want to look at those as stock gets down below. So we don't want to do anything that's not accretive for the shareholders. So again, we don't want to dilute the shareholders and reward the gap for leaving, but rather reward the people for staying. So we only really look at those typically when we get down below book value.

[Operator]

Your next question is from Frederic Bastien from Raymond James.

[Frederic Bastien, Senior Vice President]

Are you guys comfortable with the level of inventory that you're kind of carrying across segments?

[John Gregory Reid, CEO, President & Director]

Yes, we came into the year just a little bit heavy, Fred, on service centers side. We're resetting down the distribution side that's cleaned up. We had the opportunity last year in Canada that was just created by the safeguards. So that's rebalancing now. Our energy inventory is in a very good position. So again, we came in just a little heavy going into Q1 for service centers and we would like to have seen, primarily based on this -- the last 2 weeks of December, basically the customer base to shut down for the year. So we think that it will rebalance very quickly. So overall, I think our turns will be back to normal levels or above very, very shortly.

[Frederic Bastien, Senior Vice President]

And how would you describe sort of inventory levels on the industry side at -- in energy? If I recall a few years back, there was a lot of excess and it took some time for everything to work through the system. So I was wondering what the position is right now across the board.

[John Gregory Reid, CEO, President & Director]

Really clean, and people have done a great job going through, looking at that, continuing to push obsolescence as an aged inventory to push that up. So we feel like we're really clean and in a very good position right now.

[Frederic Bastien, Senior Vice President]

Okay, cool. A couple of more questions on the distribution side. I know it's actually a smaller business, but it has been contributing nicely to profit. I noticed that there was a fairly high level of inventory. It's down from what you had at the end of September, but it's still up significantly. Does that pertain a pretty solid Q1 for that business?

[Marion E. Britton, Executive VP, CFO & Secretary]

So what happens, Frederic, is particularly in Canada, we have to bring in when the Great Lakes are open. So we do always bulk up at year-end, but we did a lot of purchasing in the -- after these announcements of June 1, July 1, those announcements shipments arrived, they're actually being delivered to our customers. No concerns because a lot of the Canadian is presold.

[John Gregory Reid, CEO, President & Director]

Windows had opened up there, Fred, that we could bring in specific product, plate being one of them that we could bring in. It was very advantageous for us in Canada.

[Marion E. Britton, Executive VP, CFO & Secretary]

So we'll move back to the June levels as we move through this first half of the year.

[Frederic Bastien, Senior Vice President]

Okay. And then, separately, I mean, you did mention that -- in your comment that last year's disruptions and trade sources did positively impact that particular business. What's the outlook now that, I guess, those disruptions have gone from short term to pretty much being ongoing?

[John Gregory Reid, CEO, President & Director]

The pricing is starting to come back to what I would call a more stable level. And if you look at the North American pricing for coil products, for example, if you take the world market, you add in tariffs and then you add in the freight to come in, we're at those levels of that balance. They're again out of balance where the price was well above that. I think the concern for people to import was, obviously, the instability that's starting to stabilize now. So we're seeing pricing actually move now with input costs, be it scrap or demand, which is more normal for our industry. So I think we'll move forward from that, and we'll stay at a more normalized level. So you've seen coil seems to be balancing out now at an appropriate price level. Plate still a little heavier than the world market, but demand is very, very strong in North America. So we think we may see plate drift a little bit in pricing. But again, overall, we think that's the strongest product in the market right now. So going forward, I don't think we'll see this much volatility, barring if there's any significant trade changes that are just unforeseen.

[Frederic Bastien, Senior Vice President]

Okay. Working capital wise, I guess, with demand stable -- at least your outlook for demand to be stable and pricing softening somewhat from what you've experienced in 2018. How should we think about working capital? Are we done now with the investments and we should expect working capital start throwing off some cash?

[Marion E. Britton, Executive VP, CFO & Secretary]

Yes, so in the first quarter, we will use cash because of AR always goes back up. We had less revenue at the end of the year and then we have to pay bonuses and income taxes from last year, which -- but as we go through the year, we believe that it should be relatively flat unless big changes in prices.

[Operator]

Your next question is from Anoop Prihar from GMP.

[Anoop Prihar, MD & Special Situations Analyst]

I'm just curious to ask you, John, over the course of 2018, which of your products experienced the most price distortion if you can attribute it only to the impact of the tariffs?

[John Gregory Reid, CEO, President & Director]

Probably the coil, and closely followed by plate.

[Anoop Prihar, MD & Special Situations Analyst]

And I'm assuming those were both positive variances?

[John Gregory Reid, CEO, President & Director]

They were, yes.

[Anoop Prihar, MD & Special Situations Analyst]

Was there any product that was negatively impacted by any of this activity?

[John Gregory Reid, CEO, President & Director]

Nothing that was significantly impacted. There was a little bit of high product in Canada only, just it was a timing issue, but that cleaned up pretty quickly. It was about a 60-day window.

[Anoop Prihar, MD & Special Situations Analyst]

I guess, if you look at the price of the stock relative to your financial performance, I mean, the market is obviously a bit confused over all the noise surrounding the tariffs. Is there any way we can peg what the EBITDA impact was last year as a consequence of -- I guess, it's a positive tailwind from all of this?

[John Gregory Reid, CEO, President & Director]

Your guess is as good as mine. It'd be very difficult to pin that down.

[Anoop Prihar, MD & Special Situations Analyst]

Yes, that's what I figured. But it's definitely a tailwind, right?

[John Gregory Reid, CEO, President & Director]

It was, yes. It definitely -- it lifted pricing. And again, as we've always said, at our price we do better.

[Marion E. Britton, Executive VP, CFO & Secretary]

Yes, so selling price we anticipate not to drop off as much. But in the year, we did get some of the lift in price, which drove the higher gross margins, particularly in service centers and steel distributors in the sort of first half to maybe Q3 in service centers.

[Anoop Prihar, MD & Special Situations Analyst]

Okay. And then just secondly, Marion, in terms of Q4, the gross margin in steel distribution dropped down a little bit. Is there some definitive reason we can attribute to that or is that just general business activity?

[Marion E. Britton, Executive VP, CFO & Secretary]

So the volumes that we bring in presold never carry as high margin as when we take a inventory risk on them, and more percentage was driven by both our Canadian operations and our U.S. operations and both tend to presell more so than the group as a total, so that drove it down a bit.

[Operator]

There are no further questions at this time. You may proceed.

[Marion E. Britton, Executive VP, CFO & Secretary]

Okay. Thanks, everybody, for attending. We'll talk to you in the next quarter.

[Operator]

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