Stelco Holdings Inc

TSX:STLC

Earnings Call Transcript 2018-Q1

[Operator]

Good day, and everyone come to the Stelco Holdings First Quarter 2018 Earnings Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Don Newman. Please go ahead, sir.

[Donald P. Newman, Chief Financial Officer]

Good morning, everyone, and welcome to Stelco's first quarter 2018 earnings call. Joining me on the call today is Alan Kestenbaum, our Executive Chairman and Chief Executive Officer. Yesterday, after the close, we issued a press release over being Stelco's financial results for the first quarter of 2018. This press release, along with the company's financial statements and management's discussion and analysis, have been posted on SEDAR and on our Investor Relations website at stelco.com/investors. We have provided a link to the presentation referenced on today's call on our website as well. I'd like to inform everyone that comments made on today's call may contain forward-looking statements, which involves assumptions, which have inherent risks and uncertainties. Actual results may differ materially from statements made today. We do not place undue reliance on them. Stelco management disclaims any obligation to update forward-looking statements, except as required by law. With that in mind, I would ask everyone on today's call should read the legal disclaimers on Page 2 of the accompanying earnings presentation and also to refer to the risks and assumptions outlined in Stelco's public disclosures, in particular, the first quarter Management's Discussion and Analysis section relating to forward-looking information and risks and uncertainties as well as filings with securities commissions in Canada. The appendix of our presentation and the non-IFRS performance measures and review of non-IFRS measures of our first quarter MD&A provide definitions and reconciliations of non-IFRS measurements that we use today. Please also note that all dollar figures referred to in today's call will be in Canadian dollars unless otherwise noted. Following our prepared marks, Alan and I will take questions. To maximum efficiency, we ask that all participants would ask just one question followed by one follow-up question before requeuing. With that, I'd like to turn the call over to Alan.

[Alan Kestenbaum, Executive Chairman & CEO]

Thank you, Don, good morning, everyone. Our solid first quarter financial results demonstrates the progress we have made in a short period of time as we focus on driving efficiency and volume increases. The momentum noted during last quarter's conference call has accelerated into the first quarter and continues to accelerate. This didn't happen by itself. This has resulted from the execution of the initiatives we have put in place to drive further improvements, including expanded production capabilities, increased output and volume and expanding our logistics options and lowering our costs. As expected, you are seeing the initial benefits of these efforts in the first quarter, as noted by our strong financial results coming in at the high end of the guidance we published on March 28, 2018. If you turn to Slide 4, you can see the first quarter revenue increased 25% year-over-year to $482 million as our shipments improved 23% year-over-year to a record of 613,000 net tons and as we benefited from higher steel prices versus last year. Average selling price per ton was $786, which equates, by the way, to USD 610 per net ton in the quarter net of customer discounts and rebates compared to $764 in the fourth quarter and $774 in the first quarter of last year. As a reminder, our average selling price includes sales of higher-value products, not just hot-rolled coil. Stelco Inc. adjusted EBITDA was $70 million in the first quarter, representing an industry-leading 15% adjusted EBITDA margin. On a sequential basis, from the fourth quarter of 2017, revenue increased 7%, our shipments were up 4%, our average selling price was up 3% and adjusted EBITDA was $1 million higher compared to the prior period. While these results are encouraging and validate our operational progress since taking over Stelco last July, we believe it is just the beginning. Given the excellent and continuing-to-improve business environment, our lead times are 8 to 10 weeks between making a sale and shipment. We expect to realize most of the orders booked in Q1 in our Q2 revenue, which is reflected in our Q2 earnings guidance. But those Q1 booked sales are still below current market prices. Consider this, our average sales price of $786 per ton, which includes higher value-added products, such as cold-rolled and coated, are still $315 below the current spot prices for just hot-rolled coil produced shipment, which is approximately CAD 1,100 odd based upon public -- published indices. And the substantial portion of our sales are based upon spot prices, albeit with a time lag. You can see the opportunity Stelco has to generate substantially stronger profit and create value for our shareholders going forward. In addition, shipping constraint caused by the well-reported trucking shortage impacted our costs and volumes as it did our competitors in Q1. Nevertheless, we grew shipping volumes to an annual run rate of 2.5 million net tons in the first quarter from 2017 shipments of 2 million tons. But we could have shipped more in the first quarter with optimal shipping capabilities. However, as distinguished from many of our competitors, since Q1, we have solved this issue by significantly diversifying our shipping options, while lowering costs by firstly, leasing more than 300 rail cars that significantly increased our rail shipping capabilities; and secondly, to begin to ship barges from our own stock at Lake Erie Works, which has opened for outbound shipment. That means, the new Stelco can now ship by truck, rail, barge and ship to destinations around the globe. On the sales front, we continue to make progress on penetrating the auto industry through multiple channels as well as direct to OEM, and we are investing in our facilities to meet ever-critical end-user requirements. This is in the context of our overall and differentiated strategy of tactical flexibility in terms of sales and production to maximize economic return on our assets. As a result of that, and for additional margins on cold-rolled and coated products due to aggressively priced imports, we continue to sell more hot-rolled coil than value-added products at this time, but we are positioned to quickly change that as market conditions change. In response to investor demands for increased liquidity in our stock, Bedrock Industries completed a secondary offering of 10 million shares. This appears to have achieved the desired result as average trading volumes in our stock have roughly tripled since the closing of the secondary. We followed this with a successful series of investor meetings, where we received significant new investor interest. And we'll continue to do this investor outreach in the coming weeks as well participating in conferences and non-deal road shows. Our strategic priorities remain, first, to optimize production from our assets, grow our sales, expand our margins and maintain a strong balance sheet. In combination, we continue to believe that these initiatives can meaninglessly draw -- meaningfully draw shareholder returns, while maintaining services and manageable capital structure. Second, we plan to use our strong balance sheet and experienced management team to execute attractive, timely and accretive M&A growth opportunities. Moreover, as part of our interest in driving total shareholder return, we have approved at yesterday's board meeting maintaining our dividend of $0.10 per share payable to shareholders of record as of May 15, 2018, and to be paid on May 18, 2018. Additionally, our largest shareholder, Bedrock Industries, acquired carry interest in favor of Stelco's legacy pension plan in respect of Bedrock shares for an amount of $142 million due to its confidence in the continuation of the shareholder distributions and growth in value. With respect to Section 232, earlier this week, the White House issued a proclamation extending the exemption from steel tariffs to Canada and other countries, including Mexico and the European Union for 30 days, while discussions continue to secure a long-term agreement on this matter. We continue to see strong steel demand in our primary market and view this as a tremendous opportunity for the North American steel industry. With China cutting back on steel production, demand for the raw materials used to make steel at an integrated mill, such as ours, prices are likely to continue to decrease over these raw materials over time. At the same time, the price of scrap [indiscernible] which we use in limited amounts [ in ] increased quantity; and electrodes, which we do not use at all, are rising significantly, which have further caused cost increases for many of our competitors. We believe Stelco is one of the lowest-cost producers in North America and we are forced to benefit from both our distinct competitive advantages as well as strong demand environment. With that, I'll turn the call over to Don to discuss our financial results in retail. Don?

[Donald P. Newman, Chief Financial Officer]

Thank you, Alan. Since the details of our quarterly financial performance were touched on by Alan, are included in the earnings press release and could be found in the earnings presentation that is accompanying this call on Slides 5 and 6, I'd like to keep my comments at a high level. We experienced robust growth in revenue in the quarter, both year-over-year and sequentially due to volume increases and to improve pricing. We're also impacted by several cost categories, which offset some of the revenue increases. As you'll see, a number of those cost impacts were isolated to Q1. During the first quarter, purchased scrap costs increased significantly, adding approximately $6 million in cost to our operations compared to the fourth quarter of 2017. The increases in scrap market prices are one of the reasons the market prices for hot-rolled coil are trending higher. That said, due to the lag that we have in our business, we experienced expenses related to increase in scrap costs before we can capitalize on the higher HRC prices. In addition, winter weather conditions impacted our operations and expenses. During the first quarter, an early freeze on the Great Lakes and severe cold weather resulted in incremental fuel and electricity costs of approximately $6 million and $2 million in incremental raw material shipping costs.I'd note that we executed a number of strategic outages during the quarter, including at our hot strip mill. The outages were intended to improve reliability and efficiency and were in preparation for hot strip mill enhancements planned later in 2018 and in 2019. The outages resulted in an incremental R&M cost of approximately $6 million in the quarter. As Alan noted, during the first quarter, we felt the impact of the well-publicized and widespread shortage of trucking assets across the U.S. and Canada. That caused a sharp increase in trucking costs throughout North America. According to the American Metal Market, average U.S. trucking spot market rates for the last week of the first quarter were up over 25% from the same time in the previous year. According to Bloomberg, U.S. spot rates were up 28% through March 23 compared to a year earlier. This phenomenon negatively impacted our costs in the first quarter by -- between $4 million and $5 million compared to the fourth quarter and the first quarter of 2017. As discussed on Slide 7, we believe our investment in new rail cars and the enhancements to our Lake Erie dock position us much better with respect to shipping volumes in the second quarter. Year-to-date, we have added approximately 220 rail cars to our fleet, some of which were in service by the end of the first quarter and most of which will be in service by the end of May, which is benefiting our second quarter shipping volumes. We'll be adding an additional 150 (sic) [ 160 ] rail cars in the balance of the year. In addition, trucking market conditions validate the investments we've made to expand our shipping and logistics capabilities and international reach by enhancing our dock at Lake Erie Works. We reached a meaningful operational milestone when we began to ship products by March -- in March using a third-party dock, and we're now shipping from our own dock. The combination of these 2 factors has increased our ability to ship products by hundreds of thousands of tons per year, and we no longer rely so heavily on trucking to facilitate shipments to our customers. The noted investments in shipping efficiencies should further benefit our profitability, enabling us to leverage the higher volumes and price improvement.Now let's move to Slide 8 and talk about our balance sheet and liquidity. Looking at the balance sheet at the end of the first quarter, we had $499 million of total liquidity for the consolidated group, including $226 million in cash at Stelco Holdings and Stelco Inc. and $273 million of undrawn capacity under our ABL revolver facility. Furthermore, we had no long-term debt. Stelco Inc. carried trade and other receivables of $214 million at March 31, compared to $203 million at the end of 2017. Our inventories stood at $370 million at March 31 compared to $448 million at the end of 2017. And our trade and other payables stood at $205 million at March 31, compared to $310 million at the end of 2017, and includes $33 million related to our inventory monetization arrangement, which was reduced by $90 million through repayments during the quarter. Now turning to Slide 9. We are reaffirming our second quarter earnings estimates today. We expect to see a step-up in profitability in Q2 due to the impact of higher-priced sales that were booked in Q1 and to improve shipping capabilities. As a result, we expect adjusted EBITDA of between $120 million and $150 million in the second quarter, a significant improvement to the $76 million reported in the second quarter of last year.Before I turn the call back over to the operator for Q&A, I'd like to mention that Alan and I will be participating at the Oppenheimer 13th Annual Industrial Growth Conference in New York on May 8 and are scheduling meetings with attending investors. We're also participating at the Deutsche Bank ninth Annual Global Industrials and Materials Summit in Chicago on June 5. I'd now like to turn the call over to the operator for Q&A. Operator?

[Operator]

[Operator Instructions] And we'll take our first question from Matthew Korn with Goldman Sachs.

[Matthew James Korn, Senior Metals and Mining Analyst]

So first the simple one, if I could. You mentioned the logistical -- the additional logistical ability that you're adding, the mill enhancements. What should all this mean as we think about your shipment mix as we go into the end of this year and into next year? Should we see much more of a shift into coated, into cold-rolled? Should the percentages look a little bit more like we saw a year ago versus what we're seeing today?

[Alan Kestenbaum, Executive Chairman & CEO]

So we, Matt, the way we run our business is through a strategy, which is differentiated. You don't hear it discussed that much in the steel industry, and we call it tactical flexibility. Tactical flexibility means that we have the ability to sell and service every market, cold-rolled, hot-rolled, coated products, the most sophisticated auto products. And in fact, we're making huge strides in penetrating those markets and reacquiring customers in those areas. However, we run our business to maximize cash flow and profits and, therefore, while we're positioned to be in any of those markets, our strategy is to maximize profitability. And if the profitability is in one product or the other, we will pursue that by area and really focus our sales strategy on that. As I mentioned in my comments, due to import competition in Canada on cold-rolled and coated, at the moment, there's more opportunity and more profit to be made on more hot-rolled. However, if we -- if conditions change and profitability increases in those other areas, we quickly shift and service the higher-end markets, which we're fully capable to make. And we continue to invest in upgrading the assets in anticipation of those markets improving and servicing those markets very, very aggressively.

[Matthew James Korn, Senior Metals and Mining Analyst]

Got it. So it's more of a matter of you let the available margin dictate your mix as opposed to pursuing a particular value-add mix.

[Alan Kestenbaum, Executive Chairman & CEO]

That's correct.

[Matthew James Korn, Senior Metals and Mining Analyst]

Got it. Then let me follow-up with this: You mentioned a little bit on potential risk, maybe some of the trade barriers and the opportunities maybe to develop next-best markets if that was required. What exactly and where would those markets be? And would that change if there became a speed bump to trade. If certain markets became harder to penetrate, would that change any of your planned investment, which you have scheduled today?

[Alan Kestenbaum, Executive Chairman & CEO]

So that's a great part of Stelco. First of all, 80% of our sales are in Canada right now as a domestic producer. But because of the transportation, logistics benefits that we have now completed and we're now able to use, we service every market. And again, just like I answered your prior question, how we allocate our tonnage, we allocate our tonnage to where we can get the highest price and the best margins. At the moment, we're doing that in Canada. We're positioned to enter shipments to the United States. We're positioned to ship to Europe. We can ship into Asia. We can ship into South America, Mexico, anywhere. And that's how we're positioning the business. The same answer to the question you asked me about product mix. We service the market. We have an incredible versatility on our logistics. And because of those logistics, we'll service the market to drive the highest profits.

[Operator]

And we'll take our next question from Ian Zaffino with Oppenheimer.

[Mark Zhang, Associate]

This is Mark signing on for Ian. I just had a quick -- couple of quick ones. In regards to ASP, it improved during the quarter. But obviously, adjusted EBITDA per net ton actually declined. Is this, I guess, mainly related to the elevated transportation costs in the quarter? Are there any other factors we should take into consideration impacting results?

[Alan Kestenbaum, Executive Chairman & CEO]

Yes, what you want to consider is, we've kind of laid out in the MD&A a number of things that impacted that, that dropped through in the quarter. One, as you pointed out, was the incremental transportation cost of $4 million to $5 million. We also had the strategic outages that we took during the quarter, hot strip mill being the primary. That was about $6 million of incremental R&M. And we also had the impact of weather.

[Mark Zhang, Associate]

Okay. Got you. And I guess, in regards to your new shipments capabilities, is there any details you could share on how much incremental EBITDA per ton that could yield or generate going forward?

[Alan Kestenbaum, Executive Chairman & CEO]

Look, generally, several months ago, we put out a number that we expect on average. Of course, our full volumes have stayed about $10 a ton on shipping costs. But a lot of this is going to depend on -- again, the prior question that was posed to me is, where are we going to make these shipments to? We always look at things in terms of maximizing EBITDA. And assuming market stays the same, across the board, we expected an average of $10 per ton savings, but that could change. For example, if we have higher markets elsewhere and the freight costs are higher, you might see a higher freight cost well offset by better sales prices.

[Operator]

And we'll take our next question from David Gagliano with BMO Capital Markets.

[David Francis Gagliano, Co]

A lot of ways we can go with this call, obviously. I wanted to focus in on just on pricing. Completely understand the lag in the first quarter. Just looking forward, if we dreamed the dream for a second, and we assume that prices actually stay relatively stable over the next 2 to 3 quarters, is there any reason that we should not see Stelco's realized price hit that $1,100 per ton mark that you mentioned just on hot-rolled a few minutes ago?

[Alan Kestenbaum, Executive Chairman & CEO]

We don't have to dream the dream. Those are the prices today in the market. And we realize the prices are -- not only are we realizing prices, our discounts to CRU, which when this company first about a year ago, had to go to fight for market share, our discounts to CRU are decreasing. So no, those prices that are out there today are not a dream. Those are happening now as we book new orders.

[David Francis Gagliano, Co]

Okay. Perfect. Very helpful. And then just my follow-up, 2-part follow-up. Operational questions. Just merchant slab business, first of all, how much did you purchase in 1Q? What was the EBITDA? -- Or how much did you process, I should say, in 1Q? What was the EBITDA contribution from the merchant slab side? And what's a reasonable assumption for merchant slab volumes in 2018? And then also same idea with the excess coke, EBITDA for the first quarter. And how should we be thinking about that for the full year?

[Alan Kestenbaum, Executive Chairman & CEO]

Well, let me address the coke question first. So we're low on coke, and this is one of the things that we've done. We have gone and found assets within our company where we have extra ability to make additional profits. So unlike the way other people manage their businesses, where they just produce enough raw materials to satisfy their business, we look at it as separate profit center. So we anticipate that we're going to sell this year approximately 250,000 tons of coke and the margins are excellent. I don't think we've given the EBITDA guidance on that, but they're quite substantial and at margins that are higher than our overall EBITDA margin reported in our numbers. So the business is quite attractive right now, and we'll continue to do that. Look, on the slab question, we're looking at bigger picture here right now, and we are big advocates of NAFTA. And we're strong believers that NAFTA could be a great market. And as the importation of slabs from outside of NAFTA into the NAFTA market does not suit our long-term interest and, therefore, the answer to your question is the import is 0 slabs and that 0 EBITDA resulted from imported slabs because we are not importing slabs right now. If we can access slabs within NAFTA, that will change.

[Operator]

And we'll take our next question from Curt Woodworth with Crédit Suisse.

[Curtis Rogers Woodworth, Director & Senior Analyst]

Alan, how are you thinking about sort of the buy-versus-build decision to solve for you excess rolling capacity? So clearly, I guess by build, I mean through reinvestment spend at Hamilton. Spot price and the payback on a restart would be, I don't know, 3 to 4 months, maybe less. So can you talk us -- walk us through what you would need to see to restart that facility? And how are you sort of weighing that against the opportunity set on an M&A basis right now?

[Alan Kestenbaum, Executive Chairman & CEO]

So we always evaluate buy versus build, but I don't consider Hamilton build. Hamilton exists, and it's a restart.

[Curtis Rogers Woodworth, Director & Senior Analyst]

I said [indiscernible]

[Alan Kestenbaum, Executive Chairman & CEO]

And it's -- pardon me?

[Curtis Rogers Woodworth, Director & Senior Analyst]

Well, I said reinvestment.

[Alan Kestenbaum, Executive Chairman & CEO]

Oh, reinvest. Yes, so we do classic reinvestment decisions. Typically, we look for paybacks that are below 3 years with 25% to 30% ROI. That's our standard for all of our growth CapEx initiatives. And so the math around greenfields are out of the question. They don't work. They haven't worked. So to your question, we evaluate expansion opportunities -- restart opportunities on the ROI metrics that I mentioned. And M&A is evaluated pretty much the same. We look at M&A opportunities, like I have done throughout my career, which is to buy below our multiples and to do transactions that are immediately accretive. And then on top of that, look to draw in synergies. We are seeing, because of our balance sheet, and we're unique because of our balance should, we're seeing an exceptional amount of deal flow and concentrating right now on a couple of opportunities that look very interesting to us. And we'll see where that goes. We're always evaluating opportunities. The pipeline is very full with organic opportunities and also some of the inorganic ones. But we're very patient, and we've a track record of building huge shareholder value on that basis. And we've got no specific announcements to make at this time, but we're extremely focused and busy in this area.

[Donald P. Newman, Chief Financial Officer]

And Curt, just tie it back to our balance sheet strategy. We maintain a healthy level of liquidity, so we can take advantage of the opportunities when they're there. And fortunately, we have a lot of opportunities.

[Curtis Rogers Woodworth, Director & Senior Analyst]

Okay. And then, I guess, just on 2Q. Can you give us a sense for what the volumes you're assuming in your guidance look like? And are you -- do think you'll have the ability to source more slab to get more of a higher exit rate relative to your Lake Erie capacity at some point this year?

[Alan Kestenbaum, Executive Chairman & CEO]

Look, we're going to ship more this quarter because we've opened up the shipping lane. The reason why we didn't ship more in the first quarter was not because of business. It was because of the shipping lanes. We only had trucks. Now we have trucks, rail, barge, ship. We're accessing all that now. We're going to ship more. And the guidance that we've provided, we're very comfortable with. With respect to slabs, if we can source slabs within NAFTA, we will -- we have capacity on the hot mill, and we have the ability to probably drive another additional volumes out of that. But at the moment, we have no announcement to make about sourcing slabs within NAFTA. We will not source slabs out of NAFTA. We're opposed to it. We think that strategically long term, it's not in the interest of the North American steel industry, and we're trying to be industry leaders by driving that velocity.

[Operator]

At this time, I'd like to turn the call back over to Mr. Alan Kestenbaum for any additional or closing remarks.

[Alan Kestenbaum, Executive Chairman & CEO]

So in summary, I'm encouraged by the results we're reporting today. We are on the right path, and the wind is at our back. Stelco remains ideally positioned in a growing industry with one of the newest and among the most technologically advanced integrated steelmaking facilities in North America that has significant organic growth opportunities contained within it. Moreover, I believe the full benefits of the initiatives completed and those underway will benefit us as we go forward creating another step-up in our performance. But we aren't stopping there. We are a growth company, and we are considering all initiatives in pursuit of shareholder growth. Thank you very much for joining us on this call today, and have a nice day.

[Operator]

And that concludes today's presentation. Thank you for your participation. You may now disconnect.