Stelco Holdings Inc

TSX:STLC

Earnings Call Transcript 2019-Q1

[Operator]

Good morning. My name is Britney, and I'll be your conference operator today. At this time, I would like to welcome everyone to the conference call regarding Stelco's first quarter results for 2019. [Operator Instructions] Thank you. Mr. Newman, you may begin your conference.

[Donald P. Newman, Chief Financial Officer]

Good morning, everyone, and welcome to Stelco's First Quarter 2019 Earnings Conference Call. Joining me on the call today is David Cheney, our Chief Executive Officer. Yesterday, after the close, we issued a press release overviewing Stelco's financial results for the first quarter of 2019. 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. Please note that we have streamlined financial reporting starting in Q1 by eliminating voluntary public financial reporting for our operating company, Stelco Inc. After the IPO in late 2017 and throughout 2018, Stelco Holdings Inc. did not have full prior period comparative information because it did not exist as a legal entity until September of 2017. As a result, we voluntarily filed financial statements and MD&A for our operating company, Stelco Inc., which did not have prior period of comparative information -- which did rather have prior period comparative information. Now that Stelco Holdings Inc. has prior period comparative balances for all of 2018, we have discontinued the voluntary filing of Stelco Inc. disclosures. I'd like to inform everyone that comments made on today's call may contain forward-looking statements, which involve assumptions, which have inherent risks and uncertainties. Actual results may differ materially from statements made today, so do not place undue reliance on them. Stelco management disclaims any obligations to update forward-looking statements, except as required by law. With that in mind, I'd like everyone on today's call to 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 sections related to forward-looking information and risks and uncertainties as well as our 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 the non-IFRS measures that we'll 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 remarks, David and I will take questions. [Operator Instructions] With that, I'd now like to turn the call over to David.

[David Cheney, Chief Executive Officer]

Thank you, Don, and good morning, everyone. We continue to demonstrate the benefits of our tactical flexibility business model in the first quarter of 2019 by delivering year-over-year improvements in revenue, continued strong adjusted EBITDA and adjusted EBITDA per ton and meeting tariff-adjusted EBITDA margins. As we look forward, demand and pricing from our -- most of our key customers and end markets remain stable, and we are utilizing our logistics infrastructure to continue to expand our market footprint. Stelco's priority is to maximize the long-term returns for our shareholders. Underpinning this focus are 5 key priorities: expand and serve our customer base, optimize our assets, maximize profitability and cash flow, maintain a strong balance sheet and grow the business. These priorities drive our decision-making process, and I am pleased to report progress across all of these initiatives. First, expanding and serving our customers. Our customers are a vital foundation of our business. As part of taking on the CEO role, I have had privilege of meeting with many of our customers. The theme of these conversations have been consistent and encouraging. Our customers are optimistic about their businesses, their potential to grow, and they are very pleased with Stelco products. The one consistent request, they want to buy more products from Stelco, that is absolutely music to my ears. We want to partner with our customers, grow with them and offer products that are in high demand. Our recent investments in advanced high strength steel, High Strength Low Alloy Steel, cold-rolled and other value-added products are all part of expanding our product offerings for existing and potential new customers. We are confident these investments will deliver strong returns. One specific example. We are now in the final stages of the installation of our batch annealing furnaces and upgrade of our temper mill, a $35 million project announced in Q4 2017. This will allow Stelco to annually produce 200,000 tons of high value cold-rolled fully processed steel. We are targeting to start production from these annealing operations in June, and we already have our first orders in hand. Consistent with our goal to increase production revenue through optimization of our assets, we shipped 612,000 tons of steel in the past quarter, which is consistent with shipments a year ago. Meanwhile, a number of our peers have announced year-over-year declines in shipping levels. Additionally, we are making final preparations for the rejuvenation and upgrade of our coke batteries at Lake Erie. At Stelco, we don't invest in our assets to simply restore to prior operating levels, we invest to implement best-in-class technology with the goal of achieving better efficiency and improved productivity. With that in mind, we anticipate we will potentially increase coke production levels by as much as 100,000 tons annually from the 2018 production levels. As a reminder, we generated $53 million in non-steel gross profits in 2018, largely from the sale of coke and coke-related products. The increased production will result in increased coke available-for-sale or potentially for internal use should our organic or inorganic growth create that need. The upgrades are scheduled to begin in the second half of 2019 and will be completed in mid-2020. In regard to maximizing profitability, we continue to manage under our tactical flexibility business model with a clear focus on maximizing profitability and cash flow. We believe our tariff-adjusted EBITDA margins of 15% are among the highest in the North American steel industry. As a reminder, we're the only reporting company that faces a headwind with these tariffs. We reduced tariffs from $23 million in Q4 to $13 million in Q1, a decrease of 43%. Part of this has been the previously announced transition away from U.S. -- from the U.S. hot-rolled market and more towards domestic shipments, including diversification into more value-added products, such as galvanized steel and, soon, fully processed cold-rolled steel. We are just in the stages of this transition, but are running fast to capture new customers and new markets in these value-added products. Importantly, we have increased our sales into the auto sector and are now directly serving OEMs and Tier 1 producers. This is good news. But the better news is that we have a lot more accounts we are working with to get qualified, and we intend to capture an additional market share, or, frankly, I should say, recapture the market share that Stelco previously had more than 7 years ago in this highly valuable sector.Our focus on the auto sector is a very well timed and not by accident. Two days ago, Toyota announced a commitment to invest in the Canadian auto sector. For the first time ever, the extremely popular Lexus NX and NX Hybrid-SPORT utility vehicles would be produced outside of Japan. It is no surprise to us that Toyota chose Cambridge, Ontario, which is very close to our operations, as the first location for this production. Simply put, Canada is and will continue to be the preferred destination for industrial manufacturing. We have a growing list of profit-enhancing opportunities. At Lake Erie, we have progressed on a number of projects that will improve our cost structure and overall efficiency. I have already mentioned the coke battery work. Not only will it increase production, but it will reduce costs. In addition, in the very near future, we expect to make a final decision on the selection of a partner for our co-generation power plant to support the Lake Erie facility. As a reminder, we believe this project should reduce our energy costs by approximately $20 million per annum and require minimal investment for us. Now to the land. I am extremely pleased to announce that we are now generating returns from the surplus land at our facilities. Recently, we signed a long-term lease with a new tenant for a currently unused industrial building at our Hamilton site. The average annual lease rate is in excess of $10 per square foot. Folks, we told you this was coming. Demand for industrial land in the GTHA, Greater Toronto and Hamilton Area, is very strong. This lease, together with ongoing discussions with additional tenants, is further validation of the very strong demand that exists. We have a full team in place to accelerate the development of the land, and we will continue with our efforts to entitle the lands, unlock the value and, in turn, create significant value for the shareholders. Expect to hear more from me on this topic very soon.We see technology as a potential source of competitive advantage for Stelco, and we are introducing the latest technologies, such as artificial intelligence, data analytics and digitization, into the business to measure and improve profitability as well as customer accessibility. We'll share more about the benefits of these technologies and our strategic use of them in the future. I'd like to pause for a moment and move away for the numbers and details. Like our customers, our employees are a critical foundation for our business. We have a young vibrant workforce as well as a base of richly-experienced employees capable of mentoring our newer employees in the art of making the best steel in the world. Our investment in technology gives our employees the tools to compete and win in this rapidly changing and highly competitive environment. It is the investment in technology as well as the overall transformation of the company that has, once again, made Stelco the manufacturing employer of choice in Ontario. To me, this is one of the most rewarding parts of the Stelco turnaround.All of our initiatives have one objective in mind, maximize shareholder returns, including the return of capital. From March of last year through March of this year, we paid $295 million or $3.32 per share in dividends, including $250 million in special dividends. Further, our Board has approved payment of another regular dividend of $0.10 per share, which we paid at the end of May. Even with the substantial return of capital to our shareholders and roughly $145 million invested in CapEx since the beginning of 2018, we ended the March 2019 quarter with $577 million of liquidity and no financial debt. Many of the things I've already discussed contribute to growing the business organically and driving more profits and cash flow to the bottom line. While we are rich in organic opportunities, we also see significant opportunities to grow inorganically. This management team has an excellent track record of executing successful and accretive M&A. We have constructed the business to support growth, starting with the pillars of a strong balance sheet and liquidity. Our Executive Chairman, Alan Kestenbaum, is actively leading efforts to evaluate a number of strategic and accretive M&A opportunities that have started to emerge. Overall, we are optimistic for the future, and Stelco is extremely well positioned to deliver attractive organic and inorganic growth. This sets us up for what will be a solid 2019. With world steel demand expected to remain strong and rising raw material prices, we see the potential for steel prices to improve. We continue to diversify our product mix into higher value-added products. We continue to focus on cost reductions. With our tactical flexibility business model, the improvements we've made in production and the diversification in customer base and product mix, the future is very bright for Stelco. With that, I'll hand the call over to Don to talk more about financial results.

[Donald P. Newman, Chief Financial Officer]

Thanks, David. Revenue in Q1 totaled $517 million, adjusted EBITDA was $63 million, tariff-adjusted EBITDA was $76 million and tariff-adjusted EBITDA margin was 15%. Our Q1 revenue of $517 million reflects an average selling price of $827 per ton, 612,000 tons of steel shipments and $11 million of non-steel sales. Revenue increased 7% from $482 million in Q1 of 2018, as average selling prices increased $65 per ton from $762 per ton to $827 per ton, while shipping tons remained consistent year-over-year. From an EBITDA standpoint, we performed in line with market expectations. Adjusted EBITDA for the quarter totaled $63 million, and tariff-adjusted EBITDA was $76 million. As noted, we significantly reduced tariff-related costs sequentially from $23 million in Q4 2018 to $13 million in Q1 2019, a $10 million or 43% reduction. Of course, in Q1 2018, tariffs were not in effect. So to measure the underlying performance year-over-year, it's important to compare tariff-adjusted EBITDA. Tariff-adjusted EBITDA increased from $69 million in Q1 2018 to $76 million in Q1 2019, an increase of $7 million or approximately 10%. We ended the March quarter with $577 million of liquidity, including $285 million of cash and $292 million of borrowing capacity under our $375 million ABL revolver. The ending cash balance reflects payments of $109 million of dividends in the quarter as well as investing $44 million in CapEx, including strategic investments such as our new annealing furnaces, pre-spend for the coke battery work and advanced and high-strength steel capabilities. We've also continued to maintain a debt-free position, giving us maximum flexibility to strategically grow our business, and ended the March quarter with significant tax shields, including NOLs, capital cost deductions and shred credits. In total, we can shield $809 million of pretax income from taxation, the equivalent of $203 million of tax liabilities. Of course, timing of utilization of the shields will be dependent upon our profitability and deduction rules. Those tax shields, I would remind you, remain 100% reserved on our balance sheet.That concludes our prepared remarks. Now I'd like to turn the call back over to the operator for Q&A. Operator?

[Operator]

[Operator Instructions] And your first question comes from Curt Woodworth from Crédit Suisse.

[Curtis Rogers Woodworth, Director & Senior Analyst]

David, just first question on, I guess, how you're thinking about strategic options with respect to Hamilton. Clearly, a lot of people are worried in the U.S. regarding all the mini mill capacity coming online. So I just wanted to see sort of what -- if you had any updated thoughts on Hamilton. I saw that there was -- the union put out a press release regarding a deal to potentially restart the pellet plant at Pointe-Noire. So that's my first question. And then, I guess, with respect to Hamilton, would there be any optionality around that plant to potentially make a merchant pig iron product? Or is your thinking you would want to leverage ultimately the full rolling mill capacity there?

[David Cheney, Chief Executive Officer]

So Curt, that's a great question. Okay, I think the first point is, Stelco is incredibly asset-rich. You identified the blast furnace at Hamilton, but the reality is we have a number of other assets within Stelco that all have the ability to provide either additional products, either production-wise or on the downstream side. So we evaluate maximizing utilization of all the assets. We have the ability to potentially launch the blast furnace in Hamilton. You're absolutely correct. It could be used to make slabs. It could be to make merchant pig iron, and we're evaluating all of those options. And at the appropriate time, we'll make some further comments.

[Curtis Rogers Woodworth, Director & Senior Analyst]

Okay. And then, I guess, with respect to the second quarter, can you give us some more specific guidance around volume levels, mix? I think one of the issues we struggle with a little bit is that, sometimes, there can be a disconnect between the hot-rolled selling price up in Canada relative to what the U.S. indices are publishing. So sometimes, there's variance there. So can you just comment a little bit on -- I guess, clearly, directionally, the ASP will be lower, but if you can give any magnitude of color on how you see, too.

[David Cheney, Chief Executive Officer]

Yes. I'd be disappointed if you didn't ask the question. So let's start with the focus for the company, which is maximize utilization of the assets. We have the ability to produce and sell between 2.5 million and 2.6 million tons of steel. That range is predicated on what is the mix. As you know, the more value-added products have a lower yield and, therefore, a slightly lower production level. So if you start that as a base, and that's what we shipped last year, we're targeting to ship that again this year. In terms of the mix, I think you're going to see, starting in Q2, a mix more in line with what we delivered in 2018. And then as the batch anneal comes online, you're going to start to see a greater percentage of product coming out of the Hamilton coated facilities. And look, in terms of pricing, we see prices as bottomed in the end of Q1, and recent orders and recent pricings have actually picked up from that trough level. And we're seeing pricing on a quarter-to-quarter basis is relatively flat. Remember, we had some high prices -- relatively high prices rollover from 2018. Prices dropped in the quarter, but have recovered quite nicely. So I would target us to relatively flat pricing on a quarter-to-quarter basis.

[Operator]

Your next question comes from Matthew Korn from Goldman Sachs.

[Matthew James Korn, Senior Metals and Mining Analyst]

So David, you mentioned in the release that in most of the markets that you're in right now, you're seeing fairly stable demand. Where are the end markets right now that are looking a little weaker, that aren't stable? And how much did you estimate that those are down year-over-year? Because we're getting a lot of questions, too, on pricing falling. Demand is -- we're hearing from a lot of the mills that things are stable, and people are trying to square that circle.

[David Cheney, Chief Executive Officer]

Yes, it's a good question. I think what we're seeing is a little bit on the energy side is a little bit on the slightly weaker end. We're -- as you know, it's -- people always like to talk about the weather after Q1. But the fact is, is that it's been a tough winter in Canada, in the Northeast. So the construction market, construction build is a little slower in starting. But the rest of our -- we expect construction to -- that bid to ramp up. And we're starting to see it now, particularly with some of the orders we're seeing for our construction galv business. So those are the 2 areas that are, on a relative basis, a little on the weak side.

[Matthew James Korn, Senior Metals and Mining Analyst]

Got it. And then let me follow up with Curt's question, too, because last -- if you look back in the second quarter last year, you had a great recovery. I think as you flexed a lot of your logistical ability, they were kind of coming into their own versus the first quarter, where you saw some limitations and some bottlenecks. And so are you looking at -- from what you can see so far, you see kind of pricing as kind of flattening out. You're seeing activity pick up. Should we see, in terms of the volume itself, a fairly substantial recovery to 2Q? Or should we keep our expectations fairly limited now?

[David Cheney, Chief Executive Officer]

I would say that there's 2 pieces to that. The first is, last Q2, we had an incremental 100,000 tons of shipment, which really was a result of the inventory from the mini outage we had as well as the logistics bottleneck. So I would take that 100,000 tons as kind of a one-time pop. And then we'll get back into shipment levels that are generally in line with where we're at right now, maybe a little higher, a little lower, but it's, I would say, in that range.

[Operator]

Your next question comes from Piyush Sood from Morgan Stanley.

[Piyush Sood, Research Associate]

I think there were some recent news on the possibility of a rollback for some Canadian safeguard tariffs, especially on products like hot-rolled coil. Could you talk a little bit about that? What's the time line? What are the risks out there? And then what's your position on it currently?

[David Cheney, Chief Executive Officer]

Okay. It's a great question, and I'm really glad you asked. So let's start with just some -- set the baseline and some facts here. The first is that the retaliatory tariffs of 25% against U.S. producers remain in place. The safeguards against non-U.S. sources of hot-rolled coil that are not currently covered by antidumping measures were always meant to be a temporary measure. So keep in mind that there are antidumping measures from China and other countries around hot-rolled coil. So the fact is we're not expecting to see a significant increase in HRC imports. But what's really important in the underlying message from the government is that the government had initiated a process to eliminate most of the tariff exemptions from U.S.-produced steel that Stelco could produce. So we call these remission orders. There were a number of Canadian consumers of steel, particularly high value-added coated automotive steel, that have been exempt from tariffs. And we're expecting those to roll off by the end of June. So that's actually a big upside for us. It's going to enable Stelco to further accelerate the advancements we've already made into the high-end auto markets. So I would say, net-net, when you get to the real details of what the government said, our focus is on getting rid of these exemptions around the coated products. On the HRC side, China, India, Brazil, they already have antidumping measures. So we think we're well protected.

[Piyush Sood, Research Associate]

That's good to know. And could you talk a little bit about the M&A opportunities you mentioned in the prepared remarks in terms of are they more upstream, are they downstream?

[David Cheney, Chief Executive Officer]

Look, we always remain agnostic around whether we focus on upstream or downstream. That's really the key to the tactical flexibility model. What we're really focused on is finding opportunities, up, down and lateral, that are going to return the maximum return to our shareholders. So we look at each situation on its own merit. We are focused on maintaining a clean balance sheet. We're focused on acquiring high-quality assets that have the ability -- that we can drive significant synergies of. You remember when we bought Stelco? The company was producing 2 million tons. We quickly got it up to 2.6 million tons, and that wasn't by accident. So if you think about that as a bit of an example, when we look at M&A opportunities, we want things that are high quality, where we could drive immediate improvements and pay off the purchase price.

[Operator]

Your next question comes from David Gagliano from BMO.

[David Francis Gagliano, Co]

A lot of them have been covered, but I did want to focus on just -- on the comment about pricing being relatively flat quarter-over-quarter basis in the second quarter. When we just look at current U.S. prices, they obviously dropped off quite a bit here recently. When we look at it versus a lag to price for the first quarter, that recent drop-off, this is U.S. only, right? So I just kind of want to get a feel for if you're seeing the same thing. The recent drop-off in pricing has brought spot to down about almost 10% versus what looks like we think flow-through results. So my question, is the comment regarding flattish quarter-over-quarter pricing tied to lags more than anything? Or is pricing different in Canada?

[David Cheney, Chief Executive Officer]

David, it's really different in Canada. What we've seen in our order book is prices hit their bottom in the March time frame. And our recent orders have shown an improvement or restabilization in pricing. So we've seen them come up. So based on where we stand now, again, if you go through the evolution of Q1, we had some higher prices in the beginning of the quarter from -- left over from '18. Prices came down, hit a bottom at the early part of March, and then have started to tick up a little bit. So when we look at the net-net of that, assuming the current environment holds true, we can see prices as flat quarter-over-quarter. Clearly, there's still -- as we sit here, we have 2 months to go. And it can move up or down a little bit, but what we're seeing now is relatively flat.

[David Francis Gagliano, Co]

Okay. And so everything stays the same? 3Q would be the same as 2Q then. That's what you're saying? There's no lags that are going to flow through at a lower price in 3Q either, right?

[David Cheney, Chief Executive Officer]

I don't have a crystal ball into Q3.

[David Francis Gagliano, Co]

Right, okay. And just last or related question is lead times. What are roughly your lead times right now?

[David Cheney, Chief Executive Officer]

Yes, they're roughly about 4 weeks.

[David Francis Gagliano, Co]

Okay, okay. And then just bigger -- slightly bigger picture. Just regarding the reline in 2020, is that -- can you give us just an update on the status and the timing and how that impacts the next few quarters, et cetera?

[David Cheney, Chief Executive Officer]

Yes. Look, I think the reline is still targeted for Q2 of 2020. Look, in keeping with what we've always shared around the Stelco philosophy is not just, again, invest to restore production and capacity. So when we do the reline, we're treating this as a strategic outage, and we expect to come out on the other side of that with more tonnage. That number isn't exact yet, but we think we can come out of that with at least 200,000 tons of incremental production as we implement what we want to do from a technology and a process perspective.

[Donald P. Newman, Chief Financial Officer]

David, I would also add that the blast furnace is running quite well from a day-to-day basis. We maintain our assets quite actively, and the asset is performing well.

[Operator]

Your next question comes from Maxim Sytchev from National Bank Financial.

[Maxim Sytchev, Managing Director and AEC]

Two quick ones for us, please. Can you provide an update on the CapEx number that we should expect for 2019?

[Donald P. Newman, Chief Financial Officer]

I think as you look at what we've talked about in terms of our capital plan for 2019, last year, we spent $101 million around CapEx. And what we've said is that we expect to spend about $40 million in 2019, around our co-covenant rejuvenation and another $40 million on that same project in 2020. So as we look at the annealing project that is coming to nearly to a conclusion here and the co-covenant spend and some other strategics, I think the way to think about our CapEx, it would be higher than what we spent in 2018, largely due to these strategic investments. And we haven't given guidance in terms of what to expect, but I think one way to think about it is to see the pace of investment of 2018 and to potentially add the coke investments as an incremental or something in that range. That would give you some idea.

[Maxim Sytchev, Managing Director and AEC]

Okay, that's helpful. And then on the iron ore side, I mean, obviously, you can't specifically talk about the contract, but should we expect, I guess, normalization of the increase as the time progresses? Or is there still a step function in terms of how we should be thinking about the cost on the iron ore side as the year progresses?

[David Cheney, Chief Executive Officer]

It's -- yes, I'd love to answer that question, but, as you know, we are constrained by a very, very tight confidentiality agreement around the contract. So it's difficult for us to answer questions related to pricing on our iron ore. And we do have several years left on that contract.

[Operator]

There are no further questions at this time. Please proceed, Mr. Cheney.

[David Cheney, Chief Executive Officer]

I'd just like to thank everyone for your time, and have a great day.

[Operator]

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