Stelco Holdings Inc

TSX:STLC

Earnings Call Transcript 2020-Q1

[Operator]

Good morning. My name is Pam, and I'll be your conference operator today. At this time, I'd like to welcome everyone to this conference call regarding Stelco's first quarter results for 2020. [Operator Instructions] Thank you. Mr. Harris, you may begin your conference.

[Trevor Harris, Vice President of Corporate Affairs]

Good morning, everyone. And welcome to Stelco's first quarter 2020 earnings conference call. Joining me on the call today will be Alan Kestenbaum, our Executive Chairman and Chief Executive Officer; and Paul Scherzer, our Chief Financial Officer.Yesterday, after the market closed, we issued a press release overviewing Stelco's financial results for the first quarter of 2020. 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 investors.stelco.com. 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 involve assumptions that have inherent risks and uncertainties. Actual results may differ materially from statements made today, so do not place undue reliance upon 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 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 relating 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 annual MD&A provide definitions and reconciliations of the non-IFRS measures 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 today's prepared remarks, Alan and Paul will be taking questions. [Operator Instructions]At the outset of today's call, I would like to take a moment to address the COVID-19 pandemic and the response of our business to date. I think it's extremely important to acknowledge the unprecedented efforts that have been put forth by frontline workers around the world in an effort to contain this virus and to care for those who have been infected. It is also important to recognize those who have dedicated themselves to keeping our vital supply chains open so that people have access to groceries and other essential items and have also allowed essential businesses such as our own to continue to operate and support the economy.We would also like to recognize the entire Stelco team who have risen to the occasion and performed exceptionally throughout this crisis. It is due in large part to the dedication and commitment of our employees that Stelco has been successful during this challenging time.Over the past 2 months, we have made significant changes to the manner in which we operate our business to ensure the health and safety of our employees. For example, we have limited access to our facilities to only those who are essential to our continued operation, and we have imposed strict social distancing guidelines. We have procured portable hand wash stations and instituted streamlined procurement procedures to ensure employees can access the cleaning and sanitation supplies they require.We have also imposed strict screening procedures to ensure that employees returning from time away from work and all external contractors are evaluated prior to accessing our facilities and they are referred for additional medical evaluation as necessary. As circumstances continue to evolve and the economic recovery begins, we will continue to seek direction from public health agencies and the government to ensure our employees, their families and the community at large remains safe.Stelco is committed to doing our part to flatten the curve and to overcome the COVID-19 crisis, and we look forward to contributing to the broader economic recovery in the weeks and months ahead.With that being said, I would now like to turn the call over to Alan.

[Alan Kestenbaum, CEO & Executive Chairman]

Thank you, Trevor, and good morning to everyone. I want to thank all of you for joining this morning's call as we discuss our first quarter results. A few days ago, we had the opportunity to speak with you about our major milestone achieved by achieving an agreement with U.S. Steel to acquire an option to take a 25% interest in Minntac, the largest, lowest cost and most efficient iron ore mine in the United States. We also announced the 8-year extension of our iron ore pellet supply agreement, which puts us in position to not only maintain our low-cost position on a permanent basis, but following the upcoming blast furnace upgrade project next quarter, improve on that position even further while also significantly increasing output by 300,000 tons. That means lower costs and higher revenues.As Trevor noted, we are extremely thankful for the efforts of all the frontline workers and all those who are working diligently to keep supply chains open as we collectively navigate through the COVID-19 crisis. Thanks in part to their efforts and the continued dedication of our own employees, Stelco has been able to weather this crisis, and we are proud to post these results for the period despite these and other market headwinds.We were able to sell out our mill and ship to our capacity in the first quarter despite the onset of the COVID-19 crisis and the impact it had on some of our customers in the steel market overall. Also of note, of the 621,000 tons we shipped, we maintained an annual run rate of approximately 600,000 tons of value-added shipments on our cold-rolled and coated products, once again validating our investment in new state-of-the-art galvanizing batch anneal and tempered capabilities that target higher value-added customers.The diversification of our product mix, combined with our ability to respond to the demand of our customers and take these products to the value-added market, will continue to be a key part of our company's continued growth as we seek to lower our costs through raw material contracts, operational improvements and the blast furnace upgrade as well as improve on revenue by expanding our volumes and value-added product mix.In addition to filling our order book for Q1, our order book for the second quarter is now more than 85% filled, and we will utilize our tactical flexibility strategy to pursue market opportunities to fill the remainder of our order book for the second quarter with profitable orders. This is an astounding achievement in this market, which we hope will be further driven by the price increases of about USD 50 to USD 60 per ton announced across the industry in the last few days, driven in part by supply curtailments and higher scrap prices.Average pricing for the quarter did improve modestly, up almost 7% from the fourth quarter of 2019 to $705 per ton. However, this is still significantly lower than the peaks of $980 per ton that we achieved back in 2018 and historical mid-trough pricing.Despite these challenges and this challenge -- despite these challenging prices, our 621,000 tons of shipments, combined with strict cost discipline and our industry-leading low-cost structure, enabled our business to generate adjusted EBITDA of $20 million for the quarter. All of this would not have been possible if we had not stayed true to our core principles.Since turning the start of this new Stelco chapter back in 2017, I have been very clear about the principal commitments that remain at the core of our business and drive our success. We continue to maintain a strong balance sheet, remain disciplined and utilize the tactical flexibility model in order to maximize profitability and cash flow. These are critical measures to ensure that we are able to return maximum value to our shareholders. This includes growth in total shareholder return, including our historical commitment to paying dividend despite the dividend suspension announced last week.Since our ownership period began less than 3 years ago, we have paid out in excess of $340 million in dividends to our shareholders and intend to continue this practice in the future. We also remain focused on growing our company, both organically and inorganically, in a manner that generates shareholder value while being mindful of market risk and even unexpected pandemic crisis like COVID-19.We are using this period to continue to take costs out of our business, conserve cash and look at growth opportunities that are opportunistically priced and that will position us well in the long term. We are investing in the business in a responsible, value-creating manner.In the third quarter, we are commencing a major blast furnace upgrade and reline project, which will give us an additional 300,000 tons of production and reduce our costs through increased efficiencies. This, combined with our newly announced long-term pellet supply and mine purchase option agreement, should improve on our already achieved position as one of the lowest cost steel producers in North America.Our remaining capital plans for the last 3 quarters of the year includes approximately $80 million of net capital expenditure, of which $20 million is maintenance CapEx and $60 million is for growth projects.With respect to the coke battery, in light of the COVID-19 crisis, we are deferring future rehabilitation work as it is not necessary at this time and evaluating a number of alternatives that could expedite the project as well as completely overhaul the battery by replacing [ mole ] and flues and refractory brick. We will continue to evaluate the various options and expect to share additional updates on this project in the first half of 2021.As we continue to navigate these challenging times and as we move towards a more normalizing economic environment expected in the months ahead, Stelco will continue to improve, innovate and utilize its core principles to deliver improving margins and generate returns for our shareholders. I remain excited about the future of our business, and I am extremely confident that the dedicated men and women who make up the Stelco team will continue to excel and allow our company to excel through the balance of 2020 and beyond.Now I will turn the call over to our CFO, Paul Scherzer, to share some information specific to our financial results.

[Paul D. Scherzer, Chief Financial Officer]

Thanks, Alan, and good morning, everyone. I want to start by saying how delighted I am to have joined the team at Stelco last month. As an investment banker for close to 25 years, I spent a lot of time working with steel companies and their executives and have to say that it's been fascinating for me to switch sides and actually be in the seat that I now occupy.I've known Alan for well over a decade and have known Stelco for longer but have still been surprised with how seamless my transition has been. That's a testament to the executive team at Stelco and the culture of the organization. I couldn't be happier through my first 7 weeks in the role, even with the somewhat unexpected working conditions and macro environment that we've all found ourselves in.Switching now to the reason you've all joined us today. Those of you who are with us for our call on Friday last week to discuss our strategic agreement for iron ore supply and the option to purchase 25% of the Minntac iron ore mine will recall that I outlined many of our expected results at that time. None of the information I provided to you at that time has changed materially, but I will take a few moments to review some of the highlights.As Alan has already noted, our business faced some market headwinds in the first quarter with average pricing realizing only a modest improvement over the fourth quarter of 2019, well off what we saw at the peak of the market in 2018. However, our business met the demand of our customers, and we successfully shipped to our capacity during the quarter.Also of note during the period was a noticeable decrease in our shipment volume of other products, including slabs and nonsteel sales from the fourth quarter of 2019. At the same time, we experienced a 17% increase in hot-rolled sales period-over-period. This is yet another example of our business's ability to identify, adapt and pursue the highest margin products in the market at any given point in the cycle.The result was $445 million in revenue, a $10 million improvement over the fourth quarter of 2019 and a net loss of $24 million. In turn, this translated into adjusted EBITDA of $10 million or $32 per net ton, representing a 100% increase over the previous quarter, although the denominator was low, too low, in fact.It's important to note that these results were achieved with the blast furnace that, while the newest in North America, is scheduled for the imminent and necessary upgrade that Alan described in his remarks. We anticipate emerging from that project with higher capacity and more efficient hot end operations, which should drive stronger shipping volumes, revenue and earnings. I look forward to being able to report meaningfully higher EBITDA figures once we complete the project and ramp our hot end back up.As of March 31, Stelco maintained a strong liquidity position of just over $300 million made up of $232 million of cash on hand and $74 million of availability under our existing asset-based credit facility. Of course, this position was reduced by $28 million last week upon the closing of our strategic agreement regarding the Minntac mine but remains robust to allow both future payments for that transaction as well as to fund the capital plan that Alan outlined during his remarks, which currently anticipates approximate net spending of $80 million for the balance of 2020, with the majority attributable to our blast furnace upgrade and reline project scheduled for the third quarter.Overall, our financial position is strong. We remain confident in our approach to strategic investment in our business and are committed to maintaining rigorous financial discipline so that we can continue to deliver strong results for our shareholders. There is no doubt that the current economic climate, largely attributable to the COVID-19 pandemic, has created challenges for our business.However, in my short time here, I've seen the ability of our leadership group and employees to adapt to changing conditions and take full advantage of opportunities in the market as they present themselves. Without a question, we will continue to be financially responsible and manage our business in a manner that allows us to take full advantage of any opportunity that will improve our competitive position in the marketplace and enhance the value of our business.

[Trevor Harris, Vice President of Corporate Affairs]

Thank you, Alan and Paul. That concludes our prepared remarks today. And now I'd like to turn the call back to the operator for Q&A. Operator?

[Operator]

[Operator Instructions] Your first question comes from David Gagliano with BMO Capital Markets.

[David Francis Gagliano, Co]

I just have a couple of topics I was hoping we could drill down on a bit further. First of all, on the reline, and then secondly, on the cadence of mix and volumes over the next 2 quarters. On the reline, in the MD&A, it spells out a bit more about potential phased-in approach to the reline instead of the full reline. Can you talk a little more about the thought process behind the potential phased-in approach? What would drive that? And what -- and when would Phase 2 happen in that approach? That's my first question.

[Alan Kestenbaum, CEO & Executive Chairman]

Yes. Sure. So let me explain. The blast furnace upgrade and reline project that we have is a phenomenal project that has actually payback. I mean, people don't talk about paybacks in terms of reline projects, but it has a payback if we do the full project of less than 18 months. It's 1.5 years payback, which is really incredible for what typically is just a reline.And that's a testament to the work that our Chief Operating Officer did by going out and identifying 13 basic aspects of our most recently built blast furnace in North America, which was built actually a long time ago, in 1985, and getting it up to 2018 standards, which are various things that were identified to some significant research that he and his team identified. So the payback on the full reline is very, very quick. The payback on the incremental money that we're talking about spending for the full reline actually is about 6 months. That's how dramatic it is. That extra piece is a significant part of the payback.And so we'd like to do the full reline now. And the only reason we may not do it or really the only reason that we may not do it, barring anything else unexpected, might be the health and safety of the workers. So we've been able to identify that we can do it with safe social distancing and running the project very well. But as we get into some of the other phase of it, that is -- that would be the one area where if this is difficult to -- difficulty to recruit, for instance, in face of the COVID, that would be a reason why we would defer.If we would defer it, we'd save about $30 million this year. It would get deferred somewhere between 2 and 3 years, and the net difference in time is 15 days additional if we did the deferral. So that's basically the outline of it. The preference is to do it now. We are anticipating a return to more normalized conditions as we get in towards the end of this year. And therefore, we want to be ready for it with the full project that it gives us the full benefits of all the additional tonnage and all the cost savings.So that's the thought process. So the reason not to do it would be if we encounter difficulties due to recruitment or proper safe management of this project to be -- to COVID. And if we can get it done, it will be amazing because what better time to do this than during a period like this for 2 reasons: one, it feels really good to be able to give people work and get people to come in and work in the facility and get people much needed employment; and two, get it out of the way during this environment.

[David Francis Gagliano, Co]

Okay. That's helpful. And then just switching to the cadence on the volumes. Quarterly results each quarter include hot-rolled -- volume for hot-rolled, cold-rolled, coated and other. Those are the 4 buckets that we get. And those numbers have been pretty volatile, I guess, on a quarterly basis. And I'm wondering if you -- obviously, you've indicated volumes overall, I think, are expected to be flat in the second quarter versus the first quarter. But can you give us a sense as to what you expect, just in terms of at least perhaps a range in terms of the mix in each of those buckets for the second quarter?

[Alan Kestenbaum, CEO & Executive Chairman]

Yes, I don't have the information to provide for -- in all those categories, but we do expect to be able to continue to ship a similar quantity of the value-added products along the range that we achieved in the first quarter. That's our expectation. We're not expecting to ship any slabs or any of the other products indicating continued shift in migration to the higher value-added products, as Paul outlined during his remarks.

[David Francis Gagliano, Co]

Okay. And the slabs would jump in that other bucket, correct, if they were to be shipped?

[Alan Kestenbaum, CEO & Executive Chairman]

Could you repeat that, please? What?

[David Francis Gagliano, Co]

The slabs, if there are slab volumes, it shows up in the other bucket. Is that right?

[Alan Kestenbaum, CEO & Executive Chairman]

I don't know what you're looking at, but we don't have any slab shipments this quarter, but I don't know what you're looking at right now.

[David Francis Gagliano, Co]

Okay. I'm sorry. And then the last question for the third quarter...

[Paul D. Scherzer, Chief Financial Officer]

Sorry. Dave, it's Paul. Just to jump in on that with the slabs. Yes, we do show slabs and other. But obviously, with the furnace coming down, we're not going to be selling any slabs or in fact, building up some slab inventory, so we could keep servicing our customers through the blast furnace outage.

[David Francis Gagliano, Co]

All right. Great. That's helpful. That's a good segue to my next question and my last one, sorry. Is the third quarter volumes with the outage -- let's assume market conditions stay the way they are and the price increases don't really stick and they're even kind of sitting around USD 500 hot-rolled coil environment in the third quarter with merchant slab markets unchanged. What's the current thought process with regards to overall volumes in the third quarter? How much will be third-party slab purchases versus just reducing overall volumes to the third quarter?

[Alan Kestenbaum, CEO & Executive Chairman]

Yes. We're not ready yet to give guidance on second half shipments. As you recall on -- I think last year, we provided guidance at some point on the volumes. But we're not in a position yet to provide guidance yet on that. But yes, it would include opportunistic purchases of slabs to keep volumes up. We have a slab bank that we've been building in anticipation of the outage, and we've been doing really well.When the market gets weakened as a surplus, we've jumped in and made some purchases to support our shipments during the outage. Once the outage is over, we expect to be able to get to higher volumes than ever in Q4 because of the additional volume. So it's a little bit too early for us to be able to give you some good guidance on second half.

[David Francis Gagliano, Co]

Okay. Understood. Can you just give us, the last question, in a sense to the inventory, the slab inventory that's been built up at this point, how much?

[Alan Kestenbaum, CEO & Executive Chairman]

No, we would rather not disclose that at this point.

[Operator]

Your next question comes from Tristan Gresser with Exane BNP.

[Tristan Gresser, Research Analyst]

Yes. One question from my side regarding your Q2 outlook. You said you expect stable volume sequentially in Q2. Can you help us understand why Stelco appears more immune on the volume side? When we look at U.S., European peers, they are guiding 20%, 30% lower sequentially. Also, in that regard, can you give us some color on your pricing and mix expectations for Q2? I know you touched on mix, but anything on pricing would be helpful.

[Alan Kestenbaum, CEO & Executive Chairman]

On your first question on volumes, look, I really have to give a lot of credit to the management team on why Stelco was able to do something that no other steel mill has been able to do, which is fill up their order book. And I'll break it down to 2 levels. First of all, our -- the way we service our customers. We really take care of our customers. We make sure that we are reliable. We make sure when things are good, when things are bad, we make sure we take care of our core customers. And so we think we've built a tremendous loyal customer base that other companies don't service.And the reason for that is, when you call our company and you ask for a quote, you get a quote like on the spot, immediately. Our salespeople get -- have the ability to respond immediately to every question, shipment questions, availability questions, price questions. It's negotiated on the spot. There are no long-term delays. People respond within seconds. Everybody is available.We saw this crisis coming. We saw it hit China, and we sat in the room back in January and we said, you know what, this problem is hitting China. When China gets sick, this is not good for the metals business. Let's go out, get aggressive, get ahead of this thing and sell.Now we had no idea, like everybody else, no one had any idea that this problem was going to hit us in North America the way it has. But we knew that when something impacts China, it's not good for the industry. And so we went out and aggressively solicited business, and it was the right decision and really, really happy both on the decision-making process.We instituted hedges where we felt we needed to protect ourselves from the pricing environment, and a real great job done by the operational team to produce the material, the purchasing team to make sure we're buying things at the right price and really, again, to our sales team and our customers that really like us.And so why no one else can do it? I think I've given you the things that we do. I can't explain why others don't. But I'm really pleased that this -- at this great team that we have here, and that's what I attribute our ability to sell out the mill while others have not been able to.And in terms of pricing, there's -- we don't really know yet because there's been so much volatility going, and we generally don't put out pricing guidance now and we're not going to now either. But the other thing I'll point out is what people don't really get in this business is the impact of scrap to pricing.And obviously, during a pandemic, when you have a situation where there's less and less scrap available in the market, scrap prices are going to go up and you saw it happen right now. Scrap prices have gone up. Price increases have been significant, $50, $60, $70 a ton price increase is announced because of the cost push related to scrap.And so one of our important principles in this business is to keep our costs very low so that we can gain during this price increase environment. So it's difficult. We still have another 15% of our book to sell out. We're hoping to do quite well with that. And generally, we don't give guidance, but pricing is something that really is counterintuitive to what people expect and also very different than the way things were 15 years ago.

[Operator]

There are no further questions at this time. Mr. Scherzer, please proceed.

[Paul D. Scherzer, Chief Financial Officer]

Yes. Thank you. I just wanted to jump back in for a moment just to clarify or rather to correct a comment I made earlier in my prepared remarks. In speaking about adjusted EBITDA for the quarter, it was $20 million, which is up $10 million from the fourth quarter of last year. $32 per net ton that we realized of adjusted EBITDA was, in fact, and is, in fact, the correct number. So I just wanted to clarify that mistake for the record. And it looks like we have no more questions. So I'll just pass it over to Alan for closing remarks.

[Alan Kestenbaum, CEO & Executive Chairman]

Thank you, everybody, for joining the call today. We look forward to speaking with you again soon. We wish you all a good and productive ability to function during this time as you possibly can. Stay safe, be well and be looking to talk to you real soon. Thank you.

[Operator]

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