Stelco Holdings Inc

TSX:STLC

Earnings Call Transcript 2023-Q2

[Operator]

Hello, and welcome to today’s Stelco Holdings Inc., Second Quarter 2023 Earnings Call. My name is Bailey, and I’ll be your moderator for today’s call. All lines will be muted during the presentation portion with an opportunity to questions and answers at the end. [Operator Instructions].

I would now like to pass the conference over to Trevor Harris, Vice President of Corporate Affairs. Trevor, please go ahead.

[Trevor Harris, VP of Corporate Affairs]

Good morning, everyone. And welcome to Stelco's quarterly earnings conference call. Speaking on the call today to discuss our 2023 second quarter results will be Alan Kestenbaum, our Executive Chairman and Chief Executive Officer; and Paul Scherzer, our Chief Financial Officer.

Yesterday, after the market close, we issued a press release overviewing Stelco's financial results for the second quarter of 2023. 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, which have inherent risks and uncertainties. Actual results may differ materially from the statements made today, so 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 to read the legal disclaimers on page two of the accompanying earnings presentation. And also to refer to the risks and assumptions outlined in Stelco's public disclosures, in particular, the second quarter 2023 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 MD&A provide definitions and reconciliations of the non-IFRS measures that we use today. Please also note that all dollar figures referred to on today's call will be in Canadian dollars unless otherwise noted.

Following today's prepared remarks, Alan and Paul will be taking questions. To maximize efficiency, we would ask that all participants who would like to ask a question, please limit themselves to one question and one follow-up before re-queuing.

With that, I would now like to turn the call over to Alan.

[Alan Kestenbaum, Executive Chairman and CEO]

Thank you, Trevor. And good morning, everyone. The second quarter of 2023 showed substantial improvement over the first quarter of this year. And so Stelco once again leading the North American steel industry with a 26% adjusted EBITDA margin. The $215 million of adjusted EBITDA that we reported for the quarter represents the 231% increase over the previous quarter. Across the board, our financial metrics for the quarter showed great improvement as the business continued to experience relief from certain inflationary pressures that have impacted our costs for the last several quarters.

We also experienced positive shifts in the market with improved pricing and a return to more historically normalized lead times. Those together with continued resilience in the broader economy allowed us to take advantage of our industry leading low-cost position and effectively deploy our tactical flexibility business model to deliver stronger results in the second quarter. As a result, we remain in a position to continue to deploy our capital in the best interests of our shareholders with whom our management team remains closely aligned.

Accordingly, we are once again paying a cash dividend of $0.42 per share with this dividend Stelco will have returned $1.9 billion in capital to our shareholders over the past five and a half years. When taken as a percentage of market capitalization, this level of returns to our shareholders leads the entire North American Industry over that time period. It also represents a return of more than eight times the equity capital raised from our IPO.

I'm very pleased with the efforts of our entire team that led to our success this quarter in the coming months, I’m optimistic that we will realize continued cost reductions as we expect to sell out our production in the third quarter and take advantage of opportunities in the market. I also look forward to further demonstrating our long within a commitment to our value shareholders by continuing to evaluate means to deploy our capital in an creative manner.

Having said that, we do remain cautious about the broader economy sector headwinds, including upcoming auto labor negotiations and shrinking lead times across our entire industry. As we head into the fourth quarter. Thank you for your time this morning. I will now ask Paul Scherzer to detail some of our financial results.

[Paul Scherzer, CFO]

Thanks, Alan. And good morning, everyone. I'm pleased to report that we had a successful second quarter that delivered significant improvement across all of our major financial metrics. Thanks in part to a 27% increase to our average selling price over the first quarter, we were able to grow our revenue to $841 million this quarter. On its own, that would be an excellent accomplishment. However, we take great pride in our ability to derive those dollars through to the bottom line by taking advantage of our low-cost position. We were able to leverage the inherent strength of our business and convert that revenue into $123 million of adjusted net income, which represents over a 1,000% improvement over the previous quarter.

As Alan noted, we once again led the North American industry with adjusted EBITDA margin of 26%. And we also saw a 250% improvement in adjusted EBITDA per net ton over the first quarter, reaching $329. These results are further evidence of the power of our tactical flexibility model. It should be noted that this success was achieved in spite of a 6% reduction in shipments through the quarter. Looking forward we anticipate our shipping volume for Q3 will be approximately 675,000 net tons.

Overall, our financial performance allowed the business to generate cash from operations and we once again ended the period with total liquidity in excess of $1 billion including $784 million dollars of cash. By continuing to drive our revenue through to the bottom line we have positioned our business to be able to capitalize on market conditions. And continue to allocate capital in the best interests of our shareholders, including the $0.42 dividend per share and will be payable this quarter.

It is gratifying to see the business we have built in respond to the changing dynamics in the market. And to capitalize on the opportunities that were presented last quarter. We have invested heavily in our assets to modernize our facilities in order to reduce costs and maximize the efficiency of our operations. These investments in the commitment of our employees have allowed us to demonstrate our ability to navigate challenging periods, and emerge to deliver industry leading results and margins.

Going forward we’ll not deter from the principles that led to our continued success. We will maintain a strong balance sheet exercise and unwavering focus on our costs. And ensure that we deploy our capital in a manner that is in the best interest of our shareholders. I remain confident that our commitment to these principles will continue to deliver successful outcomes for our business. Thank you for taking the time today.

[Trevor Harris, VP of Corporate Affairs]

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

[Operator]

Thank you. [Operator Instructions]. Our first question today comes from the line of Katja Jancic from BMO Capital Markets. Please go ahead Katja. Your line is now open.

[Katja Jancic, BMO Capital Markets]

Hi, thank you for taking my questions. On the cost can you talk a little bit more about how much you think costs could decline in third quarter? And then looking to ‘24? What are some of the puts and takes on the cost side? We should be thinking about?

[Paul Scherzer, CFO]

Yeah, hi, Katja this is Paul. Good morning. And thank you for the question regarding costs. So, we were we were still opt in this past quarter. And really, as we look at it, it's the continued call which as you know, cycles through our business, it's a fairly long cycle and as the coal lands, gets converted to coke finds its way into steel. So, we were up again, on our coke costs this past quarter, it looks like we've now hit right around what should be our maximum coke cost, given the way the operations are running on coke making and given our coal buy which this year was a little bit better than last year, so that shouldn't be going up anymore.

But that was the primary driver for the increase in costs. We also based on having a fewer tons that we shipped, we saw a little bit less absorption on that. So, I'd say that's the biggest driver, one other one on materials. Just to point out we had a little bit more galvanized in the mix this quarters or zinc cost was up a bit overall. Going forward, we should see costs, we really kind of get leveling on coke. So, probably moving down a bit overall, we're definitely as prices have come down, we’re in the lower scrap price environment. So, we'll see some benefit from that.

[Katja Jancic, BMO Capital Markets]

And maybe can you just remind us on the medical side? Are you already contracting for next year?

[Unidentified Company Representative]

Yeah, we don't. We don't, get out that kind of information. When we contract. We were we recognize that coal was a commodity. Generally speaking, it's falling right now, has been falling. We expect to continue to see it fall along with some continued demand slowdowns. So, but we don't disclose how and when we enter into the market.

[Katja Jancic, BMO Capital Markets]

Okay, thank you. I'll hop back into the queue.

[Unidentified Company Representative]

Thank you.

[Operator]

Thank you. The next question today comes from the line of Bill Peterson from JP Morgan. Please go ahead, Bill. Your line is now open.

[Unidentified Analyst]

Hi, this is Benett on for Bill. Thank you for taking my question this morning. I wanted to ask about shipments and utilization which came in a bit later than expected. Could you provide some color on what contributed to that quarter-over-quarter decline? And what gives you conviction in hitting those 675,000 tons next quarter?

[Paul Scherzer, CFO]

So, as you know, we sell out every quarter, which explains our conviction to kind of -- we did experience in the second quarter a decline in shipments as you noted, and you can see it in the buildup of our inventory. And that's because of customer pushback on not taking deliveries when they contract it to take it. And a lot of that was pushed into July when it was more convenient for the buyers to take their shipments. So, our shipments, I think are reflective of what's been going on in the broader economy, which is, as I alluded to in my remarks, there is some fear of what happens if the auto industry goes out on strike.

Buyers definitely trying to monitor their own inventories, and are cautious about it. And subsequently, they push back shipments. And our shipments declined. When you look at the results that we had, which were lower than forecast, you can see that inventory show up in - you can see the lack of shipment show up in our inventory. And you can also see that if you took those shipments and made them, we would have hit our forecast. So, at the end of the quarter, some shipments deferred - deferred some of the shipments. So, now going to your other question that conviction the third quarter.

We can, we have conviction in the sense that we have sold out the material where I would add a note of caution is, we very likely could see the -- in this current quarter, third quarter repeat of what's in the second quarter with buyers remain cautious. Especially, since who knows what's going to happen with the auto industry strikes. Potential strikes, labor issues there. And if that happened, us and everybody else would experience a drop in customer offtake from the contracts, so that, while we have conviction from the sensitive, we have contracted volume.

It's not a typical to see that not be hit, because customers last minute decide to depart shipments into a fallen quarter. And we're seeing that already now. We saw an uptick in July, and people who didn't take their June shipments, we very likely could see that in September as well, depending on what goes on in the broader market.

[Unidentified Analyst]

Great, thank you for that color. And then if I could have a quick follow-up sticking to the theme of working capital build, or using the expecting then more of a reversal into the next quarter? And then could you remind us how you're thinking about capital allocation in the back half of the year, given minimal CapEx needs and the sound cash balance? In other words, because we assumed some buyback similar to what we saw in the back half of last year?

[Paul Scherzer, CFO]

So, with respect to the working capital buildup, yeah, it's correct. That worked its way down in July. But as I said, we don't -- it remains to be seen what's going to happen in September. So, while we did see a working capital drawdown in July, we hope that continues through the end of the quarter as anticipated, but if the same thing repeats itself with, there's reluctance from the customers, we could see it stay steady at the same level as last quarter. With respect to capital allocations.

As I mentioned, we're going into a - in cautious period now. And we're going to be very, very careful in how we spend our money. That's, that's one thing we like having large cash balances. It gives us opportunities for all kinds of capital allocation decisions and positions us well to do that.

[Unidentified Analyst]

I know. Great, thank you so much, and best of luck.

[Paul Scherzer, CFO]

Thank you.

[Operator]

Thank you. The next question today comes from David Ocampo from Cormark Capital. Please go ahead, David, your line is now open.

[David Ocampo, Cormark Capital]

Thanks. I just had two quick questions. The first one on your cash balance. Alan, how are you thinking about your excess cash? I think in the past, you quoted $300 million to $400 million as what you'd like to keep on the balance sheet. But just given the uncertain times, especially with potential auto strike, does that number gravitate higher? Are you still comfortable with that $300 million to $400 million range?

[Alan Kestenbaum, Executive Chairman and CEO]

We're still comfortable with that, we're the right sized company, we're able to sell out volume and really the most prolific markets. If you recall, during the depths of COVID, Q2 of 2020, we were the only mill running full out at that time. So, we're pretty confident about being able to continue to move, move the material. As I've mentioned in the prior question, we do have some timing things that occur, but we're not at a point where we would change our view on, cash balances, having said that, we've been extremely disciplined on when to spend the cash.

As you recall, last year, we had a magnificent year on capital, on capital allocation returns to shareholders. And we've got a long view on that. And we'll continue to conduct ourselves similarly on doing the best thing that we can which is, whether its dividends, share buybacks, potential, potential M&A activity, if any appears, we will continue to monitor all that as we decide what the level is. But all things being equal that $300 million to $400 million still gives us good comfort, because we also have plenty of liquidity on undrawn credit facilities.

[David Ocampo, Cormark Capital]

And second one here, if I take a look at the cash flow statement, it does look like there is a pretty sizable employee benefit commitment that went out. And it does look like commitments for the year are another $78 million to go. Paul, can you tell us the timing on that, that relates primarily to the free cash flow sweep from ‘22?

[Paul Scherzer, CFO]

Yeah, it's two elements, David. So we've got the regular, I guess three elements, we've got the regular scheduled payments throughout the year. And then we have the cashflow. I won't call the sweet but the excess cash flow payment based on last year success. That is the biggest component of that. And then we also, if you recall, we had a long-delayed payment related to ‘21 tax savings benefits. And that was related to some administrative matters. That just took some time to pay so that half of that went out in the quarter, half of that is going out this quarter.

So, of that remaining $78 million the most of that is going to go this quarter. The benefit of where we are and all that is remember, we have a maximum pension payment over time of $400 million. By the time we get to the end of this year, it's going to be a very limited amount to go. And if we make any excess cash flow payment next year, that'll be done by the middle of next year. In a worst case, it's early in 2025.

[David Ocampo, Cormark Capital]

Okay, so if I looked at kind of your payments due by ‘26, ‘27 time period looks like it's 72 million for those two years. Is that kind of the ballpark where you guys think the benefit payments [Indiscernible]?

[Paul Scherzer, CFO]

Lower at that point, it should be lower at that point.

[David Ocampo, Cormark Capital]

Okay, got it. Thanks, guys.

[Operator]

Thank you. The next question today comes from the line of James McGarrigle from RBC Capital Markets. Please go ahead, James, your line is now open.

[James McGarrigle, RBC Capital Markets]

Hey, good morning, and thanks for taking my question. I just wanted to ask a question on the inorganic opportunities that you'd highlighted on the last call. I know you'd mentioned, you're going to be cautious in the current environment, you have about $400 million of cash available. But, would you be comfortable borrowing in the current environment, potentially raising equity in the current environment, if the right opportunity were to prevent itself?

[Paul Scherzer, CFO]

No, I don't think we'd be raising equity or issuing that.

[James McGarrigle, RBC Capital Markets]

And, on some of those inorganic opportunities, do you see any, potentially a need or any opportunity potentially from, expanding into EIF or furnaces, whether or not that would be through an organic investment or potentially buying, another EIF competitor as we've seen a few of your U.S. peers do?

[Paul Scherzer, CFO]

Look, from our perspective, the EIF business is not part of our strategy. At the moment, we've discussed this and several occasions, we continue to be concerned about raw material supply. Others have different views. That's my particular view. And so, we're not planning on moving in that direction. But, obviously, there's plenty of choices for investors to choose what strategy they like, our strategy does not involve moving towards EIF at this time.

Having said that, we're opportunistic buyers, we're commodity people, things become available, and they're cheap. And they make sense. We're not religiously opposed to anything, whether it's EIF or otherwise, but we would need to see, really, really excellent value in our company and accretion. And most of that has to do with purchase price, less to do with strategy. So, never rule it out. But right now, that wouldn't be the direction we would likely go in.

[James McGarrigle, RBC Capital Markets]

And then I want to ask, if you had any thoughts on some of the ongoing negotiations between the U.S. and the EU under the carbon tax structure, I'm not sure if they're going to meet that October deadline that they had previously set. So, any thoughts on there and any potential impact on your business one way or another?

[Paul Scherzer, CFO]

We're not in those discussions. So, I don't have any insight on that.

[James McGarrigle, RBC Capital Markets]

Okay, and lastly, one of your competitors was talking about kind of some initiatives around hydrogen. And as a way to potentially reduce some CO2 emissions from some of its furnaces. That's something that your team is in discussion with, or something you're keeping an eye on?

[Alan Kestenbaum, Executive Chairman and CEO]

Yeah, absolutely. We've done a whole host of de-carbonization initiatives that are being worked on right now. Hydrogen is one of them. We've got a whole suite of things that we're working on to, to help change the carbon footprint of our facility. Super exciting area for us. So, remains under this in a working phase. We've got excellent cooperation from all kinds of providers, financial providers, some technology providers, but hydrogen definitely is one of the areas that we're looking at.

[James McGarrigle, RBC Capital Markets]

Awesome, I appreciate you taking the time, and I'll turn the line over. Thank you.

[Alan Kestenbaum, Executive Chairman and CEO]

Thank you.

[Operator]

The next question today comes from the line of Curt Woodworth from Credit Suisse. Please go ahead, Curt. Your line is now open.

[Curt Woodworth, Credit Suisse]

Yes. Hey, good morning. Alan and Paul, I was wondering if you could give us an update on kind of capital spending expectations for the rest of this year, and next year. And if you have any updated views on the battery recycling plant that you guys are planning.

[Paul Scherzer, CFO]

Yes. So, on capital, I think can look for us to be kind of flat for the rest of this year. And next year, a lot of that is driven by our expectations for business performance, which we think was going to be kind of consistent with how things are this year. So, we're going to be very mindful of our CapEx spend.

I think that puts us in the vicinity of about 150 million for next year and about half of that remaining for this year. And we also, as I mentioned in the previous caller, we're very, very focused now on our de-carbonization efforts, which, which is something that it's hard to pinpoint, because there's a lot of availability of alternative financing for that.

And so, how we spend and where we get the sources of funding may or may not be in our CapEx budget, depending on what the sources are. So, but anyway, I think you can look for the balance of this year to remain as projected about 100 of the balance of whatever we haven't spent 150 for this year, and also the same for next year. What was the second question you had?

[Curt Woodworth, Credit Suisse]

Just an update on the batteries. Battery recycling [multiple speakers]

[Paul Scherzer, CFO]

Yeah. So, with that stands -- that's been delayed. The reason why it's been delayed is that the technology provider that we have partnered with, well, they're excellent and have done tremendous, tremendous work they haven't like, frankly, all the battery recycling companies that are out there today are still working to get the right specifications on the output provider to provide to the delighted that the annulled makers. And so we're sitting in a wait and see position right now, enough spending money waiting for to see the company actually produce the quality that's needed.

Those tests are ongoing, they're expensive, and the automakers themselves are not really certain what they need. So, there's ongoing dialogue of making things, a match, I have to say that just met with these folks the other day, I think they're and or ahead of any of their competitors. I'm glad that we're doing this quietly. So, they have the time to take all resources and put it into development. As you remember, there's two parts of this is the black mass [ph] creation. That's easy. We can do that.

Anyone can do that. But the question is, what do you do with that black mass and that's converting it to hydrometallurgical process into finished goods, whether it's lithium, cobalt, nickel. And those products themselves is where there's still a lot of dialogue back and forth as to hitting the exact specifications. So, our perspective is no reason to build a black mass site and start processing something unless we can actually recycle it into the full final product. And that development is ongoing. The pilot plant in Germany continues to operate, works with big, big counterparties to achieve those results.

And once those results are achieved, we expect to break ground. Now, just to give you kind of a sense of timing, we should have been there already, based on the initial schedule, we're not. And so remains difficult for me to project like when, but we're pretty comfortable end of life batteries aren't really going to start coming out in any kind of large numbers for another three or four years. So, we still have plenty of time to do this. But it is unclear because from a technology perspective, like virtually every one of its competitors, they're not quite there yet in delivering a product pure enough to go into an automaker.

[Curt Woodworth, Credit Suisse]

Great, thank you very much.

[Operator]

Thank you. There are no additional questions waiting at this time. So, I'd like to pass the conference over to Alan Kestenbaum for any closing remarks.

[Alan Kestenbaum, Executive Chairman and CEO]

Thank you, everyone, very much for your attention today. And we will get back to work. And continue to really try and drill down on lower costs as we move into this environment that we think might be ahead of us. And we look forward to speak to you next quarter. Thank you.

[Operator]

This concludes today's conference call. Thank you all for your participation. You may now disconnect your lines.