Stelco Holdings Inc

TSX:STLC

Earnings Call Transcript 2020-Q3

[Operator]

Good morning. My name is Veronica, and I will be your conference operator today. At this time, I would like to welcome everyone to the conference call regarding Stelco's Third Quarter Results for 2020. [Operator Instructions] Mr. Harris, you may begin your conference.

[Trevor Harris, Vice President of Corporate Affairs]

Good morning, everyone, and welcome to Stelco's Third Quarter 2020 Earnings Conference Call. Speaking 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 third 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, which have inherent risks and uncertainties. Actual results may differ materially from the 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 third 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 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] With that, I'd like to now turn the call over to Alan.

[Alan Kestenbaum, CEO & Executive Chairman]

Thank you, Trevor, and good morning, everyone. I appreciate everyone taking the time to join us on today's call to discuss what it was an eventful and successful third quarter. As we explained in previous calls, our primary goals for this year were to: firstly, increase penetration in the value-added higher-margin end markets, such as the automotive sector; second, to cement and secure our future iron ore pellet supply; and third, to follow through with the successful completion and commissioning of our blast furnace upgrade project. While the first 2 of these goals were achieved earlier this year, this quarter was marked by what I am proud to say was the extremely successful completion of our blast furnace upgrade project on time and under budget. Today, Stelco is prepared for the future, and we are excited to have commissioned North America's first truly "smart" blast furnace. Our leadership team consulted with top experts from around the world, and we have implemented cutting-edge technology in our Lake Erie Works blast furnace that will increase our steelmaking capacity by up to 300,000 net tons per year and reduce our hot-rolled steel coils cost by as much as $30 per net ton. These outstanding results further improve our industry-leading cost structure and position Stelco to deliver positive returns to our shareholders and across the market cycle. Of course, the fact that this was all accomplished during a global pandemic and through a brief interruption caused by the previously reported cyberattack is a testament to the commitment and dedication of our employees and our valued business partners. I would like to extend my personal thanks to our Chief Operating Officer, Sujit Sanyal, whose leadership and expert guidance was invaluable in delivering this exceptional result. Additionally, our timing could not have been more perfect. The blast furnace upgrade project took place during a cyclical low-price environment during Q3, and we have completed it just in time to enjoy the current strong pricing environment that has already improved by as much as 50% over the recent lows. We are now deploying our assets to take full advantage of increasing demand in this improved pricing environment. During this quarter, we did estimates on shipping volumes by selling out all available products once again. Our end markets are strong. For this quarter, we are again sold out in our booking orders now for Q1 delivery. In the coming months, we expect to complete work on our new pig iron caster that will enable us to further enhance our tactical flexibility and maximize our profitability by serving EAF producers and foundries who are interested in these valuable iron units as they face continued supply squeezes and price increases in the scrap market. Work is also continuing on our previously announced 65-megawatt electricity cogeneration project at Lake Erie Works that will further reduce our operating costs even further once commissioned in mid-2022. We certainly believe that the more than $670 million we have invested in this business, since our acquiring the company in 2017, has returned Stelco to its place at the head of the pack in the North American steel industry. We intend to use all of the tools we now have to operate smartly and further improve upon our industry-leading cost structure and margins. Moreover, as significant shareholders ourselves, the entire executive team and the Board is aligned with you, our valued shareholders. And we will now turn our focus to increasing shareholder value by increasing cash flow, maintaining our strong balance sheet and continue with share price friendly actions as we have done historically. In addition to our strategic capital investments, since we took over in mid-2017, we have not only invested over $670 million in capital back into the business but we have also delivered over $330 million in dividends and share buybacks. That is $1 billion combined and all at a free cash flow from operations in just 3 years while not accessing the capital markets for debt or equity issuances. No steel company can boast of that record. And we are very proud. Once again, thank you all for taking time to join our call today. I would now like to turn things 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. When we elected to take the production outage to support our blast furnace upgrade project, we knew it would have a negative impact on our results. However, our timing could not have been better as we were able to complete this project during a period where we saw realized pricing erode to $683 per net ton, a decline of 2% over the previous quarter and far below prices being realized currently. Our shipping volume was actually above what we had expected, but well below normal levels at 334,000 net tons in the quarter as a result of blast furnace outage and generated revenue of $237 million for the period. The good news, as Alan indicated, is that we are seeing significantly higher price levels in the fourth quarter and expect to take full advantage now that our blast furnace has resumed operations, and we have the capability of producing up to an additional 300,000 net tons of hot metal per year. Certainly, we have also been impacted by the headwinds created by the global COVID-19 pandemic, but our ability to work in partnership with our loyal customers and our valued business partners has resulted in us being able to sell out all of our available production every quarter-to-date in 2020. Despite the extended outage at our blast furnace for most of the third quarter, year-to-date, we have shipped over 1.5 million net tons, a decline of only 15% over the previous year. Our shipments this quarter are expected to be approximately 600,000 net tons as we begin to reap the benefits of our blast furnace upgrade project. At the same time, we have continued to benefit from increased penetration into value-added markets with cold-rolled and coated shipments up by 35% year-to-date over 2019 volumes. We continue to be pleased by this performance and expect our penetration of these markets will continue to deepen in 2021, affording us additional tactical flexibility as we work to continue growing our overall margins. Certainly, the third quarter was abnormal for our business due to blast furnace upgrade project, but the resulting benefits will serve us well through the fourth quarter and in future years. The expected increase in production capacity and reduced coil costs, combined with recovering demand and pricing in the market, should allow us to drive higher revenue, margins and EBITDA as we enter the new year. This quarter, as we work through this critical phase of our strategic capital plan and invested over $67 million in net capital expenditures, we did see a reduction of available cash. However, our company remains in a strong financial position with $137 million of cash on hand and available liquidity under our revolving credit facility. We anticipate that we'll be able to capitalize on positive shifts in the market and see ample opportunity to replenish our cash holdings as production, shipments and revenue all increase in the fourth quarter. The completion of the blast furnace upgrade project marks the conclusion of the most significant portion of our capital investment strategy, but we are continuing to work on other key investments, such as the new pig iron caster, which we anticipate commissioning by year-end. We understand the importance of continued investment in our facilities in order to meet the developing demands of the market and to implement cutting-edge technologies that will improve our efficiency and product quality. While our investments will be more modest in the near term, our approach will remain disciplined and focused on delivering returns for our shareholders. It is not a secret that 2020 has been a challenging year for everyone. In the face of a global pandemic that has brought with a great uncertainty, I'm proud of the resilience of our business. It is clear that the work done by our team over the past 3 years has created a foundation for growth, and the implementation of our tactical flexibility model has allowed us to not only react but thrive through these unprecedented market pressures. Entering the fourth quarter, I am confident our management team will continue to execute our strategy and leverage the value we have built in our operations to deliver industry-leading results and positive returns for our shareholders.

[Trevor Harris, Vice President of Corporate Affairs]

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

[Operator]

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

[David Francis Gagliano, Co]

So I guess I'm going to try and drill down a little bit on the near-term expectations, just to help us tighten it up a little bit. One, first question with 2 parts. First, can you comment on pricing lags. Obviously, we've seen a huge run-up in prices. And can you give us a sense as to what we should expect for lagged prices on your side? Maybe you can frame it within the context of the commentary you made about $680 a ton, far below prices you're realizing right now. Given your order books are pretty much done for the year and into January, what are the realized prices you're getting for the fourth quarter? That's the first part. And then the second part is somewhat related. Can you give a sense as to the mix of that 600,000 tons of shipments in the fourth quarter?

[Alan Kestenbaum, CEO & Executive Chairman]

Yes, I can -- I'll handle that. Look, generally, we've been running at a bit of a shorter lead time than probably other producers. Just we wanted to make sure that we finished our blast furnace on time, which we did. So really pleased about that. So the short answer is about 2-months lag. But we just closed our order books last week. So some of that is less. So you'll see a range of prices that -- what prices might have looked back a couple of months ago through even the present time. In terms of the value-added products, we're expecting something in the vicinity of about 150,000 tons. That's 25% of the expected shipment tonnage in that area.

[David Francis Gagliano, Co]

Okay. That's helpful. And then just a bit of a bigger picture question. Obviously, with the reline behind, everything is looking great in the market right now. Can you comment a little bit on your thoughts around capital allocation? Obviously, inorganic growth initiatives have been very topical in the past. And I'm just curious how that ranks relative to, say, coming back to capital returns for investors as we get into 2021?

[Alan Kestenbaum, CEO & Executive Chairman]

Well, with most of the capital requirements behind us, we have a few left that we've mentioned. But we're going to -- as I've said in my remarks, our focus now is going to be on share price appreciation and whatever that takes, could include dividend reinstatement, could include other capital market activities, but we're going to look to grow the business. A big believer here in being best of breed, lowest cost and anything that we might do would further support that and sort of having any good ideas that would further support that, which include not diluting our cost position. So sort of that, we're just going to be accumulating cash and using that cash in a way to benefit shareholders.

[Operator]

Your next question comes from Michael Doumet with Scotiabank.

[Michael Doumet, Analyst]

Just as a follow-on to maybe some near-term considerations. You talked about lead times. Any considerations for production inefficiencies related to either the blast furnace restart or the cyberattack that we should consider for Q4?

[Alan Kestenbaum, CEO & Executive Chairman]

Yes. And that number is embedded in the number that was indicated by Paul, and that's already embedded in there. We expect higher shipments because of the additional 300,000 tons of capacity that comes in this blast furnace outage as we get into Q1. So we've indicated a number for this quarter, just so you have some idea specifically to address that question. And as you can see, it's like amazing, how we're able to get out of the starting gate so quickly after this major upgrade project. So very proud about that and will get better as we move into next year as we realize the full benefit of the additional 300,000 tons of capacity.

[Michael Doumet, Analyst]

Okay. Just to elaborate on that, Alan. I mean, should we assume that the cost structure given the volumes in Q4 and presumably, the volumes in Q1 will get much better sequentially into Q1?

[Alan Kestenbaum, CEO & Executive Chairman]

Well, we're already running now, like now, like we're sitting here in November. So we're already running right now at that level. So I wouldn't use the word sequentially. What I would say is in line with the slightly lower volumes for this quarter, yes, it's going to get better from a reporting perspective because we won't have the start-up piece of it that occurred in October. So -- but we're already experiencing that right now. So yes, as you get into Q1, we should be realizing the full benefit of that cost structure across the entire quarter.

[Michael Doumet, Analyst]

Got you. Okay. And if I can squeeze one more in. The noncash nonfinancial net working capital declined quite a little bit this year. How much of that should we assume to be sustainable? Or said differently, how much do we expect working cap to be a drag on free cash flow in the upcoming quarters?

[Paul D. Scherzer, Chief Financial Officer]

Yes. Michael, it's Paul. I'll take that one. So yes, cash, obviously, went down a fair bit in the quarter, a result of CapEx and the lower shipments and lower prices. I would say that you'll see our cash balance start to tick back up fairly rapidly as we go through the coming quarters. And you'll see us return to something approaching our normal levels, just given realizations of the higher prices and the higher shipments.

[Operator]

Your next question comes from David Ocampo with Cormark Securities.

[David Ocampo, Analyst of Institutional Equity Research]

I just wanted to drill down a little bit more on your cost structure here. I think when I look at the cost curve that you guys have, if you take out $30 from your old chart that you have, you're closer to $400 a ton. And you have a bit of smaller initiatives on the horizon like upgrading your coke ovens on the cogen agreement. How much lower can that number go? And are we at that $400 number now?

[Alan Kestenbaum, CEO & Executive Chairman]

So the answer to your question, we expect that we're going to be able to get, as we reported earlier, about $16 million to $18 million savings per year from the cogen project. So that equates to about $6 a ton and probably another $10 a ton in that vicinity on the coke battery project. I just want to make sure we're getting the currencies correct. The number that you indicated is in U.S. dollars. The savings numbers I just gave you is Canadian dollars, just to be clear. So if you took the -- if you actually took the CAD 16 million that I just said, it's probably an aggregate of about USD 12 million, something in that vicinity.

[David Ocampo, Analyst of Institutional Equity Research]

Okay. That's good. And when I take a look at steel prices, even on the forward curve, you could lock in at pretty attractive prices. And I know you typically operate more on a spot basis. But given where steel prices are today, I just wanted to get your views on hedging more of the order book.

[Alan Kestenbaum, CEO & Executive Chairman]

Yes. So we do opportunistically hedge when we like the prices. We're very mindful of pricing now. I think CRU now just -- it's jumped up to $710 or something like that yesterday. And so these are prices that are above the cyclical mid-cycle prices of about $600 average, going back 5 years. So when we see prices starting going over the mid-cycle average, we think about hedging some of our book. We also think about selling part of our book and take advantage of locking in some of that, but not all of it. I think our investors also, one of things they love about Stelco and what makes Stelco an incredibly unique investment is the following. We have tremendous torque to the upside to price increases. We also -- of the companies that do have fixed that don't depend on the very volatile scrap market, but you still have relatively flat costs. We also don't have pensions, and we don't have OPEB sitting in the prospective of a defined benefit plan, and we don't have significant interest payments. We don't have -- we have negative net debt. So I think one of the things that's great about Stelco -- what's unique about Stelco is you get to play the strong market and you get to play the upside that comes with that. So we're balanced. We don't go all in any one way. We are -- we do try and sell forward. We do try and hedge opportunistically, but we also like our investors to enjoy the upside, and the markets look very, very strong right now. Prices have increased rapidly. We're not that surprised by that. We expected that to happen as scrap dried up and scrap prices went up and also a lot of the buyers, I think, had expectations that prices might fall, but they didn't. And so there's a lot of rush to buy right now and filling up pipelines that had gone dry, supply lines rather that had gone dry. So this is all coming at the right time. So we try and keep a pretty balanced approach to -- so we can be as much as we can to people, which is -- which what I mean by that is give people a tremendous torque to upside, leverage the price to upside with the ability also of locking in at the some of our book to make sure that we lock in some of the pricing excitement that exists right now.

[Operator]

Your next question comes from Seth Rosenfeld with Exane BNP.

[Seth R. Rosenfeld, Research Analyst]

I have a question with regards to the mix in some of your end market exposure to autos, in particular. Can you just give us an update following the blast furnace reline with regards to your efforts to have better penetration to the auto OEMs. There's been some recent industry press about many of the established mills having very kind of aggressive negotiations going into 2021. Has that been an opportunity for Stelco to come in and try to take some share with some of the auto OEMs?

[Alan Kestenbaum, CEO & Executive Chairman]

I think there's 2 developments in the market that is helping those efforts. One, with all our capital behind us and our continued push to get into the auto industry, that's starting to pay off. These are companies and some at the OEMs that are slow to change, but we've continued to push and make progress in that area. Albeit, as I've said on prior calls, not as fast as we would like. We'd like it to go faster, but they definitely is starting to see some fruits from the hard push. The other thing that's going on in terms of consolidation in the industry that has occurred, it's given us a bit of an opening in terms of some customers wanting to explore new supply opportunities in light of the consolidation that's taking place.

[Seth R. Rosenfeld, Research Analyst]

Great. And if I can ask a second question, please, with regards to CapEx. Can you please just confirm the expectations for CapEx budget for Q4? And then also looking ahead to 2021? And within that, can you give us an update, please, on plan for the coke oven modernization plans?

[Paul D. Scherzer, Chief Financial Officer]

Yes, Seth, it's Paul speaking. So on CapEx, we still have a little bit of the blast furnace that basically has bled into Q4. So there's a bit of that. We have some remaining spending on the pig caster in the quarter. And then there's a little bit of just ongoing coke oven spend as well as normative CapEx. So for this quarter, CapEx probably is, call it, in the neighborhood of $50 million, $55 million or thereabouts, depending on when we actually get going on the coke oven project, which could change that number somewhat. As we look forward to next year, we're going to be done effectively on the projects other than coke oven and minor projects. So that will be a much lower year than this year was, lower than last year was. Not prepared to give any sort of guidance just yet with respect to it. But the number will definitely be lower as we're starting to head into more of a maintenance and small accretive project mode other than the coke ovens.

[Seth R. Rosenfeld, Research Analyst]

I was just asking if you can confirm the total CapEx cost for the coke oven, please?

[Paul D. Scherzer, Chief Financial Officer]

No. Sorry, we're still finalizing engineering and timing on that. So we're not prepared to give a final -- to give the number on that yet.

[Alan Kestenbaum, CEO & Executive Chairman]

And while we're on the subject of coke, I just want to add another positive development that has occurred in the market that as you guys know, we do take advantage because we're low on coke when prices go up. Right now, the international coke market price has moved up substantially and so we're back in that business of selling coke again. So that's another positive development. And it's another reason why we keep as much flexibility as possible within our system.

[Operator]

Your last question comes from David Gagliano with BMO.

[David Francis Gagliano, Co]

Okay. I just had a follow-up to that last comment, and then I wanted to ask the question I was going to ask. Just on the coke -- merchant coke side. Can you frame that out a little bit more in terms of the potential impact? It was at times a fairly significant contributor to EBITDA. So I'm wondering if you could just give us a sense as to near-term expectations, something a little more on the quantitative side on that one. And then the only other question I actually wanted to ask was just some commentary on the land position. Any updates with regards to the land package and intentions there?

[Alan Kestenbaum, CEO & Executive Chairman]

Yes. So on the coke side, I mean, it's a rather very recent development that's still unfolding. In terms of what we would sell and how much this very quarter right now, so it's very near term. I'm little hesitant to put out a number at this point until we complete those discussions. But it -- we expect to return to something that would be noticeable as it had been previously this quarter. And we don't know we're in that list, but right now, it looks like -- it looks like it will be something noticeable. In terms of the land, that's continuing to progress. We're in the stage now continued as we were last quarter in terms of trying to get the severance approved by the city. Like in all these projects, there's always various little things that you need to go through to get that done, and we're still in that process. Every couple of weeks, we get a request for something else. And we're still seeing good cooperation from the city on that. And as we get to that, we should be prepared to make further comments on that.

[Operator]

Mr. Kestenbaum, there are no further questions at this time. Please proceed.

[Alan Kestenbaum, CEO & Executive Chairman]

Okay, guys. Well, it's great talking to you again. This was a quarter that was one that we were very well prepared for. We executed well. We're not surprised by how successful it was in terms of execution of this because it was a well thought out plan project. It came in under budget and in time expected. And so now we're really ready to roll. I really have not seen a business like this that has the cash flow generation, I indicated before, $1 billion over 3 years, put back into the business and dividends. And that was with a cost structure that is not as good as what we have now as of this outage. So we're really ready to roll here. We're very, very excited. More to come. And look forward to showing this to you guys in our performance and look forward to talk to you guys soon. Take care.

[Operator]

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