Stelco Holdings Inc

TSX:STLC

Earnings Call Transcript 2022-Q3

[Operator]

Thank you for standing by, and welcome to the Stelco Holdings Inc. Third Quarter 2022 Earnings Call. My name is Sam, and I'll be your moderator for today's call. [Operator Instructions]

I'll now hand the call over to Trevor Harris at Stelco. Trevor?

[Trevor Harris, executive]

Good morning, everyone, and welcome to Stelco's quarterly earnings conference call. Speaking on the call today to discuss our results for the third quarter of 2022 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 2022. 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 the call to read the legal disclaimers on Page 2 of the company -- 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 2022 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 would now like to turn the call over to Alan.

[Alan Kestenbaum, executive]

Thank you, Trevor, and good morning, everyone. Through the third quarter of 2022, Stelco was once again able to demonstrate our resilience and take full advantage of our structural cost advantage, while at the same time delivering positive returns to our valued shareholders.

For the seventh consecutive quarter, we emerged as the North American industry leader with a 29% adjusted EBITDA margin. For context, the next closest margin was 25% and the industry average was 17%. This is a significant achievement that was accomplished in the face of significant market headwinds, driven by deteriorating pricing and inflationary pressures on our input costs.

Moreover, we were able to increase our volume of shipments over the previous quarter and utilize our low-cost advantage to deliver strong adjusted EBITDA. This success has put Stelco in a position to demonstrate once again the strong alignment between senior management and our co-investors and return capital to us and them through dividends and share repurchases.

In addition to increasing our regular dividend by 40% to $0.42 per share this quarter, we are also pleased to announce a special dividend of $3 per share that will return an additional $165 million of capital to our valued shareholders. This, in addition to the repurchase and retirement of approximately 29% of the shares that were outstanding at the start of this year, including 17 million shares or 25% in Q3 and the current quarter alone.

We continue to lead the industry in return of capital to shareholders as a percentage of our market capitalization, and with the dividends announced today, we will have returned $1.8 billion since we went public in November of 2017. Notwithstanding our success to date, we are focused on the challenges that lie ahead with market conditions that we expect to remain challenging in the near term.

While inflation has had an impact on many of our courses, we are starting to see that abate with some input prices, especially for coal, natural gas and alloys beginning to turn downwards. Stelco will continue to explore every opportunity to improve our industry-leading cost structure and take advantage of the more than $900 million of capital investments we have made into our facilities since 2017.

Most recently, during the third quarter, we began to realize the benefits from both our upgraded coke battery and our new electricity cogeneration facility, which commenced full operations. It will provide us with excellent opportunities to improve productivity and reduce both cost and our carbon footprint.

During the quarter, we also successfully reached new 5-year agreements with our unionized employees, that will ensure stability in our workforce as we work together to navigate these challenging times. The inflationary environment that is impacting our business is also impacting our employees personally, and I am pleased that we were able to work with the union leadership and members to reach agreements that protect both our workers and their families as well as the company. I look forward to continuing to work together with our valued union partners to keep Stelco is a leader in the North American steel industry.

As we move forward, we will not deviate from the successful strategy that has continuously delivered strong results for our business. Our core principles and values are strong. We maintain a strong balance sheet, which will give us operational, strategic and capital flexibility. We will utilize our tactical flexibility model to pursue the highest possible margins across all product lines from pig iron to coated products, and we'll deploy our capital in a responsible manner that benefits all of our shareholders.

We have worked hard to unlock the potential of our business and established Stelco as not only a low-cost steelmaker in North America, but also as an attractive investment for our shareholders, and we'll continue to work on these principles.

With that, I will turn it to Paul and ask that he provides some additional comments regarding our financial performance.

[Paul Scherzer, executive]

Thanks, Alan, and good morning, everyone. As expected, the third quarter proved to be quite challenging in the face of inflationary pressures and reduced pricing in the market. As a result, we did experience reduced financial performance compared to the peak we realized in 2021. However, the inherent strength of our business, which is our low-cost operating structure, allowed us to generate $357 of adjusted EBITDA per net ton and maintain our position as the North American industry leader with respect to adjusted EBITDA margin.

This was achieved despite a reduction in our average selling price of 20% over the previous quarter and a reduction of 36% over the third quarter of 2021. The slight increase in shipments over the second quarter offset some of those price pressures and led to revenue of $846 million and adjusted EBITDA of $245 million.

The relative success we achieved allowed the business to maintain a strong cash position and overall liquidity. At the close of the third quarter, we had $250 million availability on our revolving credit facility and cash in the amount of $1.395 billion.

In keeping with our desire to effectively deploy our capital to the benefit of our shareholders, subsequent to the end of the quarter, we completed $288 million worth of share repurchases, under our substantial issuer bid that was in addition to the share buybacks when we completed during the third quarter. With the completion of these buybacks, we repurchased approximately 29% of the shares that were outstanding at the beginning of this year and still have a cash balance today in excess of $1 billion.

As Alan noted in his remarks, our management team remains strongly aligned with our shareholders, and we are exceptionally proud of the capital returns we've provided to date. Following the payment of the dividends announced today, the total capital returned to shareholders since our 2017 IPO will be in excess of $1.8 billion. By any measure, we view this as a remarkable achievement for our business.

Of course, we are aware of the challenges that lie ahead. And while we have made note of the inflationary pressures and deteriorating pricing that impacted our business through the third quarter, we must also make note that these negative pressures other than the aforementioned reduction in some of our inputs are likely to abate in the near term.

Accordingly, we are again reiterating our guidance for the fourth quarter that assumes that the lower prices and shorter lead times being experienced currently slowly impact results to prevail through the remainder of 2022. However, we will continue to focus relentlessly on cost in order to maintain our industry leadership and so that we can capitalize on any opportunities presented by the market.

I remain confident that the strength we have built through strategic capital investments and the creation of an industry-leading cost structure will see Stelco persevere and succeed. We will continue to take the necessary steps to mitigate and overcome the challenges that face our business and stay true to the core principles that contributed to our success to date.

Thank you for taking the time today to join our call.

[Trevor Harris, executive]

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

[Operator]

[Operator Instructions] Our first question comes from the line of David Gagliano with BMO Capital Markets.

[David Gagliano, analyst]

I'm going to try and ask these in 2 questions. So first of all, current market dynamics question. Obviously, price is down, demand weak, lead times soft. There's 2 parts to this one. First, what we see in indices and things like that suggest price is down quite a bit in the fourth quarter versus the third quarter. I don't want to put a number out there. Just I'm trying to get a sense as to given where we are in the quarter and your lead times on your order books, what's a reasonable expectation for quarter-over-quarter decline in realized prices. And then also any indications of life at the end of the tunnel here, given that we're heading into a typically a seasonally stronger period? That's my first question.

[Alan Kestenbaum, executive]

Sorry about that. David, I don't think we're going to provide you like actual prices. I don't think we can do that. But it is down, and you'll see that in our results. As you know, we're active in the industry here. The indices are, I think, are finely reflective of what's actually going on. Very often, there's a very significant lag. So I think if you refer to the CRU prices, I think you'll get a pretty good sense of how things have moved quarter-over-quarter, keeping in mind that did take them time to catch up and get into a lag. So that's in terms of that. In terms of an outlook, one of the great things about this business is you don't worry about it going at a style. And as long as you're producer like us that's able to produce constantly with the margin, you keep going. I do see some things shaping up that suggest as we get into Q1, the environment will be better. And a lot of that is driven by scrap. And we've seen this now over and over and over again, most recently during the COVID time during 2020 when remarkably prices of steel went up even at 50% utilization because scrap became very tight.

Scrap is not tight now by any measure. Scrap is continuing to decline. But we're starting to see the early seeds of the types of things that generally do create scrap tightening and let me list them. One, lower prices result in lower collection. Two, slowdown in housing starts means less demolition, and therefore, less steel to come back into the steel scrap supply chain. And the other thing that we're starting to see is a depreciation finally is the U.S. dollar. And what that does is bring back exports. Really, really early signs. Typically, this time of the year, you get into the winter time and collections themselves get hampered by weather conditions and things like that. So I do think that as we move into Q1, we'll start seeing some better conditions. And that's kind of our outlook and how we're playing it. And for Q4, we're doing really well from an order book perspective. You talked about weakening demand. I think that the macroeconomic statistics definitely show that there would be weakening demand, particularly in construction and other things.

But we're not a giant producer. We make almost 3 million tons a year. So we don't -- we're not as exposed to -- we're not as sensitive to these types of drops in demand. So we work with our regular customers. Their businesses, I'd say, flat, not down, definitely not going up. And so we're holding our own, filling our order book and doing what we do. And that's how we manage the business. It's a cyclical business. When we get to the lower operating performance periods like now, we hold our own, and we continue to make money and look at what we can do, which is reducing our costs.

And as I said, it's my anticipation, but definitely could be wrong. I can see a scenario, where interest rates go up, everyone follows the same statistics. We definitely see a scenario where demand gets weakened as construction goes down further and maybe it hits the auto market. So we're ready for that. We know the upturn will come. My crystal ball is telling me to look towards sometime in Q1, but we're prepared -- totally prepared to be wrong about that prediction. And we'll continue to do what we do, which is to continue to work on our cost structure to stay profitable during the trough of the business.

[David Gagliano, analyst]

Okay. That's very helpful color. I appreciate it. And then just another 2-part question. Just first, on the other part of the business, costs -- unit costs actually, up quarter-over-quarter, but better than what we were looking for and better than what we've seen from a number of the other steel producers of the U.S. So I'm just wondering if there are any incremental quarter-over-quarter changes meaningfully one way or the other coming in 4Q? That's my first part. And the other part on the capital allocation. Now we shifted to special dividends. Obviously, we had a nice period of buybacks. Still a lot of cash on the books. What's the updated thinking on priority of uses of cash on a go-forward basis between specials, between buybacks and investment options.

[Alan Kestenbaum, executive]

Right. Okay. So on the question of capital allocation. And well, let me first touch on the first one, about Q4. As I mentioned in my remarks, we definitely are seeing a downturn in input prices in various different places. I'll highlight the ones that we're seeing it more, which is in coal, natural gas and scrap prices. However, like other producers, we do source our coal in advance. And so we're not going to be seeing the impact of that during Q4 because we're still working off some old contracts. But I think unlike a lot of other competitors out there that haven't pulled back a lot of capacity, there's a lot of contracts out there that are sitting that are going to have delayed deliveries and therefore, less near-term demand because they need to fulfill contracts. So from our perspective, as you know, we're up in the [indiscernible] we have our input. So we do get the benefit near term in Q4 from the natural gas, from the scrap, those things do impact right away and continue to impact us right away.

And so we'll see that as a benefit. We do expect to see some lower costs in Q4 as well, and then even further as we move into next year as we start rolling in some of the lower-priced other inputs like alloys, like coal, like other things. And then we continue to negotiate with other inputs as well to see how we can cut costs. So that's why I think you'll see -- I think you'll see some moderation in course in Q4 based on those inputs, and we'll continue to see that as we move into next year when we get into some of the new contracts that we have at lower prices.

With regards to capital allocation, I think we've done a really good job in being balanced. And when I say balanced, it's about keeping enough cash around to have operational and strategic flexibility. So we've achieved that. We've taken off 29% of our shares this year. I don't know how many companies in the world have done that in any industry in this year, especially at a time where equity for the most part were escalated, notwithstanding some recent performance, but they were escalated. But we actually waited. If you look at most of our purchases were done in Q3, Q4 when equity markets were down.

So we missed the big boom in the first half of the year. We missed the most recent boom because we got these done when equity markets were weaker and [indiscernible]. I'm incredibly proud about our discipline. I'm not just throwing money when we have nothing else to do with our money and start buying shares back. When you look at most share buybacks, they're done at the top of the market. And -- because they don't have better investment ideas and very often management team who are not aligned like we are with the shareholders, feel that they need to go and prove to the world that they think the stock is undervalued.

But here, you got to remember, 20% of the stock is in management's hand. So we think exactly like our managers and timed our buys at a price that we consider very good about. I think it was $35 on this most [indiscernible], $37 on the one before that. we've been incredibly disciplined. We didn't buy back stock when it was $56 a share. We did when it was much lower. So I think patience and waiting and discipline and long-term perspective is what drives this management team. So that's in terms of the buyback. The special dividend, yes, we had some extra cash. We want to keep some extra cash. We certainly could have made the special dividend larger, but we can do another special dividend. If we feel that either from a strategic perspective, there are no great alternatives.

So we feel comfortable with the cash accumulation in the business. And so we can do that again, and we've retained that flexibility. This is our third special dividend since we bought the company, took it public in 2017. So I think we've now established a track record of willingness to do special dividends. So we'll continue to look at that. And then finally, we think we're getting into a period where we're going to see some opportunities, let's say, would be the nicest way I can say is in our sector. And it's something that I have spent the career doing, looking for really good price opportunities.

And if we find them, we may not. But if we do, we want to be able to be flexible enough to be able to transact on those opportunities. And so I think we're in a really good place right now. As Paul said, we've got about $1 billion of cash, a little bit more than that. We've got an undrawn revolver. We've got a lot of liquidity here. We're going through some tough times, but tough times are good for us because it puts us -- gives us the ability to be on offense while we continue to generate cash flow. So I'm really happy with where we are right now. I think we've got a great record -- track record on our capital returns and it's not a surprise. We're aligned with you guys. We're -- as I said, management here owns 20% of this company and so we think like you. And we want to do what's best for the shareholders. And sometimes, that means keeping some cash on the books to do strategic things. And sometimes it means paying phenomenal dividends like we did today, increasing the dividend like we did today and sometimes that means opportunistically buying back stock.

[Operator]

Next question is from Michael Doumet with Scotiabank.

[Michael Doumet, analyst]

Obviously, a nice quarter. First question is on maybe if you can quantify the impact of the weaker Canadian dollar to your P&L. I'm assuming it helped on the revenue, and I'm not sure if there's a lag on the cost side. So again, any way you can quantify that, maybe the sensitivity to EBITDA from [indiscernible]?

[Alan Kestenbaum, executive]

Yes. Actually, there's not much because a lot of our costs in U.S. dollars -- are in U.S. dollars. So we're pretty balanced. We've analyzed this over and over again to see do we gain when the Canadian dollar is weak, do we gain when the Canadian dollar is strong. And if you look at our cost structure, principally on our inputs, the 2 biggest ones, iron ore and coal, that's all U.S. dollar price. And then on the sales side, no one really speaks in Canadian dollars on price. It's always U.S. dollar price and then converted at the exchange rate. So I would say very little sensitivity or impact to Canadian dollar strength or weakness.

[Michael Doumet, analyst]

Okay. And then maybe second question, just, I guess, thinking about cash here, given the rising cost of debt here, how are you thinking about the inventory monetization agreement into next year? And maybe if I can tack on. Any updates that you can provide us on the EV recycling JV?

[Alan Kestenbaum, executive]

Sure. On the inventory monetization, probably satisfied with that agreement works well, and we'll continue to do that. Keep in mind, we're also running very large -- not very large, I mean, but the increased interest on -- interest earnings on the cash that we have. So we're pretty happy with that arrangement. And what was the second question?

[Michael Doumet, analyst]

Just an update on the EV recycling JV?

[Alan Kestenbaum, executive]

Right. So we are -- we continue to work on that. We're at the stage now, where we're expecting updated samples from the hub part of this operation, which is in Germany. As you know, they've been providing samples and qualifications for the actual end product, and that's what we're in the process of doing right now to battery makers. That -- we see that as a very important milestone to be reached to make sure that the product that's going to come out of this at the end, it's fully acceptable to very specific battery makers that are willing to commit to the specs and that process is ongoing, and that's what is occurring right now.

[Operator]

The next question is from the line of Alexander Jackson with RBC.

[Alexander Jackson, analyst]

I was wondering if you could maybe touch on potential opportunities that you were talking to earlier with respect to using that cash? And then as well, are there any other opportunities maybe internally other projects, potentially cost-saving project or margin-enhancing projects that you guys are looking at?

[Alan Kestenbaum, executive]

So within our CapEx budget -- annual CapEx budget, we have a certain amount of growth projects and some of it is normative. And so we're constantly looking at refinements to the operating model -- operating footprint rather than we have to increase and enhance margins. And so we've got several of those untapped for this year. And then in terms of outside investments constantly on the lookout and always engaged in various conversations and knowing that [indiscernible] of those don't occur. And -- but you still stay in contact with people in case they can occur. And I think we are the company is very, very well positioned right now financially, is to be able to transact at a time where valuations have come down and are more reasonable and transactable.

And so that's kind of our mindset right now. I'm certainly not going to speak about any specific opportunities, but we're always in the mix, looking at various things that would makes sense for us. And then the other thing, I mean, I don't know if you guys have seen the announcement on this, but the government of Canada announced, put us on the list of 10 companies in advanced stages of the -- of our request to provide financing for our decarbonization efforts. We've not been very vocal yet about what it is that we're doing, but we've got a number of very, very exciting initiatives, which will be -- involve large amounts of capital and hopefully, from sources that don't depend on our cash flow. So those are super exciting. We've not unveiled them yet because we're still refining what that will be. And -- but we are, as a Government of Canada announced in -- increasingly advanced stages of negotiation with them to access the capital to make those kind of investments.

And our goal is to be able to get outside funding for everything that we're doing, taking advantage of the public and private partnership initiatives that the Government of Canada has shown willingness to do. And I really give the government tremendous amount of -- really excited and really proud of being in Canada because it's really one of the only governments I can think of that's actually sitting and taking this decarbonization initiative seriously and they're putting their money into it, and saying, we're not just going to dump this on industrial players, we're going to be in partnership with you. And so it's also very, very exciting. And if we can achieve what it is that we're trying to do here, I think it will be an incredible differentiating -- differentiated company when it comes to those efforts. So those are the 3 buckets. There's the budgets internally, which is part of the CapEx, normal CapEx review, which is ongoing. There is what I just mentioned, decarbonization, and then constantly looking for strategic transactions that could change the size and pace of the company.

[Alexander Jackson, analyst]

And just maybe 1 follow-up on that third bucket. Is there any themes that you're thinking about with respect to those opportunities? Is it within sort of the bread and butter steel production or raw materials or maybe something outside of the box. If maybe you can answer that or maybe it's just all the above coming across your desk?

[Alan Kestenbaum, executive]

No, it's definitely not all the above. It's everything in the box and not outside of the box. And the reason for that is our investors invest in our company because they want exposure to the steel industry. That's the first decision they make. And my experience running public companies is when you dilute that -- the purpose of the company and start moving into other things that might be good investments, you end up creating a confused company that people are not interested to invest in. So we've stayed true to core. And it's interesting. A lot of people ask us all the time, hey, you guys are -- don't have -- you only have spot exposure and the spot market went down and you don't have this long-term contracts and everything else, which I've always said those contracts are very one sided. You have buyers out there that don't take materials when the prices are high or they renegotiate when the prices drop. And my long-held belief is those contracts are just one-sided contracts.

And the best proof I can give for that because everyone's always saying to us, you're exposed to the spot market. You're exposed, the price is down. Just look at our margins. In a terrible quarter, right, we were in third quarter, we have, by far, the highest margins in the industry and no long-term contracts. All spot exposure. So I think we have the winning formula here, and we're going to continue to stay with that formula. It works for us. And I think we just prove it on the ball field. And despite everyone's questions, oh, you don't have long-term contracts or what about when prices drop, our investors want steel exposure, period. They don't care if you had -- they don't care if you have a long-term contract.

They want dividends, they want share buybacks, they want price -- and they want exposure to the steel industry. And so we have stayed firmly in that camp. And one of the things that I love about our third quarter results is the fact that we have shown that even with the declining price the way it is, you're not insulated. Because at the end of the day, it's run by operational footprint and it's run by smart purchasing and smart selling. And I think that's the beauty of this company. And I think as we -- one of the things I love about these down environments, it lets you reestablish the company and reset your costs and it also lets you operate at a margin and demonstrate that you can operate at a margin despite everybody else's popular views about what you should and shouldn't go into. So tactical flexibility is our theme, both from a corporate perspective, financial perspective and an operational perspective.

[Operator]

That concludes our Q&A session as well as Stelco Holdings Inc. Third Quarter 2022 Earnings Call. Thank you all for your participation. You may now disconnect your lines.