Stelco Holdings Inc

TSX:STLC

Earnings Call Transcript 2018-Q4

[Operator]

Welcome to the Stelco Holdings Incorporated Fourth Quarter and Full Year 2018 Earnings Conference Call. Today's conference is being recorded. At this time I would like to turn the conference over to Don Newman, CFO. Please go ahead, sir.

[Donald P. Newman, Chief Financial Officer]

Good morning, everyone, and welcome to Stelco's Fourth Quarter 2018 Earnings Conference Call. Joining me on the call today is Alan Kestenbaum, our Executive Chairman; and David Cheney, our Chief Executive Officer. Yesterday, after the close, we issued a press release overviewing Stelco's financial results for the fourth quarter and full year 2018. The press release along with the company's financial statements and management's discussion and analysis have been posted on SEDAR and on our Investor Relations website at stelco.com/investors. We have provided a link to the presentation referenced on today's call on our website as well.I'd like to inform everyone that comments made on today's call may contain forward-looking statements which involve assumptions, which have inherent risks and uncertainties. Actual results may differ materially from statements made today. So do not place undue reliance on them. Stelco management disclaims any obligation to update forward-looking statements, except as required by law. With that in mind, I would like to 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 fourth quarter management's discussion and analysis sections relating to forward-looking information and risks and uncertainties as well as 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 fourth quarter MD&A provide definitions and reconciliations of the non-IFRS measures that we will use today. Please also note that all dollar figures referred to in today's call will be in Canadian dollars unless otherwise noted.Following our prepared remarks, Alan, David and I will take questions. To maximize efficiency, we'd ask that all participants who would like to ask a question limit themselves to 1 question and 1 follow-up question before requeuing.With that, I would now like to turn the call over to Alan.

[Alan Kestenbaum, Executive Chairman]

Thank you, Don. And good morning, everyone. As you have seen, we are very proud to have had another strong quarter where we believe we led the North American industry in adjusted EBITDA margin and exceeded analyst consensus on all of our key metrics including adjusted EBITDA, adjusted EBITDA margin, shipments, average sales price and total revenue, which is a testament to our continued efforts to build and improve our business. This continuous push on all fronts will not abate but rather will accelerate as we continue to executive on our business plan. When we IPOed this company, we laid out four goals focused on creating shareholder value.First, with increasing production and revenues through optimization of assets. To that end, we shipped more than 2.6 million to steel in 2018, 31% more than the company shipped in 2017. We also significantly increased utilization of nonsteel assets like our coke production and generated $53 million of nonsteel gross profit, a 231% increase from 2017 nonsteel gross profits of $16 million.Our second goal was maximizing profitability and cash flow. In 2018 Stelco holdings achieved record profits, I repeat, record profits of $541 million in adjusted EBITDA and $614 million in tariff adjusted EBITDA, generated through our tactical flexibility model as we quickly targeted products and markets with the greatest potential for profit.To measure this we are introducing in our operations the latest technology such as artificial intelligence, profit analysis and order management. In the third quarter, we incurred $39 million in tariff related costs while shipping 586,000 tons of steel in the period. To reduce tariff impact and maximize profits we shifted focus to sell more into Canada. The outcome is clear because in the fourth quarter we decreased our tariff related costs to only $23 million on 673,000 tons of steel shipped. That's a 41% reduction in total cost and a 49% decrease on a cost per ton basis in just one quarter and we're only getting started.We continue to post what we believe are North American-industry-leading EBITDA margins. In Q4, our adjusted EBITDA margins were 22% and our tariff adjusted EBITDA margins were 26%. For the full year, our adjusted EBITDA margins were 22% and our tariff-adjusted EBITDA margins were 25%.To put this in perspective, as we compare our margins to our peers who are, may I remind you, all are the beneficiaries of these tariffs. As opposed to the target of these tariffs we believe we outperformed peers between 500 and 1,600 basis points in the fourth quarter and between 400 and 1,600 basis points for the full year 2018.We believe our performance -- our performance reflects our cost position and execution of our tactical flexibility model from a production and sales perspective. From a cash standpoint, Stelco Holdings generated $473 million in cash flow from operational activity. We are using that cash generation prudently to grow the company, maintain strong liquidity, but also returning capital to our shareholders.Our third goal was to maintain a strong balance sheet and financial discipline to maximize shareholder return. We started the year with $250 million of cash and $519 million total liquidity, including cash and capacity under our completely undrawn revolver. We ended 2018 with $438 million of cash and $741 million of total liquidity.We have maintained a debt-free position, invested $101 million in CapEx. And including the dividends announced today, returned $295 million to shareholders in the forms of dividends including $250 million or $2.82 a share in special cash dividends and approximately $45 million in 5 quarterly dividends of $0.10 per share each quarter.Our fourth goal was to grow the company organically and inorganically with a clear focus on maximizing value. We are very selective on where we invest capital. Organic investments must meet rigorous return requirements and all growth projects compete for capital. And now we are starting to see more actionable inorganic opportunities.This management team has an unparallel proven track record of value creation to a highly selective and opportunistic M&A strategy.On the tariff front we are continuing with efforts to reduce our -- reduce our tariff exposure into 2019 and fully support the Canadian government's efforts to eliminate the 232 tariffs against Canadian Steel. We welcome and appreciate the Canadian government's implementation of various measures, including provisional safeguard measures in Q4 2018 that has helped to prevent the surge of offshore imports into Canadian -- into the Canadian market.As an update on the land, we are continuing to build our team who remain focused on progressing the marketing for leasing purposes of certain suitable buildings as well as the entitlement process, including preparation of the land for sale and development.Finally, I would like to introduce David Cheney as our newly appointed Chief Executive Officer. David is new to the role but not new to Stelco. David and I have worked very closely together for several years and he has earned my full confidence. David and I worked together in the acquisition of Stelco. And he has been deeply involved in the day-to-day management of Stelco since the acquisition.I am continuing my daily role as Executive Chairman and will continue to oversee all aspects of the company and will be able to expand my focus on growth initiatives in driving the company's strategy.Stelco has delivered very strong results since our acquisition. And I am very confident that this executive change will bring even stronger results and significantly accelerated growth.With that, I'll hand the call over to David.

[David Cheney, Chief Executive Officer]

Thank you, Alan. It's appropriate that Alan started the call by reviewing our strategic goals which drive our focus and action every day. Growth, continuous improvement and data-driven decision-making are core to our strategy. And not only did we significantly grow revenue and shipments, we did so more efficiently. For example, in 2017 we shipped 964 tons of steel per employee while in 2018 we shipped 1,187 tons of steel per employee, a year-over-year efficiency improvement of 23%.Efforts to leverage existing assets also resulted in new production records, including new records in coke production, iron production and steel production. And these are markets that we intend to improve upon in the future.We are also investing to expand our capabilities to penetrate higher value-added markets. Our efforts this past year to invest in our facilities to better participate in auto advanced high-strength steel, AHSS, high-strength low alloy steel, HSLA, and value-added coated products will pay off in the short and long term. We also continue to make progress on installing batch annealing and tempering capabilities which will allow us to produce annealed cold-rolled fully processed products starting mid-2019. This has the potential to be one of our highest margin products. We have made good progress in selling into the automotive market so far this year as well as other markets.This sets us up for what we believe will be a strong 2019. We see the potential for steel prices to improve, demand is strong. We have upgraded our product mix to higher value-added products and we continue to control costs. With our tactical flexibility business model, the improvements we have made in production and the significant enhancements we have made to our logistics capabilities, we are ready to take full advantage of these opportunities.As you can see, we are focused on creating a differentiated business. Stelco is driven by disciplined capital allocation, including dividends, share buybacks and timely M&A, a culture of continuous improvement including the introduction of new technologies to optimize production and the priority of returning the benefits of this strategy to shareholders.On a personal level, I'm very excited to be assuming this new role at Stelco. I look forward to continuing working with Alan, Don and Sujit and the rest of the team to build upon the successes we have achieved to date. Now I will turn the call over to Don to talk more about financial results.

[Donald P. Newman, Chief Financial Officer]

Thanks, David. Q4 was an excellent way to cap off a record-making 2018. Q4 2018 revenue was $648 million, adjusted EBITDA was $145 million and tariff-adjusted EBITDA was $168 million. Our Q4 2018 adjusted EBITDA per ton was $215 and tariff-adjusted EBITDA per ton was $250 and our adjusted EBITDA margin and tariff-adjusted EBITDA margins were 22% and 26% respectively in the quarter.On a year-over-year basis, in Q4 2018 we posted double-digit and triple-digit growth across the board. Year-over-year growth in revenue, 43%. Growth in operating income, 115%. Growth in average selling price, 28%. Growth in shipping volumes, 14%. Growth in adjusted EBITDA, 110%. Growth in adjusted EBITDA per ton, 84%. And an expansion in adjusted EBITDA margin from 15% in Q4 2017 to 22% in Q4 2018. On a tariff-adjusted basis, growth was even better with tariff-adjusted EBITDA growing 143% year-over-year. Tariff-adjusted EBITDA per ton increasing 114% to $250 and tariff-adjusted EBITDA margin expanding from 15% in Q4 '17 to 26% Q4 '18.We've also included Bloomberg consensus figures on Slide 5 for your reference. In Q4 we recorded strong shipping volumes, posting total shipments of 673,000 tons in the quarter. We also made significant headway in Q4, reducing the impact of tariffs from $39 million in Q3 to $23 million in Q4 and will continue to actively focus on increasing domestic sales to take advantage of market opportunities that we believe the current trade environment is presenting. The sequential decrease in average selling price reflects steel price declines in a broader market and was the primary driver in sequential decline in EBITDA measures and margins.For the full year 2018 revenue totaled $2.5 billion, up 54%, from $1.6 billion in 2017, with the $859 million increase due to 617,000 ton increase in shipping, which is a 31% increase in volumes and due to a $117 per ton, 15% increase in average selling price per ton.Stelco Inc. 2018 adjusted EBITDA improved to a record $544 million, a 152% increase from $216 million in 2017. After adjusting for $73 million of tariff-related costs that we incurred 2018, Stelco Inc. tariff-adjusted EBITDA was a record $617 million. Adjusted EBITDA margin in 2018 was 22% and tariff-adjusted EBITDA margin was 25%, substantial improvement over adjusted EBITDA margins of 13% in 2017.We're in the enviable position of being [ long ] coke production, which contributed to our full year 2018 nonsteel gross profits.In the second half of 2019 and the first half of 2020, we'll be initiating a capital project to rejuvenate a number of our coke ovens. We'll still have adequate coke to meet our internal needs, but we may have less excess coke related products for sale to third parties in 2019 than we had in 2018. By following the rejuvenation of the coke facilities we'll have even more coke for sale starting next year than we had in 2018.Increased sales of other nonsteel products and byproducts are expected to largely offset margin loss on coke-related sales during the coke renovation projects in 2019. We anticipate CapEx related to the coke oven project will be in the range of $35 million to $40 million in 2019 and a similar amount in 2020.That concludes our prepared remarks. And now I'd like to turn the call back over the operator for Q&A. Operator?

[Operator]

[Operator Instructions] We will now take our first question from David Gagliano from BMO Capital Markets.

[David Francis Gagliano, Co]

Looking ahead, I just wanted to do a couple of sort of near-term type of questions first of all just to get them off of -- to check them off the list. On first quarter we've seen prices obviously have come down quite a bit on a 2-month lag basis, just doing the math on my side, it looks like it's about almost CAD 150 per ton decline, again on a 2-month lag basis. So the first question is for the hot-rolled businesses is that a reasonable zip code in terms of change in pricing quarter-over-quarter?

[Alan Kestenbaum, Executive Chairman]

From Q4 to Q1?

[David Francis Gagliano, Co]

Correct, given, at least my understanding is again things are priced on a 2-month lag basis. So I'm Q1 is pretty locked in at this point.

[Alan Kestenbaum, Executive Chairman]

Well, actually, so what we've been is the following, lot of the data out there like the CRU, it references the U.S. market. What you've seen in the U.S. market has been a very significant decline and that we have not seen that type of declining in Canada. A lot of that having to do with the very effective countermeasures that the Canadian government imposed. So what you've seen in terms of decline in the CRU and other published reports, we have not seen that type of decline in Canada. We did see some decline, as you've noted in our Q4, and as we get to Q1 here we're starting to see as a result of a lot of the very positive things going on in the market, whether its cost push, the strong demand, et cetera, pricing started to -- starting to go up. Our lag is closer to 1 month, so what you saw in our Q4 numbers is pretty reflective of those conditions that I described, but importantly the delta between what was -- that had been between the Canadian market and the U.S. market has shrunk in significantly as a result of the U.S. market declining more precipitously and rapidly. But in Canada -- so in Canada, we've not had that that type of decline.

[David Francis Gagliano, Co]

Is there a way to quantify the type of decline that we have had, just so we're calibrated as we get into Q1?

[Alan Kestenbaum, Executive Chairman]

Yes, I mean we don't like to provide pricing information like that. Just on a relative basis you see the CRU, the published information, and what we're saying is and what we've seen is that the pricing did not have that type of decline in Canada.

[David Francis Gagliano, Co]

Okay, all right. And then just to follow-on, it's kind of a two-part unrelated question. I was wondering if you could also comment on mix as we get into 2019. Obviously, 4Q is significantly more weighted towards the hot-rolled coil side. I'm wondering if you could comment on what the expectation should be for, say, first quarter second quarter mix. And then the second question, totally unrelated, completely understand the management transition, it sounds very similar to what you did elsewhere in your prior life. I'm just wondering if you could just comment on the timing, what was the thought process behind the timing of the transition?

[Alan Kestenbaum, Executive Chairman]

Sure. First of all, on the mix. We had planned already for a while, even before the tariffs came into being that this company which had become a predominantly hot-rolled producer was going to change its product mix in order to recapture part of the market we had lost specifically in auto sector. We also, the other thing we identified was that the market here did really not have ample supply of annealed cold-rolled coil, just for our callers that may not be familiar with the difference. We were making full hard cold-rolled, we did not have the capability to make annealed which is basically different tempers which gives the material more properties and many more diverse applications. So we announced when we first took over the company back in the middle of 2017 that we were going to make that change. And that project is nearing completion during this coming quarter. We will at the end of this quarter start shipping some initial products. And we also have some other products that we are working on. But those are the two main ones. And so what the -- and fortunately the timing couldn't have been better because we have the 232 which came in, which makes us want to diversify our product mix more. And so we're able to do that now because we've upgraded the hot-strip mill to be able to produce more grades of auto steel. We have upgraded the galvanized line also to meet more stringent requirements in the auto sector. And cold finishing materials that I have just described. So we're going to see a fairly significant shift in mix to more the value-added products. This year we had a significant increase albeit starting off a low base, but we had a significant increase in auto sales, to the auto sector. We've captured markets from some of the U.S. suppliers that are forced to retreat from this market because of the countermeasures of the duties. And so we've some market share. So our sales into the auto sector both in hot-rolled coil as well as galvanized is going to be increasing. So you will see a mix there, which is higher value-added product. And then the cold-rolled which we expect to get up to in the initial phase to about 200,000 tons which was completely nonexistent before. So you will see a real double benefit from this product shift mix. One, continued reduction in tariffs paid. Two, a higher market share of these value-added products and therefore we should have a double benefit in cost avoidance related to the purchases and the hot-rolled in terms of the tariffs and the other benefit from selling the higher value-added products. In terms of the management changes that we've talked about here. We've been thinking about this for a while. So the CEO's and Chairman's job and especially as we define them here in this company is a very, very hands-on approach. We've completely changed the management team here from the beginning, bringing in new CFO, new Chief Legal Officer, new Chief Operating Officer and really revamped the entire company. And we had David come in as Chief Business Development Officer. We spent the last part of the 1.5 years really fixing operations, getting them to where they are today to a low-cost producer by making these management change and working really, really hard to stabilize these operations here. And now the company is working very well and it's now time for the company to go into its next phase which is the growth phase. And the growth phase as we see it and as I mentioned in some of my comments we're starting to see an increase in M&A potential opportunities. And those require a lot of time and a lot of thought and lot of careful planning. And so we thought the best thing to do at this point being that, I had been working with David very, very closely over the last year in from a management perspective, he knows this company inside and out, he knows what are the key drivers that I and the rest of the board focuses on in terms of keeping the business very agile, big believer and adapter in tactical flexibility, methodology that we have here. And so being here present every single day in Hamilton and being able to focus on the details of the business and freeing me up to go out and find Stelco two, three and four so that we can bolt on to the Stelco business and really grow this business. I believe that we have the balance sheet and the expertise to exponentially grow this business. We're in a very enviable position, we're in a unique position. And the way to do that is really full time focused on that type of growth. So as I've done in the past, been able to both focus on the business, but to do that you really got to have the right pieces in place. People that are dependable, people that can really implement the strategy that we have developed here and the proof is in our numbers. You can see the results that we have. And I look at this as a step forward for the company. This is not a step-down, this is a step forward. And this is a way for the company to really start phase 2 of what had been a long-term plan for the growth of this company. And I'm very pleased that we have been able to reach this stage as successfully as we have and we are expecting to achieve a lot more and having someone dependable, reliable, strong, knowledgeable like David in that seat is going to be -- is going to enable me to be able to go and continue to build this business to the next level.

[Operator]

[Operator Instructions]. We'll now take the next question from Phil Gibbs from KeyBanc.

[Philip Ross Gibbs, Vice President and Equity Research Analyst]

Just had a question on the news from the call here this morning that there is going to be some revitalization of the coke assets. I know you and I had spoken about it a couple of weeks ago and didn't know how soon that may be or if it was going to happen. Maybe just some color on what incremental coke production you could get out of those assets. And it sounds like more of a 2020 timing there. And is the thought behind that wanting to enhance the merchant business or eventually feed Hamilton or both? And then any comments you could also make on Bedrock. It looks like move here to look at the Pointe Noire pellet assets.

[Alan Kestenbaum, Executive Chairman]

So with respect to the coke operations, look, it's clear that it's a good thing to be -- to have coke to feed your operations as we have spoken about before. One of the key points here is the domestic production. And we're not unique here, but domestic producers have an advantage on buying coal compared to all of their overseas seaborne market buyers of coal, which of course is what you produce coke from. So we know that in order to do -- to have flexibility, to increase our business, do whatever, to Hamilton or any other type of increase we want to do, we know we need to have more coke. Being short of coke is a big disadvantage in this market. So we made the decision in terms of capital allocation as a really no-brainer to enhance the coke production. We last year shipped 200,000 tons of merchant coke. Once this is completed, we'll be in position to ship 300,000 of merchant coke or use that coke internally. We'll have that flexibility. Either way, the returns on capital on this is almost a 2-year payback, if not even less if we simply look at the merchant market. And of course it also positions us well to be able to expand production internally here should we chose to do that.

[Philip Ross Gibbs, Vice President and Equity Research Analyst]

And then on Pointe Noire, Alan, anything that you could comment there on a pellet, potential pellet restart in Bedrock's interest and if you see concentrates as pretty widely available in Canada to feed that?

[Alan Kestenbaum, Executive Chairman]

So look, on the -- I think you are referring to the union's announcements that was put out the other day on Pointe Noire, that was the union's announcement. We really don't have much more to say at this point, but we will once we are in position to speak about it, will certainly inform the market fully and comment on all aspects of it. So that was the union's press release that you are referring to and we will absolutely comment on this once we are ready to.

[Operator]

We ended the question-and-answer session. I would now like to turn the conference back to Kestenbaum for any additional or closing remarks.

[Alan Kestenbaum, Executive Chairman]

So in closing, I want to thank all of our stakeholders and workers for producing this record year, and remind everyone that your management team owns a significant amount of stock in this company. And our alignment with you what drives our decision-making, especially when it comes to capital allocation and growth. We are poised financially and from the management perspective for continuation of our operational excellence to continue to deliver outstanding results and growth through both organic and inorganic growth. Thank you all. Have a very good day.

[Operator]

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