Q2 2022 Russel Metals Inc Earnings Call

I.

Good morning ladies and gentlemen and welcome to our second quarter 2022 earnings conference call for Russell Metals. Today's call will be hosted by Mr. Martin Jarefsky, Executive Vice President and Chief Financial Officer and Mr. John Reed, President and Chief Executive Officer for Russell Metals. Today's presentation will be followed by a question and answer period. At that time if you have a question please press star 1 on your telephone keypad.

I will now turn the meeting over to Mr. Martin Jarofsky. Please go ahead Mr. Jarofsky. Great, thank you operator and good morning to everyone. I plan on providing an overview of the Q2 2022 results and if you want to follow along I'll be using the PowerPoint slides as references that are on our website and you can just go to the investor relations section. If you go to page 3 you can read our cautionary statement on forward-looking information.

Before I go into detail on the quarter, let me put a context around a few things.

The strong financial performance that we realized through most of 2021 and the first quarter of 2022 continued into Q2 of 2022. Most importantly, we saw relatively consistent performance and strong performance across our business units. So let's go to page 5 and begin to talk about market conditions.

Steel prices have remained very healthy for the past 18 months or so. As you can see on the left chart, even though there has been some recent price moderation, particularly for sheet and now more recently for plate, the price levels that we realized in Q2 and even the prevailing price levels remain well above historical norms. Over the past two years we've managed our way through a series of supply chain and logistic issues. While those issues are continuing to some degree, they have improved.

The right charts illustrate the recent movements in service center inventories for the industry. Inventory levels in Canada, which is the top right chart, and the U.S., which is the bottom right chart, have edged up a bit over the past few months, but they remain at or below pre-pandemic levels.

The key thing from our viewpoint is demand, as it remains solid across our regions and most of our end markets. We do expect to see some seasonal slowdown in Q3 due to normal vacation schedules, including the construction holiday that occurs in Quebec in late July and early August , but our customer takeaways remain active.

If we go to the financial results on page 6.

From an income statement perspective, we generate a record, quarterly revenues of almost $1.4 billion in Q2 that beat the previous record that was set in Q1. Margins picked up across the board as compared to Q1, with the results being sequential improvements in EBITDA, EBIT and net income. There were two non-cash items of note in Q2 results. The Tri-Mark Joint Venture had an earnings contribution of $8 million.

but it was offset by an $8 million accounting adjustment for the rise in benchmark, interest rates and credit spreads. The net of the two factors was a near zero P&L effect for the quarter. But if we set aside the accounting treatment and look at cash, in July , Tramark declared and paid cumulative preferred and common share dividends to Russell that totaled $14 million.

These dividends will be reflected in our Q3 cash flows.

Stock-based compensation had a mark-to-market recovery of $4 million in Q2 versus nil in Q1.

From a cash flow perspective, we had $72 million increase in working capital and this was driven by an increase in inventory that was due to higher average prices for inbound product and a little bit higher tonnage, some of which arrived right around quarter end. Looking forward, the lag effect from the recent steel price moderation should flow through to our average inventory costs and ultimately our cost of goods sold as we move through Q3. CAPEX of $8 million is consistent with Q1. We are continuing to advance a series of value-added equipment projects over the balance of $22 million.

for an NCIB.

One point of emphasis to illustrate the change that has occurred to our financial profile over a relatively short period of time is that our book value per share is now almost $23 per share as compared to less than $15 per share at the beginning of 2021. Lastly, we have declared a quarterly dividend of $0.38 per share.

On page 7 we have our segmented P&L information.

The service centers continued to do very well. Revenues were almost a billion dollars in Q2 and was driven by good demand in product prices. Tons were comparable to Q1 and average prices were up 6%.

Gross margins moved up 2% to 24%, which translated to very strong gross margin dollars. Bottom line results from our service centers were strong with EBIT of $120 million.

In energy we are continuing to see positive market sentiments. Our energy revenues were up 16% versus Q1, despite what is often a seasonally slower period due to spring break-up in Canada. Gross margins were up 27% versus 25% in Q1. Looking back over the past three quarters, they reflect, the gross margins reflect, the results since the monetization of the OCTG line pipe businesses and you can see how it's translated into higher average margins across the board.

got a few observations. Overall our inventory turns remain strong at around 4, which is solid by historical comparisons as we continue to focus on efficient inventory management, especially in light of volatile market conditions.

By sector, our energy and service centers came down a bit from Q1, but that mostly reflects some unsustainably low inventory levels in certain of our business units that occurred at the end of Q1.

For steel distributors in yellow, the inventory turns declined in Q2 as there was a sizable amount of inventory that arrived near quarter-end. This inventory position should normalize into Q3.

On page 9 you can see the impact of the inventory turns on inventory dollars.

Total inventory picked up to a little over a billion dollars at June 30th from $894 million at March 31st. This was driven by higher product prices, a pickup in business activity in the field store business, and in Western Canada more broadly, and the timing of some inventory that cleared the ports for a distribution business near quarter-end.

As we look forward, I expect there to be some reduction of inventory tonnage as we maintain a proactive approach to managing our volume, as well as the lag effect from the recent price declines that will flow into the average cost of our inventories.

If we go to page 10 you can see the overall impact on capital utilization and returns.

Our capital deployment is up to around $1.5 billion, which is similar to 2018, 2019 and early 2022 levels. However, that capital is being used much more effectively. The portfolio changes that we implemented along with favorable market conditions has resulted in strong returns, which have maintained at around 50%. This level is attractive by historical comparisons as well as versus our competitors.

The other takeaway from this slide is that we look over the past three to four years we've seen a wide range of market conditions. In periods where markets are strong we've generated great returns. In periods where market conditions are more challenged we've generated low returns but we were able to realize substantial free cash flow from working capital.

If we go to page 11 there's a few takeaway observations. 1.Sound loosely if allowed.

On our last call we talked about M&A deal flow. A series of opportunities were evaluated during the quarter, but we remain committed to our criteria and most often the acquisition valuations have not been attractive as compared to internal opportunities.

We've talked about value-added processing equipment projects in the past and we are advancing both smaller projects as well as looking at other opportunities that could lead to modernized regional hubs.

In addition, I mentioned the NCIB earlier on the call and will be completing the filing shortly as I think it makes sense to have flexibility to opportunistically deploy capital through share buybacks.

From an outlook perspective, we see the same macroeconomic headlines as everyone else.

But we actually are positioned very well regardless of market circumstances.

Inflation is top of mind, but we have an operating philosophy that is centered around a variable cost model with high operating flexibility so that we can adapt as market conditions evolve. As the last two years have shown we adapt very well.

Also, an important element of the variable cost model is our variable compensation component. That variable compensation is used across the company and tied to return on net assets.

interest rates have moved up but our drawn debt is all fixed rate and we have a large cash position and no drawings under our bank line.

For the service centers, I already mentioned our inventory metrics, but history has shown that we could generate a lot of free cash flow from working capital in a counter cyclical environment. In energy, we made a lot of changes to that part of our portfolio in 2021, and we are now starting to reap the rewards from the late stage recovery of our field store businesses and from the cash dividends that we are starting to receive from the Tri-Mark joint venture.

In closing, on behalf of John and the other members of the management team, I would like to express our appreciation to everyone within the Russell family. It has been a great first half to 2022 and is a direct result of the strong contributions by our 3,000 plus team members. Operator, that concludes my introductory remarks and you can now open the line for any questions.

Thank you. Thank you. Ladies and gentlemen, we will now begin the question and answer session. Should you have a question, please press the star followed by the one on your touch tone phone. You will hear a three tone prompt acknowledging your request.

If you are using a speakerphone, please lift the handset before pressing any keys.

First question comes from Michael Tupole at TD. Please go ahead.

Thank you. Good morning.

Morning.

Maybe to start, a question on the service centers, tons shipped, which were consistent year over year. What would tons ships have looked like on a same store basis excluding the impact of the void metals acquisition?

Yeah, but.

Boyd metals represents about 10% of our overall volumes. So that's the way to make that adjustment if you want to take that into account Michael

Okay, perfect. Thank you.

And then how do you, maybe to follow on, how do you see the same storage unshipped evolving in the second half? And it's 2023 if you have any visibility on that at this point.

Michael, I think what we see going forward, your normal seasonality will be in Q3, but we see everything moving really on a pretty flat basis. So we think it's pretty stable out there right now. Demand is solid.

So again, outside of your normal seasonality, we don't see a lot of change.

Okay, perfect. So obviously gross margins in the quarter were very strong with steel prices having pulled back as you noted in your outlook. Can you help us think about service center gross margins in the third quarter?

you know, what should those look like given the pullback here?

On the gross margin, you'll go back and...

probably normalize to historical levels during the quarter and then start to rebound as they flush out. And based on the turn number, you should see that flush things flush out in third quarter as long as we don't continue to drift south on pricing.

Okay, so sorry just just so I'm clear John are you saying.

I understand they should moderate, but then edge back up once you've sort of flushed out.

Some of the higher cost inventory, is that the suggestion? Yeah, I think you'll see a modest increase once they flush it all out because you've got people racing to the bottom right now. So we'll flush out as we get through the higher cost inventory. It'll start to move back up just a little bit probably in Q4.

Okay, and normalized run rate margins for that business once we sort of look through all the volatility service center gross margins, is that still kind of in the 22% range or something thereabouts? What is that looking like these days?

Yeah, that's a, Mike, that's a fair order of magnitude and obviously it moves around a little bit, but in the low 20% ranges.

Okay, maybe I can just squeeze one more in here just on. Just one last thing that that's in percentage terms, obviously, in dollar margins. The dollars are higher than they have been historically and probably should continue to be higher than they have been historically just because we're talking about a higher top line.

Right.

Fair enough. Thank you.

And then just, I guess, carrying on with the same type of question, just on gross margins, can you also help us with thoughts on energy products and steel distributors here in the short term? And then I'd also be curious if you could shed a bit of light on…

what you think energy products, normalized gross margins look like given all the changes in the business that have occurred over the last several years.

Why don't I deal with that last question first and then John can talk more of the macro. In terms of energy products...

margins on a normalized basis going forward basis. If you look at the last couple quarters, that is a pretty good reflection of how that business, those businesses should operate now that the OCTG line pipe business has been stripped out. You know, if you looked in the past, you saw a blended margin in the mid teens, give or take, sometimes higher, sometimes lower with a lot of volatility. Now that we stripped out the OCTG line pipe business, which was single digit margins, it brought down the average. And for the last three quarters, we're

the vested business is gone, you see margins in the mid-20s. And so that is the new norm.

Okay, so there wasn't a lot of, you know, you had a lift in service centers due to the pricing environment. That same dynamic wouldn't have been at play to a material degree in energy. And so what we're seeing is actually representative of kind of a normalized market.

Yeah, it was a pretty true reflection of how that business is operating.

Perfect. And then, yeah, if John has any thoughts on the first part there just around, I mean, I think you sort of answered it to an extent with your comments there on energy, but anything further on energy plus steel distributors over the short term here.

I think still distributors will come down. They'll normalize down to more historical levels, but the thing Marty categorized it felt, what you see right now is what you get with the energy side. That was the reason that we pulled away or exited the OCTG line pipe. The volatility was really there. This is more of a service-driven business. I think we've said it in the past, but it looks and feels like our service centers. It's got a little bit higher gross margin profile than that mid-20 range.

Thanks for the time, and I'll get back in the queue. Great. Thanks, Mike.

Thank you. Next question comes from Frederick Bastian at Raymond James. Please go ahead.

Good morning guys.

Hey Fred.

Just wondering, how do your activity levels at the energy products field stores compare to where they might have been in prior peaks of activity?

So you said in prior peaks for it.

Yes.

Yeah, we're still we're it's.

it's down from where prior peaks were. So we've seen obviously an uplift from the trough, but in some ways I'll characterize it, we might be in the middle innings of a nine inning ballgame.

Got it. And, okay, that's helpful.

Thanks for that. Also just curious about your normal course issue a bit. What's driving this decision?

Not counter to intuitive but it seems to go against some of the philosophy of the firm dating back a few years. Maybe I'm off but if I am please correct me. Just wondering what the philosophies are behind that.

Please hold for the next available operator. Thank you for calling Czern. I have the name of the conference you're joining. I would like to join Russell Metel for his call. Thank you. Can I have your first and last name, please?

Yeah, well, the philosophy isn't trying to reconcile the history. It's trying to look at the current. And in the current environment, we've been very fortunate as we've generated a fair amount of cash flow. We have an extremely strong balance sheet, very high liquidity, and we see a disconnect in our share price.

So we think it's appropriate as we look at where our share price is trading at relative to other opportunities to deploy capital. We think it makes good value sense for our shareholders.

Okay, that's all I have. Thanks for your answers.

Great, thanks Rich.

Thank you. Next question is a follow-up from Michael to Palma Tidi. Please go ahead.

Thanks. So maybe just picking up on Fred's last question there. Can you maybe just more broadly talk about the thinking around capital allocation priorities? So, you know, to Fred's point, historically, NCIB hasn't really been, it's been an option, I guess, but you haven't had that sort of a top tier option in the mix. So where does that kind of rank now? And when do you, when do you, under what scenario do you get active with that versus directing capital to other priorities?

Yeah well in some ways I view it less as a what's number one, what's number two, what's number three in terms of priorities. We have a capital structure that gives us flexibility to do multiple things.

And we think it's appropriate to push on a number of levers as it relates to capital allocation. So our priorities haven't really changed. So we're continuing to push on value-added projects, internal investments. We continue to actively look at M&A opportunities externally. We continue to pay our dividend. And now we're also putting in place the NCIB that gives us one other lever to look at.

how to be opportunistic and how to push on the various levers of capital. So for us it's not one or the other or the other, it's we have a lot of flexibility to do whatever makes sense or multiple things in this case that make sense. Going back to my comment before about our liquidity, we've got net debt to invest the capital of about 7% today.

We got $500 million of liquidity. So we could do multiple things right now that make sense for shareholders.

Okay, that makes sense. And on the value add side, just looking at the capex year to date, I think you're at 16 million. Are you still looking at 50 million for the year or has that number maybe come down a bit?

It's a good question, Mike. It's probably come down a little bit. The projects that were embedded in that 50Million dollars are still on the table and are still going to be completed. There's just some timing slippage that rather than they're perhaps being done in the 4th quarter of this year, they'll leak into 2023. But for all intents and purposes, this year's number will probably down from the 50Million, but it doesn't change the specific projects that we have underway other than the timing of them. plastic

Okay, perfect. And maybe one more here. Just jumping back over to the energy product segment.

Okay, perfect. And maybe one more here. Just jumping back over to the energy product segment.

Are you able to comment on what the like for like underlying revenue growth in that business segment was in the second quarter if we exclude any drag?

on sales from the OCTG line by businesses that you've exited or vended into the JV.

We can, I don't have that number in front of me, Mike, but it's up. Let me get back to you with that number. I just don't have it handy.

Okay, and then maybe just just one other part to that, like, when have you fully lapped the divestitures of the businesses you've exited such that.

you know, we wouldn't have to make an adjustment like the one I'm asking about.

for all intents and purposes next quarter. So the joint venture was set up in early July of 2021, and there was still some cleanup of the US OCPG line pipe business, but it was relatively insignificant. So when we look at Q3 this year versus Q3 of 2021, that'll be a fairly cleaner comparison.

Okay, appreciate it. Thank you. Okay, thanks Mike.

Thank you and as a reminder if you have any questions please press star 1 now.

No further questions, you may proceed.

Great, thanks operator. Well, appreciate everybody dialing in. If you have any follow-up questions, please feel free to reach out. Otherwise, we look forward to staying in touch during the balance of the quarter. Take care everybody.

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