Algoma Steel Group Inc. (ASTL) Earnings Call Transcript & Summary

We are right on time, if it's going here. Okay. Perfect. So we're going to get going. So next up is Algoma. Algoma is Canadian-based, U.S.- and Canadian-listed steel producer, sheet steels. Company came into existence in 1901 but has only recently reentered the public domain via lease back in October 2021. I think I got this right. In terms of finished steel volumes, Algoma ranks as the third largest steelmaker in Canada, the only producer of plate steel in Canada, which I'm sure we'll hear more about. In the early stages of a major multiyear transformation, changing from a blast furnace-based steel maker to a mini mill EAF-based steelmaker within its existing operations in Sault Ste. Marie, Ontario. Joining us today is Mike McQuade, CEO of Algoma.

Thanks very much, David, for the introduction. I do want to thank all of you for your interest in Algoma Steel. It is great to see both old and new faces alike, and I have to mention how refreshing it is to see people face-to-face after what's been, really, 2 long years of virtual meetings. It's also refreshing not to have to find the mute button. Let me tell you. So we're very excited to tell the Algoma story and the incredible journey that we're on. By way of background, for those of you who may not know me, I'm Mike McQuade, CEO at Algoma Steel, and I've got over 40 years' experience in the steel industry. Formerly, I was with Stelco and for the past 3 years with Algoma. I've served in varying roles during my career, spanning operations, sales, finance and accounting and served on Algoma's Board of Directors prior to taking over as CEO the beginning of 2019. I have to say, reflecting on the 40-year career, I don't think I've ever, ever been as excited about the prospects for our industry and, more specifically, our company as I am right now. Algoma is in the midst of a transformational journey, building upon a foundation laid over the past few years that is designed to forever change how steel is manufactured in Sault Ste. Marie, making us both greener and more efficient. Over the past several quarters, Algoma has generated record earnings and free cash, delevered the balance sheet and is now well capitalized and well positioned to execute on our strategy. Our team is focused both operationally and financially on our transformation to make the business greener, more competitive, more resilient across the steel cycle with substantial reduction in our carbon footprint. We expect that our new strategic direction, coupled with our pristine balance sheet and access to government funding that I will discuss later, will position us for continued success, creating a compelling value proposition for investors. Now let's get on to the story of who we are and what we do at Algoma Steel. For over 120 years, we've been producing steel in Sault Ste. Marie. Today, we're a premier low-cost producer of flat-rolled steel products, including sheet products and more importantly, we are the only Canadian plate producer of heat-treated and as-rolled discrete plate products. We're geographically advantaged with our location at the heart of the Great Lakes where we have access to multimodal transportation, including lake freighters, barge, rail and truck. Turning to Slide 4. Here you can see how our strategic location gives us convenient access to our customers, our major raw material suppliers and the major industrial hubs around the Great Lakes, which support both our current and future operations. Algoma's operations are a major economic driver of our community. And with that comes a sense of pride and responsibility amongst our workforce and community to uphold the legacy of over a century of proud steelmakers and to preserve that opportunity for generations of steelmakers to come. A quick side note. Recently, in true Canadian fashion, I found myself at the local hockey arena, taking in a Soo Greyhound (sic) [ Soo Greyhounds ] game, it's our local junior hockey club, and was with some of our employees and pleasantly surprised to meet and have the opportunity to meet a fifth generation steel worker family for Algoma Steel. The significance of this is that Algoma Steel has been, and still is, very much a part of the fabric of Northern Ontario and especially Sault Ste. Marie. It's important that we protect it, and the best way to do that is to make sure that the business is foundationally sound and positioned for future success. A busy slide, but it's the building blocks that we're going to continue to add to. Here on Slide 5, we highlight the foundation that we have built over the last few years that position us to fundamentally transform our business. We've identified these into 4 strategic buckets. You can see here on the left, that we feel will contribute significant value creation for the business over both the short and long term. And you will see we're in the enviable position of realizing the benefits today of strong markets while simultaneously investing for an even stronger future. Our first area of strategic focus is on investing in our business through a combination of operational and capital improvements. Over the past 3 years, we have spent or committed over $200 million on growth CapEx. This impressive level of reinvestment in the business includes capital improvements and enhancements to our Direct Strip Production Complex, a technologically advanced, advanced mill for manufacturing hot-rolled coil. We have built a second ladle metallurgy furnace, and we are currently upgrading our plate mill. The plate mill investment will continue to modernize our facility and allow us to pursue markets that are currently served by offshore producers due to Algoma's current capability and capacity constraints. We've also embarked on a number of efficiency projects designed to improve our internal performance and reduce our reliance on third-party contractors. Collectively, our focus is on maintaining and improving our position as a low-cost producer. The next major project we have already undertaken is our decision to transform to electric arc furnace production. I'm excited to tell you much more about this in a few minutes. The next area of strategic focus is practicing strict financial discipline. We have an extremely strong balance sheet following a very busy 2021. Our return to the public markets in October injected USD 306 million of equity. And with the addition of cash generated from operations, we were able to pay down all of our senior secured debt in November, leaving us with a net cash position of approximately CAD 500 million as at December 31. Furthermore, we have additional liquidity via our undrawn ABL as well as $420 million of committed financing from the federal government to support the construction of our EAF project. This balance sheet provides Algoma with options and has afforded us the opportunity to commence a capital allocation program, which includes a regular quarterly dividend and the initiation of a normal course issuer bid program that gives us the flexibility to be opportunistic and allow for the purchase of shares in the open market from time to time. We see these 2 pieces as first steps in deploying capital that we have, not spending cash that we don't have or expect to realize some day, while maintaining the agility to pursue investments, whether it be in our own stock or other strategic avenues that will be accretive in value for shareholders. We will continue to evaluate all of the allocation options through a lens of financial discipline with the ultimate goal of returning maximum value to shareholders with a long-term horizon. Our third area of focus is strategic partnerships. We continually look for opportunities that can help further derisk the business, whether it be major raw material suppliers like iron ore, scrap or coke or longer-term initiatives to secure electricity for our EAF project. We constantly work to expand our partner base and look to align ourselves with like-minded companies, allowing us to create win-win strategic partnerships. As I mentioned earlier, the strategic focus of derisking the overall business also forms part of our capital allocation decision matrix as we constantly assess potential partners against the backdrop of current market conditions. Our last-but-certainly-not-least strategic focus is our commitment to ESG initiatives, geared to driving performance, reducing risk and developing a culture of organizational excellence. It all starts with safety. It's our #1 priority and the first topic we discuss on each of our earnings calls. Paramount to Algoma success are its people. And nothing, nothing conveys to the employees and their families, their importance to our business than ensuring that each and every one of them go home safe and sound at the end of every shift. Calendar '21 was Algoma's safest year ever. Something we'd be proud of for sure. However, we will relentlessly pursue our goal of 0 workplace injuries. Since our return to public markets in October of '21, we have a newly constituted Board, which brings diversity of skill and thought and a mandate of strong governance. These leaders bring exemplary experience with background spanning the steel, construction and automotive industries, all complementary fits with our business. Collectively, it's these building blocks which have formed a foundation that allow us to continue building on our track record of success. Now let's get to the financial details on Slide 6. We show here the tangible results we have achieved, including record revenue, earnings and free cash flow in consecutive quarters. We again demonstrated the cash generation capabilities of our company, helping to position us to make the capital allocation moves I discussed previously. Strong markets certainly support these results. However, we continue to look forward to what's next, and we will continue to add blocks to the foundation that we have built to date. Our fiscal third quarter included achieving a number of major milestones, including our return to the public markets, the retirement of all of our senior secured debt and the formal decision to proceed with our transformative EAF development project. So let me dive now into why we're so excited about the EAF project. The project entails dual furnaces that are designed for a combined annual raw steel production throughput of 3.7 million tons, matching our downstream finishing capacity that is currently underutilized while simultaneously lowering our carbon emissions by approximately 70% when fully operational. This level of CO2 reduction would represent 11% of the entire federal government and 100% of the provincial government's 2030 targets for industrial emitters, as set forth under the Paris Accord, something we are particularly proud of. We expect to have lower conversion costs, more nimble operations and a significant reduction in earnings volatility. And importantly, as we secure additional power in the future by partnering with the province, we will have the opportunity to move entirely to electric arc steel production, further unlocking value to all of our stakeholders. We expect that our environmental profile across the spectrum will significantly improve. And with the low-carbon nature of the Ontario Power Grid, this will transform us to being one of the leading producers of green steel in North America, significantly improving our ESG profile and reducing exposure to carbon pricing as stringency and pricing inevitably increase. We view this as a major competitive advantage relative to other steel producers and another contributor to long-term value. And a quick word on financing for this project. I'll show you the construction plan and update. With the strength of our balance sheet and the government support, which is a redistribution of the funds from the price on carbon that is in place in Canada, we have the capacity to completely fund 100% of the project costs, which include a significant budgeted contingency. So you can understand why we're so excited about this project. Project work is underway, on time and on budget. We have partnered with a global leader in Danieli to supply the EAF technology. And the long lead time equipment has been ordered and is currently being fabricated. Piling and foundation work is underway, and we expect the 2 EAFs to come online in 2024, following a 30-month construction phase. This will be followed by a continued transition away from blast furnace steel production as increased power supply becomes available from the grid with the support of the provincial government. Locally, the Public Utilities Commission is commencing the process to build a local 230 kV power line to service our new furnaces, and GE has been contracted to provide 2 gas turbines and overhaul our 110-megawatt combined cycle power plant. As you can see in the photo, we're fortunate to have the footprint, allowing the construction of the facility and bringing it online over the next 30 months and achieved without disrupting production to our current facilities as we continue to safely operate in and benefit from a favorable steel market and pricing environment. This project will fundamentally transform who we are and how we operate, positioning the company as a next-generation steelmaker, focused on sustainability and poised to be successful across all phases of the steel market. We're proud of what we've accomplished and are focused on the future, entering a phase centered on new project development and construction with the dual EAF furnaces. Our team is focused both operationally and financially on this critical investment to make our business greener, more competitive and more resilient. We expect our strategic direction, including this transformation, will create a compelling value proposition for all of our stakeholders and a compelling investment opportunity for the long term. Thanks very much for your attendance here today and your interest in Algoma Steel. I look forward to any questions you may have.

All right. Thanks very much for the informative presentation. Just to cut to one of the questions that we get a lot here. I'm just going to give some numbers out. I'm not going to ask you to validate them, but maybe you can if you want. Current cash position, $588 million on our numbers; free cash flow, $526 million, roughly $500 million, 28% free cash flow yield. Current cash position is 43% of the total enterprise value of the company last I checked, something like that, with a lot of cash coming, well financed with government support. So a lot of the question early stages is what you talked about on capital returns. Can you speak a little more to how Algoma will balance the longer-term strategic financing with near-term capital returns to shareholders?

Sure, David. Thank you. And it is -- it's a very common question in the meetings we've been taking and calls from investors. It's only been 4.5 months since we did return to the public markets, less than 20 weeks that have just flown by. During that time, we have, as I said, taken a lot of calls with investors, not the least of which is our historical investors in Algoma, the former senior secured debt holders, and they've been with us for more than 7 years, and they recognize the value. There's no doubt that they recognize the value and the conversion to electric arc. Their resounding message is they believe in that value proposition for us, and that is the use of EAF technology to reduce the cost, sustainability across the cycle and reduce our CO2 emissions. They understand the $85 million to be spent in the balance of this year on our plate mill operation to displace that 40%. The way we approach it is really through a more traditional SWOT analysis. So if we think about it building on the strengths of Algoma steel, investing in the plate mill is the only Canadian plate producer. When we think about the price on carbon in Canada and the potential for it to grow significantly, certainly a threat to the business. So eliminating 70% of our CO2, again, addresses that threat, but it also provides an opportunity as we move across that SWOT spectrum and the opportunity to be a low-carbon supplier to the marketplace. And we're starting to see the inquiries with respect to carbon intensity and certainly believe that we will put ourselves at the forefront of being the supplier of choice. And then we think about, finally, the weaknesses in the business, and there's been a lot of talk about the availability of scrap. I prefer to think about it as iron units as opposed to scrap versus and do believe that there's going to be a natural transformation, a supply-demand balance that's going to pull iron units, whether it's from a blast furnace pellet into a DRI/HBI or pig iron form. The supply-demand of the ever-changing dynamic with respect to EAFs versus BOFs is going to look at that. So where we would be focused principally is on iron units. As you know, we've announced the establishment of a joint venture with Triple M, a major scrap supplier for us, but we would look again through the lens of that SWOT analysis and think very seriously about iron units as we migrate over the next 30 months and then the following year as we commission the facility for those prime iron units that we would need. And that's the -- really, what we're looking for is value creation long term.

It's a good answer. So the question on the iron units, which is some new commentary from my perspective, would that include an investment, say, for example, in a DRI facility or something like that?

Quite possibly. As I say, we would look at securing iron ore -- sorry, iron units in some form or another. We think about the scrap, and again, I think folks are really focused on prime scrap. There is a surplus of scrap. We're in the heavier end of hot roll for automotive, really, frame parts in the plate mill. It's actually conducive to nonprime scraps. So we aren't as exposed as if we were in cold roll coated auto-exposed panels as an example. So our demand for prime is less than what many might think, number one, but we would look to expand, whether it's through scrap with our joint venture or whether it's in pigging operations, DRI/HBI, partnering with somebody, those are all things, as I say. We're 20 weeks into this. We're becoming, I guess, known once again, having been around for 120 years, lots of inbounds. So we're through a very disciplined approach, again, of only looking at the cash that we have, not that we might have or are going to have. And I think the other point that I would make and have made quite regularly is we have worked extremely hard, extremely hard to get that balance sheet to the position it's in, and we'll protect that. There have been far too many CCAA's Chapter 11 equivalents in Ontario that we -- and not exclusively but very much centered around debt, more debt, more expensive debt and ultimately. So we will be very, very judicious on behalf of our shareholders with the balance sheet and the business.

Okay. That's helpful. Two questions from the app here. Coming back to the -- from the strategic back to the cyclical in the here and now. We've gotten some mixed messages from some of the steel companies in terms of current market conditions, and I was wondering if you could just share what you're seeing in your order books and the market where you are.

I'm in the bullish camp. I won't put a pin in a price, but I do believe that the fundamentals, and I go back to supply-demand, will have us with -- notwithstanding some headwinds perhaps right now and maybe some tailwinds with pricing in Europe, but overall, I look at supply-demand fundamentals. Capacity utilization, relatively high. I think the offshore pricing and availability of the offshore steel is limited and more attractive to stay-in-home markets. I think there's been some consolidation that's been beneficial. I think there's a number of factors domestically. I also believe that carbon is going to play a significant role. I think governments on both sides of the Canada-U.S. border, very much focused on a carbon border adjustment, and we'll call it level of playing field, particularly important in Canada where there is a price on carbon, and I see that as a means -- imported steel carries 3 to 6x the carbon content of a domestically produced ton of steel. So if you're in North America consuming steel, the greenest option is to make it here, and that carbon border adjustment is going to be absolutely essential. The fact that the government is aware of it, having conversations with the steel company, I think, bodes extremely well for the fact that there will be a level playing field, and that will be supportive of a very strong and healthy North American steel market.

Okay. Just in the near term, are your customers, generally speaking, destocking or starting to restock? Are you seeing any change there?

They have been destocking, and it's obviously very dynamic with news each and every day. What I think they're looking for, again, in the service centers, as they're watching that decline in the price, they're looking for it to decelerate. It will be a curve and as it decelerates, and they are on the low end of their historical average. I think December numbers were probably in the mid-60s in terms of days of inventory. 75% to 90% might be a more reflective number. So they'll destock. I don't think they want to get down to the low 30s where they were during long lead times of 14 and 16 weeks, but I do believe that they'll look very closely, and then you'll see that curve start to decelerate or the fall start to decelerate. That will start to extend the lead -- sorry, they'll expand their order book, start to at least stop the destocking or slow the destocking, start to get into restocking, and we'll see that bottom. And they'll look for stability and then get back to trying to establish a more norm. So...

Okay. And just another one from the app here. Percentage of production that's commodity-grade hot rolled versus actually galvanized, cold rolled and then also plate.

So we are, let's see, somewhere in the 10% cold roll. Our plate represents probably another 15%. Balance would be in the hot rolled coil.

Okay. And then just on the -- sorry, I had another one then. It disappeared on me here. But just -- sorry, coming back to the strategic side. So one of the things that's, in my view, perhaps, overlooked is the derisking element associated with operating the blast furnace as the EAFs are coming on. If you could just speak to what the plan is in terms of operating the blast furnace during the transition period and also iron ore sourcing post the expiration of the contract with Cliffs.

The iron ore contracts are in place through the end of 2024, and with the winter season build, we'll be into 2025. That's the iron ore contracts. We'll operate the blast furnace, and combining the local electricity grid with our 110-megawatt cogen capability, we'll be able to produce what we do right now, and we'll use up to a 40% hot metal charge. So we will be scaling back the blast furnace. It will involve some modifications requiring reducing the [ tower ] size and the like, but we will have up to about a 40% charge for that hot metal until the electricity grid is upgraded. Electricity grid has to be thought of in 2 pieces, the local leg of about, I will call it, 10 miles of 230 kV service into the plant that will afford us electricity on an uninterruptible basis; and then the provincial upgrade across the province, either coming from East from Sudbury or north from Wawa, to bring electricity 230 kV service on an uninterrupted basis to Sault Ste. Marie. So we'll continue to operate the blast furnace. While we are in the second half of the useful life of #7 blast furnace, as measured in kind of tons across the hearth, there's still life in that furnace and, in fact, as we slow down the production, fewer tons across the hearth. So we're confident that we'll have this transition. And really, that hot metal is going to provide the prime iron units and virgin iron and also be less dependent on electricity until it's available at scale through the upgrade of the province.

Okay. That's helpful. Thanks very much, and with that, we've got to wrap it up. Thanks.

Thank you.