Commercial Metals Company (CMC) Earnings Call Transcript & Summary

Hey, good day, everyone. This is Timna Tanners. I cover metals and mining for Bank of America. I'm delighted to welcome you to the conference, and if you've been following along so far, thank you for your attention and for understanding our situation with this virtual conference. We're sorry to have missed you in Miami this year. And hopefully, this will be our one and only virtual conference. If you do have any issues, feel free to reach out to us. I am delighted to introduce, at this time, Commercial Metals to our conference. We have with us the Chairman, President and Chief Executive Officer, Barbara Smith; plus the Vice President and Chief Financial Officer, Paul Lawrence. There are slides up on the website. If you followed with us, you've seen that you can control the slides, they will not move automatically. And with that, I will turn the call over to management to begin the discussion.

Thank you, Timna, and thank you for holding this conference. It's been a long dry spell since we've had the opportunity to interact other than by phone. So it's been going well for us today. I thought I might make a few comments about the company for those that may not be as familiar with Commercial Metals. And I'm not going to go slide by slide to the slides that are posted that you can certainly go through those at your leisure. Commercial Metals, just as a reminder, is the leader in concrete reinforcement. We're a highly focused producer of long steel products. We're the #1 producer of rebar in the U.S. and Poland. And we believe we're serving some of the best economies in the world in Eastern Europe. And then up until the virus, the U.S. economy was also really, really strong, and we look forward to the economy recovering as we begin to open up. In addition to being a leader in rebar, we also are a significant player in merchant bar markets, and we are a company known for innovation. We have a highly flexible, low-cost operations. We've led some of the latest innovations in technology, being the first to build the latest micro mill technology in Mesa, Arizona 10 years ago and followed that with our second micro mill a couple of years ago in Oklahoma. We also have a long history of being in the downstream fabrication business, which provides significant demand pull for our mill operations. It connects us to the end customer, and we'll talk later about how that also allows us to buffer any economic cycles because we operate it off of a backlog, and entering this COVID pandemic, we had a very healthy backlog and that is supporting us through this period of time, and we think it will continue to support us going forward. Over time, we have completely repositioned the business. If you know the company has been around for over 100 years. We have been going through a portfolio rationalization in the last several years and more recently, completed a significant acquisition, which allowed us to gain that #1 market position in rebar. That acquisition was concluded a couple of years ago and the integration was nearly flawless. The synergies far exceeded our expectations. And again, today, that puts us in a really strong position as that leader in concrete reinforcement. We do -- we are very proud of our balance sheet. Following the acquisition, we had a stated strategy to delever and we have completed those actions. And so we find ourselves with a very strong balance sheet, strong cash flow generation, good cash flow on the balance sheet, tremendous amount of liquidity, which will give us lots of flexibility going forward. Our business model is we operate in a vertically integrated fashion. As I mentioned earlier about fabrication, but we support our mills with upstream recycling. All of our processes, our electric arc furnace that we -- everything is made from recycled content. And so we source a lot of our need from our own recycling operations that supports our mill raw material. And then our mills support our fabrication business with their raw material need, which is essentially rebar. If you look at our geographic footprint in the United States, with the acquisition, we have a very broad geographic footprint covering most of the key markets in the U.S. And we do have significant coverage in the largest consuming states and the states which have been -- has the largest growth in population and economic activity in the last number of years. We are headquartered in Texas, and Texas has been a real pro business state and has seen a lot of economic growth, and we think that again, that's something that's going to carry us forward into the future. I guess I'll make a comment or 2 about Poland as well. Poland has been a great success story for the company. It's a similar business model. We do have raw material sourcing, the mill and fabrication. It's been a good growth market, one of the best growth markets in Europe. We continue to see really strong activity even through the pandemic, construction activity supported by a lot of infrastructure development that has been ongoing in that region has also helped us through the current environment. So maybe there, I'll pause and we can open it up to questions, which are probably what's most relevant to folks on the phone.

Okay. Thanks, Barbara. For those of you tuned in, please feel free to also ask questions. I've got a bunch. So as you know, I've been concerned about excess supply in the industry. But as you point out, you are definitely a reinforced bar-focused company and it's quite a different market. But did want to ask a little bit more about some of the more recent market conditions. One thing that's come up is the fact that scrap prices have been on the rise even as steel demand has been weaker. And there's reasons for that, right? The availability of scrap has shrunk along with demand. But has the long products market or rebar been more successful in passing through those prices? And can you talk a little bit about why the rebar market can be more resilient maybe than other products?

Yes. As you know, Timna, if you've studied this market for a long time, we really focus in on metal margin, which is selling price less the cost of raw material. And as you also know, in our end markets, rebar, in particular, we have the ability to adjust prices based upon changes in raw material prices. So we don't typically enter into those long-term supply agreements that you might see on automotives or the aerospace side. So we have more ability to pass through the raw material price changes. And I think the other thing that you've seen over the last number of years, rebar prices and margins, metal margins have been much more consistent and stable. And then since the acquisition, they have been more stable at elevated levels, which is really the intended consequence of that consolidation. And I think it proves out the thesis that a more consolidated market is more stable and more rational. And so yes, as you point out, when the country went into the shelter-in-place and you saw some pullback in manufacturing activity, that, of course, made the demand for scrap, it lowered the demand for scrap even though we were -- we have been operating really without interruption since the pandemic began. But other steel companies have been affected. And there have been a number of announcements where folks have shuttered capacity, either permanently or temporarily, which has reduced the demand for scrap. Now in the last couple of weeks, scrap prices have been moving higher. And naturally, in this time of year, which is the busy season, you would naturally see scrap prices move higher. But in this case, I think it's a result of states beginning to open up and manufacturing activity beginning to come back to life. Having said that, you still do have quite a bit of capacity that's shuttered. So it's causing some imbalances where -- but it depends on the type of scrap that you need to source. Certainly, industrial scrap is in less plentiful supply at the moment. We consume obsolete grades so that's of lesser consequence to us. But we also have had the ability to adjust our selling prices to take into account those fluctuations. And in fact, in the more recent shifts when the scrap prices moved down, we didn't have to give back all of that scrap price reduction to the market, which allowed us to see some improvement in our margins. We'll see what happens now that scrap's moving higher, but I would anticipate a fairly stable metal margin like we've seen for the last 12, 18 months, even longer.

That's a good point that rebar prices didn't really have the same decline as other products even when scrap did go lower. And I think for some people who are newer to the space, there's not the same awareness but you can't just flip a switch and go from rebar to sheet. So the rebar producers in the U.S. are consolidated, like you said, after you bought some Gerdau's assets and now there's fewer producers. So that tightens things a bit. And then just to wrap up that side, the supply side though, you really aren't seeing as many imports. Is that -- is there a risk that the global market's shaking up a bit under COVID-19 that imports could come back? Or do you think that the different tariffs and measures are in place to kind of protect the U.S. market?

I do think the measures and the policy of this administration has been quite effective. And as you know, that's definitely created a more level playing field for us, and we've taken advantage of that and benefited from it. We are always monitoring imports, Timna, and looking for situations where we might see offers that could cause some kind of interruption to the market here. But so far, those have been really minor in nature. It does fluctuate month-to-month, but we haven't seen any big influx like maybe has been seen in other products. So we do monitor it carefully, and we think the trade measures that are in place are helpful. And right now, there's no discussion of those being eliminated at this point in time. I would further add that there is also have been some changes to the trade regulations and administration of our existing trade laws that should create a better environment going forward. And one example, we also are watching the dollar and a strong dollar could be one factor that would attract imports to the U.S. market. But we also know that many of these countries manipulate their currencies so we watch that really carefully, and Commerce has been very keen to take action if they see abuses like currency manipulation or circumvention. We filed against Mexico for a circumvention situation. The commerce department has agreed with us. We're waiting for the sunset review to see what sort of consequence is going to result from that. So for now, most of our customers do not see enough incentive to take the risk on imports, and it's at a manageable level and we expect it to stay that way for the foreseeable future but always with an eye on it.

Sure. And even in the North American market, it's just not the same extent of new product or new capacity coming on. But I did want to ask about some of the increases recently from Steel Dynamics and Nucor, including I think coiled product, which had been something that you had touted as being unique. So just curious if you've seen much of that product in the market, or if you think that there's still not an excess amount of supply of that.

Yes. So I'll separate the Steel Dynamics capacity addition from the Nucor. And I would characterize what Steel Dynamics did was the debottlenecking to take advantage of some excess melt and then they took that downstream into rebar. They're a very much a regional player and concentrated in the northeast region. While we are up in the northeast, that's not one of our largest markets. And that capacity has filtered into the market with really very little disruption. They did put a spooler in as well. And there is a differentiator between coiled and spooled. Spooled is a superior product to coiled. And there is another differentiating factor between our spooled product and the product that SDI introduced. And that is because we run rebar in a continuous fashion in Oklahoma and Arizona, our spools can be of any size that the customer can accept. So our spools are much larger so they do create additional efficiencies for the fabricator, fewer changeovers, even better yield. So -- and in that regard, again, it's really an adoption rate story for downstream fabrication. And we are seeing really, really positive responses to that product in the market and the adoption rate. We are using a tremendous amount of the spooled product in our own fabricating operations. It facilitates further automation and fabrication. There are so many benefits in terms of safety and, as I mentioned, yield savings, productivity savings and changeover efficiencies, all of those types of things. So everyone that is using that product has really appreciate it. With regard to Nucor's 2 micro mill projects, as you can appreciate, one is they started commissioning Sedalia earlier this year. We are not seeing too much of that in the marketplace. But when they announced that mill, we had our own commercial strategy, and it's not our objective to create a war with Nucor over whatever market they're targeting. So they've carved out their space, we've carved out our space. And their stated objective is to lower their cost, and improve the cost structure for their overall portfolio and to reconfigure some of their existing capacity to other products. So if they stay true to their stated strategy, I would expect that product to be absorbed into the marketplace without significant disruption as well. As a reminder, these micro mills are small regional mills. They're 350,000 tons of capacity as contrasted to 1 million tons, 2 million ton flat roll or plate mills. And so the ability to be absorbed in the market is much easier with the micro mill than it is -- I should remind you, when we started up Arizona, it was 2009 at the height of the global recession. And nobody really talks about that having been incredibly disruptive at the time. It just trickled into the market and the product was so good and so such higher quality that it's been a tremendous success story for us, as you know.

That's a good point. The definition of a micro mill, right, doesn't sound as daunting so and that's fair. Just to round out the supply side discussion though, if I could. Just -- can you just over go over how, if demand is worse than you expect or if you need it to, is it very difficult to ramp up or ramp down your operations? I know, obviously, it's more difficult for a blast furnace. But can we talk a little bit about the fixed cost hit, or how to think about any changes in volume on your margins?

Yes. Thank you for that. And maybe I'll go back. We have -- I didn't address COVID and you didn't bring it up. So let me just say when the virus hit, our first priority was to protect our people and our operations. And so I think we were very early in terms of responding and taking steps to make changes in our operations to keep our employees safe and to work in a different fashion, whether that was distancing, more sanitation, personal protective equipment. We did a lot of quarantining in March when individuals were traveling for spring break and just out of an abundance of caution. And as a result, we've had really minimal disruptions to our operations in terms of infections. And we've also been operating. We were largely unaffected in the month of March, started to see a little bit of effects in April but more on the value-added products because of some manufacturing plants going down and then service centers destocking. But on the construction side, we have seen very little disruption, whether it's job sites or our own internal operations. But to your point, as you know, electric arc furnace is incredibly flexible in terms of adjusting supply to demand. And as we look forward and whatever is going to happen in terms of the markets, and I don't think anybody has good clarity at this time, certainly, we will make whatever the necessary adjustments are in terms of adjusting supply to demand. And I would point out before the pandemic that we made a decision, and this is again a result of the acquisition and the flexibility that we have now with our larger footprint, we took the decision to shutter the melt shop in California, which was our highest-cost melt shop. You can appreciate that the regulatory environment in California makes it less attractive from a cost perspective to operate there. So we shuttered that melt shop, and we've been supplying the California operations with billet from our existing melt shops, and we get very efficient rail rates out there. And net-net, it's a cost benefit. So going forward, we have so much flexibility now that we didn't have prior to the acquisition to service our customers from a variety of our mills. And that again plays to balancing supply and demand. We also have product mix changes that we can make depending on if one market is stronger than another market. So I'm really confident going forward that in the consolidated nature and the fact that we're 100% electric arc furnace and with our very broad geographic footprint now that we have a lot of flexibility. And as you know, we're only about 25% fixed cost if you exclude scrap. And I'm just talking about manufacturing cost. And so that's a quite different formula than if you're a blast furnace type operation.

Okay. Great. Let's talk a little bit more then about the demand side, if we could. I find that construction is the biggest end market in general for steel. And our contacts in the mills are saying that it's holding up better obviously than energy or automotive where you've had a really distinct drop off. But I'm hearing different views on the outlook for construction. One third-party forecast called for a decline of construction spending in the U.S. by 11% year-over-year. That's the only forecast I've seen. And then some of the mills are saying they haven't seen anything, some are saying small impact. So just wondered if you could tell us what you would expect and a little bit of maybe the regional color from where you operate.

Yes, thank you. It's a great question. Everybody is trying to find some clarity in the end market demand and we're no different. What I can say is the following is, first of all, if you look at just the unemployment rate and a 10% decline or 11% decline in construction is pretty small in comparison to the shock that we just put our economy through. Having said that, we are not seeing that kind of degradation at this stage. And I would be unable to make any firm predictions at this point as to where things will head from here. Certainly, we're watching all of the indicators and we'll make adjustments as we see things change. But we entered the -- this pandemic with backlogs that were really at record levels. As you know, the economy was going strong, and construction was generally strong broadly across the U.S. and similar -- we found ourselves in a similar situation in Poland. And so that really healthy backlog, high-priced backlog is what we're servicing right now. And that is going to continue to serve us well in the coming months as the economy restarts, and we can get a better handle on where demand is going in the future. And that backlog has a very long duration. There are some projects in there that are 6 months, but there are some projects in there that are 2- and 3-year projects. The other thing we monitor carefully, Timna, is the bidding and booking activity, and we're watching that carefully for any warning signs. I can say at this point, there have been no major cancellations of projects that are in our backlog or projects that were on the drawing board. We are seeing -- we are still seeing good projects to bid on and we have booked some attractive projects recently. So those are encouraging signs, but that's the area that we will monitor carefully to see if there's any change in behavior. I think other fact patterns to follow and to monitor that I think are maybe helpful to the construction sector is, first of all, interest rates are very, very low, so that's helpful to construction activity and funding of projects. I also believe that there is going to be a reconfiguring of the supply chain over time. And the -- a number of important supply chains will be brought back, things that we found ourselves short of, and that will no-doubtedly spur construction activity, whether it's pharmaceuticals or other personal protective equipment, what have you. But I think everybody is going to rethink supply chains, and I would expect a resurgence of manufacturing activity in the U.S. as a result of that. And I think that there will be some help out of Washington to encourage that, so that they designate some of these industries as critical to national security. And so I think that's a positive factor. And you and I have been talking about infrastructure as long as we've known each other, so I'm not going to predict an infrastructure bill. But I will say the following: it is one of the few tools remaining in the toolkit of Washington to stimulate the economy if the shock from this pandemic is more than what we can stand. And so I personally don't believe there will be anything resolved before the upcoming election. But I do think that whether it's some assistance for revenue shortfalls in states or reauthorization of the existing FAST Act or the even bigger silver lining of a more comprehensive infrastructure bill, I do think that it is on the radar and it is something that will happen. It's just really a question of what form will it take. And I think you asked earlier and I didn't answer it but some of the regional trends that we see, I do think that we are positioned in states that have had great economic activity and have been the beneficiary of population migration and businesses moving to other business-friendly states. You know the story in Texas quite well. I do think those trends will continue, whether there's a pause as it relates to the pandemic, it's a little too soon to make any real judgments about that. But I do think that we are positioned really well to take advantage of those broader trends that I think will continue. So I'm very, frankly, optimistic near term because we have a strong and healthy backlog, and we have a strong balance sheet and whatever bump in the road may come in the coming months, we're going to weather it much better than other sectors that you pointed out. And then I'm very optimistic in the medium to long term with all these other broader trends.

Okay. We -- that was very thorough and helpful response, but I only see 2 minutes left and I wanted to ask a couple of things. So there were some questions from those of you on the webcast. And one is about states, which I think we just touched on. The other is about North America market going fully EAF, and I guess we should just point out that rebar is pretty much fully EAF already. So the other products you don't make and that's a debate for another time. But if I could, Barbara, I feel like we should definitely touch on 1 big distinguishing factor that I see for Commercial Metals this year, which is your free cash flow and balance sheet. Can you just, in the last minute we have here, just touch on how you're different from peers there?

Yes. Thank you, Timna. Well, as you know, when we made the acquisition of Gerdau, we were very aggressive to delever our balance sheet and we had commitments to do that. We completed that before the -- this all hit. We've been accumulating cash on the balance sheet. That has continued, in fact, throughout this pandemic. If there is a disruption in demand, we will experience a significant working capital relief that will just enhance our situation. So we believe we're prepared to weather anything that may come at us. And we, in fact, believe we have the flexibility to explore interesting opportunities if they were to present themselves as well.

Okay. Well, with that teaser of what you might explore, I guess I'll have to end. But thank you so much, Barbara and Paul. We really appreciate you supporting the conference, and we really hope everyone stays healthy and look forward to seeing you next year in Barcelona.

Thank you, Timna. And there's nothing imminent on the horizon but having flexibility in your balance sheet is a great thing. So it was great to hear your voice. Look forward to seeing you soon.

Thank you.