Commercial Metals Company (CMC) Earnings Call Transcript & Summary

Good day, everyone. This is Timna Tanners, Americas metals and mining analyst with Bank of America Securities. It is my distinct pleasure to welcome our next group, which is Commercial Metals. We have with us the President and CEO, Barbara Smith; we have Vice President and CFO, Paul Lawrence; and we have IR, Jason Brocious, joining us. The format for this presentation is going to be a bit of a hybrid with a short presentation, followed by some Q&A. Of course, feel free to present your questions through us through the Veracast tool, and I'll be happy to ask them. Now at this point, I'll hand over to Barbara for the presentation. Thanks.

Thank you, Timna, and thank you, everyone, for participating in this afternoon's presentation. I will dispense with the reading of the cautionary statements, and assume that you all are quite familiar with that. And I'll make a few brief remarks. We've selected a few slides from our investor presentation, but I do encourage you to go to our website and look at the full presentation when you have an opportunity. This first slide gives you an overview of the company, looking at our geographic presence, which we are primarily located in the U.S. and in Poland. And in Poland, serving the Eastern European market as well as Germany, Scandinavia and neighboring countries to Poland. In the U.S., we span the entire geography in terms of our operations, with the ability to reach the states that are shaded where we don't have any physical operations. We are organized with 2 segments, North America and Europe. And within that, we operate a vertical integrated system, which I'll talk more about in a few slides, but we do secure our raw materials through our recycling operations, which support our mill operations. And our mill operations then further support our downstream fabricating business. On the right-hand side, you can see the market positions that we hold in all our major project -- products, starting with rebar in the #1 position in both the U.S. and Poland. And MBQ, we also are a significant producer of fencepost in the U.S., and I mentioned earlier, fabricated rebar. We also do produce wire rod in the U.S., and that is a major product for us as well in Poland. And in Poland, we do go downstream from our wire operations into wire mesh. So for those of you that are familiar with CMC and have been following the company for a while, this will not be new information to you. But for those that may be new to the story, we've been through a fairly major strategic repositioning and transformation of CMC since I joined in 2011. And it was simply to rationalize the portfolio and focus on our core operations. I'm not going to go through the time line and the series of actions that were undertaken. But what I would like to do is draw your attention to the 2 boxes in the center, which are really the result of that rationalization, repositioning and transformation. And I think it's really interesting to look at a couple of things. First of all, our ROIC when we started was underwhelming at 1%. And you can fast forward to trailing 12 months second quarter '21 with an ROIC of 10%. And that return on invested capital is really on about the same asset base, very marginally increased with the recent acquisition that we did. In addition to that, you can see that our balance sheet is in really strong position with a very low net debt to EBITDA. That was by design to lower our leverage ratio and specifically relevant given the recent acquisition that we did a couple of years ago, and we've done some major delevering since that time. So we're really proud of the transformation. You can see that it's yielding significant dividends for shareholders with the results shown here. I mentioned earlier our vertical integration business model, which we believe is significant and key to our success. And it really starts on the left-hand side with our raw materials business, which supplies a secure, reliable, low-cost source of raw material to our steelmaking operations. And raw material is such a significant portion of our overall cost, that we believe this is a key strategic advantage and important to our overall business. Also on the raw material side, it's important to note that we are continuously investing in new technology on the nonferrous separation side in order to unlock valuable material that previously was -- we were unable to sort and separate. And that not only creates additional value for us, but it also reduces the environmental impact of the very, very minor residual material that has to be disposed of once we complete our raw materials separation. Our mill operations are the economic heart of the value chain. In a capital-intensive business, the most profitable operating model is to operate at very high operating rates. And if you know CMC, through the cycle we tend to operate at rates above the industry average. There are a variety of reasons for that. But one key reason is the fact that we are vertically integrated to our downstream operations, which provide a base load for our mills, a steady diet, if you will, to that operating rate. It also is -- it allows us to be somewhat insulated and protected from imports. It does allow us also to directly interact with the end user of the product, so we can respond to changes in the marketplace very, very quickly and also provides good visibility in forward markets. You can see on the bottom the amount of raw material that's supplied to mills for both the North America and European operations as well as how much is sent downstream to -- for further fabrication to our own operations. I thought it would be worth refreshing those of you who participated or listened in to our Investor Day, which we held last August, where we laid out our strategy and our key strategic growth initiatives. Again, starting on the left, we call it network optimization. And it's simply that, following our major acquisition in 2018 in our larger mill footprint, we realized there was a significant opportunity for us to optimize this new set of operations that we have. Simply put, it's aiming at trying to drive the highest profitability through our operations by producing and shipping in the most optimal fashion, putting product, placing product on the mill that can most optimally serve the customer and the end market. So we expect to yield about a $50 million benefit from this initiative, and this work has been ongoing for a period of time now. The next major initiative core to our strategy is really to take advantage of our capability in merchant bar products. Again, by utilizing our expanded mill network, it allowed us to move product around the various operations and free up more capacity to dedicate to merchant product. And in addition to that, we've made a number of, I'll call it, smaller capital investments in order to expand our product offering in the merchant bar products because, as you all know, merchant bar comes in all different shapes and sizes. And so we had to make some investments to expand that product offering. And we also did some small investments to improve storage and product quality. I'm going to talk about the last bullet point there under merchant bar products in a minute, and that is what we have turned Arizona 2. And that's our investment that we announced back in August during Investor Day to build our third state-of-the-art unique micro mill. So before getting to that in detail, I want to touch on the Polish expansion, which is our third rolling line in our Polish operation. We have excess melt capacity in Poland, and we decided to make a modest investment in order to unleash that melt capacity and convert that semi-finished product into finished product. We are in the commissioning phase of that third rolling line. And so we look forward to updating all of you as the year unfolds as to the progress of our commissioning. And that will, as I said, utilize excess melt capacity and create an additional 200,000 tons of finished product. We expect that effort to yield an expected EBITDA of around $20 million per year. The fourth major growth initiative, which we laid out back in August was, as I said earlier, our project that we're calling Arizona 2. So we announced that we are going to be building a third micro mill at the same operating site as our existing Mesa micro mill. And this third micro mill will be a first in the world and unique in that it will also produce MBQ products. Heretofore, the micro mill technology had only been utilized to produce rebar. But we have been studying this for quite some time, and this mill will be designed and have the capability to not only produce rebar but also produce merchant product. This -- the rebar production will replace higher cost production that we had in California. We made earlier announcements, and we have now completed the shuttering of the California operations. And when the Arizona 2 operation comes online, it will essentially replace that higher cost capacity that was operating in California. As a result of the shuttering of that operation, that frees up the land for sale, and we have a process underway and look forward to updating you on the progress of that as time goes on. But the proceeds from the sale of the land, suffice it to say, will fund a nice portion of the investment in Arizona mill. So stay tuned. We do expect this mill to be commissioned in 2023. We do expect significant EBITDA benefits from that operation in the neighborhood of $50 million annually. So again, these were all laid out back in August. I think those presentations still are probably residing on our website, and I encourage you to go and look at the full presentation of our strategy and growth initiatives. And I just want to end here with a few comments about sustainability as well as our balance sheet and financial leadership. ESG is certainly a significant topic nowadays. And it's been a topic for a long time. But here at CMC, we don't look at it as a new topic because we feel that our business has been sustainable from its roots. In the founding in 1950, we were founded as a recycling company, and it's just our -- naturally part of our DNA and our business model. I do want to highlight on the bottom left that our greenhouse gas emissions are a fraction of the industry average. So again, we feel our business is, by its very nature, a very green business. We work every day in reducing energy, water consumption. We invest in innovation and leading technology, which is the -- not only the lowest cost, but also the most efficient use of all of our precious natural resources. I will say that we look forward to publishing our most recent sustainability report, which you could expect to see in the coming month or so, and I encourage you to take a look at that and examine all the progress we've made since our last report was published. On the right-hand side, you see a few highlights of where innovation plays on our business model. As a refresher, our first micro mill in Arizona was the first in the world. We followed that up with our second micro mill in Oklahoma, which also was the first in the world to have a continuous spooling operation, hot spooled rebar at Steel Oklahoma as a first in the U.S. And as I said earlier, we look forward to sharing more with you as the Arizona 2 project unfolds in the coming months and years, and we really look forward to the unique nature of that operation being, again, a first in the world. And finally, on the bottom right, it shows you the earnings capability and contribution that those 4 major growth initiatives are going to result in our bottom line. These are through-the-cycle numbers, starting with the current and building up to the future. And we have a strong track record of delivering on the results of the projects that we commit to. And I have every confidence that we look forward to these results rolling into our business as we complete each one of these projects. So with that as a very brief overview, I look forward to your questions.

I thought it was a really good overview, especially because it talked a lot about the future and where you see the company going. So we usually ask that question, and you've addressed a lot of that already. Okay. Just coming back to today, you're a big construction player, obviously, with rebar, and would really like to get your observation of market conditions in residential and nonresidential. I know res, I think, is smaller for you, can you remind us how you see that size-wise and what you're seeing in those markets?

Thank you, Timna, and thank you for hosting us today. We're actually seeing really strong construction markets. And as you know, this has been a really interesting year with now over a year since the COVID pandemic started. And I remember when the economy -- the country was shut down, there was a lot of concern in the market, and we share the concern how is this going to affect not only the U.S. economy, the world economy and certainly our business. Heading into the pandemic, we had a very, very strong economy and a very, very strong backlog. And so we sustained the business extremely well over the last year. And as time went on, we had questions in our mind as to whether projects would be delayed, postponed, canceled as a result of the uncertainty brought on by the pandemic. But what we've actually seen in reality is things moved forward much better than certainly what I anticipated when the pandemic initially hit. And you talked about residential, Timna. In the residential market, I think everybody sees all of the data. It's incredibly strong, has been incredibly strong. There's been a continuation of the population migration that's been underway for a while, but that accelerated as the months of lockdown continued. So we see very, very strong residential markets across a number of our key end markets in the U.S., and we do participate in residential. It is the lighter gauge rebar products and mesh and those type of things. But that has been a very nice contributor to the business. But as you also know, when residential is strong, the follow-on activity is nonresidential. And so we're beginning to see that nonresidential construction activity that follows residential, and we anticipate that to continue on for a good period of time. Other parts of the market that have been incredibly strong is the, I'll call it Internet economy. So warehouses and distribution centers which are generally constructed as what we call, tilt wall, so they're board slabs that are tilted and some structural steel. That has been incredibly strong, I think will continue to be a very strong market. I should touch on Europe. Our European market has been very robust in Poland for a long period of time, and it has continued throughout the pandemic. There's also been EU funding that is promoting infrastructure and other construction development in that region. And a lot of that funding is yet to be deployed, so we have that to look forward to. And then coming back to the U.S., as you all know, there continues to be a dialogue around infrastructure and investment in infrastructure. And I do think that we probably reached a moment where something will occur, and we are heavy players in the infrastructure market. So we're quite optimistic for really all of our end markets going forward.

Why don't you talk about micro mills? I think they are kind of a different technology than everyone is aware of. So why [ do you prefer ] micro mills? What are the advantages? And on the West Coast, I think it's to replace Rancho maybe, maybe that's the answer. But yes, that's a small market. So is there anything else about the West Coast? If you could just elaborate on what the advantages are to micro mills versus mini mills?

Right. Thank you, Timna. So the concept of the micro mill, which is consistent with historically the concept of mini mills is steel is very heavy, as you know, and it's very expensive logistically to get it to the end market. And so the most ideal and low-cost situation is where you collect your raw material very near your steelmaking operation, you convert it and you limit your shipping radius to, let's just say, a 500-mile shipping range because that's the most efficient, cost-effective way to serve the market. But the micro mill concept was more than just taking advantage of that regional low-cost model. The micro mill technology is, simply put, in a traditional mini mill, you melt the scrap, you cast into a billet, a billet goes offline. It then cools down, so you must reheat it before your rolling operation, and then you roll it into its final shape and configuration. In the micro mill, it's a continuous process. So you melt and cast in a continuous fashion. So the billet, if you will, is cast continuously. It goes straight into your rolling mill. So you save a tremendous amount on energy because you are not reheating the billet before your rolling operation. You save on alloying material due to the nature and the characteristic and technology of the micro mill. So it reduces your alloying cost. It reduces your maintenance cost because you no longer have a reheat furnace to maintain. It reduces maintenance costs associated with your rolling operations because when the billet enters your rolling mills, it creates certain stress on those pieces of equipment that doesn't occur when you're rolling in a continuous fashion. And the one of the more significant benefits is yield savings. Because when you have a single billet, you are cropping the head and the tail of the billet as it moves through their rolling operations to remove the impurities. And in a continuous operation, you do not have to perform that cropping operation over that yield loss. So it's much more energy-efficient and much lower cost to operate. And we've proven that now with almost 15 years of experience since our first micro mill in Mesa, Arizona.

With micro mill, the part about the continuous process makes a lot of sense. But it was always ingrained to me that the bigger is better in a mill, right? You get efficiencies, so it's a bigger mill. So the micro mill is interesting because it proves that that's not necessarily true, but also, could you build more micro mills because they're smaller, like you wouldn't necessarily overwhelm a market like you would with a bigger mill. So I guess that segues to a question of, can the U.S. market or other markets perhaps sustain some necessary additional volume with more micro mills that wouldn't overwhelm the market? So do you consider replicating this going forward in markets where a little bit of tonnage would be good, but too much would be bad?

Timna, you raised a good point, and you've been one that's always highlighted the dangers of adding new greenfield capacity because we are, obviously, a cyclical industry. And if you overshoot the market, that can really destroy a lot of value. And I think our micro mill model has proven over time that, yes, the smaller scale is significantly less disruptive to the end market and can be absorbed in a much more effective way and much less disruptive. And so I think it's always a complicated set of factors that you evaluate when looking at greenfield capacity. But we always start with the end market, and what is the size of the market? What is the market expected to grow? What is the set of competitive factors in that market? And could that capacity be absorbed without a significant disruption in the market? And I think our track record has been pretty successful in terms of evaluating those factors and making good prudent decisions. If you recall back to our Oklahoma investment, our whole thesis was around the growth in North Texas and the growth in population in Texas, and that we had limitations in terms of being able to expand our large mini mill operation in Seguin, Texas. And ultimately, we decided to implement the micro mill technology to serve the growth in this market. And it was brought online and it was absorbed, and there was really no impact to the market. So I'm getting to the answer to your question. I think that, a, this technology is the lowest cost and, b, most environmentally sustainable in the world. So I think those are advantages. The initial cost of investment is not as significant as it would be if you were building a 2 million, 3 million, 4 million, 5 million ton mill. And I think the ability to find markets where this technology can be applied, I think it opens up a lot more possibilities than if you're thinking about a much larger scale size of mill. So I'm not prepared today to talk about any specifics in that regard, but I do think that this technology has a lot of applications going forward, especially as the industry needs to convert, whether it's further conversion here in the U.S. to cleaner technology, or the less cleaner technology, further conversion into other markets to cleaner technology. I certainly think this is the technology of choice. And given if these limitations that it can't be used for all products yet. But as we are going to prove on the merchant side, we proved it in rebarring, and now we're going to prove it in merchant. I really look forward to showing the results and talking about the success of it.

Well, stay tuned. I think we have 2 minutes and I always like to sneak one in. And in this case, we really didn't get a chance to ask you too much about capital allocation. We've been talking with everyone about the amount of cash they'll be swimming in, especially in the case of the extremely high flat-rolled prices. But rebar and the margins have been good. So just can you remind us of anything that you can share on capital allocation priorities or any preferences within the options that you may have?

Thank you, Timna. I think the good news is, as I said, our balance sheet is in really terrific shape, and I know that others have really strong balance sheets as well. So I don't -- I would not anticipate us working on further delevering. So it really leaves all possibilities open for us. I laid out our growth strategies in terms of investments on the merchant capability side, and we're just wrapping up the Polish investment, so there's not too much more capital to be deployed there. But certainly, we have the investment in Arizona coming ahead of us, and we see our ability to fund that with our internally generated funds to be quite comfortable. We continue to look for other growth opportunities, inorganic growth opportunities, acquisitions. So we're always screening those types of things, and we continue to evaluate our dividend policy. And as you know, we have had a share repurchase program in place. We haven't purchased -- repurchased shares in a while, but we do remain open to deploying capital across all possibilities. I think that must have wrapped it up.

Timna, are you there?

I'm on mute. I'm wrapping up the conference on mute, what a terrible way to go. All day I've been avoiding that, but....