Reliance, Inc. (RS) Earnings Call Transcript & Summary

My name is Alan Spence. I'm the Vice President in Metals and Mining Equity Research here at Jefferies. Very happy to be here today and have the opportunity to introduce Reliance Steel, a leading and global diversified metal solutions provider. Before we get started, I do want to remind you that you have the ability to submit questions at any point in the presentation via the Ask a Question box, which we can then address at the end of the presentation. Without further ado, I will introduce our speakers today James Hoffman, President and CEO; and Karla Lewis, Senior Executive Vice President and CFO.

All right. Alan, thank you very much, and good afternoon, everyone. Thank you for joining us today. Like Alan said, my name is Jim Hoffman. I'm the President and CEO of Reliance, presenting virtually with me today [Audio Gap] Karla Lewis, Executive Vice President and Chief Financial Officer. We'd like to begin with the formal presentation and leave time at the end for your questions. At the onset, we would like to highlight our safe harbor statement. The information we're going to share with you today will be webcast live on the investors portion of our website, investor.rsac.com and is subject to Regulation FD. We are very excited to share our story and dive deeper into our business model with you today. Reliance is a leading diversified metal solutions provider. We are the largest processor and distributor of metals in North America. So we play an intricate role in the industrial supply chain. Reliance is not a metals producer. During our 80-year history, through both acquisitions and organic growth, we have grown to over 300 locations in 40 states and in 13 countries outside the United States. We are strategically located near both metals producers, also known as Metals and our customers to optimize logistics and minimize our environmental impact. At Reliance, customer service and quality are the cornerstones of our success. We focus on smaller customers who value our ability to provide high-quality products and services in small quantities on a frequent when-needed basis. Reliance went public at $14.50 per share or $3.22 per share on a split-adjusted basis on September 14, 1994. 25 years and 3 stock splits later, we closed at a record high of $121.50 per share on January 17 of this year, resulting in a compound annual total return of approximately 15.1% over this 25-year period. [Audio Gap] because we cannot control external factors, such as end-market demand and global metals pricing, we focus on the areas that we can control, which has produced positive earnings per share every year since our 1994 IPO, even during recessionary periods by remaining focused on the following key business fundamentals. First and foremost, the health and safety of our employees, customers, suppliers and communities, extraordinary customer service, effective inventory management focusing on higher-margin business and finally, our most recent emphasis on innovation and a commitment to continuous improvement. We believe these business model fundamentals as well as a few other characteristics of our model set us apart from our peers. I'd like to dive deeper into our key business models differentiators, which we believe are our key competitive advantages on the following slide. First, we are highly diversified in terms of the products, customers and geography. We maintain decentralized operating structure. Our individual businesses benefit from our scale and supplier relationships while maintaining customer relationships at a local level and operating in an entrepreneurial setting, ensuring the decision making and resources are kept close to our customers. We anticipate when needed inventory management, ensuring our inventory quantities reflect current demand levels, and we incentivize our managers closely against this metrics. Our managers in the field are responsible for pricing discipline and expense control and to understand the value they provide to our customers. We also have minimum contractual sales. We do not speculate, hedge or buy large quantities of import [Audio Gap] basis and on both the buy and the sell side, meaning we buy what we need when we need it. And finally, through our emphasis on organic growth and innovation, we continue to make significant investments in our business. We are highly focused on innovation, investing in state of the art processing equipment in order to provide even more high-quality services to our customers by simultaneously improving our gross profit margins. Two of our most important operating metrics are gross profit margins and inventory management, which we believe directly influence each other and contribute significantly to our cash flow. In 2019, we achieved a record annual gross profit margin of 30.3% and reduced our inventory by $211.8 million. This helped us generate cash provided by operation -- operating activities of $1.3 billion, an all-time high for Reliance. Importantly, our business model enables strong cash flow generations throughout economic cycles. Even in times of reduced earnings, such as the second quarter of 2020, we generated strong cash flow, and we reduced our working capital. In the second quarter of 2020, our net sales declined 30% year-over-year, primarily due to lower overall demand as a result of COVID-19, in addition to lower metal pricing. Despite the challenging circumstances, we maintained a strong gross profit margin of 30.4%. Once again, exceeding our estimated sustainable range of 28% to 30%. This is a result of the exceptional execution by our managers in the field, who focused on higher-margin business along with our investments in recent years to expand our value-added processing capabilities. We responded quickly to COVID-19 pandemic, made workforce reductions and closing facilities, servicing hard-hit industries, driving SG&A expenses down 17.5%. [Audio Gap] We generated $476 million of cash flow from operations [Audio Gap] 2020 through our profitable earnings and focus on working capital management. To provide a little more detail on our operations amidst the COVID-19 pandemic, Reliance was deemed an essential business with the vast majority of our locations remaining open. As about 65% of our SG&A expenses are people related, we reduced our workforce through temporary layoffs and permanent reductions in force, impacting a total of approximately 2,100 employees through mid-July. Fortunately, we have now recalled approximately 900 of our impacted employees or over 40%, as certain of our businesses have quickly recovered. Most notably, our toll processing operations servicing the auto industry. Our decentralized business provides flexibility to allow us to take action on a location-by-location basis. In the second quarter, our decentralized model provided us the flexibility to immediately reduce and subsequently ramp up individual operations quickly in response to the rapid changes in demand and to restructure other businesses that were severely impacted to ensure a long-term profitability. We also exercised prudent cash conservation, including a reduction in our 2020 capital expenditure budget to $190 million from $250 million, by deferring nonessential projects. Now let's turn to the discussion on some of our key business model differentiators in more detail, and why we believe that they are proven competitive advantages in all operating environments. Starting with industry-leading investments. We believe our investments in innovation over the years have successfully driven growth and continuously improvement on -- to our business. As evidenced by our higher gross profit margins, which leads to increased earnings power. Over the last 5 years, we've made capital expenditure investments exceeding $970 million, significantly outpacing our peers. In 2019, our capital expenditures were a record $242 million, of which over 50% was allocated to growth activities. As mentioned, while we did reduce our 2020 CapEx budget, we remain dedicated to growth-focused investments in many strategic projects to support our customers and deliver a strong ROI. During the current environment, we continue to be there for our customers as they weather this storm. I strongly believe that when the time comes, America will need Reliance to rebuild. In uncertain times, our customers often rely on us to do even more for that, and we are well positioned to continue to support them. I'd also like to highlight our investments in growth through acquisition activities. We've invested $642 million in acquisitions over the last 5 years. Having completed 67 acquisitions since our 1994 IPO, M&A has been and remains a strong core element of our growth and diversification strategy. Next, let's turn to our end market diversification. We believe our diversification has been instrumental in our ability to produce industry-leading operating results on a consistent basis through all market cycles as many of our industries in which we -- our customers compete are cyclical in nature. We have benefited from the diversification in the current environment as declines in commercial aerospace and energy have been offset by more stable markets like nonresidential construction, defense and semiconductor. The end market breakdown of our shipments depicted on this pie chart reflect our best estimates since it is very difficult to track which specific end market our products ultimately are used in. I'd like to spend a few moments talking about the latest demand trends in our key [Audio Gap] market. As shelter-in-place restrictions began to lift across the country in May, we experienced an increase in activity as customers focused on completing projects that had previously been put on hold. Coding activity remains strong for projects related to schools, data centers and warehouse distribution. We have also seen an increase in certain infrastructure spending projects such as bridges. As such, we remain cautiously optimistic that demand for nonresidential construction activity will continue to improve in the second half of 2020. In general, industry and heavy equipment market, including both agricultural and construction equipment is both -- is another significant end market for Reliance. Based on positive feedback from our diverse range of industrial customers, we are cautiously optimistic our businesses servicing the broad industrial market should begin to recover from current levels in the second half of 2020. We serve the automotive end market on a tolling basis, which means we process the material for a fee and do not take ownership of the metal. Automotive represents about 60% of our tolling volume. We saw a sudden and significant decline in mid-March when automotive manufacturers shut down. We quickly reacted by furthering over 50% of our workforce and our tolling operations. As the automotive companies began to open and ramp up production in early June, we were able to rapidly recall many of our highly skilled employees to support the increased activity levels. We are positive on our automotive tolling outlook as our toll processing operations support many light trucks and SUV programs that are experiencing a strong recovery. Looking at the aerospace market. Demand in defense area remains fairly stable at solid levels. However, we expect commercial aerospace demand to soften further in the third quarter. And we'll take additional cost reduction actions, if and when necessary, to ensure the continued long-term profitability of these businesses. Our long-term outlook for commercial aerospace remains uncertain at this time. Finally, demand for energy, which is mainly oil and natural gas remains under significant pressure. We continue to take proactive cost reduction measures, including additional headcount reductions and the closure of 3 of our energy-focused businesses in the first quarter of 2020. We believe our remaining businesses servicing the energy sector are well positioned to support any further recovery in energy. Although our current outlook for nearly all of our end markets remains challenging, we believe our resilient business model will continue to serve us well through the recovery that will follow these extraordinary times. In addition to end markets, our product diversification is very important to us and is key to the reducing of the volatility of our financial results. No one product dominates our mix. We try to balance our sales across the major metal commodities with an emphasis on special products. The final key business model differentiator I would like to highlight is our best-in-class service. At Reliance, we focus on smaller customers who value our ability to provide high-quality products and services in small quantities on a frequent when-needed basis. Our average order size is small at approximately $2,100 per order. So putting this in more context, we produced net sales of almost $11 billion in 2019, $2,000 at a time. Through our proprietary fleet of trucks in decentralized structure, we can provide a quick order turnaround. Over 40% of the orders -- of our orders are delivered within 24 hours to our customers placing the order. In 2019, we performed value-added processing on 51% of our orders, up significantly from our more historical level of 40%. Our growth in value-added processing has helped support our higher gross profit margins over time. I will now turn the floor over to Karla, who will discuss this in more detail. Karla?

Thanks, Jim. And I know we want to have time for Q&A. So I'll try to get through these pretty quickly. This slide shows the improvement of our gross profit margin from our historical range of 25% to 27%, up to our current increased estimated sustainable range of 28% to 30%, which we announced in February of this year. And we believe that our higher level of value-added processing services has been key to expanding our gross profit margin and also our performance-based compensation structure that motivates our people and supports our consistent and growing gross profit margin and increased earnings. Next slide, please. And no matter the operating environment, our gross profit margin is consistently best in class in the industry. On this slide, we're showing Reliance's gross profit margin in green consistently exceeding the metal service center group that's shown in yellow. And we're also showing the mills here in red as we are often grouped with the metal producers from an investment standpoint. But as you can see from this slide, our gross profit margin is both much higher and more consistent than both the service center and mill groups. So we have begun to compare ourselves to the industrial distributor peer group, which is shown in blue, as many characteristics of our business are similar. And we believe our differentiated model of diversification, small order sizes, growing value-added processing and focusing on providing value and service to our customers is the key to our stronger margin profile, making our earnings more resilient to fluctuations in metal pricing and therefore, should support a higher valuation multiple than the metals group. And we believe that Reliance should trade more in line with the industrial distributor group. Let's turn now to capital allocation. Our strong cash flow generation and access to capital provides us with the flexibility to allocate capital across capital expenditures, acquisitions, dividends and share repurchases. As Jim discussed earlier, we're focused on organic growth and acquisitions to drive our earnings higher, and we believe that these activities represent the best long-term use of our capital. However, we are also committed to returning capital to our stockholders, primarily through regular quarterly dividends and opportunistically repurchasing our stock. We've paid regular quarterly cash dividends for 61 consecutive years, and we've increased our dividend 27x since our 1994 IPO, with our most recent dividend increase of 13.6% in the first quarter of 2020. And our increased annualized dividend is now [Audio Gap] also repurchased $1.2 billion worth of our common stock over the last 5.5 years, including $300 million in the first quarter of this year at an average cost of $90 per share. And we believe that our strong profile enables us to execute on all of these capital allocations. Next, here's a recap of the last 5 years of our capital expenditures, including our record spend of $242 million in 2019, and this also highlights the increase in the percentage of our orders with processing performed that we believe has contributed to our increased gross profit margin, reaching an all-time high of 30.3% in 2019. So our enhanced gross profit margin and our effective working capital management contribute to our consistent strong free cash flow generation. And in the first half of this year, even with the impact of COVID-19, we generated $600 million of cash flow from operations. And at the end of the second quarter, our total debt outstanding was $1.5 billion, with a net debt to total capital ratio of 20.4% and net debt-to-EBITDA multiple of 1.3x. And to capitalize on the lower interest rate environment, at the end of July, we completed a $900 million senior notes offering that was comprised of $400 million [Audio Gap] of 1.3% and $500 million of 10-year notes with a coupon of 2.15%. And we believe that improved our already strong liquidity position and extended our debt maturity profile. And now to conclude, I'd like to talk about safety and sustainability, our most important core values. Moving metals safely is no easy task, and we take the health and safety of our employees, customers, suppliers and communities very seriously. We support a company-wide safety program and have a team of safety professionals that encourage and monitor safety best practices across the organization. We remain strongly committed to reducing the rate of injuries with a 10% reduction in our incident rate in 2019 [Audio Gap] on average. And while we're proud of those improvements, we will not stop until our incident rates go to 0. And to support that, we've implemented company-wide programs, including Make It Personal. So we've also heightened many of our health and safety measures in the current COVID-19 environment, trying to [Audio Gap] of the workplace when they're experiencing [Audio Gap] systems. And we're dedicated to sustainability and ensuring that our operations minimally impact the environment with the majority of the metal that we produce coming from recycled metal. So in summary, we believe Reliance is a strong investment, given our diversification, our decentralized operating structure, our industry-leading gross profit margins, our consistent profitability through all economic cycles, our strong balance sheet and countercyclical cash flow that helps fuel our growth and long-standing history of stockholder returns and our strong set of company-wide core values. We also have a strong and resilient business model and a proven ability to successfully execute in all environments. So thank you for your time and attention today, and we'll now open for questions. Thank you.

I think we'll have time for a couple of questions. And perhaps the first one around M&A. You highlighted this as being a core part of your history and your growth strategy. What are you seeing out there in the pipeline right now? Are there good opportunities? Or are you a bit more of a conservative cap [Audio Gap]

Good question. We've been asked it a lot. There are a lot of them out there. I wish they were good. That would be great. But there's just to be -- there happens to be a lot of them. We're very diligent when it comes to acquisitions. Like I said earlier, we did 67 of them. We haven't really changed our model. There are still certain things you have to meet to -- for us to want to pull the trigger. Like I said, we've looked a lot. There's still a lot out there. We're looking forward to a good 1 or 2 or 5 or whatever comes down the pike, and we're obviously well positioned to pull the trigger, if we want to do that. But that's certainly 1 of our 4 buckets of cash utilization, and we're ready whenever we come across one. Like I said earlier, we've -- we only did one acquisition last year. Really proud of the moment we did. It's a really good company, and we hope to find more of those. And if you're just looking at volume, it's way up. If you're looking at quality, we'll have to see how it works out.

And that perhaps segues nicely to the next one. When you talk about quality and the percentage of the value-add sales that is consistently nudged up in the last 5 years, do you have any medium-term targets around that? Is there perhaps a limit of where you -- maybe a ceiling? Or where are you in terms of that progress?

Well, me personally, I think, it's too low. I'm always asking folks to do more and more and more. And by the way that I just didn't make that up. Our customers actually ask us to do more and more. So we don't really have a goal. Our goal at Reliance is to focus on quality of earnings -- take care of our people, first and foremost, quality of earnings and to be there for our customers and our suppliers. So we'll continue to drive that. We have a saying internally, innovation and continuous improvement. Those are near and dear to us, and we'll continue to get better. So we really don't -- I can't tell you what the number is, where the level might be. All I know is, it should be higher. So we'll continue to spend money and expect good returns from that. And our folks out in the field, I can't say enough about how they execute the pricing and how they do provide value to all our customers. And we anticipate more of that.

Perfect. And just one last quick one here. When you think about the significant demand disruptions we've faced in the last couple of quarters, is there anything coming out of that you think is structural rather than cyclical in any of the end markets you serve? And if so, how are you thinking about your business strategy for those?

Karla, do you want to take that one?

Yes. Well, I think even prepandemic, we did talk about in the first quarter, we closed some of our energy-related businesses because we do think there were systemic changes because of technology and the way drilling is done now, primarily in the U.S. So we reacted to that. We're still a good strong player in the energy space, but we did recognize that we believe there were some structural or systemic changes that occurred there. The aerospace -- commercial aerospace industry, we're very hopeful that's cyclical, but we're not sure how long that cycle will be as people are reevaluating their travel plans, what will air passenger traffic be. So we have taken some actions on that already, but we'll continue to look for other actions we may need to take to react. But overall, I think, with Reliance, what we've done strategically is have a very diversified business. So even if we do see some systemic changes, we can react to those, we can expand in other parts of our business and react accordingly. So could be some systemic changes. Those are probably the only ones that we would highlight that we've seen so far.

That's perfect. And I think that takes us right up to limit. I want to thank you both for your time.

Thank you very much. Appreciate it.

Thanks, Alan.