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

Good morning, everyone. For those who don't know me, my name is Emily Chieng, and I lead the metals and mining team here at Goldman Sachs. Today, we have the privilege of hosting the Reliance Steel & Aluminum team. So with me today, we've got Jim Hoffman, CEO; Karla Lewis, President; and Arthur Ajemyan, Vice President and CFO, join us for our discussion today. But before we get into the Q&A and the nitty-gritty of what's happening in the U.S. steel industry, I wanted to let the team offer up some remarks and briefly introduce who Reliance is to our audience who may be less similarly given this is, I believe, Reliance's first time with us at this conference. So I'll hand it over to Jim, Karla and Arthur to get us kick-started here.

Okay. Thank you, Emily. I'd like to, first of all, thank Goldman Sachs for having us. It's our privilege to be here with you today and look forward to talk about our company that we're extremely proud of. I'll start off with what Reliance isn't, just so people understand. We are not a producer of metal, okay? We're a company that was founded in 1939, and has transformed into a leading global diversified metal solutions provider. That's what we really are. We're the largest in North America. We have a very diversified model, both diversified in geography, markets, customers, products. We run a decentralized model. We're firm believers in pushing the decision-making down as far as we can into our company. We have a very resilient model that we're quite proud of. We've had the model in place for decades, and we've improved it over the years, especially over the last 7 or 8 years. We've become more of a value-added company that we can talk about that. But it's proven to be a good company and a good stock in good times and bad. We focus on, first and foremost, the health and safety of our colleagues, our customers, our suppliers and our communities, which has really served us well throughout this pandemic. We're proud to do that. It's just in our DNA. That's what we do. But we also run the company day-to-day, week-to-week, month-to-month, year-to-year focused on quality of earnings versus the top line. Top line dollars are what they are, we don't control them. Certainly right now, the price of steel is high. And -- but we'd rather really pay attention to the quality of the returns we're able to give our shareholders. I have mentioned over the last 7 or 8 years, we've changed our model a little bit and have focused on value-added product. We noticed that many years ago that there was a lot of people in the space that simply moved metal, which is interesting and it served us well for a long period of time. But over those 7 or 8 years, we spent over $1 billion in the best and the most innovative equipment. Not because we just decided to do it, our customers have led us down that path. And we're more than happy to do that because what it's allowed us to do is become more of our part of our customers' business, about half that -- half of the $1 billion was for the equipment, the rest is for things like buying out leases and those types of things. But we spent a lot of money, and we continue to do so. Later on, we can talk about our CapEx spend and Arthur can talk about how we know we utilize cash. But that's our company in a nutshell. We're real proud of the fact we're known as a very prudent company when it comes to cash distribution. We can talk about that. And one of the other keys to know about Reliance is we focus on the smaller customer. Customers that see us for what we are. If you want to buy a metal cheap, you can call somebody else and that's your prerogative to do so. But if you want a company that can provide value and -- for not only our shareholders but for the company themselves, then Reliance is where you want to come. So we're real focused on that. We don't do a lot of contractual business. In fact, the only contractual business we do is in the aerospace space and Karla can kind of talk about that later and let you know how that works. But we found that the smaller customer, less price-sensitive, more service-oriented. For instance, last year, we did roughly $9 billion in sales, $1,900 at a time. And you can do the math on that. That's a lot of transactions. And we -- our company is set up to do that. 40% of the orders we get, we deliver the next day. Roughly half of the orders we earn today have a value-added step added to that, which is up from a traditional 40% that we've seen over the last few decades. But we were really focused on that, which has proven to be a great differentiator for Reliance other than other people who assume they're in the same space as us. So that is Reliance and we're real proud of it, and we are focused on to continue to improve not only our model, but our performance. And certainly, the last year -- and we're still in the pendant by the way, just in case anybody thinks we're not, we're still operating to make sure that our folks are taken care of and we'll expand from there. So Emily, I hope that gave you a good idea of kind of what Reliance is and, more important, what we aren't. So...

That's very clear, Jim. And I'm sure we'll touch on a lot of those very idiosyncratic nuances that we'll [ touch ] later on.

But I do want to take a step back here and first talk a little bit about the U.S. steel macro. Clearly, your role as a large service center puts you in a heart of what's going on right now. The numbers that we're seeing on the screen as I relate to pricing are pretty eye-watering at $1,500 a ton. But give us some context as to what you're seeing first on the demand side, and then we can follow up on the supply side. I know you guys sell into a lot of different end markets, the automotive industry, construction, energy and machinery and all the likes of that. But talk to us about what you're seeing in your order books and maybe sort of the view on what you're seeing for U.S. steel demand throughout the course of the year?

Okay. I'll start that and then I'll flip it over to Karla because she's much closer to the end markets than I would be at this point. But the pricing is what it is. We don't control that. Like I said earlier, we're not a producing mill. The folks who do that, the domestics who we are in our -- built into our model is our support for our domestic suppliers. It's been that way for a long time. We learned a long time ago to service our customer base the way they need to do services. You have to have a shorter supply chain. And to us, that means, by domestic, we've supported them through thick and thin and now they're supporting us the way we should be supported because we've earned it. Like I said, the price went up. The good news is the price has -- I think you said eye-watering, I haven't heard that description of the pricing. I like it, though. I might steal that one. But they're high. They're high and they're high for a reason. Some of it's -- most of it's demand-driven, which is a good thing. Some of it just recently is input as a resolve. Input charges means scrap and iron ore and things like that. So that's inflated death. But I think the main reason it's skyrocketed like it has is -- and I'm not placing blame, they were doing the same thing everybody was doing. Well, good companies were doing. When this pandemic hit, you went into a cash preservation mode because you didn't know what it was going to bring. And these folks that make metal, they're good at that. They're really good at what they do. They're the best in the world, I think. So they went into that mode. And they're not like us, they can't turn on a dime. When you start shutting electric furnaces down and laying people off and kind of running shifts in and what have you and doing as needed maintenance, it's really hard to turn and crank this thing back up. So that's what happened. They got caught with the demand surge and they've done everything they can. I'm quite proud of what they've been able to do. Just recently, they've been able to crank their mills up to more than the 80%, 90% output range, which is really hard to do, but they've done that. But the prices stayed high because of the import charges. I don't know when it's going to level off or when it's going to come down to whatever people's idea of what the right thing is. But we don't whine about that. We're all about taking care of our customers. And like I said, less price-sensitive. When the prices go up, we pass it along because we know that our customers need that. And to be frank with you, when the prices are high like this, there's a lot of dollars running through our system. And that's a lot of cash. And we're -- like I said before, we're very prudent on what we do with the cash. So we'll take it as it comes. We're not short-term players. We don't speculate, which will really get you in trouble. And we just don't do that. So that's my view on kind of macro, what's going on with pricing and what have you. And I'll flip it over to Karla, and she can give you some market-by-market info.

Thanks, Emily. Hi everyone out there. So from a demand standpoint, we are seeing strength across most of the markets that we sell into. Our largest market is nonresidential construction and we put infrastructure in with that. That's about 1/3 of our revenue dollars. And we continue to see strength in that market. We've got ongoing inquiries for new projects coming in. And remember, our nonresidential construction are not the big tall skyscrapers you see in the big cities, we're more the kind of 4 to 5 stories and below type of structures. So some of the changes going on with demographically support growth in the types of nonresidential construction projects that we support. And some of that metal, we are seeing -- some goes into residential, but it's primarily nonresidential. So that continues to be steady and growing for us. Pretty broad-based. We sell a lot of -- we process a lot of metal into the automotive industry. That's where we have our toll processing businesses, where we don't take ownership of the metal, so we don't have any price risk due to the changing volatility in metal pricing. And so we're just processing that on behalf general -- usually on behalf of the producers of both steel, stainless steel, aluminum and then we deliver that into their end users, with the majority of that going into automotive. And that continues to be strong for us, our toll processing businesses. We have had a little disruption in Q1, a little bit in Q2 because of the microchip shortage, where a few of the platforms that we are servicing have done some temporary shutdowns. So it has not had any type of a material impact on us yet, but it has had some disruption. We are generally selling into platforms that are more for the SUVs and light trucks. So those have had more strength coming out of the pandemic and even before we went into the pandemic, and more of the sedan models. So we're still very favorable on the automotive market, and there's enough general demand out there for our toll processing companies that any downtime they have due to the chip shortages, they're able to fill with other business. And then if you kind of talk about the general manufacturing and industrial sectors, I mean, we're selling into so many different end markets. And as Jim talked about, we sell a lot to the smaller customers, a lot of machine shops, job shops. We don't always know where that metal is going. But whether it's farm equipment, heavy equipment, kitchen appliance, firearms, just really all of the different markets we're selling into. Our customers are busy and that's supporting the pricing that Jim talked about, that they may not like paying the higher prices, but they're willing to pay it in order to get the metals. So we see that continuing to be very strong. The only 2 markets where we see some weakness would be energy and aerospace. So -- with energy being oil and gas. We do sell to a lot of the renewable energy markets, but we put that in that kind of nonresidential infrastructure category. So on the oil and gas side, it was pretty low levels of activity the back half of last year. In the first quarter, we saw improvement from that, not significant, but we saw some of the customers coming back into the market. So that was positive. We're seeing continued incremental activity in the energy space. And then on the aerospace, that's about -- generally about 10% of our revenue dollars. About half of that is commercial, the other half, defense, military and space. Those markets continue at -- the military, defense and space continue at strong levels and we're increasing our backlog there. So that's positive. The commercial aerospace side, the other half of that is not strong, but we do think we hit the trough in the fourth quarter of last year. We have seen -- similar to energy, we have seen some customers coming back into the market again. We think they're hitting some holes in their inventory, not on every product, but they're running out of certain products and they're back in the market replenishing some of that inventory. So we expect that to continue. Maybe a little more activity in the back half of this year, but no real substantial improvement until probably 2022 or '23. So that kind of wraps up our end markets, Emily.

Got it. That's really comprehensive, Karla. Maybe just digging a little bit deeper. I know this is a question we got a lot from our clients, it's just on exactly what is happening in the autos, the space here. So you talked a little bit about slight impact, but a lot of your consumers are able to pivot some of that steel that they might not have used for a particular product line into something else. But is there anything that you're seeing, OEM manufacturers sort of building everything that they can around the car and they're sort of parking that on the side until they get the chips come in? Or how sort of do you think about what you're seeing there? Because sort of -- it's a little bit misaligned, I think, incongruous to us at least from where we sit, around the automakers taking production down, but the impact on the steel side seems to be less. So any color there would be helpful.

Yes. And in all honesty, it's kind of different from customer to customer. But in the -- being in the metal space, we're used to volatility in pricing and we sell in the cyclical end markets. So our business is managing through those cycles. And we've been through quite a few, but this one is a little different than other cycles we've seen before. And as Jim had said, the positive thing is demand is strong. And we are hearing of some customers who are doing what you're saying, Emily, where they're trying to continue production because they believe the end demand is there. And they are kind of -- they kind of have whiff that they're sitting there waiting on certain components to come in. We can't say that everyone is doing that. But certainly, we are hearing of that. And with metal being tight, our folks are getting calls from a lot of people who maybe don't normally buy from us or maybe don't normally buy from service centers because people are just trying to get metal wherever they can. And maybe they're not getting as much as they would like to get direct from the mills or from their normal sources.

Great. That makes sense. And then maybe one last question on the demand side before we shift to a little bit on the supply side. But given where steel prices are, obviously, not that much of an issue for Reliance given there's a lot of pass-through there. But when you speak to your customers, are you seeing any signs of hesitation around buying metal at these prices? Or is demand just so strong and inventory so low and there's just a lot of restocking that's going on right now that buyers will just -- at least from what you're seeing, buyers are just coming back to you to buy metal?

Yes. So I think the beginning of the year, kind of early January when prices had started to run up, we kind of feel at that point, we all thought it was going to be one of our normal short cycles, I believe. And so we were getting some pushback from customers about pricing. And then I think we all started to better understand that this was different and it was going to last longer. And there were more factors playing into this, primarily the demand strength that was there. That now, we really don't get a lot of pushback, people just want the metal because demand is that strong.

Got it. That's really clear. And then maybe just really quickly on the supply side before we shift further into the Reliance story. But as a purchaser of steel from the mills, is it easy to buy product right now? And how quickly can you receive it? Is there any signs of that changing anytime soon from your perspective?

Well, let's put it this we're getting what we need, okay? We're -- part of being a good partner is you don't put your partner in a bad position, right? So when there's a lot of metal imports and a lot of different things come, we don't participate in that. We support our domestics. And that's enabled them, in a macro way, to reinvest in their mills. And a couple of them are building mills right now in the year 2020, 2021. And those are going to be good mills. I mean those are going to be low cost, high-quality, capabilities just galore. So that -- we've always supported that situation. So in this situation, it would -- we wouldn't be a very good partner if we try to get everything we wanted. That's not fair. I mean our -- we're big enough and we could probably play that card, but we're not going to play that card. We ask for what we've earned and what we earn is what we need. And that's -- we're fine. Now do we have holes? Sure. But here's an advantage that Reliance has that a lot of people don't. We've done 67 acquisitions since 1994. We own a lot of companies, and we call them the family of companies for a reason, and we can get into that. But these companies are able to buy from one another internally. If you have a C item that you -- that one of your A customer absolutely needs, there's 50-some-odd companies you can buy from internally with the FOC. So we've been able to patchwork this thing together. And with the support of our long-standing partners, we're chugging along just fine. We're -- again, but the key is we're getting what we need, but not what we want, so.

Great. That's really helpful. Maybe shifting gears now and focusing on the Reliance strategy. If we take a look at the financial statements, Reliance's gross profit margins have been a really impressive hallmark for the company, growing from what was 25% to 27% historically to now, what, close to -- I think you've guided to 28% to 30% sustainably on a go-forward basis and perhaps even higher this year as we've seen execution in the first quarter being very strong there. So maybe talk us through some examples around the decentralized operating model and the inventory management system, how that translates to higher margins with the small order sizes you alluded to before. And then we can -- as a second part of the question, talking about some of the value-add components that you're adding to the business and sort of the new projects, new organic growth projects here that are sort of boosting or sort of adding to margins going forward as well.

I can start that. And as I answer this question, [ Jordan ], if you could kind of bring up Page 19 and 20, I'm not sure if that works with this presentation or not. But if it get doesn't, I can certainly talk to it. But the margins, that's a great observation, Emily. We've worked really hard on increasing our margins. It's part of our grand scheme. Our idea was to invest heavily in value-added equipment. Now when I say the word value-added, it's a two-way street. It's value for us in the form of additional dollars and pretax dollars and eventually earnings per share. But it's also value to our customers. It actually takes work out of their operations. And right now, with it being so hard to get qualified workers, we've been an integral part of this growth area that we're in right now. So it's -- our model works. I would love to tell you that we sat down 8 years ago and said, "I know what we'll do. We'll just add a bunch of equipment and build it and they will come." That's really not what happened. We did notice that a lot of people in our space were kind of doing the same thing we were doing. But we have a long-standing model that really listens to our customers. And what we found when we come out of dips in businesses, whether it was 2008 or -- gosh, I've been around so long I can go back to 3 or 4 different dips. But when they come out of these dips, they don't have the wherewithal. They don't have a Reliance balance sheet to be able to go out and spend $2.8 million on a tube laser that we do and we did, and we continue to do that. And once you do that, you become a part of that customer's business. They don't need to add employees. They don't need to spend money on equipment. Back in the day, they'd call us for a truckload of beams and we'd ship truckload of beams to some warehouse somewhere, then they'd work on it. But now they call us and they'll say, "Well, [ we need ] 90 of these 3 beams, miter cut, etched, painted yellow on one side, put on a skid with some gusset plates and delivered right to the job site. So that's great value to us because everything I say along the way we attach a profit to. And it's great for them because they don't have to do the work and they don't have to have the people, and they don't have to have the expenditure on the equipment. They can just go to work and do what they do best. So that's the way we've increased our margin. And like I said, it's a -- the gift that keeps on giving. So once you get into that realm of -- a way of doing business, actually, it keeps on going. And we keep investing. I know our published CapEx this year was $245 million. If we were able to get the equipment the way we want to, but there's slowdowns in that supply chain as well, we'd probably spend more like $300 million. And like I said, that's based on helping our customers do more and more. So the margins are -- that's one of the things we focus on, and you can see in this slide. We don't really know who we are. I'd say we're not a producing mill. We're not a middle service center. We're a provider of value. And you can see here, we -- closest kind of industry that we found that was close to us on -- those industrial distributors and you can see where we've out-distanced them. And if you go to the next slide, [ Jordan ]. Yes, that's not right there. I can't really see this slide. But anyway, one of those slides talked about our margins compared to industrial suppliers, industrial distributors, and the other one talked about the return. So we've -- it's not like we targeted that industry. We just -- look, we just try to find somebody that we can compare ourselves to, and it's very difficult to do it because we've taken a different tact. So I hope that answers your question. Karla, you may have something that you want to add to that. And I'm oversimplifying how this happens, because it's not easy. And -- but we like it. And our shareholders I know like it as well. Karla, do you have anything to add to that?

Yes. I think I would just add to part of the question, I think, Emily was asking is our increased value-added processing is really the catalyst on what is driving our sustainable gross profit margin levels higher. And that is generally made up of many, many different pieces of equipment across really all of our locations. So as Jim said, the customers drive us towards what their needs are and then we invest in that. But a couple of the bigger projects we have in there currently, and we've had over the last few years, relate to our toll processing businesses that I talked about earlier, where we just process the metal for a fee. And we've seen continued growth there a lot from the automotive market, both in the United States and in Mexico. Over the past few years, we've done a lot of investment to support the increased usage of aluminum in the automotive market. But there's also -- we're also expanding our carbon steel toll processing capabilities to help support some of the increased capabilities of the mills on the carbon steel side, but we also continue to see a lot of opportunity there. And they generally have higher gross profit margins. So all of our businesses are doing more value-add and driving our gross profit margin higher. But in particular, we've had some strong growth out of our toll processing businesses.

Great. That's really helpful. And then maybe continuing on the theme of capital allocation, and maybe this is a good opportunity to loop Arthur in, in the conversation. But there's a couple of different prongs here that you guys also focus on. One, the other side of the growth equation is the M&A piece. You mentioned earlier that I think you've done 67 or maybe somewhere in that range of M&A transactions in the past. And then I wanted to touch a little bit about the balance sheet and the capital return strategy. That dividend has been increasing pretty consistently over time. But I think there's also a capacity within the balance sheet for buybacks as well. So all sort of those 3 themes, I'd love to touch on them.

Thanks, Emily. Yes, I mean, certainly, we're aware of the cash position that the company has. I mean it's -- we've talked about earlier about the acquisitions and Jim used the word prudent with our capital allocation, and that will continue to be the case. We evaluate opportunities. I mean we didn't do any acquisitions during the pandemic, and it's also kind of important to recognize kind of how we ended up with the current strong balance sheet that we have. We -- with the pandemic, we went into cash preservation. We generated over $1 billion of cash from operations. We completed a refinance. And in 2020, issued some debt and amplified our liquidity position, our debt maturity profile. So that performance during the pandemic was phenomenal, and that contributed to the cash buildup and sort of the lack of acquisitions that year also kind of contributed to that. But on the organic growth side, as Jim alluded earlier, we've been very aggressive with that. If there weren't for the supply chain disruptions in that space, our cash spend would be really substantially higher. But -- and on the return side, the stockholder return activities, in the last 2 years, we've completed close to $900 million of share repurchases. So we're pretty active on that front. We still have about 2.8 million shares remaining in our current buyback program. And consistent with our past practice, we don't necessarily talk about the timing or the amount of buybacks, but that's something that we continue to remain committed to and opportunistic with. So -- and it's just part of our overall capital allocation strategy. We could do it all, right? And we could do the M&A. We could to the organic growth. We can be very aggressive with our dividend policy and stockholder return activity. So I hope that answers your question, Emily.

And Emily, just one more thing on the M&A front. Just because we haven't bought anybody for a while, it doesn't mean we're not going to. To Arthur's point, we've got plenty of dry powder to basically anything we want or everything we want, which is an outstanding-ish problem to have. We don't really think it's a problem, it's just a really nice spot to be. Well, on the M&A front, we're good with what we're seeing out there. There's a lot of fine companies out there. It's just a matter of timing, the right ones. We don't do bad deals. We don't buy bad companies. We didn't lower our expectations. And we continue to look -- we've looked at over 100 of them last year, and that's hard work. And -- but we want to make sure -- we're very proud of our family of companies and who we want to become part of that. But the pipeline is full. There's some really fine companies out there, it's just a matter of if they want to sell and what they want to sell it for. And we've got another issue. We look at acquisitions and say, okay, do we buy this company and pay a premium for them or do we simply add more equipment to a company we already own in that geography. So we can do that, and we've done that a lot. So it might not look like we're acquiring companies, but we don't need to in that instance. And Karla had mentioned earlier, we've done some greenfield startups. They would be acquisitions if we chose to buy companies. But once again, with the kind of balance sheet we have, we can go ahead and build our own, in this instance, toll processing companies where we were invited to do that by our customers. So M&A, alive and well. And like Arthur said, we've got a lot of powder and we have a lot of flexibility to do what we think is the prudent thing to do, so.

Got it. That's very clear. We are coming towards the end of our allotted time here today. So would love to open it up to Jim, Karla, Arthur for any sort of closing comments. I think the one question we always tend to ask is, in your view, what do you think clients most underappreciate about the Reliance story? And what do we have to look forward to?

Well, yes, you have a lot to look forward to. This is a good company. We've got some really -- really a fine bench of folks who get it. Emily, I have to give you a compliment early on when you started to cover us, you recognize right away that we don't manufacture metal. We are not that guy. We're a lot different than that. And we take our role very seriously. And I've said time and time again, America is going to need Reliance to rebuild. And certainly, all this discussion around infrastructure, I think that will prove once again that we're making the right moves to be ready. And we're more than ready when that comes. It's not a matter of if, it's a matter of when that comes. But I just want to make sure that people realize that, that is important to us. And whether it comes or not, we'll continue to focus on our quality of earnings and do the right things for our shareholders and our people.

Great. Well, thanks, Jim, Karla and Arthur for your time today. It was a pleasure speaking to you all. And best of luck going forward.

Thank you very much for having us.

Thank you.

Thanks for having us.