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

Good morning, everyone, and welcome back to our next fireside chat panel. Today, I'm joined by Jim Hoffman, Chief Executive Officer; Karla Lewis, President; and Arthur Ajemyan, Vice President and Chief Financial Officer of Reliance Steel & Aluminum. Team, welcome back here today.

Thanks for having us.

So a lot to talk about in steel markets. So we'll jump straight into all of that in a sec. But there's going to be a little bit of a management shift here at the firm. And Jim, this is one of your last opportunities presenting to this crowd. But maybe, Karla -- congratulations on the retirement, by the way. But maybe Karla, maybe tying it over to you as you take over the helm -- any changes in the strategy as you think about the future for Reliance going forward?

Yes. Well, I'd say, overall, we seem to think that our strategy has worked pretty well for the company over the years. It hasn't changed significantly, but I've been at the company for 30 years, and so I've worked with a couple of different CEOs there. So I worked with Dave Hannah, Greg Mollins, with Jim. I think each of them, we've kept our core pretty consistent, our core strategy and model, but we've tweaked it and made it better every time along the way. Certain times, there was more acquisitions, certain times, there was more organic growth. More kind of tweaking, higher margin focus, more value-add, and we like all of that, and we want to keep it going and keep doing that. We do -- I think if there's anything different, maybe revisiting some of our volumes, some volume growth. We're working with our companies to try to focus on that. It's something we've been looking at the kind of ramping that up a bit. Certainly, we've seen -- we've been having our companies work more together. We call it collaboration, and we're seeing some good things there of how can we look at the entirety of Reliance and leverage that a little more. And certainly looking at continuing advancements with automation, with some of the labor challenges that we face out there now and just better utilizing technology for our customers' benefit.

So maybe let's jump into the guts of it. And what our investors are most concerned about is the state of the steel markets here in the U.S. And typically, fourth quarter is a little bit softer than usual just seasonality, weather, or holiday period. Maybe can you talk us through your end market exposures, what you're seeing in each of the verticals? What you're most excited about into the next year?

Yes. So I'll kick it off and Jim and Arthur can jump in. We don't know why you guys are so down like we think things are good, especially in the U.S. We -- Reliance, we generally service smaller order sizes, focus on smaller customers. And our average order size is $3,000 an order. We deliver 40% of our orders within 24 hours of the customer calling us. We're doing value-added processing on 50% of our orders. So our customer base is a little different than doing contract business. It's mainly spot business. We're not selling a lot of metal direct into markets like automotive or a lot of the big OEMs. So we think that -- and that's what we've done for years. And we think that really helps us navigate through markets. Reliance has been in business over 80 years and metal prices go up, metal prices go down. Demand goes up, it goes down. We also really try to diversify our product mix over -- our product mix, our end markets we serve, the geographies we're in. So this is what we do, right? We manage through volatility. So we're -- we feel very confident. Broadly, our customers are telling us that they're busy. They've got good backlogs going into Q1 and a lot into Q2 of next year. Some pullback maybe in Q4 just because of normal seasonality. Also, we still have a lot of our customers who tell us they're having labor challenges and they could be producing more if they were able to get the labor that they need because they've got the demand to pull it. Certainly, things can change, right? When you deliver 40% of your orders the next day, you don't always have the best visibility on some of the markets. I think on specific end markets, semiconductor has been really strong for us the last couple of years, continues to be strong, and we've announced some investments we're making to expand our capacity in the U.S. to support a lot of the build of more production here in the U.S. Aerospace continues to be a strong market for us. Build rates continue to go up. We continue to see our activity increasing there. Non-res construction has remained strong for us. We do typically like 4- to 5-story buildings and lower. So it's smaller projects. We're seeing those continue to be started and completed. There's activity out there. Automotive, as I mentioned, we don't sell metal as much to the automotive industry. We do what we call toll processing, where we don't own the metal. We just process it, store it, deliver it for a fee to the auto OEMs on behalf of the mills for both carbon and aluminum where we've seen a lot of growth over the last several years with the lightweighting trend here in the U.S. So we saw that pick up in Q3, and we think there's more room to go there. And again, we don't have to take on the price risk on that automotive volume, which is large volumes for us. Generally -- again, we sell into so many different markets. A lot of times, we don't know who we're selling to. I would say the only -- the one area where we've seen a little drop off in Q3 and continuing is in our toll processing business for the appliance market. So we have seen a bit of a drop there. I don't know, what did I miss?

No, I was going to try to go to this whole session without saying anything, but I'm going to...

That won't happen.

No. I mean, Karla is right on. We really don't pay attention to anything other than our balance sheet and our customers and our suppliers. We've been doing it a long time. It's positive. We have -- we generate a lot of cash and make a lot of money. We -- all the markets, Karla was talking about, seem to be doing well, and we try not to read all that other stuff. We're not daytraders, right? We're long-term investors in our customers and our shareholders.

When you think about your customer base, 40% of which you deliver to next day, do you think any of that is more sensitive to the higher interest rate environment? Have you seen any impact on the numbers of orders received at all?

No. I mean actually -- and again, I don't know that we would know if there was an order specifically related to that, but a lot of our customers have made good money the last couple of years. Their balance sheets are in good shape. So I think they're able to be buying. They -- a lot of times when prices are going down or if there's more uncertainty, people want to buy in smaller quantities, that's our business. So they buy smaller quantities more frequently. A lot of metal prices are also going down. So any increase in interest cost or taking up part of their credit line can be offset by lower metal prices. So we haven't seen really any impact from that.

Yes actually Emily -- sorry, we are more worried about our customers' credit situation when prices were going up at a rapid and significant rate as we're having to increase our credit limits to them, right? But navigating that cycle the last 18 to 24 months, we didn't really see any increased credit losses. So on the way down, to Karla's point, their balance sheets are, for the most part, are healthier. So the higher interest rate environment doesn't seem like should have a negative impact.

Maybe switching gears on the other side of the sort of top line equations, the pricing outlook. And this is where you've been pretty successful in sort of maintaining prices, although been stickier at these higher levels as we've seen the underlying commodities all start to peel back. Maybe talk a little bit about what's driving that? You've talked about increasing value-added processing over the last 5 or so years, all the success is there. What's underpinning these sort of sticky pricing levels?

Yes. So I think the fact that -- I think our model makes us sticky, right, because our customer -- a lot of these small companies, the owners out in the back during the day, managing the workforce. They come in at the end of the day. They want to make a phone call or shoot an e-mail to say, have this here for me tomorrow morning to keep my plant running, And they know that Reliance will deliver that for them. So we try to make it as easy as we can for our customers. We want to give them quality on time and really get them to rely on us to be a part of their business. And with that, that's value. We've also invested in a lot of equipment over the last 8 or so years. We saw that the processing equipment had made more advances than it had for a few decades before that, and that we were able to give our customer a better product. So with that, we can charge a little more because maybe with a smoother edge, a tighter tolerance, they were able to take some processes out of their production line. So there's value to that. So we really spent a lot of time getting our salespeople confident and making them understand that they were providing value to the customer so they could go out and charge for that. And with that, we think that has made it stickier because it's really solutions we're providing for our customers. And so we're trying to charge for that. But certainly, we do benefit from the gross profit dollars that we get when metal prices are higher than when they decline. So we might -- when prices decline, generally, we can lose some gross profit dollars, but the margin may go up because what we charge for the processing, and we also charge for special packaging, for delivery, et cetera, that price could stay the same. So the margin might go up.

And then as you think about adding more value-added processing over time, I think where just over 50% of the metal that you touch is now value-added, what does that look like going forward? How much more investment are you going to put into that to increase that from maybe 50 to something much higher than that?

Yes. So we'll keep putting in more value-added processing. If our customers are -- want it and they're willing to pay for it, and they seem to still be doing that. We mentioned the labor challenges. We do think that's pushing some of our customers to want to push more processing to us. Also, with educating our salespeople, a lot of it is having them get into our customers' production facilities and identify areas where they say, well, gee, why do you have that piece of equipment that you're running 8 hours a week? We have that sitting here. We can actually do this for you less expensively than you doing it on your own, and we've seen a lot of success with that over the years. So our customers are still asking us to do more. In 2022, we have our highest ever CapEx budget at $455 million. A lot of that is more value-added processing equipment. We're not going to be able to spend all of that and install all of that this year just because of extended lead times with a lot of the equipment makers but it will come in. And we're currently working on our 2023 CapEx budget. And we don't know what the number is yet, but there's a lot of activity out there where our customers are still looking at us to do more. So we think there's still a lot of opportunity. What that translates into in a percent basis, but we expect the 50% to continue to increase based on what we're seeing with our customers.

And the only thing I'd add is this labor situation we have right now, that's long term. So we're going to continue to invest in automation. It's easier to buy a piece of equipment to do the work that it used to take 4 folks out in the plant to do it. So we're going to -- we'll continue to do that because I personally think the companies that are going to win are the ones that are going to retain and attract talent, but that only goes so far. At some point, you have to look yourself in the eye and say, it's going to be difficult to get people who want to do that kind of work. So the money that we have spent and we'll continue to spend. We've got a really -- extremely supportive Board when it comes to spending money on the things we think are the right things. So automation is -- I don't want to speak for Karla, but my guess is that will be something we'll continue to do.

Maybe just to frame it for the audience, what constitutes -- what's sort of the most basic form of value add? And how does that sort of compare to something more complex? So we can all can visually picture what's going on.

That's a great question. Art and I've been arguing about that for a long time, what is value added? Well, if you think about it, first of all, value add is a two-way street, right? For our customers, there's value in it because they don't have to hire people. They don't have to do the work. They don't have to buy equipment. They can simply focus on what they do best. That's their value. Our value is we charge for all -- everything I just said, right? So it's a 2-way street. The customers -- and I don't -- let's just assume we do pick a number, $17 billion. Our average order size is $3,000. Somebody out there is really smart. You can figure out how many transactions that is. That's a lot. And so there's value in that. So you don't have to go to a mill and buy 100-ton heat lot of a bunch of material that you're going to sit on your floor and tie up all your cash. So to me, everything we do is value added. Now that's not fair to count it that way. But if you take all the different products we handle and do something to it to change the shape of it, whether it's cutting a bar or a tube or a laser cutting play. There is -- we'd be here all day, and I know we don't have all day to talk about all the value added we do, but we do a lot of it and our customers continue to ask us to do more. Technology is absolutely awesome when it comes to the equipment that you can buy right now, and we'll continue to be on that kind of cutting edge. So whatever value added means today, it's probably going to be different next year, and that's okay because we've got plenty of cash.

Yes. Maybe talking about plenty of cash then, M&A. We haven't really seen very much on this front over the last year, but you were a little bit more active in 2021. Do you think the slowdown in M&A activity is due to the lack of interesting opportunities out there that are coming to the market? Or is it an uncertain macro? Or bid-ask spreads simply too wide at this point?

Kind of all of the above it. One thing we won't do is lower our bar. We're just not going to do that just because we haven't done an acquisition for a while, we're still looking. We're open for business if you guys know a really good companies, come and give us a call. We'll be glad to engage. It's just a matter of really find companies that, a, are for sale. We don't chase companies that aren't for sale, you have a tendency to overspend. We don't have a goal that we're going to buy x amount of companies every year. We think that will lead you to a bad decision somewhere. There's some really fine companies out there, but they might not be for sale. There's also -- I call it fishing. I know that word has a lot of different meanings in cybersecurity and all the different things. But when somebody has one good year and they put themselves out for sale, we're not your guy. We've been around long enough to know that you got to have to have a history. And we're going to kind of normalize your EBITDA over a long period of time and figure out what the value of your company is worth. So long answer to your question, we're still looking. If one came up tomorrow, we'd buy them, if they were good. We -- I don't even know how many we've looked at. Over 100 I'm assuming this year. It's a lot, it's a lot of work, but that's okay. We're going to continue to do that. And again, I'm not going to speak for the next regime, but that's a good way to invest in the future. So we'll keep doing that.

And I guess this being the mandate for M&A still doesn't matter ferrous, nonferrous geographies [indiscernible]?

Good companies are good companies. We've -- I guess, I don't know how many years ago, I mentioned the word adjacent businesses. So I guess, we'll do some of that, too, and there's a lot of good companies out there.

Maybe Arthur turning it to you then on the capital allocation side. Obviously, you haven't spent very much on the M&A side. So share repurchases came back in a focus this year. Maybe talk us through the strategy, how you're still looking at that over the next year?

Yes. Good question, Emily. And you've probably heard us say before that we don't necessarily take a short-term view on capital allocation. And for us, no individual quarter or year is going to necessarily tell the full story. We generally take a longer view, a 5-year look back. And when you do that, the capital allocation philosophy kind of becomes a lot more clear. It's a lot more balanced between growth and returns. And when you look at it the last 5 years, it's about 50-50. And again, it's not necessarily a number we're shooting towards. It must be 50, right? A lot of that is opportunistic, depending on what type of M&A deals come up and also where the stock price is trading at. So and this year and also when you look at it as a percentage of total stockholder returns as a percentage of net income, again, not over a quarter, not over a year, but over a longer period, 5 years, we're generally in that 50-plus percent range. And 2022, the first 9 months, that's roughly where we are. So again, longer view on that front.

So much for me not saying anything, right? Just to add on with the stock buybacks. We think buying a share of Reliance is the best acquisition we can do. So that's the way we look at it, and we're happy we bought a bunch of Reliance back this year and last year, and I'm assuming in the future.

But, and just to emphasize, we expect to continue to buy good companies and bring them into the Reliance family. We expect to continue to invest in organic growth as we've been doing. We expect to continue to buy back our stock, and we expect to continue to increase dividends. And we can do all of those. We haven't -- we didn't buy more stock because we didn't complete any acquisitions, we can do both. Certainly, there might be times where we have to balance it a bit. But currently, with the way we execute, we haven't had to not do something that we thought was good for the business or good for the shareholders.

Maybe focusing on the growth strategy then and Karla, you touched on it a little bit about this before, but the semiconductor growth strategy there. Can you talk a little bit to us about what you're building, when that's becoming operational and how that's sort of aligning with the reshoring or onshoring of manufacturing here in the U.S.?

Yes. So one of our companies that Reliance has owned since the 1980s. It actually was operating out of a garage at the time. And we gave them a facility in the U.S. or out in California currently expanded into South Korea and China as the semiconductor chip manufacturing business was expanding in those markets. It's been a really good business for us. What we do there are basically bulk gas distribution systems. So this is kind of the plumbing that the air and gases are piped into the clean rooms in the fab shops. And so with the announced semiconductor builds here in the U.S., and we've had a good business here in the U.S. We just have had more growth recently in the other markets. We need to expand our capacity because the U.S. business has continued to service the fab companies with a lot of repair and maintenance work and ongoing build. They export some of it. But with the significant increase we see here during the build, but then also continuing the repair and maintenance. We're going to invest, for us, a pretty good chunk of money into that capacity expansion. The -- it's kind of a 2 phase. The first phase should be operational in Q1 of '23. It's the smaller part of the capacity expansion. So in that facility, they'll be welding the gas distribution systems, that will go into -- both into the chip manufacturing companies as well as some for the people making the equipment that the chip manufacturers use. And then the bigger rollout should be Q1 of '24. And in that facility, what they're actually doing is that stainless steel tubing and they're cleaning and electropolishing it to make tubing and valves and fittings that then get welded together. So that's the bigger part of the expansion. And we're really excited about it. Semiconductor, now if I read something that says, oh, it went down 2%. Well, it went down 2% from a really, really healthy level, and we see very strong long-term growth and continued activity in that market.

I might turn it over to the audience to see if you've got questions at this point.

Just curious if you can comment along the whole value chain where the inventories are, if there's any buildup or shortages or if anything you can comment on along aluminum and steel?

I can just tell you about our inventory. Our inventory is in good shape. We learned a long time ago, cash is king. So we don't buy into the whole idea of trying to scoop the market and get out there and speculate and buy offshore and things. So because of that and because we pay attention to our customers, we don't have these big swings in inventory. The stocking and destocking or whatever you call it, I guess there's people who do that. We don't. And so I don't know. I don't know what other companies do. If I was going to guess, if they're a heavy contract company that buys offshore, they probably have too much inventory right now. And it's probably way too -- the cost is too high. We try not to do that. Now there's times where we might have a little bit too much inventory, but with our model and the fact we own so many companies. If we get into a situation, Karla has done an awesome job over the last couple of years, and we call it collaboration. All these companies working with one another. So if we have a -- maybe a little bit too much here, there's 74 other places that you can move that to internally. So our inventory problems are really problems to us. It's just something that it's part of our model. So I don't know what other people do.

Yes. And I would just say we think at our customers and at other service centers in general as an industry, that inventory levels are pretty healthy. We don't see a lot of run up. Certainly, there is more inventory available for most products than there was in 2021 and in the beginning of 2022, but it really does vary by product and -- so you really have to remember Reliance's diversity of products. Our carbon flat rolled is about 17% of our total sales dollars. So we're heavier in some of our other products with downward pricing that we've seen in some of the products, but at different rates and different timing. Some of our products are still holding in well on pricing. There are some specialty products that we sell like into aerospace and energy, where there are still extremely extended lead times. You continue to see some price increases for certain of those products. So we think inventories are available generally more so than the -- on certain products, but still healthy inventory levels.

And just one thing, I'd been remiss if I don't -- if I didn't give kudos to the suppliers. They're a lot better than they used to be. I've been in the business for 42, going on 43 years. Back in the day, they would just run their mills and stack the inventory up and screw up the market, and they don't do that now. Thank goodness, they're a lot smarter. They get the cash thing, too, when their order book gets -- comes in too much or gets a little life, they just don't produce as much. So I'll give them credit for that, and we appreciate that. And -- if there's any of them in the room, make sure you tell him I gave them high five.

I think there was another question in the crowd.

Hoping you can touch a little bit on your ESG, sustainability goals and ambitions?

Yes. We -- the last -- last year, we started disclosing our emissions. I mean for us, for our business, it's predominantly our fleet. So it's very minimal. And then for Scope 2, you're talking about diesel fuel, et cetera. So we're looking at our data. We don't have any goals, targets published because a lot of that depends on what type of technology comes out in terms of transportation, right? And we've already, for years, try to be as efficient as we can with our routes to minimize the cost because it's such a significant part of our overall SG&A. So inherently, you're already managing that part of your business. So there's -- it's not like there's a lot of low-hanging fruit where you can go in and minimize the amount of miles that you drive. So it's something we're looking at considering. And once we have a little better understanding of all the components and technology and different solutions available to us, we'll think about...

Just to add, it's important, right? It's doing the right things. We like to -- we pride ourselves on doing the right things, and we've always done the right things. Now there's just different grading system for the right thing, right? And we're just trying to figure out that grading system. The G part, we've always gotten straight As. The E&S part, we're trying to figure out what are you looking at? And how are you looking at it? And if we're guilty of anything, we're probably not very good at reporting what they -- how you check the box. So to Arthur's point, we're getting better at that and we're trying to figure out how do you do those things. And one thing I will mention, because I mentioned our suppliers, we want to help them, too. They're up against -- they're making something and they're going to have to make cleaner product, and we're -- we want to help them with that. And it's here to stay. We take it extremely serious, and we're going to figure out how the grading system works, and we'll get our good grades and help our suppliers with their quest for green material. And by the way, that's going to cost more money. So if you're figuring -- if you want to look at their price, it's going to go up because it's not cheap to make green material. .

And I just quickly add. We have been for the last 2 years also looking at renewable energy, putting a lot more solar panels on our properties with new builds or redoing a roof. We also -- safety has always been our number one value at Reliance. So we have a safety team. We continue to try to build the culture of safety. We're better than industry averages, but we want to continue to improve on that all the time.

Do you expect the 232 duties to end any time soon? Or do you even plan for that?

I haven't even thought about it for years. I don't know. I -- we're living in kind of a strange political time right now. I don't know. There's discussion around it. It was the right thing to do at the time. It's still around in some products. It's a bargaining chip. I think now feels politically. I really haven't thought about it. I don't know if you're going to...

Emily probably studies it and plans for it more than we do. So we -- with our business model, again, prices go up, prices go down, that's probably what would happen with 232. Certainly, keeping more imports out helps keep price levels up. But with our model with the domestic mills, other than indirect pricing impacts, we don't see it as a big issue. And if it happens, we're going to deal with it, but we're not going to change our model or our strategy because something might happen.

Yes. I mean, dumping anything into this economy is just not the right thing to do, right? So they put a halt to that. But since that all happened, there's different -- some people call it capacity, I call it capabilities. There's brand-new mills being built in the United States, and they can be as competitive as they want to be. So is it necessary? I don't know. It depends on what product we're going to look at.

We've got time for one more question. Great. Well, Jim, Karla, Arthur, really appreciate you guys spending your time with us today. And thank you, everyone, for your time and attention.

Thank you, appreciate it.

Thanks for having us.