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

All right. Good afternoon, everyone. Thanks for being with us today. Karla, Arthur, Steve, thanks a lot for the time. We have the whole Reliance crew here today with us, which is great. Can we start with the beginning, please, Karla, and provide a brief introduction to the company for the people that are not familiar with your story, please?

Great. Of course. Yes, and thank you to Goldman Sachs and to you for having us here today, and thanks to all of you for joining us here. So we'll try to tell you a little bit about Reliance and answer whatever questions you have. So Reliance, we're the largest metal service center company in North America. We really operate as a lot of smaller companies. Currently, we have about 315 locations, primarily in the U.S. We are the most diversified metal service center company. We have a really broad array of products. Carbon steel is little over half of our business, but we've got a good presence in aluminum, stainless and then several other -- copper, brass, et cetera, titanium. We've purposely grown the company to be very diversified. We think that helps mitigate us from volatility of metals pricing as well as selling into cyclical end markets. So we've been focused on that. We think that serves us well. Since our IPO in 1994, we've acquired 72 companies. So we've really grown the business. Last year, 2022, we were about a little over $17 billion in sales. We focused a lot on selling to smaller customers and smaller order sizes. We do have direct OEM business, but we really try to focus on customer service. And with that $17 billion of sales, our average order size was about $3,700 in order. So our people are working hard out there throughout the field. It takes a lot to service that order size. And 40% of those orders, the customer calls us today or e-mails us, however they contact us, and we deliver it tomorrow. So a lot of really quick turnaround business. 50% of our orders, we perform some level of value-added processing, generally kind of first-stage processing, to change the size or the shape of the metal so that it fits more easily into the customers' production line. And with that model, they're willing to pay a bit of a premium for that. We really think we're providing value to our customers. The last 8-or-so years, we really had to focus on increasing the amount of value-added processing that we perform for our customers. A lot of that because they've been asking us to do that. Better equipment, in our view, started coming out where we could get a tighter tolerance, a smoother edge that can take some of what our customer has to do to the metal out of their production phase. So it's more value to them, more efficient for them to have us do it for them. So historically, we had performed value add on about 40% of our orders. As I said, that's up to just over 50% now. And with that, the company's gross profit margins have been steadily climbing as we do more value add. Historically, we were kind of 24% to 26% gross profit margin range. Now we're -- our sustainable range is 29% to 31%. So we think we've gotten our return on those investments in that value-add processing equipment. We also, at Reliance, we buy in the spot, sell in the spot. We have very little contractual business, a little bit in long-term contracts in commercial aerospace and defense. But other than that, generally spot. With that, we try to turn our inventory better than the industry and -- so that we can react to changes in that, effectively manage the working capital. So we think we've done a good job at that. Very consistent cash flows, kind of noncyclical cash flows as well. If there's a downturn, we reduce our working capital. And if there is a downturn, and unfortunately we've had to exercise this a few times, with our scale and the number of service centers we have, if we do get in an over-inventory situation in one of our operations, we can funnel that out through other of our companies. So that kind of gives us an advantage over smaller service centers out there and allows us to manage that better. We do operate our own fleet of about 1,700 trucks. So that's also a competitive advantage that allows us to deliver those small order sizes to our customers. Also, to be able to support those characteristics we talked about, we're very decentralized. We try to put the decision-making as close to the customer as possible and allow them to know their customers and to react very quickly. So I think that's Reliance.

Yes. Great summary. Thanks a lot. Obviously, M&A has been a core part of this strategy for the past few years, right? Most recent one being Southern Steel. I think 2022 was a quiet year for you. 2021 was a big year as well. So I mean, walk us through, please, how has been the integration with these acquisitions? How do you manage to integrate them all? How should we think about that going forward? And the level of consolidation in a market that is clearly not consolidated enough, right, how do we get to a more optimal level going forward?

Yes. So I mean, I feel like we've worked pretty hard on 72 acquisitions so far, but we're still just under 15% of the market. So it continues to be a very fragmented market with, we believe, a lot of opportunities still out there. We don't want everything that's out there. We -- our model is to buy good, well-run companies and make them better. Criteria, they have to be immediately accretive to earnings, have strong management teams, high integrity, focus on customer service. And we see a lot of teasers for acquisitions. There are a lot we don't move forward on. We also -- we don't want to compete with our customers. We don't want to compete with our suppliers. So that weeds out a lot of the opportunities we've been seeing. But there's a lot out there now that is attractive. I think valuation expectations are getting a little more reasonable from our view. And we've been able to reach agreement with many sellers over the years. Southern Steel, we did acquire earlier this year. It's going well. It's a pretty small company. It was strategic for us for one of our existing companies who wanted to expand into that geographic market. It broadens Southern's product mix. And when we acquire a company, because we are pretty decentralized, there are some things -- financial reporting, cash management, et cetera, that we work with them on right away. Safety, their standards, typically most companies aren't up to ours. So Steve and his team spend time there improving safety. But a lot of the employees in the company don't realize that there's been a change in ownership. They continue to operate as Southern Steel. We are going to, over time, make them better at how they go to market, how they operate, make them more efficient. So integration with the way we do it is usually pretty smooth. We've seen that there. And some people think, because we didn't do any acquisitions in 2022, it's because we reprioritized where we want to invest our capital, but that's not the case. Our balance sheet's in very good shape. We look at 4 capital allocation buckets and we think growing the company for the long term is kind of the best use of our capital, whether that's organically or through acquisitions, because we think we can continue to build and improve upon those investments. But at the same time, we want to return capital to our shareholders as well. But we've been fortunate that we could exercise all 4 of those buckets, but it just depends when the right opportunity is available. We don't want to do a bad deal. We're only going to go forward on an acquisition if we think it's the right investment for Reliance, whether that's organic growth or acquisition. So our appetite never changes. We're always working on potential acquisitions, but we don't always find the right fit.

Right. Makes sense. I was going to ask about the product portfolio and if there was an intention to go further downstream or maybe into the upstream operations. But it feels like there is none, right? If you don't want to compete with clients or suppliers, that's where you draw the line.

Yes. So we -- that's correct. We -- but we do -- we have acquired a couple of small fabrication companies, which would be a little more downstream, but they've been in kind of out-of-the-way parts of the country where we're not competing with our existing customer base. And at the same time, as I mentioned, a lot of our customers have asked us to do more for them. So as we bring more of the value-added processing equipment in -- to do that for our customers at their request, we are going a little further downstream. But it doesn't look like we're going out -- and we're not, right, going out to take share from our customers.

Right. Okay. You did mention that balance sheet is quite robust as you've -- I mean, I think you're at 0.1x net debt-to-EBITDA. Buybacks, you've been quite aggressive as well in the past few years. You mentioned the 4 buckets, I'm guessing it's growth, buyback, dividends and -- it's 4.

Well, it's 4. Growth through [ acquisition is 2 ], yes.

All right. Okay. So I mean how do you prioritize each of those 4 buckets? And what is the ideal net leverage you want to have? [ 0.12 ] seems too low or are you just -- you want to keep low to be ready for potential targets?

Yes. We used to say that, right, we wanted to be able to be opportunistic. But really with where we are today, we don't think we have to choose. We think we can do all 4 of those. But Arthur, do you want to talk about it?

Yes, sure. So we don't take necessarily a short-term view on that. And we take -- being a cyclical business, we take a kind of longer view, 5 years plus. So if you look at our returns and growth investments over the last 5 years, returns, dividends and share buybacks combined have made up a little over 50% of our net income and close to 55% of free cash flow. Does that mean every quarter or every year, that's where we're going to be? No. It's just the business, like I said, is cyclical. So we just take a longer view on that. And that -- does that mean that we're always going to be sort of balanced between growth and returns? No. It just depends on opportunities that are available that are in front of us. So some periods, we might tilt more towards returns. And in some periods, the allocation may tilt more towards growth.

Okay. Makes sense. Maybe going back a little bit to the [ core ] landscape you have today. You mentioned to have 15% of the market share. I think the second largest peer has probably less than half of that or 1/3 of that. What do you think is that ideal setup in terms of how many players? And how long it's going to take for us to get to a level where the top 5 have at least 50% or 60% of the market? I know it's potentially decades away, but it feels like we are trending towards that level, right?

Yes, I think it could take a while to get to that level here in the U.S. Like we said, there are a lot of good companies out there and a lot of family owned. We are seeing as people get to the end of their careers, they may want to have a liquidity event because the family may not be in the business. And that's been the case for quite a while now. But we continue to see that. We also hear from smaller companies that, due to various factors, it's getting more and more difficult, more and more expensive for them to participate. So we're a good exit for them. As I mentioned, we talk about the well-run successful companies, we feel we treat them the way they would like to be treated as a seller. We leave their name on the business. We operate under several different brand names. It's important for a lot of those families. And we're paying a value for the reputation they've built for the way they service their customers, for their integrity, and we want to maintain that. We don't want to go in and destroy value that they've created. But we do think, whether it's just through buying power or being part of our size, some of the financing costs back in health care where we can provide some advantages to them. But as the mill world has consolidated, we hear from smaller companies they feel it's a little more difficult for them to feel important and being a part of it. But we really think the biggest value that we bring to the companies that become part of the Reliance family are all of our other family members that are out there because they can share information with each other, they can learn from each other, share their expertise, different ideas about ways of doing things and really bring best practices to the companies. Also, we'll push the companies, maybe the family, they didn't want to -- they see opportunity, but they were a little nervous about levering up to buy some expensive equipment or to add another location. And with our resources, we're able to kind of push them to do that. It excites the rest of their team that's there. And being in a growth mode is good for morale and really positive. Steve, do you...

Yes. I mean we like to listen to our customers to see where -- what we can do to add value to the supply chain. We listen to -- 95% of purchases are domestic, so we watch our domestic suppliers, where they're adding capacity, what needs do they have so we can kind of be part of their solutions. So between our customers and our suppliers and our employees, we want to grow in a thoughtful, calculated way as opposed to just thinking about overall market share.

Yes. Sounds good. How do you think about your working capital strategy? Because Karla, you did mention that you buy on spot and you sell on the spot. Volatility has obviously picked up for commodities prices, so there might be a mismatch when we get a certain level of volatility, right? How do you manage to really work around these volatile scenarios to make sure that your inventories levels are not too far from where the spot prices are?

Yes. So really, again, we focus on turning our inventory quickly. I think Steve just mentioned our really buying domestically, that we think that helps us manage our inventory better. You have shorter lead times, so you're not as -- you're a little more risk averse because of the shorter lead time. We really talk a lot in our decentralized operations about the local intelligence. Our people locally decide which products they're buying, how much of it they're buying, who they're buying it from. It's within their control, and we hold them accountable through their compensation program. So our managers, our local management teams at each of our locations, they not only have to drive profitability, but they have to manage their working capital because their comp is based on their pretax income return on those manageable assets. And we feel that's how we can hold them accountable and that that's pretty effective with the way we've structured it.

And I think Karla alluded to this earlier, our business model is designed to handle volatility and manage through pricing cycles. And given our small order sizes, transactional nature of the business, next day delivery, arguably, we have better pricing power than you would have if you had firm pricing, right? And that allows us to capture more value, yes, and it's kind of a peak-to-trough cycle than you would if you had kind of locked in prices on the buy and the sell side.

Makes sense. You mentioned that 95% of what you buy is from the domestic market. Is that an opportunity to increase international exposure or imports? Or it's just part of the strategy really to keep the high level of domestic sourcing?

Yes, we think -- we've had the domestic sourcing for years. Actually, Reliance goes back to 1939. And I think in the '70s when they were a much smaller company, they did more import, and that's the only year in our 84-year history we lost money. So we're a little gun-shy on that. We do remember -- some of us remember that. I wasn't working here then. But we feel that the domestic buying really does help us manage the inventory. We want to know what's going on in the import market. Certain products aren't produced here, so we do have some imports. But we really think, again, it's just better for our model to be predominantly domestic.

All right. Can we talk a little bit about the brand? And I'm not sure if you're going to break down per product or maybe per region, but -- sorry, per end user. But how are you seeing the current landscape? I think we we've seen steel companies here over the past couple of days and they all presented a very interesting outlook, to say the least, all related to near-shoring, reshoring and obviously energy transition. So how do you think about that and the differences between what you're seeing now and maybe a more structural outlook?

Yes, I'll start and then you guys can kind of chime in. So I think we're probably all more bullish than any of you in the audience are. We still see our customers being busy in most markets. It is a little spotty where certain of our customers, certain parts of the business, are seeing a little weakening. But when we meet with Wall Street I think starting earlier this year, because there finally was actually an interest rate again in the U.S., everyone thought nonres construction was just going to stop. And we've seen it continue in our space, in the service center space, and in particular, Reliance. We're typically doing the smaller projects. It's usually like 4- to 5-story buildings and below. We're not -- we'll do a little bit on the big skyscrapers, but most of that's mill direct. So we've seen our customers continue to have new projects, be busy. Like some of the big distribution centers fell off a bit, some commercial buildings, office buildings. But we've continued to see data centers, hospitals, schools, airports, manufacturing types of buildings, which ties into the reshoring. We are seeing real examples in a small scale of manufacturing coming back onshore. Obviously, there's the big scale with the chip manufacturing, battery plants, et cetera, that's also going on. So nonres construction, we think -- we've seen a couple of project delays. Again, they are smaller projects. But we think that's going to be okay, but we might see a little pullback as we go into 2024. But overall, we're still positive on that. We think there's a lot of activity to come. And a lot of our products that we sell into to that market also go into infrastructure. And that's just starting the monies, just getting ready to start to be released. We've seen pretty minimal activity from the infrastructure bill right now. We think that's going to continue to incrementally increase. The Inflation Reduction Act, we actually saw spend from that start earlier, and we think that's because they did it in the form of the tax credit. So those mainly renewable energy projects could start much more quickly, but that's still early in the IRA. It takes a little longer on the infrastructure to get the funding approved. And with the CHIPS Act, that's just, in our view, good for manufacturing in general because when they build the huge fab plants, then they've got to have the infrastructure support for their subcontractors and for their employees around that. And that's where we participate. As well as directly participating in semiconductor, including the ultra-high purity gas systems that go into those companies for their clean rooms. So we think there's a lot of good activity there. Aerospace has been a growing market. We see that continuing to grow for us. A lot of opportunity there, both commercial aerospace, also defense and space. There's growth going on there. Automotive, we purposely don't really sell metal directly to the automotive industry in large quantities, but we process a lot of metal for them. We call it toll processing. So we don't take ownership of the metal, so we don't have any risk from metal price fluctuations. So typically, the steel or aluminum producers are our customer, and so we charge them a fee for us to inspect it, edge-trim it, slit it, blank it, deliver it to their customers, store it for them. So that's a really good, very consistent earnings and cash flow business for us that we've been in for a long time. We've grown a lot in that business, in particular with the increased aluminum content in automotive. It's really hard to handle -- and process and handle surface-exposed aluminum, and our company here is very good at doing that. So the auto manufacturers and the producers are excited about having our company work with them on that business. Automotive, our processing for that is up this year as the auto build rates increased. We think it stays relatively healthy subject to any big pullback in consumer spending if the economy worsens from where we are today. General manufacturing, we kind of sell a little bit to everybody. So that's where we've really seen mixed messages. For the most part, most of that has been strong. But we did talk about, in Q3, we saw some pullback on ag equipment, consumer products and some industrial machinery. So we -- and we expect we're going to continue to see certain customers, certain geographies, certain end markets continuing to strengthen or hold steady while we see some weaken. But that goes back to our strategy of being very diverse, so that overall to Reliance, any impact is mitigated. So Steve, do you want to add anything?

Yes. I'd just like to say, so our very supportive Board, they've approved $1.7 billion in CapEx over the past 5 years. We've been able to spend all of it because of extended equipment lead times. But 315 locations, 50 operating businesses, we are ready for business. And whether we're shipping to a machine shop or a job shop or a structural fabricator, they're busy. And whether they're building a school or a hospital or data center, they don't really care where that business comes from, they're busy. And we try not to watch the business news, and we are going to just keep running our business and -- moving forward and maximizing all the facilities and capabilities that we have.

Any specifics on aluminum market, because it doesn't seem to be as strong as the steel market, right?

You said, does not?

It does not. Does it?

Yes. So we would say in the aerospace-related aluminum products, it's strong, both pricing and demand. Common alloy, general engineering, right, a little pullback. Semiconductor is hitting that. We think long term, semiconductor demand is there. There's just a little too much inventory in their supply chain right now that we think will work its way out through 2024. And long term, we're very bullish on that.

Yes. And we watch our suppliers, I mean, they're opening up new capacity. So they're looking out 5, 10, 20 years. So we -- they did the research, are investing the money, and we have a lot of confidence in our outlook on the market.

What's your appetite to replicate whatever the strategy you have within the U.S. in other regions outside of the country?

Yes. So we feel we've been pretty successful in the U.S. We know the market, but we also know the supply chain. Decades ago, the producers also owned the distribution channel, and then they realized they weren't -- that wasn't their bread and butter, right? It was higher cost with their union, wages and legacy benefits, and so they really spun off their distribution businesses. And so the U.S. market, we think, works pretty well with having the service centers in there. Other parts of the world, Europe, Brazil, the producers still kind of have their own distribution channels as well. We've looked at opportunities from acquisitions and the profitability levels are just different because they're competing with the producers. So we do have some international operations. Typically, it's in specialty products, specialty end markets with high-quality standards. So generally outside of North America, we're in aerospace, energy and semiconductor. We can make reasonable profits there. We're continuing to grow those businesses and we'll look for more opportunities. But to kind of be a general line service center in some other parts of the world, the profitability levels just don't meet our standards.

Makes sense. You did mention that the new structural profitability guidance is now 29% to 31% versus 24% to 26% before, if I'm not mistaken. What is the -- what was the main reason behind it? It feels like it's -- the right acquisitions helped, but did you manage to get to be more efficient running like thousands of smaller companies and one big headquarter, how do you manage to become more efficient? Is there room to be more efficient in that as well?

Well, there's always room to be more efficient, and we hope we'll continue to do that in all parts of our business. But really, that step-up, the sustainable part of it is, we believe, our increased value-added processing, right? So we're investing a lot through our capital expenditures into value-added processing equipment. We think -- we know we need to show a return on investing in that, and we think that step-up in gross profit margin demonstrates that we are getting the right returns. So we're able to charge for that value-add service that we're doing. And we bought the equipment, but just because we bought the equipment didn't mean we were getting higher gross profit margins. There was a whole kind of training and mindset that Steve and his team had to spread throughout the company so that our salespeople understood they should be charging more because they are doing more for their customers, right? We're not taking advantage, but we're providing more value to them. So we had the investments, but then we had to bring along the pricing discipline to go with that. And that's really where we see the sustainable part. We also -- because we are a bigger company, we've got the same piece of equipment operating in multiple locations. Sometimes it takes a while to train your operators to become efficient on that. So we're able to leverage our companies to help each other to get there a little faster than maybe we would be if we were on our own.

Okay. We are running a lot of time. I want to check if there is any question from the audience. Yes?

You are a just-in-time supplier to your customers. I wanted to get a sense if -- the higher rate environment, what is that doing for your customer purchase orders? And are you carrying more inventory on your balance sheet to support them? Or any anecdotal that you have on that.

Yes. So we've -- for different reasons, right, we operate through different cycles. And when it -- either because metal prices are going up or borrowing rates are going up, when we see our customers needing to maybe more tightly manage their credit lines or their working capital, we're more attractive to them. Because maybe it's a company that would buy from the mill and they would need to buy 2 or 3 months' worth of inventory at a time to meet the mill minimum, and now they need to manage that credit and capital more closely. So if they can call us and get a week's worth or a day's worth and we deliver it to them much more timely, we generally see more people coming to us during times where it's a little tighter. And we've seen some of that already. How much does it move the needle? I don't know. But -- and we hope then that we service them so well that even when things loosen up, they keep buying from us. And sorry, and we're not carrying extra inventory because we've got the relationships with the mills, we're buying domestic and so we've got the ability to replenish our inventory. We don't have to really beef up to do that.

Any other question? Maybe one last one from me. Do you have a view on prices? Where do you think prices are heading?

Some will go up and some will go down, right? It's kind of what we do as -- from a service center standpoint. We did with our fourth quarter guidance, we did say that, well, we felt there could be some more pressure on certain products. And for instance, like carbon steel plate held up pretty well throughout 2023. We've seen some downward moves more recently, but not really unexpected. Same with structurals, they've been pretty steady, a little pressure there. Hot rolled, flat rolled going back up again. Stainless and aluminum have kind of been on a more downward trend. But in our guidance, we said we thought that we were close to reaching trough and/or stabilizing for a lot of the products. So it's a mixed bag because we handle so many different products. But overall, we think generally probably stable to, hopefully, increasing overall next year.

Yes. I mean we support U.S. manufacturing and they are investing. And they're not investing in new capacity, whether it's stainless or aluminum or carbon, to value the product. So I think for the long term, that there's an upward bias. With wage inflation, just the overall cost of everything in the supply chain, we don't think that prices are going to hit the levels that they hit in the past cycles.

Okay. That's great. Thank you very much.

Thank you.

Thanks for having us.