Russel Metals Inc. (RUS) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen, and welcome to the 2022 Year-end and Fourth Quarter Results for Russel Metals. Today's call will be hosted by Mr. Martin Juravsky, Executive Vice President and Chief Financial Officer; and Mr. John Reid, President and Chief Executive Officer of Russel Metals Inc. [Operator Instructions] I will now turn the call over to Mr. Martin Juravsky. Please go ahead, sir.

Great. Thank you, operator. Good morning, everyone. I'll provide an overview of the Q4 2022 results. And if you want to follow along, I'll be using the PowerPoint slides to reference that are on our website and just go to the Investor Relations section. If you go to Page 3, you can read our cautionary statement on forward-looking information. So let me start with a little perspective on the quarter in 2022 as a whole. In 2022, we generated record revenues of a little over $5 billion and EBITDA of $579 million. Our EBITDA and net income were the second highest in the company's history and only a little bit behind the records that were set in 2021. We generated annual gross margin of 22% and a return on capital of 33%, both are tremendous results. The results for 2022 were strong overall. But if we look at the second half of 2022, in particular, I'm even more proud of how we performed as the market experienced volatility during that period. Our business is now more resilient as we have substantially reduced the volatility of our earnings profile. In addition, we continue to show the countercyclical nature of our cash flows. In Q4, not only did we deliver good operating results, but we also generated $146 million of cash from working capital. As a result, our balance sheet is extremely strong and it gives us a great opportunity to take advantage of both internal and external investment opportunities. So let's begin by talking about market conditions, which are on Page 5. Steel prices came down in Q4 but remained at healthy levels by historical comparisons, particularly for plates. In addition, we have seen price stabilization in facts and price upticks over the past month or so. If we look back to around mid-December or so, the market was at somewhat of an inflection point at that point as it felt like prices had hit a floor. And as it's now rolled into January, there's now more upbeat tone to the market, and we are cautiously optimistic based upon what we see today. The right charts on the page illustrate the recent movements in service center inventories for the industry. Inventory tonnage levels for Canada is on the top right chart and the U.S. is on the bottom right chart. They both came down over the past few months, which is typical at this time of the year. The result is that supply chain inventories are modest than are in check. As we look at takeaways from our customer base, demand has picked up quite nicely in early 2023, and we see it across most geographies and end markets. If we go to Page 6 for our financial results. From an income statement perspective, revenue of $1.1 billion in Q4 was down from Q3, but comparable to Q4 of 2021. Overall, gross margins declined to 20% from 22% but remained very healthy. EBITDA of almost $100 million for the quarter was very good for what is typically a seasonally weaker quarter. Interest expense came down by $2 million as the increase in interest rates is allowing us to generate some interest income from our growing cash balance. Overall, we generated earnings of $58 million and earnings per share of $0.93 per share. Our Q4 results were impacted by a few nonoperating items. In the case of TriMark, we picked up $10 million of earnings from that joint venture, which was about the same amount as the $8 million of cash flow that came into us as dividends in Q4. Stock-based comp had a $2 million negative impact versus nil in Q3, and we had a small about $3 million increase in our inventory and RV reserves. One of the things that has changed in our portfolio over the past number of years is how we manage inventory in a period of falling prices. There were times in the past where we had significant NRV adjustments in some of our business units. The business units that had experienced those wild swings in the past or even no longer part of Russell or are under much tighter inventory control measures than in the past. Lastly, we had a $1 million expense for the unitization of a significant portion of our DB pension plan. This transaction closed in early Q4 and involved a transfer of around $35 million of pension assets and liabilities off our books to that of a AA-rated insurance company. In addition, it allows us to derisk and secure the current pension surplus of around $40 million for use across our other pension plans. From a cash flow perspective, in Q4, we generated, as I said, earlier, $146 million of working capital. We have a countercyclical business that generates strong free cash flow in market downturns, and we did experience some of that in Q4 with a decrease in both inventory and AR. The decline in inventory in combination of a decrease in both tonnage as well as average unit costs. I expect that going forward into Q1, we might see a small decline in tonnage and some further price drops in average cost as our on-order inventory remains below the average cost for our on-hand inventory since we use an average cost system. CapEx of $50 million for the quarter has picked up, and we are continuing to advance a series of value-added equipment projects and facility modernizations. Going into 2023, our CapEx should pick up, and I suspect it will average around $75 million or so over the next number of years. From a balance sheet perspective, we are now in a net cash position, which is made up of our term notes of $300 million that are more than offset by a cash position of a little over $360 million. In total, if we look back over the past year, our net debt position has declined by about $230 million as a result of the strong free cash flow generation. Our liquidity is $743 million and our credit metrics are strong. In Q4, we are using our NCIB to acquire shares. And since the NCIB was put in place, we've acquired 1 million shares at an average price just below $28. Our current share count is now back to around 62.1 million shares. Our capital base continued to grow in the quarter with our book value per share up to around $25.10. This represents a more than $5 or 27% increase in book value just over the past year. Lastly, we have declared a quarterly dividend of $0.38 per share, and that will be payable on March 15. If you go to Page 7, you can see our variance analysis between last quarter and this quarter. In looking at service centers, the seasonal decline in volumes impacted EBITDA by around $10 million. As mentioned earlier, we lost some operating days due to normal holiday schedules. The $25 million decline in margins was due to lower prices, which have only partially been offset by lower cost of goods sold due to the lag effect. We expect cost of goods sold to come down further in Q1. Offsetting this is a $9 million favorable variance due to the direct drive system we have on variable comp, and that went the other direction in the quarter to create that favorable variance of $9 million. Energy declined by about $6 million in the quarter and steel distributors declined by about $2 million due to the moderation of steel prices that particularly impacted our U.S. distributors business. There was a $9 million favorable [indiscernible] variance in other, which included TriMark's lower earnings in Q4 versus Q3 and the mark-to-market on our stock-based compensation. Go to Page 8, we have some segmented P&L information. The service centers continue to do well amidst the market volatility. Revenues were down versus Q3, but still represented a good Q4 results. Average prices were down versus Q3, but still up versus the historical average. Gross margin in percentage terms is down to about 18%, but is still strong in dollar per ton terms. I'll go into a little bit more detail on that in a minute on the next page. In energy, we're continuing to see positive market sentiment. There was a seasonal factor with the Q4 revenues, but overall market conditions remain upbeat as we look into 2023. Gross margins came in at 28% and they have remained north of 25% since the monetization of the OCTG line pipe business. Not to repeat the old cliché we've used in the past, but we're doing more with less. Distributors' revenues and operating results came down as they were impacted by the moderation of scale prices. If we go to Page 9, what we want to here is show a deeper dive on some of the metrics within our metal service center business. Last quarter, we started to disclose both current and historical tonnage and allows for some unit and dollar per ton comparisons. The top graph is the past 5 years for time shift. And as you can see, the typical Q4 dynamic is around a 5% to 10% pullback in volumes from Q3 levels because of that seasonal factor. In Q4 of 2022, the shipments decline was around 8%, which is within the normal range. And as we roll into Q1 of 2023, we expect to see a bounce back to more typical activity levels for Q1. On the bottom left graph, we have the revenue and cost of goods sold per ton. On revenue per ton, even though there was a pullback in the past couple of quarters, average price realizations remain around 50% higher than the long-term average. The bottom right graph shows gross margin and EBITDA per ton. Similar comments to revenues and that margins have come down from peak levels, but are strong and well above historical levels. And as one basis of comparison, even though gross margin percentages, 18% in this past quarter, which has been below the cycle average, the gross margin dollar per ton is around $464 per ton, which is much higher than historical average that tended to be between $300 and $350 per ton. Some of this increase is related to market prices being higher on average and some is due to increase in our value-added processing that is part of the portfolio and is continuing. On Page 10, we have illustrated our inventory turns. This chart shows the inventory turns by quarter for each segment with energy in red, service centers in green steel distributors in yellow. In addition, the black line is the average for the entire company. A few observations. Overall, our inventory turns remained strong at just under 4. By sector, Service Centers improved a little bit from 4.1 to 4.2 in the quarter. Our energy field stores came down from 4.4 to 3, but this is really a timing dynamic and that our inventories did pick up towards the end of the year to address the 2023 backlog of business for that business unit. For steel distributors in yellow, the inventory turns increased from 2.3 to 2.7 as our inventory position declined in the quarter. If you go to Page 11, you see the impact of some of that on the dollars for inventory. Total inventory came down by about $100 million from September 30, which we expected. This was mostly a reduction in service center and steel distributors. This service center saw a 7% reduction in unit costs and a 4% reduction in tonnage. As they said earlier, the service center tonnage may inch down a little bit but is already in pretty good shape. At the same time, we should see additional declines in unit cost with the lag effect of the inventory on order being lower than that, which is inventory on hand costs. We did see an increase in energy field store inventories. As I said earlier, it's meant to serve the backlog of business for that segment. If we go to Page 12, you can see the overall impact on capital utilization and returns. Our capital deployment is down a bit with the repatriation of some working capital, but we remain around $1.5 billion. More importantly, our returns continue to be industry-leading with a strong end of the year and a 33% return for 2022 as a whole. If we go to Page 13, I want to give you an update on our capital allocation priorities going forward. For investment opportunities, as we've talked about before, we see average returns over the cycle of greater than 15%, and we've delivered well above that over the multiple cycles. The ongoing opportunities are threefold. We are continuing to identify and pursue value-added projects. In 2022, we moved forward on a series of initiatives in both Canada and the U.S. And as we look back on the projects that have recently been completed, we are pleased with their operational and financial performance to date. Facility modernizations in several cities, we have legacy locations that can be upgraded and consolidated into newer modern facilities. These projects will allow for volume growth, improve operating efficiencies and improve health and safety conditions. In one -- in the most recent example, we just approved about a $10 million expansion project in our Joplin, Missouri operation. This branch is part of the 2021 Boyd acquisition, and it illustrates that we often uncover incremental opportunities to deploy capital and grow the operations that come via acquisitions. In terms of acquisitions, we remain committed to our financial and operating criteria. That being said, we expect to remain disciplined yet active in seeking the growth opportunities that fit into our existing business units, and we are seeing a pretty reasonable deal flow of opportunities that we are taking a look at. In terms of returning capital to shareholders, we adopted a more balanced approach over the past couple of quarters. For dividends, we have maintained our $0.38 per share per quarter dividend, which equates $24 million in the past quarter. In addition, during the back half of 2022, since we put in place our NCIB, we have purchased 1 million shares in total for around $28 million. In closing, on behalf of John and other members of the management team, I'd like to express our appreciation to everyone within the Russel family. 2022 was a really great year for the company. Not only were we pleased with the financial results, but equally important are the series of initiatives that translated into a record low health and safety incidents, strong community engagement and ongoing people development. Thanks to everyone across the company for those major accomplishments. Operator, that concludes my introductory remarks. You can now open the line for questions, please.

[Operator Instructions] And your first question will be from Michael Doumet at Scotiabank.

Obviously, another nice quarter and a strong close to the year. Marty, I'm not sure if I missed your comments in terms of margin expectations for Q1 for metal service centers, just given the firming steel prices in the last couple of months? And maybe just to build off of that to you. The spread between plate prices and HRC has remained wide, I guess, on a historical basis. And John, maybe to get your views there on the price discrepancy in the near and medium term?

Why don't we start with John to talk about the market, and then I can flip it over and talk about the margin dynamic.

Michael, and again, this observation. The spread has remained high. There has been some changes. I think [indiscernible] mills have talked about the changes to the dynamic, 2 things really again, you have about 5 plate mills in North America, one of which is not operational right now out of Mexico. So that's limiting supply on the plate side. The other is still the $232 billion in play. So that gives a premium there for that late product. We're not seeing a lot of imports. So I think the mills are at a really sweet spot, if you will, on pricing. If you take the 25% of it is the ports not attractive at this time to come in at those numbers. So I think they're in a very healthy position. Supply is good. It's not -- there's not a ton of extra material out there. At the same time, you could get -- there is some availability, so it's not out of control. So I think the mills have done a good job and been very disciplined on their pricing with plate as it in the historical comparison to the spread with coil there is a little bit more supply. It's obviously a little more volatile. You've seen it shoot up higher come down lower. But again, it seems to be operating in a good place. We've seen a rebound at the December and January 2 price increases have come through, most of which are stock the market is receiving those fairly well, scrap going up. So we think that pricing has stabilized and started to turn the corner in recent weeks.

And then, Michael, in terms of margins, in Q4, within the service centers, the margins in dollars per ton averaged around $460. What we saw during the quarter was month-over-month, it was coming down during the quarter, so October, November, December came down. So the exit margin from Q4 was lower than the Q4 average. That was a function both prices were coming down on average and cost of sold was coming down on average. What we have seen in early Q1 is more of a stabilization in the early stages of Q1 from a margin perspective. But because the pace was declining during Q4, the stabilization now is stabilizing at a slightly lower level than the Q4 average. Does that get to your question, Michael?

Yes. No, it's totally helpful. I mean, I guess, we can work the math from the Q3 and Q4 number and then align to Q1, just in terms of how you've outlined it. So really helpful. Maybe the second question, I guess, just bigger picture, and I really appreciate the new disclosures around tonnage and what that gets us to you for gross margin per ton. And if you look at the chart number Slide 9, it's historically hovered the gross profit per time at $300, and you've been well above that for several quarters now. So just trying to get a sense for where we can land and what the new normal is because you're doing a lot with the business just in terms of value-add investments. You're looking to add scale through M&A. You've talked about inventory control. So what's the new normal look like? And maybe to push this a little bit further, if you can care to quantify what a new normal could look like.

I'd love to quantify, but I'm not sure that I know how to. But I think your observation is pretty fair, though, which is the old normal is $300 to $350 , the new normal, we feel comfortable is higher, what normal looks like and when do we get normal. I mean the cycle always moves above normal, below normal and somehow we average to create what normal is supposed to be. But that's a function of both the market pricing level still remains at a pretty healthy level compared to historicals in addition to our value-added initiatives. So if the historical average was 300 to 350, we should be averaging more than that on a normal through-the-cycle basis. And as we continue to uptick on these investment initiatives, those are within our control, we'll continue to move up that margin curve.

Next question will be from Frederic Bastien at Raymond James.

I was wondering if you could please comment on the puts and takes around Energy Products results in Q4. We saw lower volumes sequentially, which is a bit unusual, but margins have it quite strong. So wondering if you could comment on that, please.

Yes. It's -- there is a little bit of a seasonal dynamic there, less than there has been in the past. One of the things is one of our business units within energy field stores had a really, really strong middle part of the year. So even though sequentially, if look down, if we kind of look past some of the lumpier type of stuff that happened earlier in the year and transactional business, day-to-day type business, that's still moving on the uptick. So we benefited from some of that lumpier stuff earlier in the year. But if we look at the more day-to-day type stuff, that was moving up through Q4 and is moving up through early stages of 2023. So that was kind of the dynamic in Q4, where you saw energy pull back a little bit. It was pulling back because it was being compared against Q2 and Q3 results where there was some of that lumpier stuff that showed up.

Okay. That's helpful. Now building on that, you had higher energy field store inventory. At the end of the year, you said that's to help address backlog. Is this backlog higher than it was 12 months ago? Just trying to get a sense of are we seeing growth within the energy field stores and what's your outlook next -- I know your visibility is somewhat limited, but in this next 6 months, what is it looking like?

Yes. So Fred, on the energy inventory, we saw a couple of dynamics happening. One division specifically, was really, really trying to play catch-up. So their sales were running ahead of their inventory, so they finally caught up. Some of the port congestion was catching them. So finally, caught up and got their inventory where it should be. So there was a little bit of a surge there. Another division Comco specifically was -- has got some projects going into Q1 and Q2 where they had to go ahead and bring the inventory in to be prepared for the projects due to the lead times. So they saw searching their inventory as well. This project based, it will be a back-to-back order. Regarding what we see going forward for Q1 is very strong in energy both in Canada and the U.S. in more of your medium to small type projects and our day-to-day business in the field stores is very strong. Breakups hard to call for the second quarter of the year as to how long it will last, what the weather impacts will be. But we think we will have a strong breakup season based on the drilling that's out there right now, but we're being told from our customers. Their backlogs are well into Q3 and early Q4 right now. So their desire is to work through breakup as much as possible weather permitting.

Okay. Another one on energy. You did benefit from nice equity pickups and you received sizable dividends from the TriMark JV last year. But what is your view on it going forward? Is it something that you're kind of very happy holding? Or is that something you would look at potentially selling your share into it?

I think, again, their business is very much busy through the year as well as these drilling programs are busy. So we're happy with the performance. Again, long term, it's something that we would probably look to [indiscernible] either with doing something with our partner that's there. We'll look to exit that business that's not part of our core portfolio. And the business we were looking to as we did exit completely in the U.S., we will probably look to exit that as well at some point in time.

And your next question will be from Michael Tupholme at TD.

I guess I want to start with the demand outlook. So you talked in your outlook about expecting a rebound in demand. And I think this is both for service centers and energy field stores. And I think the commentary was really specifically about kind of the near term and an improvement versus Q4. It sounds like part of that, I guess, is a seasonal uptick. I'm wondering if you can comment on if we sort of look beyond seasonality and any improvement as a result of that, what are you seeing in terms of underlying demand? And if we look at sort of across 2023 as a whole, any thoughts or views on what you think you can do in terms of volume growth in service centers for 2023 as a whole?

Thanks, Mike. So overall, one of the proxies that we use is mill capacity utilization. If you looked at it for the last 3 or 4 weeks, we're seeing a steady uptick in that. The backhand of 74-plus percent appears to climb again next week, we watch build inventory, those are coming down dramatically. So people are restocking the shelves that are out there along with end users. What we're seeing from the end-user demand is across the board is a very steady backlog that they're very bullish on the first half of this year. There are some impacts to inflation, higher interest rates that are impacting housing, which we don't participate a lot in housing residential, more nonrisk construction. So if the interest rates climb that get into their backlogs, but they're 9 months out right now on this backlog. So there's a pretty big lead on those. Outside of that, if you're looking at agriculture if you're looking across the board in any manufacturing of equipment, all those backlogs are really, really strong. Anything to do with energy, solar, wind, oil and gas, all extremely busy right now. So they're pretty bullish on their backlogs. We think that wind in particular in the back half of this year is going to get extremely busy. Those new subsidies start to come out of tax incentives start to come out from the government. So pretty bullish on that also with the infrastructure projects coming on board. We think those are going to really have some strong impacts for us in Q2 and beyond.