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

Good morning, ladies and gentlemen, and welcome to this conference call held by Russel Metals. Today's call will be hosted by Marty Juravsky, Executive Vice President and Chief Financial Officer; and John Reid, President and CEO. [Operator Instructions] I'll now turn the call over to Marty. Please go ahead.

Great. Thank you, operator, and good morning, everyone. Thank you for joining this discussion on short notice, but we just finalized the purchase agreement with Samuels over the weekend. After I go through some introductory comments, John and I will open the floor to questions. If you want to follow along with the introductory comments, we have the information package posted on the front page of our website, and there is a link to this presentation that you can just click on from the home page. If you go to Page 2, you can read our cautionary statement on forward-looking information. Let me start with an overview of the acquisition. First, we're really excited about this announcement. We've talked extensively over the past 2 years about how active we've been in looking at acquisition opportunities we remain disciplined in focusing on businesses that are complementary from a geographic and product mix perspective, well positioned from an asset quality and people perspective and provide the opportunity to generate a greater than 15% return on capital over the cycle. This announced transaction lines up very well with these criteria. It's a great fit and will be immediately accretive to earnings as well as over the cycle. Second, we've had the opportunity to work closely with the team from Samuel over an extended period of time in structuring this transaction, and we are really pleased that we were able to come to an arrangement that works for all parties, including Russel and Samuel, which should also benefit our respective employees, customers and suppliers. In terms of the deal highlights on Page 4, we will be acquiring 7 locations in total, with 5 being in Western Canada across Manitoba, Alberta and BC in 2 locations in New York State and Pennsylvania. We are acquiring all of their Western Canadian service center locations other than one in Delta, BC, as Samuel will proceed with an orderly shutdown of that facility and we'll be acquiring that locations of inventory and equipment for relocation. The purchase price is effectively book [ value ] the working capital at closing $29 million for the book value of the equipment plus the $10 million premium, and I'll talk more about that in a few minutes. From a key highlights perspective, the Western Canadian piece is a really nice fit as we have very complementary operations in the same geographies. Both companies have value-added processing equipment and the types of equipment mesh in very well with each other in each of the subregions. This will provide an opportunity to broaden the service offering to our customers. In addition, the acquisition will give us an opportunity to expand our nonferrous footprint as Samuels has approximately 30% of its Western Canadian business being non-ferrous. This is a similar non-ferrous expansion to what we achieved with the Boyd acquisition in 2021. There are 2 U.S. Northeast locations provide an extension of our plate and plate processing operations in the U.S. From an asset perspective, we are really impressed during our due diligence [indiscernible] with the quality of their people as well as the extent and quality of the equipment. If we were to acquire that amount of equipment to augment our existing operations, it would cost substantially more than the $29 million that is associated with that part of the purchase price. We're also [indiscernible] Samuel is focused on safety. As safety is a really big deal for us. In fact, Russel was recently recognized by an industry association and [indiscernible] an award for our safety culture. We feel very comfortable there is a strong alignment from a safety culture perspective. In terms of deal logistics, it's subject to competition clearance in Canada, and we expect to close it in the first half of 2024. I'll talk about our balance sheet in a minute, but the transaction will be financed from cash on hand, which stood at $569 million at the end of September. We go to Page 5, I've included some financial metrics. The 7 locations generated 2022 revenue and EBITDA of $700 million in revenue and $33 million of EBITDA. For the 9 months of 2023, revenue was over $450 million and EBITDA was $19 million. If we put that in context of Russel's 2022 results, the contribution from the acquisition based upon historical numbers is as follows: additional 14% to our revenues, additional 20% for our Service Center segment revenues, additional 23% on service center tonnage. In terms of EBITDA, excluding potential in around 6% to consolidated EBITDA and 9% to Service Center EBITDA. One thing to note is that the historical [indiscernible] contribution is lower than the historical revenue contribution as we found that Russel's relative profitability was significantly higher than that of the Samuel's operations. We think that because of the integration of the 2 businesses and our approach to business, there is a significant opportunity to substantially improve their relative performance. On Page 6, we have a map of the Western Canadian operations as well as a picker of the types of equipment that are in the various Samuels locations. It's really a cross-section of various coil and plate process equipment as well as the bottom right picture that is some of their nonferrous product mix. When we mesh their operations in our Western Canada footprint, there is a very interesting opportunity to reconfigure some of the locations to gain operating efficiencies and substantially reduce capital deployed. On Page 7, we show the 2 U.S. locations in Buffalo and Pittsburgh in blue relative to our existing locations in red. The Samuel operations are plate and plate processing, which will extend our geographic footprint from Wisconsin into that Northeast corridor. And that region is very well positioned to benefit from increasing infrastructure spending. On Page 8, I want to go through the buckets of the purchase price. The total of $225 million is the net book value of the assets plus a small $10 million premium. Over 80% of the purchase price is working capital and $29 million is the net book value of the fixed assets. As I said earlier, we believe that the book value of the fixed assets is less than the replacement cost. Now when we look at a typical M&A situation, we'll generally use cash flow multiples to assess value and that approach will generally result in a meaningful premium to book value. In this situation, the underpinning of our valuation is the hard assets with a very high percentage of the hard assets being liquid working capital. On Page 9, I want to give a frame of reference on the implied multiples based upon historical stated results. As I said earlier, we think that their results can materially improve as part of the combined footprint, but equally important, we think there is an opportunity to pull a substantial amount of capital out of the combined business. This capital is in the form of excess working capital by more efficiently operating the combined footprint using our inventory management approach but also potentially crystallizing value from real estate. We have done this before, and our team is really good at it. If you look at the $225 million estimated purchase price in the top row and the $33 million of 2022 EBITDA column that is in the middle, it implies a 6.8x multiple. However, our objective is to gain both P&L benefits, but also move down the chart by reducing capital deployed. As an example, the $50 million of capital were pulled out of the business, the implied multiple would be around 5.3x. We think the various business changes can be accomplished in a 1- to 2-year period. On Page 10, we have our September 30 balance sheet. As discussed, we had net cash of $272 million and available liquidity of almost $1 billion. Therefore, we'll continue to have a strong capital structure to not only complete this transaction, but also pursue other capital deployment and opportunities that could make sense. Lastly, on Page 11, I wanted to put a context around an update to the capital deployment changes that we have undertaken since early 2020 through the end of September of this year. As we have substantially reconfigured the business profile and capital structure. On the left chart, we show that we generated around $1.5 billion of cash through both $1.1 billion from operating activities plus over $400 million from asset sales, which is mostly from the OCTG line pipe business sale as well as $35 million from the exercise of options. On the right chart, we have included the initiatives that have been completed during the same period and later in the impact from this acquisition announcement as well as the field store acquisition that closed in early October. In total, the $1.5 billion was deployed in approximately 1/3, 1/3, 1/3 buckets. The first is in yellow when it relates to our growth investments, including $173 million of completed acquisitions, $233 million for announced transactions, including this deal, and $140 million for CapEx as we have started to pick up the pace of the value-added reinvestments. This is returning capital to shareholders as illustrated in blue, with $93 million in share buybacks and $358 million in dividends. This was skewed to dividends over the extended period but more recently has become balanced between the NCIB and dividends. And about 1/3 of the $1.5 billion of capital deployed was to reduce debt and build up cash, which is illustrated green and as a result of our capital structure being very strong to not only complete this deal but also pursue other opportunities if they make sense. In closing, on behalf of John and myself, I'd like to extend our thanks to the team at Russel who have worked very hard on the due diligence in structuring this transaction over an extended period of time as well as the people at Samuels with whom we've worked very closely. In addition, we look forward to welcoming the approximately 340 team members from Samuel into the Russel family. In fact, John Reid and other folks from Russel are spending today in the next few days meeting with the Samuel people across the 7 locations. Operator, that concludes my interim remarks, and you can now open the line up for questions.

[Operator Instructions] Our first question comes from the line of Michael Doumet at Scotiabank.

Congratulations on this deal, looks really attractive. I would say maybe just to start this off, Marty, just -- I think you talked about a little bit of the process on what the transaction looked like. But curious on whether you can talk about the rationale from the seller and maybe from Russel's standpoint, why there was an interest to consolidate some of the assets in Western Canada.

It's easier to speak from our perspective than perhaps Samuel's perspective because every company makes their own decisions in terms of what they focus on. And they have a fairly diversified mix of businesses that do a whole variety of things. And we think we happen to operate the service center business pretty well. So it was a very natural discussion for them looking at where they focus in different areas and this being a core business for us. So for us, it was really a function of the conversations evolve to where there is really strong fit between the locations and the products that they have in certain areas and what we do. And that's where it really grabbed it to, in Western Canada. We have a breadth of business in those locations. They have a breadth of business in those locations. And it's really -- as we peeled layers of the onion away, it just became more and more apparent as we went through it. It's just not the theory of us operating assets in similar locations is really how those businesses could be integrated together in a much more efficient manner. And that's the thing that got us excited as we went through the process. And that's on the Western Canadian side of it. And then similar but slightly different story on the 2 facilities in the U.S. Northeast. They were on a bit of an island for Samuels. And for us, it is just a natural geographic extension of what we already have in Wisconsin. Our Wisconsin operations have a really nice plate business. And that whole industrial rust belt of the Midwest and the Northeast, is really important when it comes to all the infrastructure spending that is starting to come. And so for us, being able to extend that footprint of what we do well in Wisconsin for the [ rest ], it's just -- it was just a natural fit for us.

That makes a ton of sense. And $1.05 priced above. I'd say the transaction looks quite appealing and quite attractive from your perspective. Just trying to maybe understand I guess, the 2 other parts. Just how much cost would you expect to incur to fully integrate these assets? And I guess the second part, you commented on this before, difference between the book value and the replacement value. I'm not sure if that's primarily the land.

So on the last question first, there's no real estate coming over as part of the transactions, all the locations that are under leases. So when I'm talking about the replacement cost being in excess of the book value, that's for the equipment that were related to the operations. In my reference to monetization of excess real estate, some of that is within our existing portfolio of properties at Russel owns today. So when we think about combining the footprints together, there are situations where we might have some redundant real estate, and we could blend some of our operations into their locations. So it kind of cuts both ways. So that was part of it on the freeing up some capital, some of it is the real estate that we currently hold today. Your other question -- sorry, what was the first part of your question again, Michael?

Just in terms of the cost for integration.

Yes. There will be some of that over the course of the next year and 2 years. I suspect as part of the plan to get out of efficiencies there will be some onetime costs that we will see probably through the latter part of 2024. Our focus on the front end is really going to be getting the systems up and running, getting the businesses onto the same systems. And so some of those onetime costs that will probably start to show up, I suspect they're going to be in the latter part of 2024.

Our next question comes from the line of Ian Gilles at Stifel.

Marty, with respect, you mentioned off hand, reducing the invested capital from $225 million to $175 million in your prepared remarks. Is $50 million a reasonable number to move? Is there like any sort of range you could provide us just to help us, I guess, better understand what you think you could actually pull out of the business?

Yes. I think that Matrix is provided as a range to provide some of that direction. $50 million Yes, I think we would be disappointed if that's all that came out.

Okay. And then with respect to the metals service centers and the gross margins, obviously, for a period of time, this business is going to be weaker than your existing business. But over the course of time, maybe it's a 2-year time frame mentioned in the press release, maybe it's a bit longer. But is there any reason to think why you couldn't get the Samuel business back to that, call it, 21% or 22% gross margin number that you've often talked about of where you'd like that business to be.

No Ian, this is John. It's a good question. And we're really excited and think that is a very good opportunity to get back to a more comparable to the Russel margins. And you've got additional value-added capacity that we don't have that they have today in Western Canada, we don't do slitting and there is some cut to length as some wider opportunities for us that will dovetail nicely with our existing value add. So those will work really hand in glove to do that. Again, the additional footprint and geography that Marty talked about that we'll be adding in the Northeast, we think that we'll bring some of the potential synergies through what we do in the value-added process and that they may not currently be doing we'll turn the inventory faster. Then they turn it based on our ERP systems as that's implemented some operational efficiencies that will be there and then some new equipment that will allow them to grow that margin as well along with value-added lines.

Okay. That's helpful. Maybe last one for me. The time line to close was a bit longer than I thought, I would have thought it would be [indiscernible] You mentioned the Competition Bureau in these markets, can you maybe talk about what the competitive situation is going to look like and how that competition bureau piece may play out or if at all? I just don't know if that's a boiler plate language or if there's something that you'd like to discuss.

No, it's actually -- it's 2 points. One, yes, it is fairly boiler [indiscernible] language. But in terms of the timing, your observation is correct in terms of the time line. But it's less about the competition clearance, which we think should be straightforward. But it's really a case of getting the transitional planning done properly. One of the things when you carve out businesses assets from another company, there's all kinds of back office stuff that needs to be done IT systems, finance, personnel and they run a fairly centralized business, we run a fairly decentralized business. So part of that time line is really to make sure that we get that transition planning done right so we can hit the ground running on closing. Normally, if we just bought a company with systems intact and you just buy it for what it is, hit the ground running pretty quickly. But because of the carve out from their existing businesses, and again, as I said, some of their stuff is centralized services, and so be able to put that onto our system, we're going to have to have some transitional efforts in place. That's really driven the time line from -- we'll get the Competition Bureau clearance, and then there'll be a little bit of a buffer after that to make sure that we've got those transitional services in place before we get to closing.

Got it. And sorry I'm [monopolizing] but one last question. With respect to CapEx, I mean, you talked about existing assets, you're adding new facilities. I know there had been an upgrade program going out with respect to real estate. So that $50 million a year of CapEx that we had probably all been thinking about, does that number change? Or do you want to -- or is there any updated commentary there on how much you expect spending to be?

No, not at all, Ian, that's continuing on as hosted. And as a matter of fact, probably in Q4 this year, you'll see that number tick up a little bit because some of the projects that we had underway and we are thinking about doing -- and we had planned for -- we never know the exact timing. But some of the those are starting to come to fruition in Q4. So we are on track with our other initiatives on the capital expenditure front.

Our next question comes from the line of Michael Tupholme at TD.

First one, just -- it's probably just a clarification. But in the press release where you talk about the 2022 financial metrics and then the 9-month metrics for the first 9 months 2023. The decline in the business, is that entirely price driven?

Yes. It's market conditions driven. And I think also they probably in running their business during some of the market volatility of 2023. I mean, to be candid, they didn't run it as well as we did. And so some of the decisions perhaps they made on inventory at various points in time where there was some volatility if we were running the business in 2023 under the same set of circumstances, regardless of synergies regardless of integration. We probably would have done a better job on it and would have had a higher number.

Okay. And then you touched on this, but can you speak a little bit about -- a little bit more about the mix with the nonferrous component? I think you made a reference to similarities to the Boyd acquisition. But how does the mix here compare to Russel's service centers mix? And I don't know if that's the right way to think about it. Maybe we should be looking sort of more recently. But just trying to get a sense for how it actually compares to your overall mix.

Yes, Michael, good question. And when we look at it, again, in Western Canada predominantly on the nonferrous that you're referring to, Again, they've got a unique mix. They did some unique things out there that we don't do. So it will be new product lines that we'll be adding extrusions, those type of things that are out there. So the 2 will actually blend together very nicely. We do some things that they don't do. So it's going to afford us the opportunity to really grow that very quickly in that marketplace. So again, we don't see there being a lot of overlapping product at all in the nonferrous. It's again, they are more two independents -- operations of each other right now. And so we compete very little in that area. So we think it will allow us to grow very quickly, something that would have been a 5 to 7 years log if we had to go through that on our own.

Okay. And does that mix difference in mix lead to any differences in margins even if sort of you're running this under the Russel model and there's an improvement in margins. At the end of the day, does the mix factor into where the margins can get to? Or that's not really relevant in that regard.

I'd say it's such a bigger piece for us that's out there that we don't currently have that typically runs at a higher gross margin than carbon. And so it will factor in as we start to integrate there. So we think it will give us a lift when you put any typical of Russel gross margins on the existing business of carbon and you add the nonferrous speeds that we don't do that they have we think that will give us a further margin lift as well.

Marty, are there -- you mentioned all the facilities are leased. So what would be the lease liabilities that we'll see on the balance sheet once you close?

Yes. There's the lease obligations in terms of the cash flow will be $3 million, $4 million per year, so you just capitalize that. You'll see the lease liability will go up by a little bit compared to what we have.

And then on the slide that runs through the various scenarios for implied purchase price multiple. You've already talked a little bit about the capital. I guess one clarification there. The decline -- potential decline in net invested capital, is that inclusive of the real estate benefits you think you can realize here? Or is this just on inventory management?

Well, when we're talking about the improvement, it's both. So from a capital deployment perspective, we think that there's substantial improvement on both of those buckets.

Okay. But so the bottom end of this range, for example, the $125 million would -- and I guess, all these out of the potential levels of net invested capital contemplate improvements on both fronts. It's not just one or the other.

Exactly. That's a good way to say it, Mike.

Okay. And then just again, same Slide 9, the annual EBITDA scenarios that are presented here. Can you give a bit of context for what these contemplate? Like you mentioned, I think, in your prepared remarks, sort of the midpoint of $33 million. Is that assuming the margins come up to sort of Russel's level? And a similar level of revenue to what the business is doing now? Or what are the parameters here, for example, at that midpoint, just to get a sense.

Actually, Mike, the way this is presented is it's not meant to be a forward-looking perspective. It's meant to take the $33 million was what they generated in 2022. And then just showing some sensitivity around it. If you look at 2023 year-to-date, their number on an annualized basis is what it was $19 million through 9 months and then you annualize that and you get something into the low to mid-20s. So the purposes of Page 9 was really just to say $33 million was the number that was there in 2022. Here's some sensitivities up or down on that. It goes up in the context of improvements that we can bring to the table, but there is always a market cycle attached to it, which is why it was illustrated as a sensitivity table.

And our next question comes from the line of Jonathan Lamers at Laurentian Bank Securities.

Most of my questions were covered here. But just to clarify, Marty, on the sensitivity table again and the $50 million to $100 million of invested capital that you think could be released, is that purely from the working capital and being run more efficiently on the inventory side? Or does that also include some release of real estate that you mentioned from your existing operations?

Yes, it's both. So as we move further down some of the easier hits are on working capital and the bigger hits or the lumpier hits as you work down the table will include real estate as well.

Okay. And just on the strategic benefits from the acquisition, one thing that I wasn't quite clear on, is there an opportunity for Russel's existing centers in Western Canada to also benefit from the focus on nonferrous products from the Samuel's centers? Is there an opportunity to bring more of those products into your existing operations?

Jonathan, this is John. Well, absolutely. And so I think that's going to help us broaden our product mix. And so again, they're bringing in new products, areas that we're not into today, and we can spread that across Western Canada pretty quickly because we have established facilities and capabilities to handle those products. So it's just a matter of buying more of it and making sure that what the uses needs are in the marketplace. We see that as a really strong opportunity.

Okay. And I'm not sure if you want to comment on this or not. But just on the margin for these centers being where they are relative to Russel's existing metal service centers, is the delta there really just a reflection of Russel's operating culture? Or is there anything else structurally about these centers that explain the lower margin versus your existing operations?

I think Marty touched on it a little earlier in the call. We run the businesses very differently Inventory turns are something that would be stronger at based on our ERP system. It gives us an operating advantage as well in our ERP system with the automation. So I think those things will be pretty quickly integrated in within the first year. When we look at those, again, we will be able to build off of our additional value-added capacities that we have by adding these will just broaden that. So those come with a higher margin as well. So those things collectively will allow us to move that more to the Russel level pretty quickly.

And Jonathan, just to supplement what John said. One of the things that was interesting as we went through this process is, normally, you go -- you're talking to people in the first layer, you get some financial information. You get the financial information you go, okay, the margins aren't quite what they should be. They're not quite -- we're generating, why is that? And then we got to see the facilities. And we just thought there was a disconnect between the quality of their facilities, the quality of their equipment, the quality of their people and the financial results that were generated. So we just looked at that as opportunity and upside, as John said, if we could layer on our approach with what they already have in place because it is a high-quality asset base that they have. There is a lot of equipment that is in place. There is a good team that is in place. With the focus and the drive and the approach that we have, we think we can bridge that gap.

Our next question comes from the line of [indiscernible] of National Bank Financial.

I'm just calling in for Max. I was just wondering about the customer and market profile for the acquired centers. I'm assuming since it's a Western Canada, it could be oil and gas producers, but I was wondering if there is any OEM exposure not taken in historic end market exposure?

There will be some OEM exposure. We have some now. And so again, there's obviously but Western Canada oil and gas is part of the marketplace that's out there. So we'll continue to be strong in those areas, there definitely is more OEM exposure that's out there. And so it's something that we opportunistically can build on and bring the additional value-added services that Russel already shares to that market.

Our next question comes from the line of Sean Jack at Raymond James.

So just high level curious if the transaction accretive on an EPS basis? And if not, how do you guys see that progressing forward? And when do you think that would hit.

The short answer is it is accretive on an EPS basis immediately. And as we start doing the initiatives related to operational improvement and pulling capital out of the business that only gets enhanced. But yes, it is accretive coming out of the gate.

And we currently have one further question in the queue and it's a follow-up from Michael Tupholme of TD.

Just the improvements you're intending to make both from a margin perspective and then also in terms of reducing the invested capital in this business. I think you mentioned you think those play out over sort of a 1- to 2-year period. I got it, that's 1 to 2 years post-closing. Can you just confirm and then the benefits you expect to realize on both of those fronts. Does one happen more quickly than the other? Just -- or is it sort of uniform over that period of time? Just trying to get a sense for which levers can be pulled first and fastest.

Yes, Mike, it's a good question. So first off is post-closing because there's not a lot of stuff that we can do other than transitional planning before closing. I think you're going to see it not symmetrical in the sense of one comes first and the other comes next. Things like real estate tends to be lumpy and some of that's probably in the year 2 versus the year 1. Some of the operational improvements, there's probably some efficiency gains that we're going to get in different phases during year 1, but there'll also be some onetime costs during year 1 as well. Bringing the 2 systems together is a big focus for us by systems, IT systems, is a big deal. And when we start doing that, the inventory sharing makes -- is going to be an awful lot easier. So to answer your question, it's not symmetrical of what comes first, what comes second. And some of it also going to be layered on by location. Certain locations are going to be much easier to integrate than others. So I wouldn't necessarily put a hardwired it's ABCDE in a very linear fashion and that same linear fashion across each location, across each business unit. But I think it's fair to say at a very, very high level, the first 6 months is probably going to be a lot of integration planning. The next 6 months is where you're going to start to see some results, but also some onetime costs. It's the second year, we're going to really see the dollar mover impacts.

Perfect. And then sorry, just because it relates to what we were just talking about here, and I know you're asked about this earlier, but on the subject of sort of integration costs or restructuring costs, I mean I know you commented on this earlier, but I don't know if you gave a number. Is there any way to sort of help us understand order of magnitude there?

I didn't give the number you are correct. That's very astute, Mike.

Just trying to go through my notes what you were -- but yes, anyways, sorry, carry on.

Yes. Let's put it is. I think when they start to show up, the benefits will more than outweigh them even though they do come in lumpy. But my suspicion is it will probably be somewhere in the order of magnitude of perhaps $5 million to $7 million of onetime costs that will be kicking in.

Okay. And that's sort of over that second 6 months. sort of second half of the first year, is that...

Correct. Correct.

And as there are currently no further questions in the queue, I'll hand the floor back to our speakers for the closing comments.

Great. Thanks, operator. And again, much appreciate everyone tying in on very short notice. Obviously, these things come together. And we just wanted to make sure we can assemble this group and get as much information as possible out there. So again, we very much appreciate you tying in on short notice. As John and I talked about earlier, this is really exciting for us. We've been working on this in other situations, but in particular, for a very long time. and we couldn't be more excited about the opportunities that are in front of us as we start pulling away layers of the onion, and we get to closing and we get to the period post-closing. We think it's just a terrific fit between the 2 companies. So again, thank you for joining the call. If you have any follow-up questions, please feel free to reach out. Otherwise, we look forward to staying in touch.

Thank you. This now concludes the conference. Thank you all very much for attending. You may now disconnect your lines.