Russel Metals Inc. (RUSMF) Q1 2017 Earnings Call Transcript
Published at 2017-05-07 19:37:04
Brian Hedges - CEO Marion Britton - EVP and CFO John Reid - President and COO
Michael Tupholme - TD Frederic Bastien - Raymond James Anthony Zicha - Scotia Capital Anoop Prihar - GMP Securities
Good morning, ladies and gentlemen, and welcome to the 2017 First Quarter Results Conference Call. Today’s call will be hosted by Mr. Brian Hedges, Chief Executive Officer; Mr. John Reid, President and Chief Operating Officer; and Ms. Marion Britton, Executive Vice President and Chief Financial Officer of Russel Metals. Today’s presentation will be followed by a question-and-answer period. [Operator Instructions]. I now would like to turn the meeting over to Ms. Marion Britton. Please go ahead.
Good morning, everyone. I’ll start by reading the cautionary statement on Page 3 of the presentation that was sent out. Certain statements made on this conference call constitute forward-looking statements or information within the meaning of applicable security laws, including statements as of our future capital expenditures, our outlook, availability of our future financing and our ability to pay dividends. Forward-looking statements relate to future events or our future performance. All statements other than statements of historical facts are forward-looking statements. Forward-looking statements are necessarily based on estimates and assumptions that, while considered reasonable by us, inherently involve known and unknown risks, uncertainties and other factors that may cause actual results or events to differ materially from those anticipated in such forward-looking statements. Our actual results could differ materially from those anticipated in our forward-looking statements, including as a result of the risk factors described below in our MD&A and in our annual information form. While we believe that the expectations reflected in our forward-looking statements are reasonable, no assurance can be given that these expectations will prove to be correct, and our forward-looking statements included in this call should not be unduly relied upon. These statements speak only to the date of this call. And except as required by law, we will not assume any obligation to update our forward-looking statements. I’m turning to Page 5 of the deck. As you can see, we had a very good quarter. It’s our first good quarter after a few years, so it does make us pretty excited about the quarter. We had an EPS of $0.48, earnings was $30 million compared to Q1 of '16, which was EPS of $0.13. We have free cash flow of 51 million or $0.82 per share compared to the $0.35 in the – compared to quarter-end '16. Return on equity was 14%, which was a very good number. Net cash at the end of the quarter was 90 million and declared – we also declared our dividend of $0.38 per share. Turning the page to speak a little bit about market conditions. We do see demand and prices up in the previous quarter, the Q1 quarter. Metals service center average selling price was up 11% compared to Q1 of '16, and tons were up 2% compared to the comparative quarter. In addition, rig count is up both in Canada and U.S., which obviously impacts our energy segment. Rig count is down as we go into Q2 due to spring thaw compared to Q1, but it is still up year-over-year in Canada, and the U.S. continues to stay up year-over-year. Energy products segment revenues increased 37% in Q1 '17 compared to '16, and it was driven by good activity in both – or all three areas; oil field stores, OCTG and our line pipe. Turning the page to Slide 7, highlight a couple of items here. You’ll see the increase in the revenues of 803.5 million from 662 million in the comparable quarter. Also, looking down the page, you will note that our inventories have been brought down. This is a very low number at this point compared to last year. You can see the decline – or a year ago March, which is moment of inventory in our energy area, and we'll go into that in a little bit more detail as we get into the MD&A. I also want to highlight the total net assets employed. They have stayed consistently low and that has to do with the reduction in inventories that did offset some of the increase in receivables. The increase in receivable is a good thing because that relates to higher revenues at this point. Looking down the page, debt as a percent of capitalization, 26% at the end of the quarter, has stayed consistently low even though we had some increase in our inventory – in our accounts receivable. We had mentioned our return on equity of 14% and return on capital employed is 19%, very good number for us. And if you look back across the chart, you’ll see that those are some of the highest numbers that we’ve reported in the last little while. Turning forward to the cash flow, which is on Page 10 of the slide deck. There you can see that we did have change in noncash working capital or working capital items use of 82 million, mainly driven by the accounts receivable, somewhat offset by accounts payable. But as a fact that we were able to reduce inventories in a number of areas, our buying pattern hasn’t increased to help offset that quite the same. The other item you’ll note is just down below that. You’ll see the income tax refund we had in the quarter. The U.S. changed the fact that we need to pay our final installments to the second quarter, so there will be a use related to income tax in the second quarter of approximately 10 million due to payment of 2016 income taxes. And I would also comment here that we would expect the accounts receivable to come down due to seasonal reduction in revenue in energy. Therefore, it should be a source of cash during the next quarter. Turning forward to the MD&A, Page 14 of the slide deck, the chart that we give on our segmented information. Looking at the revenues, you can see metal service center up 13%. Energy, obviously, is a huge increase in revenues, up 37%. And steel distributors is also up, driven mainly by pricing but maybe a little bit of demand in there. Going down the page, segmented gross margin, they’re all very high in the quarter, driven by the demand and the pricing increase in – steel prices in the quarter helped increase the gross margin. You can see 22.4% for metals service centers compares to 21.6% average for last year, so it is up slightly. And the energy one is definitely up compared to where we’ve run between the 16% and 17% and steel distributors also at that level. It was above our last year annual of 18.5%. That’s driven the strong operating profit as a percent of revenue reported below and we were happy to see the 6% for our total combined operations EBIT as a percent of revenues. Turning forward to Page 16. I’ll just highlight a couple of the items related to metals service centers there. The 2% increase in tons in the quarter was driven by all regions and it was nice to see Alberta is up year-over-year in this quarter. And as the activity in the energy area has helped bring back some of the activity to our service center area, we are seeing some slowness in British Columbia resource sector. And Atlantic was off a bit. They did have seasonally slow – a lot of snow in this quarter and we believe some of that will get made up during the year. The average selling price, I had mentioned previously, 11% quarter-over-quarter, but it was up 6% also from the fourth quarter. Turning forward to the next page. Talking about the energy, 17.3% compared to 16.6% in margin and some of that was driven by the strong demand and also reduction of excess inventory in the industry that helped pump up the price of that product. We also were able to move some of our slow moving inventory, which was well priced and helped the margin in the quarter. Turning forward to Page 19. You’ll see that our capital expenditures were at 6 million. Our depreciation expense is up from the prior year. We are doing some capital laser additions in a few things in the quarter. We do expend all of our depreciation expense this year via capital expenditures. Turning to the bottom of the page. This speaks to the inventory by segment. You can see that the inventory in the metals service center is up from year-end. That has to do with some tons, but also pricing is up for the value of the inventory that we’re holding. Energy product continues to go down, which I had commented on, the 280 million here is the lowest in this point on this chart. And steel distributors inventories are at relatively low levels also. Turning the page. You’ll see the turns in relation to these segments. And the 3.8 reported by energy products is a very good turn, driven both by higher revenue and the improved inventory levels. Those are my comments. I’m going to turn it back for questions.
Thank you. [Operator Instructions]. Your first question will be from Michael Tupholme at TD. Please go ahead.
This is a question for anybody, I suppose. But within the energy products segment, of the 36.5% year-over-year revenue growth that you realized in the quarter, is there any way to provide a rough sense as to how much of that would have been driven by volume versus price?
A lot of it is volume. We don’t have an actual split and part of the reason being that we sell products that’s not by tons. So obviously, valves isn’t weighted by tons, with meters and feets and that sort of thing. So we don’t have an actual. But price is a much smaller component, I would say about a third compared to the volumes two-third.
And is that the same way we should be thinking about that in terms of the drivers when we look out to Q2, or would price play a bigger role in the second quarter?
Volumes will go down because of seasonality. And I would think prices are just going to hold similar to where they are.
Okay. I guess I would looking on a year-over-year basis, which would sort of eliminate the seasonal difference, but that’s okay. I think that’s helpful. Just with respect to metals pricing. I think you just mentioned you – is it fair to say you see prices holding stable here kind of across the board on your various products just from Q1 into Q2?
We’ll see some slight correction in Q2, I think. And I don’t think it’s anything dramatic, but we’ll start to see some slight correction there in various products. If you’re going by product-by-product, some are obviously better than others. But overall, I don’t see it being a material move.
Okay. And with that, would you also expect some correction in OCTG? So I know we have already seen a little bit of a tick down in some of the products you would deal within your metals service centers, such as hot rolled coil has come off a bit. But it looks like OCTG has so far held in, if not, continued to rise. Would you actually expect that to soften a little bit into the second quarter as well?
Probably not. It didn’t get the increase that the floor pricing obtained early on, so I think it will be more of a level. But I just don’t see anything coming off dramatically. Also, you have the inventories more back-end balanced but then around four months’ supply overall in the industry now where we had been trending between 9 and 12 months on the ground. So that helps as well.
Got it. And just, Marion, having – thinking about pricing and maybe changes a little bit into Q2 in service centers, how do we think about the margins as we go into Q2 from Q1 within I guess both service centers and energy products, specifically on the gross margin line?
On the gross margin line, I would probably be somewhere between where we are for the quarter and the annual, which I gave for service centers being 21.6 and we’re at 22.4. We will come off a bit, but we are going to stay at fairly good margins. So I guess that sort of implies 22. And you were saying for energy, was that the other one?
Yes, for energy products, exactly.
In energy, it will similarly come down a bit. The thing that will drive it a little bit differently in the second quarter is the mix because the OCTG will be down versus valves and fittings, which have a higher margin. But I would bring it down maybe about half a point also.
Okay, perfect. And then just lastly for me, Marion, you mentioned with respect to working capital that given the normal seasonal trend in Q2 versus Q1, you’d expect your receivables to come down given the seasonality in energy. Would you expect overall the changes in noncash working capital to actually be a source of cash in the second quarter, or are you just commenting on receivables, but overall we could still see an overall investment?
I think it’s going to be around flat, is my guess at this point. That they – we’ll bring down the cash but we’re going to need – like AP is not going to help a lot because we’re not going to be putting a lot of inventory on.
All right. Okay. Those were all my questions. Thank you.
Thank you. Next question will be from Frederic Bastien at Raymond James. Please go ahead.
Good morning. Guys, the outlook you provide in the MD&A is concise as usual, but it’s also limited to the current quarter. How good is your visibility into the rest of the year?
That’s as good as anybody’s given the political situation that we have in – towards America. In other words, we don’t have any. And at this point in time, we don’t want to make a prediction. That’s for sure.
But as you stand today, how positive or how are you feeling?
Cautiously optimistic would be – you get the 232 cases that are pending out there that you could see in May where we’re going on energy as far as how does the U.S. look. Is it going to be U.S.-only product? How is Canada going to treat that? So just again, as Brian said, there’s a lot of unknowns that are out there. But demand is rebounding nicely in energy on both sides of the border. And we’re seeing some positive trends in the service center and steel distribution business. So again, cautiously optimistic barring any wild swings on the political front.
Okay. And as the landscape with respect to M&A acquisitions and such, has that changed dramatically from the last time we talked?
Not dramatically. A few more things out there at this point, but nothing upsize or nothing that – we’re not any different than we were looking at whatever we can on U.S. service centers and we’ll continue towards the year to do that and in other opportunity, if it makes sense.
So is the challenge there still valuations are high and trying to wreck in your brain, or trying to figure out how to make something accretive on a go-forward basis?
Well, I think the valuations are coming back into line because the earnings of everybody is improving. So I actually think the valuations are probably getting to be – they’re easier to measure now because they don’t have brackets around their earnings. So I think there’s more likely to be a transaction in the next 12 months.
Okay, that’s helpful. All right, thanks, guys. I’ll leave it at that.
Thank you. [Operator Instructions]. And your next question will be from Anthony Zicha at Scotia Bank. Please go ahead.
Hi. Good morning. Could you give us a bit of color on imports? What’s happening in the U.S.? It seems that they significantly increased at the end of April. So do you believe there are any concerns on that? And my second question is relating to infrastructure spend. Are you seeing any pickup in the United States? And is the momentum still continuing in Canada? Thanks.
On the imports, again, if you’re looking at annualized numbers, they’re not awful lot from last year. As you see, there’s a dramatic pickup coming into this quarter. Some are trying to beat potential penalties, I think. But you’ve seen primarily galvanizing cold-rolled coils that are coming in at an increased level. OCTG is coming in at an increased level right now. So overall, we’re at a healthy level in North America I think on the imports. But we are starting to see some pressures arising from the trade barriers that are being put in place, so we think that might temper. And we may see actually less imports by the end of the second quarter going into third quarter. Regarding infrastructure, there’s definitely positive momentum in Eastern Canada on infrastructure spending right now. We’re seeing a lot of the bridge work going on. It’s very positive for us. Western Canada, not seeing as much spend there. And then on the U.S. side, there’s a lot of I guess positive chatter about it. But as of yet, it’s not turning to any dollars being spent.
Thank you. Next question is a follow up from Michael at TD. Please go ahead.
Thanks. I noted in the MD&A that there was mention of the fact that you settled and paid the energy products claim that you had previously provided for. Just wondering if that settlement amount matched what you had actually provided, or was there any difference there?
Okay, perfect. Thank you.
Thank you. And your next question will be from Anoop Prihar at GMP Capital. Please go ahead.
Good morning. Marion, just a question on the energy sector – sorry, the service center. For Q1, the turns were down both sequentially as well as year-over-year despite the fact that the volumes were up incrementally. I wonder could you just give us a bit of color into what’s been going on there.
There was some opportunity, especially in Canada coming into Q4 that didn’t arrive into Q1. So there was some buying opportunities. It’s not something that will return back to more normal levels. But again, we didn’t go down maybe a quarter to half a turn, so it wasn’t a long position. Those prices were increasing early in Q1. We took advantage of some opportunities that were happening.
So you just built a bit of inventory that will sort of work itself out over the course of the year?
Okay, all right. And then just in your outlook, you did talk about energy being up in Q2 on a year-over-year basis. But to be honest, last year’s Q2 was a very modest number. I was wondering if you could give us a bit more color into just how excited you are about the opportunity there in Q2.
Well, if you look at the rig count in the States, they’re up nicely. And Canada’s rig count, although it’s often an anemic number, it’s up over 100%. So I think that there’s some good momentum there still. There’s also still a lot of drilling going on during breakup because of the fracking. So there’s increased activity even during the breakup. So I think it’s pretty positive. Now $47 oil ultimately may impact that. But to be truthful, a lot of our customers in Western Canada are actually gas and are very effective and very efficient drillers. So I think that’s going to carry us through the rest of the balance of this year.
Some concern about the fact the weather hasn’t improved at Westville. We’ve heard that from one of our operators that they believe shipments we’re going to make this quarter might get pushed to third quarter.
Do you have any further questions, Mr. Prihar?
Thank you. Next question will be from David O [ph] at CQS. Please go ahead.
Hi. Good morning, guys. There was a comment earlier that you made with respect to U.S. infrastructure spend. I was just trying to understand if you’re referring to specifically federal spending, because my understanding is that generally muni and state spending have been quite strong. I was hoping you could just differentiate the two for us please.
Exactly. Our federal spending is still kind of spinning its wheels, if you will. Locally though, if you’re looking at the local government, state governments, they have been very active on infrastructure spend. So the large progress will come from the federal.
So generally speaking, in Q1, are you happy with the level of local and state spending? And do you think that there is room to grow into the back half of the year?
Yes, I think there’s room to grow still. Again, we find it happy it’s improving. So as long as it continues to improve, we’ll continue to be happy.
Okay, got you. And can you just remind us – I apologize, I just don’t recall the number off the top of my head. Approximately what percentage of steel does – are you guys taking in from international sources, i.e., non-North American sources?
Less than 10%. And are you seeing offers coming in from any new non-named countries?
No. We’re seeing different trading partners starting to emerge in both Canada and the U.S. But again, both countries continue to be fairly aggressive on looking at trade suits. And I think we’ll start to see that taper as the year goes on. There’ll be more and more filings against different ports in different countries.
Okay. And then specifically with respect to I guess more advanced sheet products, i.e., galv and cold rolled. Obviously, the spread over hot rolled is quite dramatic in terms of spread of international cold rolled and galv versus U.S. and – U.S. cold rolled and galv is also quite robust. Do you have a sense that the import volumes will continue to increase in those two products thus bringing down U.S. pricing, or how are you guys thinking about that?
I think they will taper on the – specifically on cold rolled and galv, I think they’ll start to taper. The concerns out there is the next level down whether you’re making that a cold rolled and galv, will that start coming in May and how will that be addressed in both Canada and the U.S. But again, I don’t see anything being a major impact in those products, up or down. I think it will stay fairly stagnant, but I think it will continue to taper on the pricing spread.
Okay. And then with respect to – you guys made a comment with respect to valves versus OCTG. I wasn’t sure I totally understood it. What is driving the shift in your mix there?
Maintenance. And so as rigs come back up, you’ll continue to see they’ve got to and maintenance the rigs – maintain the rigs as they get more active and they get ready to bring the rigs back up, we will see that shift grow. So the maintenance through the Apex business that we brought in two or three years ago, as that continues to grow and if that business continues to get busy in the oil field, they usually are the first ones to become active. They have a higher margin typically than our OCTG and our line pipe.
And Marion said seasonality in the second quarter is actually OCTG pipe. That’s the one that gets hit the hardest and that’s the lowest margin of all three product areas. So that’s going to drop as a percentage of the total in the second quarter, not on the year.
Right, okay. And I apologize, I just have two more; one follow-up on that and then just another one on the OCTG side. With respect to the lower inventories, there was a comment you guys made. I think – I don’t recall if it’s pipe logics or – one of the reporting services recently put out a number saying I think we’re at two months of OCTG inventory where just, call it, a few months ago we were at 8, 9, 10. And I think it was due to at least in part than realizing that there was some inventory on the ground that was, how do I say this, I guess not really usable. Is that your understanding as well, or do you think this has actually been a very significant drawdown on inventories for the last few months there?
I think it’s been both. You’ve seen a significant drawdown. And I think there is some obsolete inventory that’s maybe the wrong string design with the changes in fracking and there may be some people who didn’t maintain their inventory aging-wise. So it’s damaged rusty [indiscernible] and so it may not be usable. So I think that’s part of it as well. So I think you have both through that.
Yes, I’m not sure I’d trust that two – I’m not sure I’d trust that two number either. There’s products that are tight, but there’s a lot of products out there that are still – and there are still product on the ground. And you got to remember that outside the distribution channel, some of the customer still have product on the ground.
Right. I guess there was a little bit of a shift with – I think it’s Tenaris who’s gone to rig direct model or I think that’s what they’re calling it. I don’t know if that plays into it at all.
It makes them another distributor.
All right, sorry. And then my final question with respect to the rig side of things. Are you guys seeing any drilling just for the sake of maintaining leases? Is that having an impact at all?
Not a material impact that we’re seeing.
It was going on before, and I don’t think it’s jumped.
All right, wonderful. Good quarter and look forward to more good results coming. Thanks.
Thank you. And at this time, Ms. Britton, we have no other questions. I would like to turn the meeting back over to you.
Thank you everyone for attending. And hopefully, we’ll talk to you next quarter.
Thank you. Ladies and gentlemen, this does conclude your conference call for today. Once again, thank you for attending. And at this time, we do ask that you please disconnect your lines. Have yourselves a great day.