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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good morning, ladies and gentlemen, and welcome to our First Quarter 2023 Earnings Call for Russel Metals. Today’s call will be hosted by Martin Juravsky, Executive Vice President and Chief Financial Officer; and Mr. John Reid, President and Chief Executive Officer of Russel Metals Inc. Today’s presentation will be followed by a question-and-answer period. [Operator Instructions]
I will now turn the meeting over to Mr. Martin Juravsky. Please go ahead, sir.
Great. Thank you, operator. Good morning, everyone. I plan on providing an overview of the Q1 2023 results. And if you want to follow along, I’ll be using the PowerPoint slides 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 begin with just a little bit of perspective on the quarter before I go into the detail. In Q1, we were very pleased with the financial results as we saw a pickup in performance across our business units. In addition, we advanced a number of internal initiatives related to our CapEx programs, systems, safety and professional development of our staff. All these initiatives have set the stage for long-term growth of our business.
We also published our Inaugural Sustainability Report, which you can find through the link on the main page of our website. We are very proud of our sustainability accomplishments, including a very low carbon footprint as measured on both an absolute basis as well as relative to our industry peers, strong governance and attention safety and engagement in our communities.
So let’s begin with going to Page 5 to have a little bit of a discussion around market conditions. Steel prices picked up late in Q4 and continue that trend into Q1. In particular, both plate and sheet had price increases on the heels of higher scrap prices and remain at levels that are above historical frames of reference.
As you can see from the charts that are on the right-hand side of the page, supply chain inventories are modest in both Canada and the U.S. And when combined with the recent pickup in demand, it allows the industry to be well-positioned from a supply and demand perspective.
Specifically on the demand side, we are seeing broad-based support from our customer base as we are focused on the industrial side of the North American economy, which from our lands, is doing quite well. I think the industrial side of the economy is still playing catch-up with pent-up demand, and we are seeing favorable demand dynamics coming from onshoring of North American manufacturing, infrastructure products, projects, spending on renewable energy and as well as a variety of other areas of demand.
If we go to Page 6, you can see a snapshot of our Q1 results. We saw a sequential pickup in revenues, EBITDA, margins and returns. If we look across the various charts going from top left, revenues were $1.2 billion versus $1.1 billion in Q4. EBITDA was $116 million versus $97 million in Q4 due to a pickup from each of our business segments.
We saw an approximate 100 basis point pickup in EBITDA margins and solid results from each of our segments. From a bottom line perspective, EPS and return on capital also improved, with EPS of $1.19 per share and Q1 2023 annualized return on capital of 27%. We continue to deliver exceptional results.
In terms of capital structure, we have net cash of $105 million versus net debt of almost $500 million at the end of 2019. The $600 million increase in free cash flow gives us a lot of financial flexibility going forward. In particular, we are pursuing a range of strategic initiatives that we think should grow the business, and I’ll talk about those items in a few more minutes.
If we go to Page 7, I’ll go through a few items related to our detailed financials. From an income statement perspective at the top of the page, I covered a number of the high-level items already, but a few other items of note.
Revenues of $1.2 billion or 8% higher than Q4. On margins, service centers and steel distributors improved while energy field stores were once again our highest margin segment. Interest expense came down to $4 million as the increase in interest rates is allowing us to generate interest income on our growing cash reserves. Overall, we generated earnings of $74 million and earnings per share of $1.19 per share.
Our Q4 results were impacted by a few non-operating items. For the case of TriMark, we picked up $9 million for our share of their earnings and $4 million of cash flow came in from dividends through TriMark in Q1.
Stock-based compensation had a $4 million negative impact in the quarter versus $2 million in Q4. We had a small $3 million decrease in our inventory and RV reserves as the improvement in steel prices reduced the inventory risk and the inventory provision.
From a cash flow perspective, in Q1, we used $18 million for working capital. There were a number of moving pieces with accounts receivable going up due to improved sales activity and AP coming up as well, all the while inventory was relatively unchanged.
CapEx of $14 million was similar to Q4, but higher than last year at this time as we are continuing to advance a series of value-added equipment projects and facility modernizations. As we said in the past, our annual CapEx should pick up and be around $75 million on average for the next couple of years.
From a balance sheet perspective, we are in a net cash position with net cash of a little over $100 million, which is made up of our term notes of $300 million that is more than offset by a cash position of a little over $400 million. Our liquidity is almost $800 million. Our book value is up again and is now approximately $26 per share.
Lastly, we have increased our quarterly dividend from $0.38 per share per quarter to $0.40 per share per quarter, and I’ll talk about that to give a little bit more context to it in a few more minutes.
If we go to Page 8, you can see our EBITDA variance between last quarter and this quarter. And looking at service centers, the large pickup in volume was the biggest factor in Q1 as it added around $23 million of EBITDA to the quarter. Margins picked up a bit as we moved through the quarter, and that could trade about $7 million of additional EBITDA by the service centers.
The operating cost for service centers did pick up a little bit as we had higher volumes and higher incentive-based compensation for that business unit. Energy field stores improved by approximately $6 million in the quarter as the capital spending in the sector continues, and steel distributors improved by about $7 million due to the pickup in steel prices.
There was a $12 million unfavorable variance in the other category, which included the slightly lower earnings in Q1 versus Q4 from TriMark, the seasonal impact of our Thunder Bay terminal operation and that should shift back the other direction in Q2 and the mark-to-market on stock-based compensation with the increase in our share price.
If we go to Page 9 of some of the segmented P&L information. The service centers continue to do well as the market improved. Revenues margin EBIT picked up and mostly impact was late in Q1, so we think there is a favorable dynamic heading into the early part of Q2.
In Energy field stores, we are continuing to see positive market sentiment. Overall, market conditions remain upbeat as we look into 2023, although there is typically some softening in Q2 due to the Canadian spring breakup phenomenon.
Gross margins came in at 27% for energy field stores and have remained in that 25% to 30% range since the monetization of the OCTG/line pipe business in mid-2021. Distributors revenues was down slightly for the quarter, but margins and operating profit were up as they benefited from improving steel prices and a favorable product mix.
If we go to Page 10, we’re having a deeper dive on some of the metrics specifically related to our metal service center business. The top right graph is the last five years for tons shipped. And as you can see, the typical Q1 dynamic is a pickup from the seasonally impacted Q4, and we did see that in a very positive way this past quarter.
In Q1 2023, we had a 16% increase in tonnage and experienced the highest volume quarter that we have seen for several years. Demand continues to look solid into the early part of Q2.
On the bottom left graph, we have the revenues and cost of goods sold per ton. Our revenue per ton even though there was a decline for the quarter versus Q4, we did start to see that trend shift late in Q1 with a 3% increase in March versus February.
As I mentioned earlier, we are continuing to see pricing levels that are higher than the long-term historical average. For cost of goods sold, it did come down faster than our selling prices as we realized on the lag effect of lower cost inventory in our system.
The bottom right graph shows gross margins and EBITDA per ton. Margins picked up by about $20 per ton versus Q4 and remain well above historical levels. The current margin profile of $464 per ton remains healthy as we’re seeing the continuing benefits from good demand and the increase in value-added processing in the portfolio have an impact on our results.
On Page 11, we have shown our inventory turns. This chart shows inventory turns by quarter for each segment with energy in red, service centers in green and steel distributors in yellow. In addition, the black line is the average for the entire company, a few high-level takeaways.
Overall, our inventory turns improved slightly in the quarter from 3.7% to 3.9%. When we benchmark ourselves versus our publicly traded peers, we are generally the top performer on this metric by sector, service centers improved a bit from 4.2 to 4.5, energy field stores was flat at around 3 and for steel distributors and allowed inventory turns increased from 2.7 to 3.2 as our inventory position declined in the quarter as we realized on backlog in that business.
If we go to Page 12, you can see the impact of the inventory turns on inventory dollars. Total inventory came down by about $60 million from December 31. This was mostly a reduction in steel distributors that was offset by increased energy field stores and increase in energy field stores was really to serve its growing backlog of business.
The service center saw a $12 million reduction in inventory, which is mostly due to a reduction in average cost of inventory as opposed to tonnage. Overall, our inventories are in pretty good shape as we have achieved a really nice balance between managing capital prudently and serving our customers in the marketplace.
If we go to Page 13, you can see the overall impact on capital utilization and returns. Our capital deployment is up a little bit to around $1.5 billion. More importantly, our returns continue to be industry-leading with a strong start to 2023. Our LTM returns stand at 31%.
If we go to Page 14, I want to update our capital structure. The continuation of favorable market conditions and our disciplined approach to capital utilization has given us a lot of financial flexibility. On the left table, you can see that our cash position went up to $401 million, which was a $255 million increase over the past year and $38 million increase just in the past quarter.
As I said earlier, we are realizing the return on our cash balance that substantially offset the interest cost on our outstanding term notes. Our equity base continues to grow and is now over $1.6 billion. And if you look at the chart on the right, you can see the continuation of the last number of years. Our book value per share is now $25.90 which is an almost $11 increase over the past 2 years.
If we go to Page 15, we have an update on our capital allocation priorities going forward. Given our strong balance sheet, we have a multi-pronged approach to capital allocation. For investment opportunities, we continue to seek average returns over the cycle, greater than 15%, and we have consistently delivered well above that target.
The ongoing initiatives are threefold. We are continuing to identify and pursue new value-added projects. We moved forward on a number of series of projects in both Canada and the U.S. in the past quarter, and we’re seeing more and more opportunities ahead of us that we continue to target.
Two, facility modernizations. We’re moving forward with expansions and upgrading projects in [indiscernible], Joplin, Missouri and Little Rock, Arkansas. These projects will evolve over 2023 and into 2024.
In addition, we are looking at potential projects in several other locations where we have legacy setups that can be upgraded and consolidated into newer modern operations. These facilities will allow for volume growth, increase operating efficiencies, improve health and safety conditions, and in some cases, they will also allow for the monetization of higher-value legacy real estate.
In terms of acquisitions, we remain committed to our financial and operational criteria. That being said, the deal pipeline remains active
In terms of returning capital to shareholders, we have adopted a flexible approach for dividends. As I said earlier, we have increased our dividends to $0.40 per share per quarter from $0.38. For the NCIB, we have acquired 1 million shares under the current plan and of 2.2 million shares of availability under that program.
If we go to Page 16, I want to give a little bit more context to our dividend increase. Russell has had a history of dividend increases having rate dividend 4 times between 2009 and 2014, however, it has been a static dividend for the past nine years. That being said, if we look back at the last five years, we generated almost $18 per share in earnings and paid out a cumulative dividend of $7.60 over those five years, which equates to about a 42% payout ratio.
Our change in business mix over the past few years has resulted in lower free cash flow volatility, stronger earnings power and a very strong capital structure. Therefore, we feel very comfortable to increase our dividend to $0.40 and also maintain our ability to pursue a range of other capital allocation scenarios.
Going forward, we plan to periodically review our dividend level for potential future modifications by considering the prevailing market condition as well as our earnings, capital structure and alternative uses of capital.
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. 2023 is off to a great start. We are very pleased with our financial results, but equally important, we were very pleased with the series of initiatives that led to record low health and safety incidents. Thanks to everyone across the company for your contributions on all fronts.
That concludes my introductory remarks. So, operator, you can please now open the line up for questions.
Thank you, sir. [Operator Instructions] And your first question will be from Michael Doumet of Scotiabank. Please go ahead.
Hey, good morning, guys. Nice quarter.
Hey, Michael, thank you.
So maybe first question, just on the sequential margin improvement in metals service centers. I think in your outlook, you highlighted that demand trends, steel prices increase continue into Q2. I think you also in a different section of your opening commentary, you talked about the reduced average cost of inventory. So wondering whether that implies so far higher revenue per ton and EBITDA per ton so far into Q2 and just how maybe you view the balance of Q2 in that segment?
Yes. It’s a good question, Michael, because the dynamics that occurred within the quarter, we’re heading in the right direction. So we had positive trends when we look at Q1 versus Q4 as it relates to overall margins, but the margins got better through the back end of the quarter than the front end of the quarter. And we’re seeing positive margin dynamics in the early stage of Q2 as well. So said another way, our margins that we’re seeing in April were slightly better than the margins that we saw for Q1 on average.
Got it. That’s helpful. And maybe just changing topics here. The fact that you guys have effectively no net leverage, just amazing because presumably, well, this business is working capital heavy. I’m assuming competitors are being more challenged with interest costs and credit availability. Do you think that’s translating or maybe they’ll translate into market share gains and potentially eventually M&A?
Hey, Michael, yes, I think you’re spot on there. I think it’s going to give us some opportunities in both in market share gains, and we’re seeing that now. A lot of that is being led by our value-added initiatives, and so we’re able to become more sticky with our customers. And again, putting our balance sheet in a position relative to our competitors, I think, it opens opportunities for M&A, but we’ll remain very disciplined into our criteria.
And John, it’s fair to say, too, that when we actually look at the industry data, this is not just a new phenomenon. If we look back where we are today versus the period pre-COVID, we gain market share.
Yes. That’s right.
Very nice, guys. Those are my key questions. Thank you.
Great. Thanks, Michael.
Thank you. Next question will be from Ian Gillies of Stifel. Please go ahead.
Good morning, everyone.
Hey, Ian.
Good morning.
With respect to the strength in HRC prices through Q1, is there any reason to think that you won’t be able to pass those on to your customers through Q2 as you’re actually selling that inventory because there seems to be some commentary around demand being weak in certain instances. And I’m just trying to get your view on how that dynamic is playing out.
Yes. If you look at the market right now, we’re seeing a little bit of pressure on HRC due to scrap prices going down. We’re not having any trouble passing it on. Keep in mind, I think Martin mentioned earlier, our turns are at 4.5 times. So we’re moving through our inventory much faster than the rest of the market. So we’re not seeing any trouble since we’re sustaining those high margins that we saw at the end of the quarter.
So we’re not very concerned about that and the ability to pass those on. We’ll watch the market. But again, I think this is more of a dynamic we scrub, which we’re not seeing a lot of import opportunities that are out there right now at attractive levels. Demand is very solid. So again, I think you’ll see scrap bounce along here and impact HRC up and down.
Okay. That’s helpful. And switching gears to the energy products side. It’s obviously early days and it’s horrible related to the Alberta wildfires. But is there any update you can provide on what your intentions are for that business to do in the near term here? I know it’s typically a seasonally weak quarter, but nonetheless, would be helpful.
Yes. It’s fair to say, and you’re right. The forest fire dynamic is just out difficult for people operating in those situations. It hasn’t had that direct impact on what we’ve seen in the normal seasonal dynamic that happens in Canada at this time of the year because of spring breakup. Hopefully, everybody is able to work through the forest fire situation out west.
But in terms of that being the cause and effect of what we’re seeing in our business, generally speaking, what we’re seeing from our energy business in Canada, also in the U.S. is just a generally positive trend. Yes, there’s going to be mother nature that comes to play every now again for parts of the year. But we’re trying to see through that. And the trend for that segment is pretty positive.
Okay. That’s helpful. And then if I could maybe just sneak in one last one with respect to steel distributors. I mean, the margins there were great during the quarter. Has that continued on into the second quarter? Or is that business normalized out? Just I’m trying to get a sense of what’s happening there.
It’s normalizing out, Ian, and there were some timing things that we had some material build up at the port came in late Q4. And so it flowed into Q1 to say we’re able to monetize that in the market change, but they’ll normalize out as we go through Q2.
Okay. I appreciate that. I’ll turn the call back over. Thank you very much.
Thanks, Ian.
Thank you. Next question will be from Frederic Felicia of Raymond James.
Good morning, guys.
Good morning.
Hey.
There are concerns right now that the tightening credit environment will finally catch up to the segments of the construction sector that have thus far been resilient. Just wondering what your thoughts are on this and whether you’re seeing – starting to see cracks at all in sort of the big steel heavy projects that you’re helping support?
The short answer is no right now. I mean, how things evolve over the medium to long-term with the economy. And I think it goes to broader issues in terms of interest rates and inflation that are still out there. Those are – those may or may not become relevant as things unfold. But the part of the economy of deal that we deal with is still doing fine. At the margin, there may be some pauses in individual projects here and there in the regions here and there. But looking at things in their totality across the segments that we deal with, and we deal with a very broad range of industrial type consumers.
The broader dynamic is very good. Yes, there’s little spots here and there where there may be some softening, but that’s always going to be the case when we look across the portfolio. But on average, things are pretty good, how things evolve more over the medium to longer-term. Our crystal ball doesn’t go out that far, but the short-term is generally pretty solid.
Thanks for that. The other question I have is around renewable power. There’s a lot of investments being made in North America now to support the energy transition, et cetera. And I recall this was sort of an end market that you were feeling pretty good about. Can you provide a bit of an update here and whether that comment you made in the past is still stands?
Thanks, Fred. It’s – yes, we’re very positive right now on the renewable wind solars. We’re seeing that money start to slow down in the U.S. in the initial stages. We think it will have a big impact in Q4 of this year. And so we’ll see it affect the plate market pretty dramatically. So we’re pretty bullish on what’s going on there.
Awesome. That’s all I have. Thanks.
Great. Thanks, Fred.
Thank you. [Operator Instructions] And your next question will be from Michael Tupholme of TD Securities. Please go ahead.
Thanks. Good morning.
Good morning, Mike.
A quick question about the energy field stores segment and also looking at the JV earnings. So energy field stores, you saw an improvement sequentially in EBIT. The JV earnings, though, were down a little bit sequentially so strong, but down a bit sequentially.
So I’m just – I realize they’re different businesses, but at the same time, it seems like the driver here is really just the improvement in the energy sector and the level of activity, and I would have thought that both would generally move in the same direction. So just kind of looking for a bit of a clarification on why they moved in ops direction sequentially.
Yes. So keep in mind, the OCTG/line Pipe or the JV, again, is driven by the downhole, the big project when they have it’s timing of the project and really our field stores is driven by what’s going on in the market, but they have a big large maintenance component. And so they maintain it for the life of the well as well as the installation of the well.
So they get some of these pickups intermittently in the period when you get wells going in for the JV may have a well go in and going to a low, they will go throughout. And so they’ll see that consistent maintenance and MRO type business that you won’t see in the JV.
Okay.
And in some ways, the contrast between those two businesses is part of the reason we did what we did back in 2021. They both touch on energy, but in different ways. And we feel pretty good about the field stores as being a good part of our portfolio on the long-term basis because of the dynamics that John talked about, and there are very different dynamics that impact the volatility and seasonality on OCTG/line pipe. So in some ways, it’s a little bit of a micro test that confirms the path that we started down a couple of years ago in separating out those businesses and monetizing those OCTG/line pipe.
Okay. That makes sense. Second question, I don’t think you were often asked about this, but corporate expenses this quarter looks somewhat higher than certainly than they were a year ago, but also just higher than they’ve been in general over recent quarters. So wondering if there’s anything to sort of explain that? And then secondly, how to think about corporate expenses going forward?
Yes. So there’s a variety of moving pieces in there. But using Q1 as a baseline of this year is a good place to start, Mike. When you look at year-over-year comparisons, there’s a variety of things that are in play. One is you do have mark-to-market on stock-based comp that has some variability into it. You’ve seen some inflation and also the way the connectivity to variable comp also flows in there as well.
So as market conditions improve or as market conditions come down and profitability goes up and profitability comes down, the variable comp moves with it. That’s why you will see some variance in corporate expenses. And then the last piece is there is some inflation that is occurring this year versus last year across all parts of the economy, and that’s one place that we’re seeing it.
Okay. So what we saw this quarter, do you think that’s a reasonable way to think about it over coming quarters for this year?
Yes, that’s a good starting point for your model, Mike.
Okay, perfect. And then the comment you had in the release just regarding the fact that you had evaluated a number of potential acquisitions in the quarter. I mean I know this is part of the strategy, and it gets talked about on quarterly calls quite regularly. I don’t recall seeing a comment like that in the release.
So just wondering if maybe just clarify for starters, if that is, in fact, sort of new and the motivation for including that. And maybe more importantly, like maybe just comment on the pipeline and what you are seeing in terms of the opportunity set right now given the strength of the balance sheet.
Yes. I actually don’t remember of kind of what we have said or hasn’t set in the past to be perfectly honest. But in terms of capturing where things are right now, it is active.
Now that being said, we’ve seen a lot of deal activity in terms of potential deal flow over the past period. But I think there were – it was hard to find the right situations for us as we look back to 2022. I’m probably more optimistic today in terms of the situations that are in and around us. But there’s still some more to be chopped in order to move things forward. But I’m more optimistic about the pipeline that I’m seeing today and the pipeline that we are seeing, say, six months ago.
Okay. And is it primarily the U.S. that we should be thinking about is really the focus area and more specifically service centers in the U.S.?
Yes. But keep in mind, we’ve said that for years, and then we end up doing something in Canada along the way. So we will remain opportunistic. But ideally, yes, it would be U.S. service centers that we’re focused on.
All right. Okay, that’s all I had. Thank you.
Great. Thanks, Mike.
Thank you. And at this time, gentlemen, we have no other questions registered. Please proceed with closing remarks.
Great. Thank you, operator, and thank you, everyone, for joining our call. If you have any questions, please feel free to reach out at any time. Otherwise, we look forward to staying in touch during the balance of the quarter. Thank you, everyone.
Thank you, sir. Ladies and gentlemen, this does indeed 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. Goodbye.