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Good morning, ladies and gentlemen and welcome to the 2018 Second Quarter Results Conference Call for Russel Metals. Today's call will be hosted by Ms. Marion Britton, 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 meeting over to Ms. Marion Britton. Please go ahead.
Good morning, everyone. Hopefully, you have the slide deck we've set out. I will start on Page 3 reading the cautionary statement. Certain statements made on this conference call constitute forward-looking statements or information within the meaning of applicable securities laws, including statements as to future capital expenditures, our outlook, the availability of our future financing and our ability to pay dividend. Forward-looking statements relate to future events or our future performance. All statements, other than statements of historical fact, 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 as to the date of this call and, except as required by law, we do not assume any obligation to update our forward-looking statements.If you flip to Page 5 of the slide deck, I will speak to our second quarter results. We're obviously very happy with our EPS reported in the second quarter of $1.07, which compares to $0.52 in Q2 '17 and our Q1 EPS of $0.62, which brings our 6 months' earnings to $1.69 compared to $1 at this point last year.Free cash flow, very strong, $2.37 per share and for the 6 -- that was for the 6 months and for the 6 months of last year was $1.53. Another number that is a very strong number is our return on equity at 23%. In addition, we declared our dividend of $0.38 for the quarter.Turning to Slide 6. I'll speak a little to the market conditions. Market conditions in the quarter was rising steel price and strong -- good demand. We think that steel prices have peaked and will fluctuate a bit in the second half of the year. The demand continues to be stable as we see it at this point in time.Within our metals service centers, we had a revenue increase of 35%. The metal -- the increase was made up of an average selling price increase of 17% compared to Q2 '17 and 14% compared to Q1 2018. The other portion of that quarter-over-quarter 35% increase related to tons. So on a same-store basis, our tons were up 9%, which is ahead of our competitors as we know -- the information that we know. And we also had 2 acquisitions since Q2 2017, being Color Steels and DuBose, which we bought in Q2 2018. They represented another 8% increase in tons, so that we are actually up in our tons year-over-year 17%, if you include our acquisitions. Rig count in the U.S. is up and in Canada also is up year-over-year. Just to remind you that the second quarter is a seasonally lower period for activity within Canada with the spring thaw, and that is reflected in our numbers related to OCTG, although our energy products segment did increase 8%, which was driven by activity in our oil field stores, both in Canada and in the U.S. There is a lot of uncertainty out there. We are very happy with our operations and employees, who have guided us through this uncertain period with the U.S. tariffs on June 1 and effective July 1. Canada put in tariffs, which we will continue to monitor where those tariffs take us as negotiations with NAFTA have continued on and presumably tariffs will change as NAFTA is further settled.Turning to Page 7. We have our 6-month numbers against the last 4 years' annual numbers and also 6 months last year. If you look at our revenues, you can see that we're tracking consistent with our 2014 level of activity. The 2 lines that are of important interest is the EBIT as a percent of revenue at 8.3%, highest we've had on this chart, a very high number, and similar EBITDA at 9.2%. So we're actually tracking ahead of our 2014 numbers on those 2 lines, even though we're at the same revenue levels. We're making more earnings on the same dollar revenue.Our working capital has increased due to the use of the additional revenue, our AR is similar to 2014. Inventories are higher as steel prices are higher at this point than they were during 2014 year-end, and you'll see that our net working capital in metals is a bit higher than we were at 2014 tracking along as would be expected.Turning over to the Page 10 to speak a little bit about the working capital changes, the use of cash for working capital needs. I mentioned previously that we did have cash from operations, strong cash from operations as you can see for the 6 months, $167 million. We have used $162 million in the 6-month period. For inventories, it went up $118 million in the quarter. Receivables didn't go up as much because our first quarter is very active in the energy segment but we have got our use of cash for receivables this year has been $94 million. So at this point, we've used $103 million of working -- cash for working capital purposes to grow the business, consistent with our models that when revenues go up, activities, earnings go up, we do need to have cash to fund our working capital.You'll note the purchase of business, $36.8 million for the -- within the second quarter, that's about still. I'd recommend anybody that wants a little more details on that to look at the notes and financial statements because there was no AP in that number, which makes it probably a slightly higher than anybody is modeling our number to be. Turning forward to Page 14. This is the page that gives the breakdown by segment of what happened in the quarter and year-to-date. As I mentioned to you previously, 35% increase in revenues in metals service centers, that brings us to 27% year-to-date. The interesting -- increase in earnings -- or operating cost at metals is more than double, 135% actual increase. And going down to the line below, gross margin was at 25.5%. Rising steel market resulted in us being able to capture good profit on our sales. And that we do expect will come down over the next half of the year, due to the fact that our inventory price has come up as we've had to replace inventory that we had on hand. The quarter, we ended up with operating profit as a percent of revenues at 10.2%, very strong number for a metals service center operation year-to-date at 8.5%.Turning over to energy products segment. The increase was 8%, and as I previously mentioned, mainly field stores drove that number. We did have an increase in our operating profit. And then going down to our percentage line, you'll note that the mix has driven the gross margin to be 20.9% in the quarter. It's actually up from first quarter and that was because of less OCTG sales and higher field store sales. We do anticipate that, that number will come down in the next quarter due to the return of OCTG sales, and we do have some large line pipe sales that are at lower margins in the second half of the year.The other segment, steel distributors, small, their revenue actually has been lower at this point for the year. We expect it to be slightly higher for the next 2 quarters as with supply change in relation to tariffs and where people are purchasing. Certain purchases into Canada are coming from outside North America, and we expect some volume increases there. Those operations were able to maximize their gross margin and reported 26.8% gross margin in the quarter. And they also did -- had had a strong gross margin earlier in the year to bring it to 24.2% for the 6 months. Similarly, we do anticipate that will come down as they replace their inventory in the second half of the year. So we expect that this division, even though it's small, the revenues will be up but gross margins will be down, still resulting in some good operating profits. You noticed they had a 50% increase in operating profits in the quarter. And they delivered a 16.6% operating profit as a percentage of revenues. Turning to Page 20. I'll just make a comment on capital expenditure. Basically, similar to prior quarters, we are spending money on value-added processing, and we do anticipate that our capital expenditures for the year will be approximately $10 million higher than our depreciation for the year. We currently have capital expenditures of $20 million, which compares to $14 million at this time last year and our depreciation for the 6 months is $14 million. So we're on track to what we anticipate as additional capital expenditures to grow the value-added processing.Turning to Page 21. You can see the breakout of the inventory numbers. The numbers are up, mainly driven by average cost of inventory. There is some tons increase in the numbers also but the higher price of inventory has driven that. Energy products being a low point coming off of their seasonal low. They're at 2. We're hoping that will come up during the second half of the year as the inventories go into drill rig activity. Steel distributors will continue to have higher revenues also. So we would like to see those turns come up slightly in those 2 operations in the second half of the year. Those are my comments. And I turn it back to the operator, and we'll take questions.
[Operator Instructions] Your first question comes from Derek Spronck, RBC.
Just with regards to the tariffs and the changes in the supply chain, do you think the direct impact in the repositioning is largely done at this point? Or is it still kind of being played out right now?
It's continuing to play out and evolve. Again there may be changes moving from tariffs to quotas with certain countries. As you see, the U.S. and Europe seem to be headed down that path very quickly. Canada is now looking at Section 55, where they may be picking additional tariff positions towards the Rest of the World or quota positions. So again I think that it's kind of laid the groundwork but it's definitely going to be something that continues to evolve over the next probably 6 months minimum and that we'll see changes to that.
Okay. And then, are you seeing -- or is there any concern, and I guess, Canada would have some countermeasures in place. But with imports still going into the U.S., now with the tariffs, is that import steel -- foreign import steel looking for a new home? And are you seeing an increase in import steels coming into Canada?
It's true that all this stuff is not able to go to the U.S. anymore, or if it's not, all the flat roll is showing up at the U.S. because the flat roll price, or the world price, actually, with the tariff involved is still below the U.S. number but we are seeing different trade channels that are appearing for Canada with higher volumes. And so again, Canada is looking to take action on those. And that's currently being discussed but it is opportunity -- it has provided us opportunity through our distribution and service center divisions that we see some opportunities there. We'll probably have some growth in the quarter due to products that are not made in Canada that are coming from other parts of the world.
Is there any concern though that the potential increased supply coming into Canada would pressure steel pricing in Canada?
Prices went up, obviously, in Canada. It's disconnected somewhat from the U.S. price. Typically it is -- or historically, it's been, take the U.S. price currency adjusted, you came up with your Canadian number for various products. We've now seen some of that go above. Plate demand is very, very strong in Canada and the U.S. Plate prices, currency adjusted, are actually higher in Canada than they are in the U.S. now. Coil and HSS type products are well below in Canadian pricing, currency adjusted, compared to the U.S. So we've seen a disconnect to some degree that we actually talked about last quarter as well. And I think we'll continue to see that as the world market brings more into Canada and that becomes much more a different play than it has been historically.
Okay. And then just one more for me before I turn it over. You indicated that you're expecting pricing to be relatively flat in the back half of the year. Any sort of view, as of right now, of what you're seeing in terms of pricing in 2019?
Yes. We really don't look out that far. I mean, we're looking at pricing being relatively flat for the next quarter. The back half, we could see some softening but we really don't go out that far as transactional nature as we are. Again, pricing is obviously scrap and still we're are going to drive it along with energy prices.
Your next question comes from Michael Tupholme, TD Securities.
With respect to the energy products segment, you mentioned that most of the growth there from field stores. So is it fair to assume that, that was primarily volume as opposed to price that drove the year-over-year revenue gains in energy products?
That's exactly right.
And then, how do we think about energy products' revenue growth potential on a year-over-year basis in the back half, given some of the changes in mix you've alluded to?
We're going -- again, we're going to see a shift in the overall mix. I think we'll see -- again, we've [ elected ] it's going to be steady to slightly up based on rig counts and what we're seeing out there on overall growth with the large projects we have going line pipe, those will be, again, actually lift the revenue side but they are at a much lower margin, also at much lower operating cost. So there will be shift to the model but I think we'll see a pretty significant lift Q3 and part of Q4 on that -- for that project going through.
And sorry, John, are you talking year-over-year lift or relative to the second quarter?
Year-over-year.
Okay. Great. And then Marion, I mean, you mentioned that really across all 3 of the main product categories or segments, you do expect margins -- gross margins to come down as you won't have the same sorts of holding games in the back half as you saw in the second quarter. But can you maybe try to help us out, maybe a little bit more detail around sort of the level of margin decline we can expect in the back half relative to what you saw in the second quarter?
Okay. I will attempt to. So the decline in energy products is really not related to rising prices as much as it will be related to mix and large project type -- line-type sales. So it's a little different than what we would see in the other 2 segments. I think it will come down closer to the numbers that we've reported year-to-date for 2017. So that will just get the mix back in line and cover off those large orders. Within steel distributors, they had the luxury of having products that there was demand for, and similarly, I believe they could come back to the numbers close to our 2017 numbers. The one that I don't think is going to come back as far is our metals service centers where there continues to be -- we have pretty good demand for those products, and it's probably going to range in the 22% to 23% would be my guess, which is -- should stay higher than we were at this point in 2017. The other factor, though, is with the price of steel being very high, we do bring a larger number to the EBIT line.
Okay. And sorry, when you were talking about back to 2017 type levels, we should be focused on the 2017 year-to-date, so the first half of '17's margins in both metals service centers and energy products?
That's where I'm look -- thinking. Steel -- in steel distributors, their volumes will go up slightly. They might come off a bit more but within energy products, I think that you're safe to use the year-to-date '17 number.
Okay. And where are you at now in service centers with -- in terms of the value-added processing capabilities you've been adding over time. I mean, is year-to-date through first half of '17, you were at 22% gross margin in service centers. Is that sort of the normal run rate type of level that you can achieve in a stable steel pricing environment, given the value-added processing additions you've made over time?
I think it's somewhere in that range, yes.
Okay. And then a little bit of discussion earlier about the tariffs. I wanted to ask you, John, how does the imposition of the steel tariffs in both the U.S. and Canada, how does that change your view and your approach to M&A, if at all?
It really hasn't changed our approach. I mean, we continue to -- for 4, 5 years now, we've said we would like to grow in the U.S. but again, we continue to be opportunistic when things appear that fit, whether it be a niche play or a good business in Canada. Obviously, Color Steels being the latest. That is, we evaluate them based on the individual merit and what they look like at the time. So we try not to get caught up in the inflationary times that are going on with earnings, look at the cycles of what a business can do for our shareholders. And we have an evaluation metric that we go through, obviously as well as does the company fit into our corporate culture.
And has there been any change in the number of opportunities available, either more or less, given that we're in sort of a rapidly evolving environment?
Absolutely. We're seeing a lot more activity right now.
Your next question comes from Frederic Bastien, Raymond James.
It looks like your recent acquisitions are contributing nicely to your results. So I was hoping you could provide an update on your M&A efforts right now, especially in light of the recent trade tensions?
Yes. Again, we're seeing a lot of activity, Frederic, both on the service centers side, predominantly in the U.S. and in the energy side with field stores in the U.S. and in Canada, we're starting to see more and more activity on that. So it's something that we're very actively looking at right now trying to find the right fits for Russel.
Any other DuBose or potentially Color Steels tuck-ins out there?
Yes, I think there's tuck-in opportunities out there. There is -- some larger opportunities are out there as well. So again, I think that we'll continue to look for those and see if those opportunities present themselves before the end of the year.
Okay. Can you confirm, Marion, there were no inventory impairment charges in Q2? There were some, I believe, in Q1 but nothing in Q2.
No impairment charges. No. There wasn't any.
Your next question comes from [ John Biggers ].
Just with the recent price increases around steel prices, around 30% to 40%, are you having any problems with resistance in the marketplace with also getting your inventory up, finding source of supply and resistance with customers not wanting to buy?
As far as their inventory, we're highly transactional. So we've not seen a whole lot of resistance there as we moved that through the market. Our competitors are doing the same. We have seen a little bit of apprehension on the customer side in that, that's what they want to go out on their inventory positions as far as their finished goods in relation to are they able to do their transactions, North American-wide or globally. But overall, right now, in the industries we serve through the industrials, we're not seeing much resistance.
And you are not having any problems with credit, people pitching out there, receivables or payables to you guys as far as -- because prices are up huge, are they not? I would say huge, I mean, I look around at the businesses with the mills, with Nucor, Mittal, Gerdau, all skewed huge earnings but there's got to be some resistance in the marketplace with pricing, with the customers. I don’t know how anybody can absorb a 35% increase in prices within the last year.
Again, we're not seeing a lot of resistance. Our credit, we watch it, and we have heightened our awareness on it to watch it more carefully. But our reserves are there, as you can see as well, that we -- we're not seeing anything beyond what we've normally done. So again, we're not seeing the whole lot of pressure, resistance against that pricing right now because it's become a world-wide phenomenon.
All right. Okay. Do you guys think that you will increase your dividend a little bit more with the money that's coming in? You're at $1.69 already. You're paying out, what, 38x. You're paying out $1.52. You're halfway through the year, you're at $1.69?
We review it every quarter with the board. And again, for the last several years, we have paid out in excess of 100% of our dividend. Our guide has always been that we'll be 80% over the cycle, which is typically a 5-year cycle. So again, we'll review it again with the board at the end of next quarter but at this point, we elected not to. There may be opportunities to do things in the marketplace through our value-added process and/or acquisitions that will allow for a better position for shareholder equity. So we'll review it again with the board next quarter.
Your next question comes from Anoop Prihar, GMP Securities.
John, I'm just curious to get your sense as to, in terms of the strength in the Q2 numbers as well as the year-to-date numbers, how much of that do you think reflects just underlying strong GDP fundamental growth versus your customers still trying to position themselves to make sure they're on the right side of whatever happens on the tariff front?
It's difficult to put an absolute quantum on that. But I think we've had the lift from the GDP. Obviously, the economy is very strong. If you go through every sector that we serve, everything is either very steady or increasing, so that has been good for us. You can see our increases in volumes. We think we've taken share through both our normal business channels and also the value-added process, and so that's allowed us to grow as well. But overall, that one would be just -- it would be a guess if I was trying to quantify it right now.
But there's still guys out there, you think, trying to position themselves just to make sure they don’t get caught or whipsawed on the politics.
Sure. I mean, again, people are trying to play that pricing game, and they have done it. That's normal for our business where you're trying to outbuy the market. So I think there are people that you will see -- we've seen competitors running light on inventory. We've seen others out there trying to say, "Do we need to move south of the border, do we need to move across the border and so how do we handle that?" But we've not seen a big impact to our business at this point. Harley-Davidson is a big news. It's moved but it's hard to believe that they weren't going to move that facility. So we've got one fairly large customer that may move from Canada into the U.S. but at this point, they've not made a decision.
Your next question comes from Derek Spronck, RBC.
Okay. Just circling up on -- there was an inventory impairment charge. Just wondering where that stemmed from when considering that the increase in pricing there. Could you maybe...
Frederic had asked about write-downs, and I wasn't thinking about that one. That is the energy segment where we continue to deal with some of our old inventory that was for downhole drilling and that, so we have taken a bit of a reserve against that to continue to move that out at scrapping.
Is that largely done now? Do you think, Marion, or...
It's an aging reserve, that we look at the age of the inventory and then they are assessed with a penalty only each month based on the volume. So for the most part, we feel like we're under control with that compared to where we were, especially in '13 to '14 with the shift in energy, going from the downhole into the fracking. But again, we'll always have some of that moving around just in the [ bags ] with inventory that's left over from jobs.
So it is [ different ] prices related to age of inventory and our desire to reduce the amount of our aged inventory.
Okay. I got it. And just one more on the -- there was another small impairment charge just on the ERP system, maybe a little bit of color on that as well would be helpful.
It listed in there for last quarter. We shut down the ERP system that we were looking at going to the artificial intelligence to bring over our system to new code. And so as we went through that, the -- we just weren't getting the results we wanted with the tools. So we shut that program down, and we're now investigating whether we go to a Canada program or looking at something that's more programmed in-house.
[Operator Instructions]
If there is no further questions, I will thank our employees for a great quarter. And we will speak to everyone next quarter. Have a good rest of the summer.
Thank you. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.