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Good morning, ladies and gentlemen, and welcome to the 2018 Third Quarter Results Conference Call for Russel Metals. Today's call will be hosted by Mr. John Reid, President and CEO; as well as Ms. Marion Britton, Executive Vice President and Chief Financial Officer of Russel Metals Inc. [Operator Instructions] And I would like to turn the meeting over to Ms. Marion Britton. Please go ahead.
Good morning, everyone. We're going to start with the Page 3 of the slide deck that we sent out last night, 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 our 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 shall 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 would turn to Page 5 of the slide deck, I'll highlight some of our third quarter results. Obviously, we're very happy with our operations and the results that we achieved in 2 quarters now back to back. Highest quarterly EPS in a decade was recorded this quarter. Our EPS was $1.10, double what we reported for the same quarter in 2017. For the 9 months to September 30, we are now -- have earnings of $173 million and EPS of $2.79. Free cash flow, $240 million. For the 9-month period, they were at $3.86 per share. Very strong return on equity, one more quarter for 23%, and we declared our dividend of $0.38 per share yesterday.Turning over to Page 6. We'll speak to the market conditions as we see them at this point in time. Demand remains stable. Steel prices appear to have peaked in most products. Some products are a little down. Some plates continues to coils and maybe -- maybe a little higher. Metals service centers average selling price was up 28% compared to Q3 in 2017, where metals service center tons was consistent Q3 '17 on a same-store basis. We did have increased tons related to the 2 acquisitions that were added in the period. Recount is up in the U.S., and we're calling it flat in Canada because of same street bouncing up and down quarter -- or week-over-week. Energy products segment revenues increased 38% from Q3 2017. The main reason for the increase is U.S. line-type projects. We have mentioned earlier that we have a number of line-type projects on the go that would get completed in Q3 and Q4. They started earlier this year for ordering, and they have added to this quarter significantly and will continue to add to the revenue in the fourth quarter. And also our oil sales stores have continued year-over-year higher revenue.Tariffs were imposed June 1 by the U.S., and then July 1 by Canada. We were aware of this last quarter. No change there, even with the settlement -- or not settlement, I shouldn't say, the speculation on the revised NAFTA agreement. Canadian safeguards were put in effective October 25, and they are based on a quota and tariffs above a quota system. They are in effect for 200 days and are going to be under review.Turning forward to Page 7, which shows our 5-year results information. You'll see our revenue for the 9 months is just over $3 billion, noting the highest of prior revenue of $3.9 billion reported in 2014, except we will surpass that in the 2018 year. The other numbers to note here are the EBIT as a percent of revenue, 8.5%. Very, very strong number as you can compare it to even 2014 below 6%. EBITDA as a percent of revenue, 9.4%. Looking down at our balance sheet. Net working capital of $1.2 billion, slightly higher than our 2014 numbers. Steel prices are higher, and that is impacting or about increasing, I should say, our accounts receivable and our inventory numbers. Both of them are in good shape at this point in time. We'll speak to inventory when we go later in the slide decks.Turning forward. In the information to Page 13, we did add some additional information or update on where we think we are on the tariffs and safeguards at this point in time. Obviously, they're causing a lot of uncertainty in the steel industry, the soft market. We continue to watch them and we feel that we are in good shape for whatever should happen in the future.Turning onto the next page, 14, there is the segment information. Revenues for metals service centers, up 35% in the quarter. That does include, obviously, our acquisition information. And then revenues for energy products were up 38%. You'll notice that it's over $100 million of increased revenue for energy in the quarter, and that is driven by the line-type orders. Just want to bring your attention to the impact the large orders had on our segment gross margin at 17.3%. We do receive a large -- or lower-segment margin on large projects. And thus, the mix has driven our margin down all over other operations. We're within same -- consistent with prior quarter Q2. Distributors have higher revenue in the quarter compared to last year third quarter. Looking down, you'll note the segment operating profit. Steel metals service centers did the largest contribution to our higher net income, although energy and steel distributors were significant contributors to the good results. Going down to the segment margin, just to speak to metals service centers. For the quarter, we had 24.3% compared to our unit date is 24.1%. We had been up 25% in Q2. There is some pressure on margins related to increase in average cost of inventory and selling price seeming to be flatlining now.Distributor gross margin did come down, and the higher gross margin year-to-date is because we were selling off inventory that we had at a lower price earlier in the year. We now are -- replaced most of our inventory with higher priced inventory.Well, as I mentioned before, the segment operating profit for all of our 3 segments in total is at a very high level. Very happy with how our operations have done throughout that bottom line.Turning over to Page 16. Just point out there the -- so we have the 28% year -- for the quarter higher selling price, while we have 18% higher selling price for the 9 months ended. Similarly, I had commented that our same-store sales in tons were consistent with Q3 2017. On a year-to-date basis, our same-store sales are up 5% year-over-year.And just to remind you that we acquired Color Steels September 2017, and the acquisition of DuBose was April this year. So they are adding to our revenue and our tons from -- in addition to their same-store tons being flat.Turning forward to Page 20, capital expenditures. For the 9 months, we've spent $31 million on capital expenditures. Depreciation expense for the 9-month period is $21 million. We've made the comment for the last year that we will continue to spend more than our depreciation expense because we're adding investment in value-added processing, which has helped for us to maintain our margins and our segment margins in our metals service centers. We would expect that will be at high $30 million for this year.Turning to Page 21. Just point out the inventory levels. So in the metals service centers, our tons are actually down on a same-store basis. They are up because of our acquisition. But the tons are at very good shape at 4.3%. But if you look back over the comparative periods, we see that our inventory is in good shape in our metals service centers. Energy, the inventory dollars are actually down from second quarter, but they are up year-over-year due to the line pipe business. We're doing additional activity and pricing a product in that segment. Similarly, the steel distributors is up significantly due to the fact that they've been able to bring in product. And we'll be selling that throughout the fourth quarter, but we're not concerned about any of the inventory levels at these 3 segments. Those are my comments. Going to turn it over for questions.
[Operator Instructions] And your first question will be from Anoop Prihar at GMP.
Just a couple of questions. First of all, with respect to the strength of the margins in the service center business. I know you said that pricing was strong, but I'm just curious to the extent to which the tariffs and all the noise in the marketplace have perhaps created some inefficiencies that you guys hadn't been able to exploit from a pricing perspective, and that's adding to some of the next year as well.
Yes. We had -- 2 countries performed very differently. Canada, again, this week, I think we mentioned on our last conference call, there was -- there has been a disconnect in the pricing currency adjusted. So the Canadian price didn't go up as far, so it didn't fall as far. So there wasn't the reset, I think, if you will, in the flat rolling -- profit flat rolled that happened in the U.S. that created some -- maybe some margin pressure for our U.S. service centers. And then also great disciplined market in Canada, along with our continued growth in value-added processing have stabilized those margins.
How much of the increase in the margin can you attribute to the value-added processing?
It moves around on a quarterly basis. It also moves around the price of steel. But it's -- I would say it's 1% to 1.5% right now.
Okay. And then the line pipe contribution that we had in Q3, has that -- is that spilling over into Q4 at all?
Yes. It's a significant amount that we will have in October. November and December, we'll primarily clean the big project up. We have some other projects that will turn out as well. So we're having a strong Q4. It won't be as big as Q3, but it should be a pretty good Q4 on that as well.
And I recall from our Q2 call, we spoke about pricing potentially stabilizing into Q3, and we see the Q3 numbers on the pricing just seems to keep on going. And yet we're talking about stabilizing again for Q4. I mean, is it really going to stabilize? Or you think we're going to have this pace here for a while?
Yes, we're within a bandwidth. And again, we saw it go up in Q3, but it's come back down to that bandwidth again. I think the U.S. mills may have overshot the mark just a little bit. So it's just resetting itself. But we seem to be hovering around that same area. Plate products are actually very, very strong. Backlogs are very strong. If there's going to be an increase, I think it would be in plate products. Yes. If you look at the world spread, market spread to flat rolled into plate versus the North American spreads right now, there is room for imports. And I think, obviously, the tariffs and the quotas in the U.S. and as well as what the Canadians have recently put in, I think we'll keep those in place. So we'll maintain the 80% to 85% utilization rates at the mills, which should be priced pretty stable.
Next question is from Derek Spronck at RBC.
This is Kyle Brock on behalf of Derek. Regarding the emergency measures that were recently enacted by the Canadian government, were you seeing any signs of increased foreign steel products coming into Canada as a result of U.S. steel tariffs?
Yes, a product or 2, we saw a little bit come in. The Canadian government moved pretty quickly. So again, I applaud their efforts to maintain that to keep from -- Canada from coming [ and up and running ]. So I think overall, we sell some. We exit. We're able to take advantage of some of that through our distribution division in Canada through work. But overall, there should not be a significant impact to the market. That should flush itself out within 30 to 60 days.
Okay. Great. And with respect to working capital, how should we be thinking about it in Q4 and into 2019, given a pretty significant draw in 2017 and so far year-to-date?
The receivables typically will go down at year-end. We always have a slowdown of our sales in November, December seasonality, and in particular in the U.S. because of the U.S. Thanksgiving and Christmas-driven demand down, even more than in Canada. So I expect that inventory will be relatively flat. We're not anticipating any significant price increases, and I think we've sort of -- our average cost of inventory has started to max on and equal what's out in the market at this point. So I would anticipate in the quarter we will see some working capital come in. It will go down a little bit in March quarter. It will go up again for 2 reasons. First of all, we will have higher revenue in that quarter, which will bring the AR back up. I'm anticipating steel price of inventory is going to stay relatively stable, so inventory won't change that much. But we will -- do have income tax payments that will have to be made in Canada because we have higher income in this year. And in addition, we will have bonus payments in the first quarter, which will reduce our accounts payable.
[Operator Instructions] And your next question will be from [ Robert Aro ], an investor.
My question is quite simple. As far as the U.S.A. tax on steel products, is it inflating our earnings? Or is it -- would be a boost if those taxes were removed?
We may see some margin improvement there, so we'll get some lift on that. But again, I don't see that we have anything significant either way for us on that.
Yes. So if the tariffs go out, steel prices will go down slightly, but we don't believe that it's going to have a significant impact one way or the other on sales prices. They may -- will vary by product, but are we -- we're obviously benefiting from higher steel prices as tariffs have raised steel prices, which the mills upgrades them all. So -- but it has not significantly driven our margins in our minds.
Okay. On that same question, if the tariffs was removed on Canadian exports only and the United States kept their taxes on for other foreign imports, does that make a difference?
That's really probably our best scenario. It could go out if the -- if Canada and the U.S. and Mexico, if they -- we believe that tariffs, they may go to a quota system, may not, but it would give us reasonable trade in North America, and it would benefit the North America pricing compared to the world market for imports. And they would be kept at bay to some degree. Obviously, North America needs imports. They don't produce enough to cover all of our demand needs. And I think that would allow us to have a little bit of spread there. It would keep the mill manufacturers in North America busy operating level, which would obviously keep the pricing at a more stable level for us and a little bit of an inflated level. So again, that to us is probably our best scenario, as if we -- if we eliminated the tariffs that are in North America right now and we trade really would maintain them on the rest of the world. The real problem is not in the U.S. It's not in Canada. There's old capacity in the world market, predominantly driven by China. And that's what's going to maintain -- they've got to maintain an aggressive move.
[Operator Instructions] And at this time, Ms. Britton, it appears that we have no other questions.
Okay. I thank everybody for attending the call, and we'll talk to you next quarter.
Thank you. Ladies and gentlemen, this does conclude your conference call. Once again, thank you for attending. And at this time, we do ask that you please disconnect your lines. Enjoy the rest of your day.