Algoma Steel Group Inc. (ASTL) Q1 2022 Earnings Report, Transcript and Summary

Greetings, and welcome to the fiscal 2022 quarter 1 conference call. [Operator Instructions] As a reminder, this conference is being recorded Friday, August 20, 2021. I would now like to turn the conference over to Brenda Stenta, Manager of Communications with Algoma Steel Inc. Please go ahead.

Good morning, everyone, and welcome to Algoma Steel Inc. First Quarter Fiscal 2022 Earnings Conference Call. Leading today's call are Michael McQuade, our Chief Executive Officer; and Rajat Marwah, our Chief Financial Officer. As a reminder, this call is being recorded and will be made available for replay later today in the Investors section of Algoma Steel's corporate website at www.algoma.com. On August 19, we published Algoma Steel's financial results for the first quarter ended June 30, 2021. Algoma's financial statements and management's discussion and analysis have been made publicly available through the Investors section of our corporate website. The information that is being presented today has also been added to the requisite shareholder and lender data sites. And as a result of the pending transaction with Legato Merger Corp., a copy of the presentation has been filed with the Securities and Exchange Commission on EDGAR. Comments made on today's call may contain forward-looking statements, which involve assumptions and inherent risks and uncertainties. Actual results may differ materially from statements made today. In addition, our financial statements are prepared in accordance with IFRS, which differs from U.S. GAAP, and our discussion today includes references to certain non-IFRS financial measures. With that in mind, I would ask everyone on today's call to read the legal disclaimers on Slides 2 and 3 of the accompanying earnings presentation and to also refer to the risks and assumptions outlined in Algoma Steel's first quarter fiscal 2022 management discussion and analysis. Please note that our financial statements are prepared using the U.S. dollar as our functional currency and the Canadian dollar as our presentation currency. Our fiscal year runs from April 1 to March 31, and our financial statements have been prepared for the 3 months ended June 30, 2021. Please note, all amounts referred to on today's call are in Canadian dollars, unless otherwise noted. Following our prepared remarks, Mike and Rajat will take questions from current Algoma shareholders. [Operator Instructions] I now turn the call over to our CEO, Mike McQuade, for his prepared remarks.

Thank you, Brenda. Good morning. Welcome, and thank you for joining Algoma's earnings call for our first fiscal quarter ended June 30, 2021. We appreciate the continued support and interest from our shareholder base and would like to welcome additional listeners on today's call. Considering the tremendous interest and excitement surrounding our pending transaction with Legato Merger Corp., we have opened the call to public listeners to provide an update on performance for our first quarter ended June 30. Optimism continues for steelmakers across North America. Continued strong demand in key end markets and record pricing are creating significant opportunities for participants across the industry. With strong cash flows, our focus on operational efficiency and the strategic advancement of our capital initiatives, we are positioning Algoma as a next-generation steelmaker, focused on sustainability with attributes that we believe will make Algoma successful across the steel market cycles. The work that our Algoma team members have completed over the past 24 months have provided tangible results. These include: The process control upgrades to our direct strip production complex; the engineering, construction and commissioning of our second ladle metallurgy furnace; and the implementation of our plate mill modernization initiative, Canada's only discrete plate mill. Furthermore, we have spent the last 20 months turning the idea of transforming to electric arc steelmaking into a structured plan, working with key stakeholders to position Algoma to make a final investment decision, a decision that we believe will position Algoma with world-class steelmaking assets to complement the investments we have made in our downstream facilities. This proposed investment in electric arc steelmaking is also expected to significantly reduce our carbon intensity and pave the way for Algoma to produce some of the greenest steel in North America while helping to build the infrastructure of tomorrow. None of this would be possible without the continued dedication and efforts of our workforce. Their continued diligence in the face of the COVID-19 pandemic to protect themselves, their families, their coworkers and ultimately our business and in the ever-changing threat of variants of concern has allowed us to operate unimpeded and delivered strong results over the past quarter. Beyond COVID-specific workplace safety, we have also seen a positive impact on all of our safety metrics. On Slide 4, you will see that our focus on safety continues to have a positive impact on our lost time injury performance, including 0 lost time injuries over the last quarter. I commend our entire team for their collective success on safety performance, a top priority at Algoma Steel. We have several reasons to be very optimistic about what lies ahead for Algoma, and I will share more details later on the call. But first, I will pass it over to Rajat to go over the financial highlights of the last quarter.

Thanks, Mike. Good morning, and thank you for joining the call. I would also like to welcome the new listeners on today's call. We believe Algoma's results underscore a compelling investment opportunity, and we look forward to sharing more details. We are certainly excited as we move closer to an Algoma public listing later this year. Before we get into those details, I'm happy to report that we had a very successful June quarter, the first quarter of our fiscal year ending 31st March 2022. On our last quarterly call, we presented guidance for the first quarter, and I'm happy to say that we met and exceeded these targets. We shipped 610,000 net tons in the quarter. Shipments were similar to prior quarter and up 47% from 416,000 net tons in the same quarter of last year, primarily as a result of a return to run rate utilization levels compared to the pandemic lows experienced last year. Our steel revenue was $765 million in Q1, up 21% from $633 million in the prior quarter, driven by higher net sales realization due to unprecedented demand. In comparison to the same quarter of the prior fiscal year, revenues increased by $423 million as net sales realization were higher by $439 per net ton, resulting in a 124% increase in steel revenue. As a reminder, both our contract and spot orders are subject to a pricing lag due to price mechanics and mill lead times. We have started to see these positive results flow through our earnings. And what is even more positive is that prices have continued to rise now for 53 consecutive weeks. On the cost side, Algoma's cost of goods sold per ton increased slightly quarter-over-quarter as some commodity price increases have an effect on selected raw material inputs. Offsetting these increases, Algoma remains focused on our cost saving initiatives, and to date, we have captured run rate savings of approximately $42 million on an annualized basis, and we remain on track to reach our $50 million target. Further to that, based on our employees' contributions and our enhanced earnings performance, Algoma is accruing for increased profit sharing. When compared to the same quarter of last year, cost of steel products sold per ton is approximately 3% higher. Please keep in mind that Algoma was eligible and we did receive benefits under the Canadian Emergency Wage Subsidy program last year as the pandemic impacted our business substantially, which allowed us to keep our employees working during this period of low production volume and mitigated high fixed cost on a per ton basis. We generated $281 million of adjusted EBITDA during the quarter, which beats our guidance of $250 million compared to $167 million of adjusted EBITDA in the prior quarter. We are continuing to reap the rewards of even higher pricing moving through our results. However, due to the lagging nature of our order book, we expect to realize today's higher prices in the subsequent months and fiscal quarters. With the earnings performance, we generated $275 million of cash from operations prior to changes in working capital. We fully repaid our ABL during the quarter. And after considering CapEx, cash interest expense and changes in working capital, we ended with $21 million of cash on the balance sheet, which gives us liquidity of approximately $304 million, in line with our guidance. With the impact of higher selling prices on our accounts receivable and the traditional restocking of inventories after the winter period, there was a usage of working capital during the quarter. I will get into these changes in more details on Slide 7. Please note that the chart shown on Slide 7 only includes inventory, trade receivables and payables net of prepaids, which are the main drivers of working capital movement. Before we get into the details, I want to reiterate that our financial statements are prepared using the U.S. dollar as our functional currency and Canadian dollar as our presentation currency. As a result, there was an impact of exchange variation on the reported financial results. While there was not a significant change in rate quarter-over-quarter, there was a large impact when comparing year-over-year results as the exchange rates at June 30, 2020, was $1.3576 compared to June 30, 2021's closing rate of $1.2394. The significant appreciation of the Canadian dollar versus its U.S. counterpart has an impact on balance sheet items as they are converted at the end of period rate. When compared against the prior quarter, inventories increased by $55 million over the quarter from $415 million to $470 million. Raw material inventory increased by $18 million as we restocked inventories from the lows at the end of the March quarter. In addition, there was an increase in the value of work in progress and finished goods inventory totaling approximately $37 million. This is attributable to higher carrying cost of inventory as cost of certain raw material increased and higher volume of work-in-progress inventory, which was produced to accommodate the planned maintenance to one of our steelmaking vessels in the next quarter, mitigating impacts to shipments. Accounts receivable increased by $54 million from the prior quarter. This increase is attributable to the significant increase in sales realization in this rising price environment. Accounts payable balances increased by $23 million, having a favorable impact on working capital. This is attributable to the resumption of normal raw material shipment over the quarter coming off of the winter slowdown where the Great Lakes are not navigable for vessel traffic. With these solid results behind us, the logical question that arise is how we expect our performance to be over the next quarter. As you can see on Slide 8, there has been a significant increase in the index price of steel from August of last year till now. Strong demand, coupled with extremely low customer inventory levels across the supply chain continue to support full flat-rolled steel price above historical peaks. Demand from key end markets include automotive remains strong, and we expect this to continue into next year. We feel that the investments we are making in our plate mill will serve as well as traditionally as rolled plate is priced higher than hot-rolled coil. Today, this relationship has inverted. However, with infrastructure spending, we feel the traditional relationship will return and Algoma will reap benefit at that point with higher production capacity and broader market reach for our products. With the macroeconomic drivers in North America market, we believe that price will remain elevated for the foreseeable future with the new paradigm for steel selling prices. All of these factors provide for very positive forward-looking guidance. Shipments in the second quarter of 2022 ended September are expected to be in line with the current quarter. We expect shipment volume of over 600,000 net tons. As mentioned earlier, we do expect to take a 2-week maintenance outage for the annual reline of one of our steelmaking vessels. Net sale realizations are again expected to be directionally higher as we expect to see price climb month-by-month in parallel with the significant index price increase we have experienced with further upside in October to December quarter. We can expect adjusted EBITDA performance of approximately $400 million plus/minus. With the strong earning of performance, we are positioned to generate significant free cash flow. By the end of September, we anticipate we may have over $300 million of result in cash and full access to our undrawn revolving credit facility. Also reflected in this guidance is the reduction of special contribution to our defined benefit pension plan in response to us having reached 85% funding on a solvency basis. This significant liquidity is expected to provide us the opportunity to improve our capital structure and pursue other strategic initiatives. To take us further through our strategic activities, I will now turn over the call to Mike.

Thanks, Rajat. We had alluded to the significant earnings generation that is anticipated. And on the last call, we mentioned that these record steel prices present an extraordinary cash generation opportunity, an opportunity that we're taking full advantage of. While the market certainly has provided tailwinds, it is the dedicated strategic approach we have implemented that is allowing us to capitalize. As a team, we collectively have laid the foundational building blocks for our strategic direction. On each and every call, we have highlighted elements of our strategic approach, whether it's our approach to risk management, cost management, talent building, performance management or strategic CapEx. We continue to strengthen the core, including our people and our assets, and we remain focused on building these growth platforms that are designed to create a sustainable future. We continue to reap the benefits from our Project Aurora efficiency initiatives, and to date, have produced over $42 million from our cost on a sustained annualized basis. And we're not done, targeting an additional $8 million, pursuing our goal of $50 million of annualized savings. Driven by our employees, we have implemented both operational and capital improvements that helped deliver the strong earnings performance in the past quarter and which we believe will continue to generate significant value in the quarters and years to come. Over the past 20 months, our team embarked upon a discovery exercise, exploring the potential of a transformational conversion of our operations to electric steelmaking. This proposed transformation has the potential to provide numerous benefits, including incremental capacity and improved more variable cost structure that is better correlated to market conditions, a significant reduction in greenhouse gas emissions, which substantially mitigates the increase in risk and cost to heavy industrial emitters. We are currently working through the last elements of this project which will allow for our Board of Directors to make a final investment decision. We envision this project unfolding along a time line, which is referenced on Slide 11. To summarize, we expect a 28- to 30-month construction phase, which will allow for the first arc on the electric arc facility in early 2024. Subsequently, there will be an expected commissioning ramp-up period and product certification process, which we expect to take approximately 12 months while running in parallel with our current operations. After that time, we expect that Algoma will operate its 2 electric arc furnaces in combination with liquid iron from the blast furnace to maximize the utilization of available grid electricity as Algoma works with key stakeholders to increase the power supply to our site. Electricity is critical for this project. Algoma continues to work with industry and government stakeholders to pursue opportunities that may shorten the time line to reach full electrical steel production, shedding our reliance on current coal-based operations and thus expediting the full benefits of the project, which includes the reduction of over 3 million tons of CO2 on an annual basis. That's the equivalent of shedding a coal-fired power plant or removing approximately 1 million gas-powered vehicles from our roads. Potential solution being reviewed is to use a battery storage system that would allow Algoma to access more grid power sooner, purchasing electricity that is currently reserved as a safeguard to the existing grid. This solution could be operational ahead of a long-term system upgrade currently being studied by the province. Another key milestone to completing this project is securing appropriate financing. As you know, we've been active in our pursuit for financing, pursuing avenues to derisk access to the necessary capital to complete this project. The strength of the steel market, the value drivers of Algoma, including our capital investments and operating cost improvements combined with the potential to drive further value with an electric arc transformation positions Algoma for success and ultimately resulted in the merger agreement with Legato Merger Corporation. Assuming no redemptions from the SPAC investors, the merger could see up to USD 306 million in cash added to Algoma's prospective balance sheet. This is an attractive investment for all participants. Our current performance and continuing market conditions suggest that Algoma will surpass its full earn-out target of adjusted EBITDA of USD 900 million with the projected calendar year adjusted EBITDA of USD 1.1 billion. As a result, again assuming no redemptions by SPAC investors, Algoma shareholders may retain 74% of the business in return to public markets represents an attractive valuation multiple for current and prospective investors. Enhancing this transaction further, Algoma has secured, subject to the execution of definitive loan agreements, a commitment of $420 million from the federal government by the way of the Strategic Innovation Fund in the Canada Infrastructure Bank as part of a broader effort by the Canadian government to realize environmental goals in reducing greenhouse gas emissions. With the pathway to a final investment decision, the appropriate financing and the significant free cash flow generation expected in the coming quarters, Algoma expects to return to the public market later this year with an enhanced capital structure, a significantly reduced leverage profile and a strategic direction that will position Algoma as a sustainable producer. With the solid foundation of the business today, coupled with the exciting prospect of our future developments, we are focused on evolving a compelling value proposition for our shareholders, both current and prospective. Moreover, Algoma has an attractive valuation relative to other North American steel industry peers. And with the current prospective cash flows anticipated over calendar 2021, the implied valuation is likely to further improve, creating an outstanding opportunity. Exciting times to say the least for the steel sector and for Algoma Steel, in particular. Thanks very much for your continued interest in Algoma Steel. We very much look forward to what the future holds. Now I'll turn it back to the operator and questions, please.

[Operator Instructions] We do have a question coming from the line of [ Anton Gorbanov with AMC ].

Could you please talk about the steel price assumptions that underlie your next quarter guidance?

Sure. So I can provide some guidance on how we are -- how the pricing is flowing through. So we had mentioned earlier that it's -- we have 65% contracted volume and 35% spot volume. Spot has been running at, let's say, normally runs 6 weeks lead time, but has been running at around 12 to 14 weeks lead time. So the pricing that we are seeing in the September quarter will be based on 3 to 4 months lead time on the spot side and 1 month to a quarter lead time on the contract side. So 65% contract which is quarterly lagging and monthly lagging. And it's -- September quarter will be dependent on June quarter and the month lagging with the 1 month before. And on the spot side, it will be 3 to 4 months lag. So that may be able to help you to construct the pricing.

Got it. That's helpful. So maybe just to put another way, it sounds like the main variability from here, at least when it comes to revenue line item, is shipments, right, because prices at this point are fairly known. Is that correct?

That's correct.

[Operator Instructions]

And operator, perhaps a reminder that the questions today are being restricted to existing Algoma shareholders. The invited guests are on listen-only mode, but we're happy to circle back off-line with anybody who does have a question with respect to the presentation.

And there appears to be no further questions at this time.

All right. Well, thank you. Listen, once again, thanks for your interest in Algoma Steel and taking some of your valuable time to spend with us this morning. Please stay safe, and look forward to speaking with you again next quarter. Thank you.

That does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.