Algoma Steel Group Inc. (ASTL) Q2 2024 Earnings Report, Transcript and Summary

Greeting. Welcome Algoma Steel Group Inc. Fiscal Second Quarter 2024 Earing Call. [Operator Instructions]. Please note this conference is being recorded. I will now turn conference over to your host Mike Moraca, Treasurer and Investor Relations Officer.

Good morning, everyone, and welcome to Algoma Steel Group Inc's second quarter fiscal 2024 earnings conference call. Leading today's call are Michael Garcia, 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. I would like to remind you that comments made on today's call may contain forward-looking statements within the meaning of applicable securities laws, 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. Last evening, we posted an earnings presentation to accompany today's prepared remarks. The slides for today's call can be found in the Investors section of our corporate website. With that in mind, I would ask everyone on today's call to read the legal disclaimers on Slide 2 of the accompanying earnings presentation and also refer to the risks and assumptions outlined in Algoma Steel's First Quarter Fiscal 2024 Management's 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 01 to March 31 and our financial statements have been prepared for the three and six months ended September 30, 2023. Please note all amounts referred to on today's call are in Canadian dollars unless otherwise noted. Following our prepared remarks, we will conduct a question-and-answer session. I will now turn the call over to our Chief Executive Officer, Michael Garcia.

Thank you, Mike. Good morning and thank you for joining us to discuss our fiscal second results. As always, I will begin my remarks by addressing what truly matters most to us. The safety of all out employees. At Algoma we believe in safety without compromise and continued dedication has led to a significant improvement in our loss time injury frequency rate over the past decade. Furthermore, we bring the same focus and attention to safety as we continue progressing on the largest capital project in our history our EAF Transformation Project.I want to commend the team for working 420,000 hours with no loss time injuries to date and want to emphasize the importance of safety, especially as we enter the winter months. We will continue to work diligently as we relentlessly pursue our goal of achieving zero workplace injuries. Next, I'll cover key events and milestones during our fiscal second quarter and subsequent to its end. As well as update you on the progress of our transformative EAF project.I will then turn the call over to Rajat for a deeper dive into the numbers and the discussion of our strong liquidity and balance sheet before closing with an update on market conditions. Our results for the fiscal second quarter of 2024 were in line with our previously disclosed guidance for both shipments and adjusted EBITDA.These results reflect solid operational performance against a challenging backdrop in steel markets, where the recently resolved UAW strike at various US auto making facilities impacted demand and pricing. During the quarter, we continued progress on phase II of our plate mill modernization project. Including commissioning and testing of the inline shear. We expect the shear to be online later this month and to wrap up plate production through the end of the year.This higher production level will allow us to capture market opportunities and to build inventory ahead planned outages for the implementation of the final phase of the modernization project. The project team has worked through the detailed implementation steps and identified opportunities to further de-risk this phase. Originally, we had planned on one outage standing 40 days.However, we have identified advantages to splitting the outages into two shorter duration outages of up to 20 days, which we expect will mitigate the impact on our customer base while also reducing commissioning risk. The first outage will be in April of next year and the second outage will be scheduled for later in the calendar year to align with our planned maintenance outages providing further advantages. We still expect increase in production volume over the course of the year with much less impact on our customers. Turning to other strategic initiatives.We have made significant progress on securing key raw material inputs during the quarter. We signed a two-year extension to our existing iron ore purchase contract with U.S. Steel with an option for a third year at our sole discretion.By extending the existing contract, we now anticipate our iron ore volumes needed to make the transition to electric arc furnace steel making are fully covered giving us certainty of supply and uninterrupted access. On the coking coal front, we have settled our calendar 2024 contract needs and pricing for this raw material is expected to be down low double digits in 2024.So given the certainty of labor, due to the 5 year union agreement signed last year, the contract for our iron ore needs for the next few years and our coking coal contracts for calendar 2024 we have solidified our inputs and created better visibility into our cost structure for the next several quarters, positioning us to expand margins especially as steel price has continued to improve from recent strike impacted weakness.We are optimistic as forward prices have hovered around $1000 U.S. per ton for hot rolled coil in recent days, reflective of the pent up demand and low inventory levels at certain customers. Next, I'd like to update you on our progress during the quarter on our transformational EAF project. This will still will ultimately increase our throughput capacity by roughly a third, from 2.8 million tons per year of liquid steelmaking capacity by conventional means today to 3.7 million tons, employing dual EAF furnaces upon completion.The higher output will match our expanded downstream finishing capacity as we increase throughput at our plate mill. Importantly, this will improve overall product mix while simultaneously lowering our carbon emissions by approximately 70% when fully operational.When factoring in the makeup of our power supply when we switch to EAF operations, we expect to be one of the greenest producers of steel in North America.During the quarter, cumulative investment in the EAF project reached $456 million or 54% of our expected total project cost at the midpoint of our project budget.We have made meaningful progress since quarter end securing uncontracted portions of expected project cost, and as of today, approximately 80% of the total project budget is under contract.We expect to contract the remainder that as of the project budget by the end of March 2024. Furthermore, it is important to point out that as of now, only 5% of the total contracted amount is subject to time and material adjustments, meaning the vast majority is under fixed price terms.This demonstrates significant de-risking of the EAF project over the past several months as we progress towards the startup commissioning in late calendar 2024.As a reminder, our startup plan continues to include normal production from our existing steel making facility, while ramping up steel production from our EAFs in calendar 2025. Followed by a complete switch to EAF production.I spoke earlier about our successful efforts to secure coal and iron ore inputs for our existing operations and when you think about the inputs for EAF steelmaking, one of the most important is power.As we mentioned previously, we already have the required power to run the electric arc furnaces at our current run rate of 2.2 million to 2.4 million tons of shipments without relying on the blast furnace, utilizing on-site power generation and the current grid.We can utilize hot metal from the blast furnace opportunistically which would provide further upside to our current capacity. In this quarter, we received a system impact assessment for the second phase of our project, which means when the local 230K Volt line installed, we can run either EAF unit without running our on-site power plant.Also subsequent to the quarter end, the Ontario government's announcement and issuance of an order in council to accelerate regional power infrastructure upgrades provides further assurance for our long-term power requirements for our EAF project. All-in-all a significant amount of progress has been made substantially de-risking the availability and cost of the power needed for new EAFs. It’s an exciting time in Sault Ste Marieas our existing facilities operate normally and work on the EAF accelerates. I would like to once again thank all of our employees whose execution continues to deliver solid operational and financial results safely while simultaneously driving the EAF project forward.Now I will pass the call over to Rajatto go over our financial results for the quarter and give more details on the expected funding of our capital expenditures.

Thanks, Mike. Good morning and thank you all for joining the call. Our second quarter results included adjusted EBITDA of CAD81 million which reflects an adjusted EBITA margin of 11.1%.Cash generated from operating activities was CAD57.2 million. We finished the quarter with CAD213 million of unrestricted cash and our $300 million revolving credit facility remains undrawn, representing total liquidity in excess of CAD500 million. We mentioned in our previous calls and included in our strategic direction, our focus on financial discipline.We have structured our balance sheet with the only long-term debt in the form of government loans linked to our capital projects and maintained a very low leverage profile with ample liquidity to manage through market fluctuations and complete our capital initiatives.I'll now dive into the key drivers of our performance in the quarter. We shipped 549,000 net tons in the quarter, up 26.1% as compared to the prior year period. Our plate and strip operations continued to run well and our normal seasonal maintenance is occurring as expected, including our annual steelmaking vessel realign. As a reminder, this normal seasonal maintenance typically reduces production by 20,000 tons to 30,000 tons.As a result, we would expect our fiscal third quarter production to be lower sequentially as compared to the fiscal second quarter.Net sales realizations averaged CAD12 to CAD13 per ton, down 4.3% versus the prior year period. The decrease versus the prior year levels primarily reflects overall softer market conditions in the quarter.Plate pricing continued to enjoy a significant premium relative to hot-rolled coil during the quarter, driven by resilient demand, particularly from spending on infrastructure projects and durable goods.As a reminder, we are the only discrete plate mill in Canada and we look forward to the incremental terms from the plate mill in the calendar fourth quarter and beyond as a result of the new shear installation.Steel revenue in the quarter totaled CAD665.8, up 20.7% versus the same quarter of last year reflecting the increase in shipments that were more than offset by lower average realization per ton of steel. On the cost side, Algoma's cost per ton of steel products sold average CAD10.21 in the quarter, down 1.6% versus the prior year period. The main drivers of the decrease versus the prior year period include the positive impact of increased volumes versus the prior quarter, our cost of steel products sold were approximately 7% higher, attributed to lower volumes, higher costs related to various raw materials and utility inputs, including natural gas and purchased coke.Cash flow from operations totaled CAD57.2 million for the quarter compared to a use of CAD66.1 million in the prior year period.Our inventories at the quarter end were CAD822.7, up 8.3% during the quarter due to normal seasonal bed patterns. We expect to build inventories further during the calendar fourth quarter ahead of winter as we typically do at this point in the year and to release inventories in the first half of calendar 2024, heavily weighted towards the first calendar quarter. Now I'd like to provide additional color on our funding plans for the EF project.As previously noted, our outlook for the total cost of the project remains in the range of CAD825 million to CAD875 million. To the end of the quarter, we had spent CAD456 million or 54% of the expected total cost.Leaving CAD394 million to be spent. We're well positioned today when we look at our expected sources for those expenditures.We have cash on hand of over CAD200 million, another CAD93 million of available capacity on our Federal CEF loan, and approximately CAD150 million of cash to be generated from drawing down excess working capital with approximately 70% of this coming in the fourth fiscal quarter and the balance coming in the following fiscal year.Combined, this exceeds the remaining expected capital requirement to complete the project. With that, I'll turn the call back to Mike Garcia for closing comments.

Thank you, Rajat. Looking at the state of the North American steel markethot-rolled coil index prices fell approximately 25% in the calendar third quarter as the concerns about and the reality of a UAW strike weighed on the market.Capacity was curtailed at several North American mills as a result, and inventories across distributors were drawn down.We do expect this to meaningfully impact EBITDA in the current fiscal quarter, as lower prices and lower shipments on account of our planned maintenance outages are felt. Looking further out as labor settlements have been reached over the last few days pricing has rapidly moved higher and we have seen forward curve pricing climb to near CAD1000 per ton, which will provide significant upside in the fourth fiscal quarter.We are also supported by the fact that plate pricing continues to demonstrate a significant premium as overall demand per plate products remains high which in turn continues to benefit our average price realizations. We will relentlessly maintain our primary focus of operational excellence and maintaining prudent financial discipline regardless of volatility in our end markets.This will ensure our ability to execute our EAF project, ushering in the next phase of our company that defines the future of Algoma, provides for the long term value creation of our stake holders and solidifies our leadership position at the forefront of green steel production in North America. Thank you very much for your continued interest in Algoma Steel. At this point we would be happy to take your questions. Operator, please give the instructions for the Q&A session.

Thank you and at this time we will be conduction question and answer session. [Operator Instructions].Our first question comes from the line of David Ocampo with Cormark Securities.

Thanks. I guess my first one here is for Rajat.Based on kind of your annual buys that you have for your raw materials and your new iron ore contract, do you guys think we've hit peak raw material prices and how should that trend into next year?

Yes. So for coal, definitely it comes down and I don't know you see how the index fluctuates, so that affects to some extent as we have two contracts right now running,but I would say that you are you're right that we should see cost coming down in the future.Normally, the winter months have some challenges primarily based on a high cost of utilities, natural gas and power that goes through, but other raw materials should start coming down as we go into the next year.

Okay and then I guess just sticking with you, Rajat, I mean, if I take a look at your inventory levels, they're still a little bit elevated.They actually saw an uptick in the quarter. Can you just walk us through how those raw materials or finished product begins to unwind and how much cash we can expect to unlock in the next several quarters?

Sure. So, we normally build during December and this is typical, and then we'll release in March, and then we'll do the same next year, but when you look at March to March, or March end to March end, we should release, you know, around CAD100 million in working capital and I say working capital, it includes inventories and some other on the payable side as they go hand in hand.So you'll see that happening and then there is another CAD50 million odd that we should see in the following year.So we should see that CAD150 million coming down. It's taking a little longer as I had mentioned earlier as well that we have inventories which will take a little bit longer to run down and this is primarily on the - on the raw material side. On the finished goods and [Indiscernible], as cost comes down, we should see that improving, but from tonnage perspective, we should see some optimization happening.

Got it and then my last one, it could be for whoever wants to take it, but you typically set your annual contracts around this time at least that 10% that you typically hold out on. Was this done before the resolution of the UAW strike or post the strike when we saw much better pricing conditions?

David, this is Mike. I think it's happened throughout. It's still happening now. So it really depends on the specific customer and kind of the historical timeframe, but we definitely began it, on the cusp of the strike, but it's continuing to happen as we're speaking.

Okay perfect. Thank you so much.

Our next question comes from the line of Katja Jancic with BMO Capital Markets.

Hi, thank you for taking my questions. First, maybe on the plate side, I think you mentioned that the demand environment remains healthy and prices elevated, but what we're seeing in the U.S. that one of your peers has actually announced that they are reducing prices, and it seems that the demand environment is softening.Can you talk a bit more? Are you seeing a different environment in Canada and how much are you selling into the U.S. Market?

Thanks, Katja. This is Mike. So when you think of our plate book of business, the majority of it is in Canada. It's roughly a 70/30 split between Canada and the U.S. and again, I think as reflected in the spread, which still remains large and actually opened up a bit this week we are still seeing pretty robust demand for our plate business.I think there are some segments of the plate market that are maybe under a little bit more pressure than others. I'm sure you saw the cancellation of the wind tower projects, but that's not a segment that we're in.So we still feel relatively confident about the plate spread and where our book of business is.Does that help?

Yeah that's super helpful.Thank you for that and then just on near term costs side, given that the production level is going to be lower this quarter, how should we think about cost per ton, should they be higher or what are some of the puts and takes there?

So it will be higher, just because of the volume.So the so the so when you look at puts and takes for the coming quarters, let's say or the coming quarter, at least, is that the volume definitely will impact, other costs are more or less very similar, utilities might continue, which is natural gas and power with some pressure on higher pricing.So that's how the next quarter will play out. Quarter after getting back to normal production levels, because the outages are out and then you still have the utility pressure and then you get into get into the summer months where you start getting into much normal situations.So that's how we see the costs playing out over the next couple of quarters.

Okay. Thank you.

Our next question comes from the line of Ian Gillies with Stifel.

Hi, everyone. With respect to the plate mill modernization and new shear being installed. If I recall correctly, I think that was supposed to be done at some point during this past quarter.It sounds like it's still ongoing. Has there been some sort of delay there impacted volumes or am I misreading the situation?

No, I think what we had mentioned before was hot commissioning was beginning in this quarter. And we're pretty much right on schedule with that project.It is a pretty involved hot commissioning exercise and so we're still on track as we bring up that shear into more normal production in November and then consequently in December and through the first quarter of next year.

Okay. That's helpful and as you think about once you get past the two brief outages next year,do you have a good sense of where you think volumes are going to be post that?Or is that number still a bit influx depending on what might happen and if you do have a good idea, would you be willing to quantify it for us?

Well, I think what we're aiming for, prior to the firstoutage in April is to roll in a 10% to 15% increase in our plate business and then building from there.The plate business, it's a very important market segment for us. We are spending a lot of time with customers now about and it's really kind of two pieces.It's recovering our position at some of our historical plate customers. We had some challenging times last year with the commissioning and the startup from phase 1 of the projects.So we had a little bit of room to recover, so to speak, but we've made the type of improvements in quality and promised performance that we believe the customers require of us and now as we bring on more capacity steadily through next year, we'll build our business with the quality and promised performance improvements as well as the increased flow path to handle it.

Okay. That's helpful. Thanks Mike. If I could just squeeze in one more. With respect to what you're seeing from your customers right now and as it pertains to the rise in HRC prices.How much of it do you think of this run is due to structurally stronger demand? And how much do you think is tied to inventories being rebuilt because I know buying had been pretty weak.I know it's a tough question to answer, but any commentary there I think would be helpful.

Yes, it is a tough question to ask. Definitely, there is, an aspect of it and probably a significant aspect in the early days the first few weeks, couple of months that is tied more to a recovery from the positions people reach during the strike. Inventories were, I think, at two months, which is quite low.Lead times for the mills were out at eight weeks for the most part. So I think the initial stages of it have been a recovery from the concern and the specific outages tied to the UAW strike.I think going forward is where it'll really kind of demonstrate whether the rest of it, any further pricing beyond where we're reaching now will, I think, be more tied to fundamental demand and economic activity.

Understood. Thanks very much. That’s helpful.

Our next question comes from the line of Lucas Pipes with B. RileySecurities.

Thank you very much for taking my question.The first one is circling back on annual contracts and with the decline in raw material costs in 2024, would you expect the margin on annual contracts to increase or stay the same go down would appreciate your perspective on that?

Sure. So, the contracts that we do are mostly index based and there is a very small amount that's on fixed price where you see that that happening, but overall, we should see margins improving because costs should get optimized and if the pricing remains at the level it is or lower, we should see higher margins. So relatively margins will be better because the cost comes down, but most of our contracts are index based, so it's heavily based on the on how the pricing moves throughout the year.

Got it and thank you for that and can you remind us roughly what percentage would be fixed versus loading?

We normally do around 5% or so fixed of our total bookand we normally do contracts around 50% to 60%. So 5% is fixed and the balances all flow based on monthly and quarterly contracts.

Very helpful. Thank you for that and then my second question is on your coke procurement during the transition phase. Can you remind us what the strategy varies, what would you expect the mix to look like? And any possible savings on the on the capital side, as you as you transition. Thank you very much for your color.

Yes, Lucas. So we continue to maximize production from ourinternal coke batteries and we continue to spend critically required capital to maintain those batteries in a safe operating condition,but the fact remains, even when they're running very well, we are still short of coke.So we'll continue to purchase coke externally as we've done in the past. We always try to minimize that number, but we expect that go forward into the future and we've gotten a little bit of a benefit here recently because the market price of coke has come down pretty significantly, but our approach remains the same.We will have to maintain the batteries, even though they don't have a long life or a life for us beyond our final transition to EAF production, but we're still spending some amount of required sustaining capital to keep them safe and operating profit properly.Does that help?

It does.I do have a follow-up question. There's talk of some potential idling of blast furnace in 2024. So I would think that overall there's more coke available from a merchant basis.Is that tempting or when you kind of think about, if you just answered the question before that if you want to kind of maximize your internal needs, but is there a point where that can switch and where it makes more sense to buy more coke on a merchant base?

Yes, I think at the end of the day, it comes down to economics.So we have to have a good understanding of our internal coke production cost, including the yield loss that you'll get in coke when you buy it externally and transport it here, but certainly if the economics change significantly in that decision internal production versus external purchase that's something we'll be tracking and be aware of and prepared to act on it.

And how quickly could a switch occurs that decision you have to kind of make once a year, or can you be flexible as the year progresses and supply demand changes?

Yeah. No, we can we can be pretty quick in that.It's not within days, but probably within months, we can we can switch. We don't have to wait for a year. Because what we do is that we do contract out based on our optimum production internally and if we have to switch that based on opportunity available in the market to buy at a price which offsets our own production then you have then we have that flexibility and we can move quickly within months.

Very helpful. Really appreciate all the color and continue best of luck. Thank you.

Thanks Lucas.

Our next question comes from the line of Ahmad Shaath with Beacon Securities.

Hi, guys.Just a really quick one for me on the EAF project. Did I read that right? The hybrid scenario is not on play anymore and you guys going to start commission on both EAFs, what your thoughts on the on the grid connectivity?

No, I think hybrid is definitely still in play, but what we mentioned was that we wanted to emphasize that we will be able to match our current output with only running EAFs coal charge and the power that is available today and with the recent decisions by [Indiscernible] and the completion of the system impact study.So there's been a full kind of understanding of the impact of our power demand and the nature of it by the operator of the grid in Ontario. And they've issued some conclusions based on that.However, we still have the optionality to continue to run our blast furnaces and take advantage of hot metal from those blast furnaces at a reduced blast furnace rate to augment our production through the EAFs if we want to increase the total amount of steel produced and again, that'll go back to the economics and how that decision looks from an economic perspective.

Got it. That's very helpful. And, maybe alittle bit related on that. On the carbon tax credits, I saw the, at least from an income statement perspective, the number was a little bit higher, but it doesn't look like it had a big impact on your cash flow.So maybe that's one for Rajat, just to walk us through as we go forward. How should we think about that? All the blast furnace is continuing to operate.

Sorry, Ahmed, can you repeat the question?

Yeah. I'm just trying to understand the potential impact on your cash flow from the carbon tax payment, because it was substantial in this quarter, somewhat or CAD12 million.I haven't seen that number in a while. Maybe help us explain why they're a little bit bigger, but from a cash flow perspective, it doesn't look like it, in fact, operating cash flow.So just trying to understand how it will impact your numbers.

Got it. I thought government tax.So yes, carbon tax, so the way to look at carbon tax is, roughly pay on 5% of our emissions, which is roughly 200,000 tons and the price for this year is CAD50 million and for next year is goes up by another CAD15 million.So that's how the total cash out comes out and normally if the cash out goes in November. From accounting perspective, it was based on the estimates that come out until the time they are finalized those estimates are looked at and the accounting happens and that's how you see a big number coming in this quarter, which is the September quarter, but from cash out perspective and total expense perspective, it still remains a simple math of roughly 200,000 tons on an average and the price that gets published each year on what we need to pay it on.

Thank you that is very helpful and last one for me, if I heard you correctly, you do expect margins to improve, but because of the volume situation in fiscal Q3, we should expect a small dip and then calendar 2024 margins should start improving?

Correct.

We have reached the end of the question and answer session.I'll now turn the call back over to CEO, Michael Garcia, for closing remarks.

Thank you again for your participation in our second quarter fiscal 2024 earnings conference call and for your continued interest in Algoma Steel.We look forward to updating you on our results and progress when we report our fiscal third quarter results scheduled for February.

[Operator Closing Remarks].