Reliance Steel & Aluminum Co. (RS) Q2 2017 Earnings Report, Transcript and Summary

Greeting and welcome to Reliance Steel & Aluminum Company Second Quarter 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator instructions] It is now my pleasure to turn the conference over to your host, Ms. Brenda Miyamoto. Thank you. You may begin.

Thank you, operator. Good morning and thanks to all of you for joining our conference call to discuss our second quarter 2017 financial results. I’m joined by Gregg Mollins, our President and CEO; Karla Lewis, our Senior Executive Vice President and CFO; Jim Hoffman, our Executive Vice President and COO; and Bill Sales, our Executive Vice President of Operations. A recording of this call will be posted on the Investors section of our website at investor.rsac.com. The press release and the information on this call may contain certain forward-looking statements, which are based on a number of assumptions that are subject to change and involve known and unknown risks, uncertainties or other factors which may not be under the Company’s control, which may cause the actual results, performance or achievement of the Company to be materially different from the results, performance or other expectations implied by these forward-looking statements. These factors include, but are not limited to those factors disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016 under the caption Risk Factors and other reports filed with the Securities and Exchange Commission. The press release and the information on this call speak only as of today’s date and the Company disclaims any duty to update the information provided therein and herein. I will now turn the call over to Gregg Mollins, President and CEO of Reliance.

Good morning, everyone, and thank you for joining us today as we discuss our second quarter 2017 results. Continued steady demand along with strong execution by our managers in the field resulted in a gross profit margin of 28.4%, driving our second highest quarterly gross profit dollars in the Company’s history of $702.1 million. Current pricing levels are higher than both the first quarter of 2017 and the second quarter 2016, which positively contributed to our earnings. However, mill prices were pressured somewhat in the second quarter of 2017, especially for carbon and stainless steel products, which prevented us from enhancing our gross profit margin as we did in both the first quarter of 2017 and the second quarter of 2016 when multiple price increases were announced by the mills. In a period of rising prices, we are typically able to increase our gross profit margin as we obtain the higher prices from our customers before we receive the higher cost metal into our inventory. The absence of meaningful price increases and our receipt of higher cost metal during the second quarter of 2017 along with the added elements of a competitive landscape due to continued uncertainty around possible Section 232 action and increased imports in the market, collectively pressured our gross profit margins more than we had anticipated. In addition, the positive momentum we experienced during the first quarter of 2017 for both demand and metal pricing trends did not meaningfully accelerate into the second quarter as confidence around infrastructure spending and tax reforms stalled. Because of this, in June, we announced updated guidance for the second quarter that reflected our expectation of a lower gross profit margin although still strong and within our range of 27% to 29%. Demand band was at a low end and our average selling price slightly exceeded the top-end of our original guidance range of flat to 2%. Recently, there has been a great deal of uncertainty in the marketplace, much of which we believe stems from the pending Section 232 investigation by the United States government. Uncertainty impacts demand momentum as customers change their inventory buying patterns and hold back on capital investments. In addition, imports increased during the quarter as we believe metal buyers were bringing in foreign metal before any steel import restrictions which may result from the Section 232 investigation. Higher inventory levels along with pricing uncertainty increased competition and pressured our gross profit margin. Although we were able to increase our average selling price for the second quarter of 2017, by passing through the higher prices that were in effect at the end of the first quarter, mill prices for carbon and stainless steel products experienced downward pressure during the second quarter with some relief for carbon steel products near the end of the quarter. Our average selling price was up 11.3% from the second quarter of 2016 and up 2.4% from the first quarter of 2017. Overall, customer sentiment remains positive which translated into continued, healthy customer demand in the second quarter of 2017 with our tons sold roughly flat with the first quarter of 2017. We continue to anticipate customer demand levels will hold with the potential for improvement in the second half of 2017 subject to normal seasonality and into 2018 with yielding more meaningful upside if the administration’s infrastructure plans are implemented. Beyond pricing discipline, our managers in the field continued their strong execution in terms of inventory management, helping us achieve an inventory turn rate of 4.5 times, based on tons, consistent with our 2016 inventory turn rate. We are very comfortable with current inventory level. Turning to capital allocation, our strategy remains consistent, made possible by our effective working capital management and solid earnings levels providing cash flow from our operations. We will continue to grow our business through a balanced combination of organic investments and acquisitions while also returning cash to our stockholders. The majority of our 2017 capital expenditure budget of $200 million will be spent on growth activities. We continue to work with our customers to determine which value added services are most beneficial to them as well as to proactively identify areas in which we can provide additional services. We believe our gross profit margin improvement over the past two years compared to historical levels directly demonstrates the return on these capital investments. On the M&A front, we have not completed any acquisitions so far in 2017. The pipeline remains active and we will continue to evaluate opportunities to grow through acquisitions of well-managed metal service centers and processors with end market exposures that complement our diversification strategy. From the stockholder return perspective, quarterly cash dividends and share repurchases remain core to our capital allocation philosophy. While we did not repurchase any shares of our stock during the quarter, we will continue to be opportunistic in our approach. We increased our regular quarterly cash dividend by 6% in the first quarter of 2017, marking the 24th increase since our 1994 IPO. We have consistently paid regular quarterly cash dividends for 58 consecutive years. In summary, we are very pleased with our success in raising our sustainable gross profit margin range to targeted growth of our value added processing capabilities and specialty products coupled with our focus on pricing discipline and inventory management. In the first six months of 2017, we increased our pretax income by $60.1 million or 23% over the first half of 2016. We remain optimistic about the potential for increased infrastructure and equipment spending which we believe should improve both metal demand and pricing that will support our efforts to drive earnings even higher. I will now hand the call over the Jim to comment further on the operations and market conditions. Jim?

Thanks, Gregg, and good morning, everyone. Before I begin, I would like to take a moment of thank our folks in the field for their continued hard work and dedication. They did a tremendous job navigating through the market uncertainty in the quarter and I’m very proud of their achievements. Now, I will discuss demand and pricing of our carbon steel and alloy products as well as our outlook on certain key end markets we sell those products into. Bill will then address our aluminum and stainless steel products and related end markets. Demand for automotive which we service mainly through our toll processing operations in the U.S. and Mexico remained robust throughout the second quarter. Our growth continues to be driven by the increased usage of aluminum in the automotive industry. Over the past year, we have expanded our facility to support automotive demand for both carbon and aluminum processing. I am pleased to announce that during the second quarter, we finished construction on our new U.S. facility in Kentucky which was completed on time and on budget. We began shipping product from this facility late in the quarter and so far it has been operating in accordance with our expectations. In addition, our facility in Monterrey, Mexico, which became operational in the third quarter of 2016, has also been performing well. Second quarter demand in heavy industry which includes railcar, truck trailer, ship building, large manufacturing, tank manufacturer and wind and transmission towers was in line with levels experienced in the first quarter of 2017. During the quarter, we saw positive signs of activity, specifically with the lighter agriculture equipment which was encouraging, as well as a slight uptick in construction equipment spending. We expect demand in heavy industry to remain at similar levels throughout the remainder of the year, subject to normal seasonality. Demand in non-residential construction market including infrastructure continues to experience steady growth, the volume remains far below peak levels. During the quarter, we experienced increased uncertainty in the marketplace in anticipation of the outcome and resolution of key government decisions including the Section 232 investigation, tax reform and domestic infrastructure spending. We remain cautiously optimistic that domestic infrastructure spending will improve which we believe bodes well for Reliance. As a result, we are continuing to invest in value-added processing equipment for businesses that sell into non-residential construction and we will remain well-positioned to absorb increased volumes in our existing footprint and cost structure as this end market improves. Demand for energy, which is mainly oil and natural gas, continues to improve with both rig counts and drilling activity increasing, though completion activity remains low. Coating and overall activity improved during the quarter and mill lead times are extending. Importantly, beginning in the first quarter of 2017, our businesses servicing the energy market are once again contributing positively to our earnings. The increased activity in this market is an encouraging sign and we are well-positioned to support demand growth as energy continues to recover. Mill pricing for almost all of the carbon steel products we sell into these end markets was under pressure during the second quarter due to the more competitive environment resulting from uncertainty over Section 232 and increased import levels. In mid-June and again in July, however, mills announced price increases for certain carbon steel products that are now in effect. And we anticipate further price increases if the 232 investigation results in restriction on steel imports. Pricing for alloy products has been steadily improving and further improvement in activity levels in the energy market should support increased pricing going forward. Thank you for your attention. I’ll now hand the call over to Bill to comment further on our non-ferrous markets. Bill?

Thank you, Jim. Good morning, everyone. First, I too would like to thank our folks in the field for their solid operational performance during the second quarter. We appreciate your continued hard work. I’ll begin today by reviewing pricing and demand for our aluminum and stainless products, as well as key industry trends in the markets for these products. Aerospace continued to perform well during the quarter and remains one of our strongest end markets. Today lead times continue to be about 9 to 10 weeks for aluminum aerospace plate. The backlog for orders of commercial planes remains healthy and we expect build rate should continue to improve modestly in the second half of 2017 led by single-aisle planes. On our last conference call, we noted increased activity from many of our defense customers and that trend continued in the second quarter. Further, we continue to ramp production in regard to our participation in the five-year $350 million Joint Strike Fighter program. We’re extremely pleased with our strong position in the aerospace market and look forward to increasing our market share as overall demand continues to grow. On that note, our entry into the aerospace market in India through our All Metal Services subsidiary in the UK remains on track to become operational by the end of the year. We’re maintaining our positive outlook for the aerospace market. Turning to the semiconductor market, activity remains strong, especially in the U.S. and Pacific Rim regions. We maintain our positive outlook for the balance of this year as well as into 2018, based on solid demand trends. Moving on to the pricing, the majority of our sales into the aerospace market consist of heat treated aluminum products, especially plate, as well as specialty stainless steel and titanium products. Most notably, a 5% increase for heat treated aluminum plate was announced during the first quarter and went into effect in April. Since then, pricing and demand have remained stable. We expect this trend to continue in the third quarter. Most of our common alloy aluminum products are sold to sheet metal fabricators that support a variety of end markets. Demand for common alloy sheet in the second quarter was stable and in line with the first quarter trends. From a pricing standpoint, the conversion price increase announced for April has full domestic support and we believe the recently announced increase for the fourth quarter will also be supported domestically. We’re also seeing less aggressive import offerings which we believe relates to the Section 232 aluminum investigation. Lastly, demand for our stainless steel flat products which are primarily sold into the kitchen equipment, appliance, and construction end markets, has remained solid. That’s said, we experienced some pricing pressure during the second quarter as the price increase announced in April has announced in April has been rolled back. As a result, we experienced some downward margin pressure on sales of our stainless steel products during the quarter. Thank you for your time and attention today. With that, I’ll now turn the call over to Karla to review our second quarter 2017 financial results.

Thanks, Bill, and good morning, everyone. Our net sales in the second quarter of 2017 were very strong at $2.48 billion, up 12.3% from the second quarter of 2016 with our tons sold up 1.4% and our average selling price per ton sold up 11.3%. Compared to the first quarter of 2017, our net sales were up 2.3% on steady tons sold with our average selling price per ton sold up 2.4%. Our gross profit margin in the second quarter of 2017 was 28.4%, down from 31.1% in the second quarter of 2016 and 29.8% in the first quarter of 2017. As Gregg mentioned, there were multiple mill price increases in the first quarter of 2017 and the second quarter of 2016 which allowed us to temporarily expand our gross profit margin as we pass through the higher mill price before we received a higher cost metal in our inventory. Given the absence of mill price increases in the second quarter of 2017 and our receipt of higher cost inventory that reflected the mill increases announced in the first quarter in addition to the downward pricing pressure on carbon and stainless steel products due to uncertainty in the marketplace and increased competitive pressure, we are very proud of our second quarter gross profit margin of 28.4%, which is solidly within our estimated sustainable range of 27% to 29% and produced 702.1 million gross profit dollars, the second highest in Reliance’s history. Consistent with the first quarter, as a result of higher metal prices compared to year-end 2016, we recorded a net LIFO inventory valuation charge or expense of $10 million for the second quarter of 2017 or $0.09 earnings per diluted share. We continue to estimate a net LIFO inventory valuation expense of $14 million for the full year of 2017. We did not record a LIFO inventory valuation adjustment in the second quarter of 2016. As a percentage of net sales, our SG&A expenses were 19.2% compared to 20.7% in the second quarter of 2016 and 19.7% in the first quarter of 2017. The decrease as a percentage of net sales was primarily due to higher selling prices, which increased our sale. Interest expense decreased by $3.2 million in the second quarter of 2017compared to the second quarter of 2016, mainly due to the refinancing of our 6.2% senior notes with bank debt in November 2016. Our effective income tax rate for the second quarter of 2017 was 31.2% compared to 32.7% in the second quarter of 2016. We currently estimate that our full year 2017 effective income tax rate will be approximately 32%. Net income attributable to Reliance for the second quarter of 2017 was $103 million or $1.40 per diluted share, up from a $1.38 in the second quarter of the 2016 and down from $1.52 in the first quarter of 2017. Although our earnings benefited from higher selling prices in the second quarter of 2017, the reduction in our gross profit margin from the elevated levels in the second quarter of 2016 and the first quarter of 2017 offset this improvement. Turning to our balance sheet, as a result of our effective working capital management, we generated $35.9 million in cash from operating activities during the second quarter of 2017. We spent $38.7 million for capital expenditures and paid $32.8 million in cash dividends to our stockholders in the second quarter of 2017. At June 30, 2017, our total debt outstanding was $2.08 billion and our net debt to total capital ratio was 30.7%. As of the end of the second quarter, we had $740.5 million available on our $1.5 billion revolving credit facility. Our effective working capital management along with our solid earning enables us to fund our increased activity level with significant liquidity available to continue to grow the Company and return value to our stockholders. Turning now to our outlook. We remain cautiously optimistic with regards to business activity levels in third quarter of 2017 subject to normal seasonal patterns. Given our expectation that current demand will remain steady except for the typical third quarter decline in shipping volumes due to customer shutdowns and vacation schedules in addition to one less shipping day in the quarter, we estimate that our tons sold will be down 3% to 5% in the third quarter of 2017 compared to the second quarter of 2017. Given the recent increases in carbon steel pricing and the potential for fewer imports, we believe metal pricing momentum is positive. Therefore, we expect our average selling price in the third quarter of 2017 will be flat to up 3% from the second quarter of 2017. As a result, we currently expect earnings per deluded share to be in the range of $1.15 to a $1.25 for the third quarter of 2017. In closing, we’re pleased with our overall financial performance in the second quarter due to the solid operational execution by our managers in the field in a competitive environment. We are excited to demonstrate the increased earnings capacity that exists in our Company, if and when market conditions improve, and we look forward to updating you on our continued success in the coming quarters. That concludes our prepared remarks. Thank you for your attention. And at this time, we would like to open the call up to questions. Operator?

Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Seth Rosenfeld with Jefferies. Proceed with your question.

Good afternoon. Thanks for taking my question. Starting out, I’d like to get a bit more update on current order activity. How are your customers positioned do you think ahead of any potential further trade measures within the U.S.? You noted earlier in your prepared remarks that with the policy uncertainty, customers are perhaps delaying purchases, but perhaps more comments over trade restrictions in the back half of the year. I guess I would think that would perhaps drive more willingness to rebuild inventories at current lower price levels. Is that just not what you’re seeing from your own downstream customers right now? And then second question on the stainless market. We’ve heard from two of your biggest suppliers talking about continued market headwinds and effect of further destocking, perhaps base price weakness for Q3 but much more positive outlook for Q4. Is that in line with your own expectations or do you still see more potential for destocking in the U.S.? Thank you.

Hi. This is Gregg. I’ll take question number one and give Bill the opportunity to response to two. I think what the trade case is that there definitely has been some uncertainty in the marketplace with our customer base, and they’re just being cautious. That doesn’t mean that they don’t have business, okay, that they need to buy material to support that business that they have on their book. But, I think they still have maintained a level of cautiousness, and frankly I think most of us have; we fall into the same boat. But on the other hand, our demand in second quarter on tonnage basis was basically flat as compared to the very first quarter. So, we’re really not complaining about the demand situation. It would be better if infrastructure was -- the bill was funded and we saw more activity in that regard. But as business is today, we’re really not having much complains on that. The uncertainty is always problematic. But, at the end of the day, our customers do have business on their books and they do need to buy metal. And I think the results speak for themselves on tonnage being flat in the second quarter as compared to first quarter, which was a good quarter.

Seth, I think what you said is exactly correct. In our comments where the April increase was rolled back on stainless, I think we’ve seen a very competitive market. We expect that market to continue to be competitive into the third quarter. And there is some speculation and talk about maybe pricing starting to stabilize, improve as we get into Q4. So, I think from our point of view, we’re hearing the same thing and we hope that is the case.

[Operator Instructions] Our next question comes from Phil Gibbs with KeyBanc Capital Markets. Please proceed with your question.

A question on the guidance, the pricing outlook of flat to up 3% for the third quarter versus the second quarter. Are you seeing that based on your realizations thus far in July or are you expecting pricing to get better in August and September to meet that?

So, far, Phil, the price increases that were announced in the latter part of June and also very recently, some flat rolled products, they’ve held. The mills are not negotiating, at least as far as we’re concerned and they are pretty setting their ways on the mill price increases. So, we feel pretty good about that. Section 232 has been a question in everybody’s mind; it looks like there is going to be a delay in that. How that’s going to impact the pricing market is anybody’s guess. But so far, the announcements that have been made in the latter part of June and just recently in the last week, they have held and we’re optimistic that they will continue to hold and hopefully improve at some point in time, depending on a number of things, 232 as well as just imports in general. So, we are hoping that the imports start to decline a little bit, especially from the second quarter of this year.

Yes. I guess my question was more along the lines of whether or not you need to see prices improve from here relative to what you’ve realized in July to get to that flat to 3% range.

Well, I think those increases were announced in June and July would put us in that 0% to 3% increase range.

Yes, because there were some price declines during the quarter, Phil, I think, which is what you are getting to. So, to get back up to that average, we would need prices to improve a little bit from where those that were in effect when we ended the second quarter. But to Gregg’s point, the recent announcements we think get us up to flat and then we see potential upside of potentially more price increases for certain products through the quarter.

Okay. And the next question here is just on inflationary pressures that you may be seeing in the marketplace, whether that be a tighter labor market and/or a tighter freight market or anything else you may be seeing out there because I think we’re starting to see or have been seeing just general inflation start to creep back into the fold, anything you comment on there would be helpful.

I think if you look at our SG&A line, Q2 is pretty consistent with Q1. However, this year, we are up a bit from last year, somewhat because of those inflationary factors. We’ve put most of our wage increases in effect at the beginning of the year. So, we had some impact from that, just kind of normal inflationary factors, healthcare et cetera. So, we kind of see that across there. From the freight side, we’ve run primarily our own trucks at the majority of our locations. So, we had that the driver wage increases. Freight, since it’s up a little bit with the cost of gas and things but probably not the level of inflation that some people who are using more third-party carriers are experiencing.

And just a sub question on the labor piece will just be, are you in the mode to be hiring more folks right now or are you looking to sort of maintain or prepare back what you have for productivity side?

I think where we are from an employee standpoint, headcount, I think we’re fine where we are right now. I don’t anticipate unless we get a little bit of a bump on some of the infrastructure, some of the other industries that we support, we’re in pretty good shape where we are today.

Ladies and gentlemen, we have reached end of the question-and-answer session. I would now like to turn the call back to Gregg Mollins for closing -- oops, excuse me. Someone jumped into the queue. Our next question comes from Lee McMillan with Clarkson Capital Markets. Please proceed with your question.

Hi, everyone. Good morning. Just had a follow-up to Phil’s first question. I want to make sure I’m getting this right. It sounds that the price increases from June and July are embedded in your guidance. If I think about those as possibly being somewhat 232 related and then since then we’ve gotten the delay, I’m trying to balance that. You said that the recent increases get us up to flat. So, I am sort of wondering, what drives prices higher from here if I’m thinking about that correctly?

I think, Lee, overall, as Gregg commented earlier, we think demand is still good and will hang in there, subject to the normal seasonal patterns in the quarter. Mills are busy. So, we anticipate that the prices will hold even without 232. And with that continued kind of steady demand, we believe there will more than likely be fewer imports arriving during the third quarter than we saw during the second quarter, which also leads towards pricing support.

Our next question comes from Novid Rassouli with Cowen & Company. Please proceed with your question.

Good morning, guys. Just on that, what you just said Karla, the fewer imports. I wanted to see what is giving you guys the confidence that we will see fewer imports, and if there is any products that you could single out that you think will decrease going into 3Q?

We think that there is a potential for that because we saw quite a bit -- I think June was the highest import month that we’ve had since early 2015. We think we’re going to see a gradual decline beginning in July, getting more reduced in the month of August, September. And even with the 232 delay, if people were to start increasing their purchases of imports today, that wouldn’t be ramping [ph] for another 90 days. So, we think there is a period of time here where there is going to be reduced imports. And with that with mills run on flat rolled at roughly 90% of capacity which is big and the other products running in the 75% capacity range that there is a potential for further increases moving into the future.

We just basically go by the offerings that we get. You got to remember, 95% of what we sell as domestic product, we prefer to deal with our domestic friends and partners and even the offers that we do get, because we get offers, they are not that great. And there is not that many of them and the spread isn’t anything right about. [Ph]

Got it. Okay. That’s very helpful. And then you guys have not made any acquisitions thus far in 2017. I just want to see if there are any specific reasons, why or are there deals out there that nothing looks attractive or if you can just give us a little bit more color and your thought process there.

Well, there has been some activity, okay. But, very honestly, some of that is a little bit out of our realm of responsibility. So, we’ve chosen not to pursue it. We think that there has been some reluctance from some sellers to get into the marketplace today, based on tax reform potential out there. So, we think there are some people that would maybe not be sitting on the sidelines -- are sitting on the sidelines in anticipation of some tax level that will help them personally. But, recently, we’ve seen a little bit of increase in activity, which is encouraging for us. But as you know, we’re pretty particular in the companies that we acquire; they have to be well-run, well-managed, immediately accretive to earnings. And that criterion that we have is we’re going to stick; it’s served us well over the years and we’re going to stick with that going forward. But, we have, it’s been recent weeks seen little bit more activity than we did the balance of the first half of the year.

And I think, Novid, as you’re aware and as we’ve done consistently for years, we’re opportunistic when the right opportunities are out there. So, it’s not a decision by Reliance to not complete any acquisition so far this year, it’s just based upon the opportunities that are out there that fit our criterion that we have that Gregg just talked about.

Our next follow-up question comes from Phil Gibbs with KeyBanc Capital Markets. Please proceed with your question.

My questions has been asked and answered. Thank you.

Ladies and gentlemen, we’ve reached the end of the question-and-answer session. I would like to turn the call back to Gregg Mollins for closing comments.

Thank you. Thanks again for your support and for participating in today’s call. We would like to remind everyone that in September, we will be in Boston, presenting at KeyBanc’s Basic Materials conference. We hope to see many of you there. Thanks again for joining us and have a great day.

This concludes today’s conference. You may disconnect your lines at this time. We thank you for your participation.