Ryerson Holding Corporation (RYZ) Q2 2017 Earnings Report, Transcript and Summary

Good morning. My name is Kelly and I will be your conference operator today. At this time, I would like to welcome everyone to the Ryerson’s Second Quarter 2017 Earnings Webcast and Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question and answer session. [Operator Instructions] Thank you. Jeff Horwitz, you may begin your conference.

Good morning. Thank you for joining Ryerson Holding Corporation’s second quarter 2017 earnings call. I’m here this morning with Eddie Lehner, Ryerson’s President and Chief Executive Officer, and our Chief Financial Officer, Erich Schnaufer. Kevin Richardson and Mike Burbach, our two North American Regional Presidents, will be joining us for Q&A. Before we get started, let me remind you that certain comments we make on this call contain forward-looking statements within the meaning of the federal securities laws. These forward-looking statements involve a number of risks and uncertainties that could cause actual results to differ materially from those implied by the forward-looking statements. Such risks and uncertainties include, but are not limited to, those set forth under Risk Factors in our annual report on Form 10-K for the year ended December 31, 2016. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date they are made, and are not guarantees of future performance. In addition, our remarks today refer to several non-GAAP financial measures that are intended to supplement, but not substitute, for the most directly comparable GAAP measures. A reconciliation of the non-GAAP financial measures discussed on today’s call to the most directly comparable GAAP measures is provided in our second quarter 2017 earnings release filed on Form 8-K yesterday, which is available on the Investor Relations section of our website. I’ll now turn the call over to Eddie.

Thank you, Jeff, and thank you all for joining us this morning. First and always first, a thank you to our customers for their business, which we never take for granted, and to my Ryerson teammates for their excellent execution in the quarter. Ryerson’s second quarter highlights strong performance amidst conflicting business and industry conditions. Second quarter operations weathered significantly higher steel import levels and falling nickel and carbon prices, which impacted Ryerson’s pricing power, resulting in margin compression. In addition, Ryerson saw some mix-shift impact to margins, as sheet and stainless related demand was relatively stronger than bar, plate, aluminum and carbon demand in the quarter which exacerbated some of the margin compression, given that stainless steel is approximately 25% of our product mix and sheet products are 61% of our shape mix. These products experienced the most acute margin compression in the quarter. As metal-dense business investment picks up we would expect long and plate demand to pick up as well. As we prefaced the expected second quarter margin pressures during our first quarter earnings call, the magnitude of the decline was greater than anticipated as import levels were higher than industry forecasts while nickel and carbon hot-rolled coil prices moved lower. For nickel, the declines began in March as over-supplied ore markets and demand lags in China brought London Metal Exchange spot prices down more than 25% from peak to trough in a six-month period, with accelerated declines in April and May, causing a mismatch between on order tons pricing and adjusted spot selling prices. In the case of carbon hot-rolled coil, CRU index prices fell approximately $80 per short ton, or 13%, through the quarter from their early April peak before bottoming and rebounding in late June and July. The section 232 investigations have been a non-event in terms of recommended actions so far, but the very public and well covered process with widely careening headlines heightened price volatility and import draws in the quarter. The headlines have also brought needed scrutiny and attention worldwide to the conflated hypocrisies and breakages in the current global trading system pertaining to industrial metals. This is a continuing and elongated storyline and we will monitor and act accordingly as new information is gleaned through the process. On balance, the 232 investigations have been positive for the industry even with outcomes remaining in suspense. Ryerson self-help continues to be the better fact pattern for discussion, despite the noted margin compression and muted pricing power relative to rising purchased metal costs. During the quarter Ryerson grew market share, demonstrated expense leverage, and maintained supply chain acuity, managing our days of supply below 70 days for the second consecutive quarter. In fact, our cash conversion cycle of 70 days is exceptional when considered with further market share gains and better expense leverage as we turned inventories quickly to blunt the duration and magnitude of margin compression and LIFO expense impacts moving through the quarter and beyond. Our strategy built around speed, scale, value-add, culture, and analytics provides our customers with exceptional service, as is evident in our market share growth, with industry-leading expense and working capital metrics. As we embark on the second half of our 175th year as an iconic metals industry leader, Ryerson has proven adept at executing its business plan well in all environments as we focus on balance sheet deleveraging and smart, targeted growth investments to enhance value-added products for our customers and profitability for our stakeholders. Taking a closer look at our financial progress, revenues were $875 million in the second quarter of 2017, up 7.5% from the first quarter of 2017 and 18.3% from the prior year period. Net income attributable to Ryerson Holding Corporation for the second quarter of 2017 was $0.6 million compared to $14.8 million in the first quarter of 2017 and $5.6 million in the second quarter of 2016. Erich will speak to second quarter LIFO expense impacts in more detail later in the call. Adjusted EBITDA, excluding LIFO, was $51.5 million in the second quarter of 2017, 5.2% lower sequentially and 8% lower compared to the prior year quarter, but exceeding the high end of our guidance range provided in late June given better than expected volumes. Turning to the current economic environment, metals prices were more volatile with downward trends evidenced in the second quarter of 2017 compared to the first quarter of 2017. Hot-rolled carbon steel prices and average London Metal Exchange nickel prices fell 13% in the second quarter, and average Midwest aluminum prices fell 3% over the same period. Day-to-day and week-to-week volatility was more pronounced. Through May 2017 U.S. imports of steel products grew by 22% compared to the prior year period according to the U.S. Department of Commerce data. The elevated metal spreads between the U.S. and the rest of the world made the U.S. a preferred destination for an oversupplied international market. The decline in metals prices and expansion of international to domestic pricing spreads impacted our industry’s ability to raise average selling prices in-line with the rise in average inventory replacement costs, leading to the margin compression experienced during the period. From a demand perspective, conditions continue to be favorable when compared to the prior year period, but incrementally so. Demand momentum declined relative to the first quarter of 2017, further dampening pricing power, with North American service center shipments up 1.7% in the second quarter of 2017 compared to the second quarter of 2016. Further, U.S. service center inventory levels are at 2.1 months of supply in June, below historical averages of 2.4 months. Looking downstream at industrial demand, U.S. industrial production increased 2% in June compared to the prior year period according to the Federal Reserve, the seventh consecutive month at or above zero after 16 months of decline. Chicago regional PMI reached 65.8 in June, its highest level in over three years, signaling improved manufacturing sentiment. Factors impeding demand growth were high import levels as mentioned, low productivity growth, and GDP growth of less than 2% year to date. Low single-digit service center growth and tight inventory levels, coupled with improved industrial production suggest modest year-over-year demand recovery should continue into the third quarter. When looking at all relevant variables in totality, second quarter macro fundamentals were a mixed bag summing to something incrementally positive. The third quarter of 2017 macro fundamentals affecting the industry are aligning toward incremental strength over the second quarter of 2017 as price drivers are stable to improving, demand looks solid after a holiday induced softness at the beginning of July, and global industrial metals demand has firmed. Turning now to end markets, Ryerson saw volume growth in the second quarter of 2017 compared to the first quarter of 2017 in commercial ground transportation, consumer durable, construction equipment, HVAC, and oil & gas industries, offset by modest declines in food processing and agricultural equipment and industrial machinery and equipment industries. Compared to the year-ago period, Ryerson experienced growth in metal fabrication and machine shops, HVAC, construction equipment, and oil & gas sectors, offset by modest declines in industrial machinery and equipment, consumer durables, and food processing and agricultural equipment industries. Consistent with the first quarter, Ryerson noted shipment strength in the U.S. and Mexico relative to Canada and China when evaluating market share gains year-over-year and against industry benchmarks. Overall, we are seeing the most encouraging signs from the oil & gas end market as rig counts have more than doubled compared to the prior year period, and the construction equipment and HVAC end markets with construction spending near five-year highs according to the U.S. Census Bureau. Looking a bit more into the third quarter, we anticipate margins stabilizing and turning higher as inventory replacement costs reset, particularly in stainless, while hot-rolled coil carbon prices have moved higher over the past several weeks. Further, we anticipate continued modest demand improvements compared to the prior year given current business conditions. With that, I’ll turn the call over to Erich, who will discuss the highlights of our second quarter 2017 performance.

Thanks Eddie, and good morning. As Eddie highlighted in his remarks, Ryerson’s revenue grew year-over-year by $135.6 million in the second quarter of 2017, with increased prices and higher tons sold compared to both the prior quarter and prior year periods. We increased sales to $875.4 million, up 7.5% compared to the first quarter of 2017 and up 18.3% compared to the second quarter of 2016. However, average inventory replacement costs rose by more than average selling prices, leading to margin compression experienced during the period. Net income attributable to Ryerson Holding Corporation was $0.6 million, or $0.02 per diluted share, in the second quarter of 2017, compared to $14.8 million, or $0.40 per diluted share, in the first quarter of 2017, and $5.6 million, or $0.17 per diluted share in the second quarter of 2016. Excluding losses on the retirement of debt and impairment charges on assets in the second quarter of 2016, net income attributable to Ryerson Holding Corporation was $16.9 million, or $0.52 per diluted share. Ryerson achieved adjusted EBITDA, excluding LIFO, of $51.5 million in the second quarter of 2017 compared to $54.3 million in the first quarter of 2017 and $56 million in the second quarter of 2016. Average selling prices increased 3.1% sequentially, as Ryerson’s prices rose modestly for all metals during the quarter. Compared to the second quarter of 2016, average selling prices increased 15.4%, primarily due to the rise in carbon steel and stainless-steel prices, which both rose over 18% during the period. Tons shipped increased by 4.2% sequentially in the second quarter of 2017 with growth experienced across all major product categories. Compared to the prior year period, tons shipped increased 2.6%, with growth in all product categories, most notably for our stainless franchise, which improved by 8.8%. Ryerson’s gross margin was 16% for the second quarter of 2017, compared to 19.7% in the first quarter of 2017 and 22% for the year-ago period. Included in cost of materials sold was LIFO expense of $14.2 million for the second quarter of 2017, compared to net LIFO income of $0.7 million for the first quarter of 2017 and net LIFO income of $7 million in the second quarter of 2016. Gross margin, excluding LIFO decreased to 17.7% for the second quarter of 2017, compared to 19.6% in the first quarter of 2017 and 21.1% in the year-ago period. Warehousing, delivery, selling, general and administrative expense decreased by $0.6 million, or 0.5%, for the second quarter of 2017 compared to the first quarter of 2017. Compared to the prior year period, warehousing, delivery, selling, general and administrative expense increased by $3.6 million, or 3.2%. Ryerson demonstrated expense leverage in the second quarter of 2017 as warehousing, delivery, selling, general and administrative expenses declined to 13.3% of sales compared to 14.4% in first quarter of 2017 and 15.3% in the second quarter of 2016. We continue to improve and effectively manage our expenses by leveraging our scale to more efficiently deliver our value-added products and services while improving the customer experience. In the second quarter of 2017, Ryerson’s inventory balance stood at 68.9 days of supply compared to 69.1 days in the prior quarter and 74.4 days in the year-ago period, the lowest level we have achieved in recent history. We continue to manage our inventory to maintain financial flexibility and adapt to changing metal prices and consumption dynamics. Cash used in operating activities was $48.6 million in the second quarter of 2017, as we grew our working capital consistent with increased activity and higher inventory costs. Given current industry conditions, we anticipate that Ryerson will generate operating cash flow in the second half of 2017. Ryerson maintained solid liquidity in the second quarter of 2017. As of June 30, 2017, borrowings were $377 million on our primary revolving credit facility with additional availability of $266 million. Including our cash, marketable securities, and availability from foreign sources, total liquidity was $326 million compared to $302 million in the first quarter of 2017. Now, I'll turn the call back over to Eddie to conclude.

Thanks Erich. Ryerson continues to enhance our interconnected network of intelligent service centers to offer great customer experiences tailored to customers’ needs, with differentiated value-added processing and distribution capabilities. Paired with industry-leading expense and working capital efficiency, our ability to generate free cash flow beyond short-term volatility driven intervals is showing up in our strong liquidity affording us further opportunities to deleverage and grow to the benefit of all Ryerson stakeholders. With that, let’s open the call to your questions. Operator?

[Operator Instructions] Our first question comes from Jorge Beristain from Deutsche Bank. Please go ahead.

Hey guys, Jorge with DB here. You mentioned that margins would stabilize and recover by the third quarter. When do you think margins could get back to the 19% to 20% range?

Hi Jorge, good morning. This is Eddie. So, I went back and I ran some numbers, and over the last 14 quarters, really since the first quarter of 2014, our FIFO margins have been right at about 18%. And if you look at that in a eight quarter window, they're about 18.7%. So the story of the quarter for us is stainless is strategic for us, and so we're making really nice gains within our stainless business, but we took a gut punch in the second quarter. I mean, if you look at stainless being almost 26% of our product mix, we probably gave up about 100 basis points in margin just on the stainless compression, where you had really strong run ups in nickel and chrome, frankly. And then we saw a really, really prolific about-face, and then we saw our competitors price aggressively down replacement costs. So once we take that gut punch and move on, we saw margins really brought about in July, and we see them expanding through the quarter, and so it's really more of a question of how good is demand and how good is the environment as we move through the balance of the year, as to how much traction we get back on margins. But from what we could see right now, we would expect margins to start, we'll, we're going through a stabilization process now and then start expanding for the balance of the quarter.

Okay, And then just on market share gains, you did really well versus the negative MSCI trends. Can you comment if you think you're going to do better in the second half by, than the typical kind of MSCI declines we see in the third quarter?

Well, here is important takeaway from our view, and that is we put ourselves in a position we've demonstrated it structurally, we could turn inventories at what we think is our industry best levels. And when you do that, you create optionality, so if there are opportunities to make buys in the second half of the year, we can do that in terms of deploying working capital and investments to generate higher returns and more market share opportunities. But I will focus you back on this point in Q2, and that is it's a real, I have to acknowledge to our organization and complement our organization, it's not the easiest thing in the world to turn inventories in under 70 days and grow market share, which really shows that we're making structural progress in terms of having inventories in the right place at the right time, being able to fulfill customer demand. So what I like more is the structural optionality of being able to move in and out of inventory, and not have to really guess where we're going to wind up. So I think we've made a lot of good structural progress in that regard.

Hey Jorge, it is Kevin Richardson. The only other thing that I would add is, going into the back half of this year versus last year, the sentiment is definitely better out in the field, and it feels better. So activity-wise, in terms of most end markets relative to this time last year, it certainly feels better going into the back half.

Okay, thank you for the color guys.

Thanks Jorge.

Your next question come from Brett Levy from Loop Capital. Please go ahead.

Hey, Eddie, Erich, Kevin good job managing through in tumultuous times. We were on the Russell call. They guided in their steel distributors business to reducing inventory in the second half by, I don't know, somewhere between a quarter and the third, at least on a tons basis, probably not on a dollars basis. As you guys kind of look at your inventory plans, and I don't know how you do any better than 68.9 turns, I mean, days of inventory. That's pretty awesome. But do you think you can reduce inventory further even though things are looking good from both a volume demand and pricing standpoint?

Brett how are you doing?

Good I know that was a complicated question.

No. Not at all. Let me go back to structural improvements that we made in the business, because Ryerson is EBITDA positive throughout our entire organization. And the company is EVA positive, which means that combination of increased EBITDA generation, with much, much better working capital management, has been accretive to equity so far in 2017 and was accretive to equity in 2016 as well. So we like that EVA performance, but we like the ability to control where that goes. So can it go lower? It can go lower, because as I've said before, there's a layer of inventory in our industry that doesn't get talked about a lot because it gets really mixed in with all the other inventory, but it goes by different names. It goes by dormant inventory. Sometimes, it goes by the name of red inventory. But if you look at dormant inventories in the industry, and it's not something that's disclosed, nor -- and it doesn't need to be necessarily. But we continue to work down those dormant inventories, and we continue to use analytics in our organization to work those stocks down so that we can have more of the things that our customers want that turn faster, and we can increase our service levels in the bargain. So there's some more structural work that can be done. But I do think there is a finite limit at which, if you continue to take inventories down, then you have to be more concerned with service levels, and you would be more concerned about having thin stocks of inventory that really could not fulfill a complete customer request. So you balance those things. But there's still some structural work we could do, but I really like the progress that we've seen in the organization over the last several years.

Just looking at pricing alone, it looks as if you're stuck in a nice position of seeing stainless, aluminum and carbon COO in a good place going into the third quarter. As you look at market share opportunities, I know you gained, a 4% market share. Is the buy option something that you're still thinking about? Or have you gotten to the point that this company is fixed enough that you just build inventories in a certain place and you'll be able to take market share? Sort of talk about the buy or build option as you look at kind of the growth opportunities for Ryerson.

Sure Brett. So if you look at our liquidity, we've rebuilt liquidity. So the more liquidity we have, the more optionality we have. And I think with that optionality, there's a working capital build that's very evident in our numbers as we've gone through the first half of 2017. That said, we store that liquidity in the balance sheet for a period of time, but our liquidity has gone up as well. So I think our optionality to be opportunistic is really good as we pursue growth opportunities via M&A, but we'll be very selective. And our first priority is still deleveraging. Now on the organic side, we continue to get better and better at placing inventory throughout our network where it can do the most good. And there's room for us in the industry. I mean, if you look at carbon, for example, carbon is 64% of this industry, and we're 48%. We have a lot of room to grow in long products, for example. So there's still places where, from a build standpoint, we can add to our portfolio, both organically and from an M&A standpoint. But we can also be opportunistic where, as deals become available that meet our criteria, we can exercise those opportunities.

Good insight guys. I’ll get back in queue.

Thanks Brett.

[Operator Instructions] our next question comes from Phil Gibbs from KeyBanc Capital Markets. Please go ahead.

Hi Eddie, Erich, how are you? Good morning.

Hi Phil good morning.

Hey Phil how are you.

Doing well. have a question on the margin commentary again for the third quarter. Eddie, are you suggesting that margins right now, at least, I would think, FIFO, FIFO gross profit margins sort of troughed out in July and that you would expect some improvement over the balance of the quarter? Does that get you to the levels where you were in the second quarter? Or are we still going to be potentially above that a bit or below that a bit? Meaning, do you expect FIFO margins to be essentially potentially consistent with the second quarter? Or is it just too early?

Yeah, so Phil, if you look at July, July being a 20-day month with a holiday and really being less than that because the holidays seemed to get longer and longer in terms of their impact to the business. I would say that July being a 20-day month, August is really that fulcrum point, because we have 23 ship days in August without a holiday. And then we go into September, which is a 20-day month. So it's early to say whether we get back all the margin when you look at that bottoming that took place in July, and it stabilizes and we start to get expansion as we move through August into September. So we want to see what demand is going to bring. And if we get robust demand in August, as August plays out and then September post Labor Day, then we should see a healthy margin profile in Q3. But it really depends on the momentum that the industry and Ryerson generates as we move through the quarter. It's a little bit early, but the trends look positive.

Yeah, then we are planning on providing some guidance in the back half of September as we see more of our results coming through the quarter.

Would the margins bottoming out in early July and potentially getting better as the quarter progresses, is that dependent on pricing getting better, or is that dependent on basically pricing staying where it is right now but just seeing the benefit of some falling input costs?

Yeah, most of it is going to come from falling replacement costs that brings that average inventory down. Some pricing support would be very much appreciated. I think we can look to some marginal pricing support as we move through the quarter, based on what we can see now in terms of macro variables and industry dynamics. So a little bit of help on pricing in terms of stable pricing to incrementally higher, with replacement costs that continue to pull that average back down again should bring things into a better balance relative to Q2 as we move through the quarter.

Hey Phil, Kevin Richardson. One of – it is painful as it is with the – just one other thing I would add to that is, is one of the benefits of having 69 days of inventory, it flows through quicker, obviously, than if you're sitting on 80 or 90 days of inventory in a pricing environment like we're coming out of.

And then Erich that you could provide on what at least preliminary LIFO expectations are for the third quarter, given that I know that we had that, obviously, that big pop in Q2?

Sure, we are expecting LIFO to actually turn. It's going to go from LIFO expense that we had in the second quarter to LIFO income. Right now, we're looking at somewhere in the range of about the single-digit million range of income in the third quarter.

And last question is just on – take out metal for a second but looking at inflationary impacts on the business. I know there was a nice pop in Q1 as maybe freight caught up, some real wage pressures in the market, catching up from the industrial recession over the last two years. What are you seeing as we move through the balance of the year in terms of just inflationary OpEx pressures, if they're stabilizing, and/or if there's anything that you can do now that you see that new baseline to start chipping away at it with management?

I’ll give an overview and I'll ask Mike and Kevin to supplement. I would say that we've done a really good job on OpEx management. That said, consistent with what I've heard in other calls and what we're seeing in the entire industry is there's two things going on. In the shorter term, there's been some inflationary pressures as our prices increase and as, I'd say, the commodities index moves up, even though it retraced a little bit in Q2, you're going to see some OpEx pressures, not so much in fuel expense, but in delivery-related costs. And there's some labor stresses that are starting to emerge throughout the space. That said, the demographics of the space are a longer-term countermeasure or counterweight to that, in that you have an industry that's also retiring to some extent. So you've got counterbalancing factors in play. One is longer-term, one is shorter term. So in the shorter term, we're managing through some cost pressures, not anything that's dramatic or significant, but incremental cost pressures that we can work to mitigate as we continue to map supply chains, as we continue to implement lean projects, as we continue to make growth investments in CapEx, we can mute and moderate those OpEx pressures, which I would characterize right now as incremental and not very dramatic.

Thank you.

Mike and Kevin, do you have a – want to supplement?

The only thing I would add to that is, is rule 01 is we try to variablize our expense as much as possible. So when we get into an environment where demand improves, the first thing we do is we hit the switch and we'll go to more overtime in our plants or we'll layer in some temps, but we don't want to necessarily add in an incremental layer of headcount until we know that it's sustainable. So – but everything else that Eddie talked about in terms of benchmarking, productivity, we do a lot of best practices within the company to understand where we can get productivity gains to offset inflation.

Hey Phil this is Mike Burbach. Not to pile on here, but I would echo what has been said. But one of the core competencies of Ryerson is looking at the expense piece. And we really have come a long ways of finding new ways to leverage our integrated network. And we take a lot of pride in the progress we've made there. And this is a key focus point for all of the field management. And anything we can do to improve productivity and leverage our resources in a smarter, more intelligent way, at the same time, not harming service, and in fact, improving service for our customers is really what we think about every day.

Thanks very much.

Thanks Phil.

There are no further questions at this time. I will now turn the call back over to the presenters.

Thank you for your continued support of and interest in Ryerson. We look forward to talking with you again next quarter.