Stelco Holdings Inc. (OTCPK:STZHF) Q3 2022 Results Conference Call November 16, 2022 9:00 AM ET
Company Participants
Trevor Harris – Vice President Corporate Affairs
Alan Kestenbaum – Executive Chairman and Chief Executive Officer
Paul Scherzer – Chief Financial Officer
Conference Call Participants
David Gagliano – BMO Capital Markets
Michael Doumet – Scotiabank
Alexander Jackson – RBC
Operator
Thank you for standing by. And welcome to the Stelco Holdings Incorporated Third Quarter 2022 Earnings Call. My name is Sam, and I will be your moderator for today’s call [Operator Instructions].
I’ll now hand over to Trevor Harris with Stelco. Trevor?
Trevor Harris
Good morning, everyone. And welcome to Stelco’s quarterly earnings conference call. Speaking on the call today to discuss our results for the third quarter of 2022 will be Alan Kestenbaum, our Executive Chairman and Chief Executive Officer; and Paul Scherzer, our Chief Financial Officer. Yesterday, after the market closed, we issued a press release overviewing Stelco’s financial results for the third quarter of 2022. This press release along with the company’s financial statements and management’s discussion and analysis have been posted on SEDAR and on our Investor Relations Web site at investors.stelco.com. We have provided a link to the presentation referenced on today’s call on our Web site as well. I’d like to inform everyone that comments made on today’s call may contain forward-looking statements, which involve assumptions, which have inherent risks and uncertainties. Actual results may differ materially from the statements made today, so do not place undue reliance on them. Stelco management disclaims any obligation to update forward-looking statements, except as required by law.
With that in mind, I would ask everyone on the call to read the legal disclaimers on Page 2 of the accompanying earnings presentation and also to refer to the risks and assumptions outlined in Stelco’s public disclosures, in particular, the third quarter 2022 Management’s Discussion and Analysis sections relating to forward-looking information and risks and uncertainties, as well as our filings with Securities Commissions in Canada. The appendix of our presentation and the non-IFRS performance measures and review of non-IFRS measures of our MD&A provide definitions and reconciliations of the non-IFRS measures that we use today. Please also note that all dollar figures referred to on today’s call will be in Canadian dollars, unless otherwise noted. Following today’s prepared remarks, Alan and Paul will be taking questions. To maximize efficiency, we ask that all participants who would like to ask a question, please limit themselves to one question and one follow-up before re-queuing.
With that, I would now like to turn the call over to Alan.
Alan Kestenbaum
Thank you, Trevor and good morning, everyone. Through the third quarter of 2022, Stelco was once again able to demonstrate our resilience and take full advantage of our structural cost advantage, while at the same time delivering positive returns to our valued shareholders. For the seventh consecutive quarter, we emerged as the North American Industry leader with a 29% adjusted EBITDA margin. For context, the next closest margin was 25% and the industry average was 17%. This is a significant achievement that was accomplished in the face of significant market headwinds, driven by deteriorating pricing and inflationary pressures on our input costs. Moreover, we were able to increase our volume of shipments over the previous quarter and utilize our low cost advantage to deliver strong adjusted EBITDA. This success has put Stelco in a position to demonstrate once again the strong alignment between senior management and our co-investors and return capital to us and them through dividends and share repurchases. In addition to increasing our regular dividend by 40% to $0.42 per share this quarter, we’re also pleased to announce a special dividend of $3 per share that will return an additional $165 million of capital to our valued shareholders. This in addition to the repurchase and retirement of approximately 29% of the shares that were outstanding at the start of this year, including 17 million shares or 25% in Q3 and the current quarter alone. We continue to lead the industry and return of capital to shareholders as a percentage of our market capitalization and with the dividends announced today, we will have returned $1.8 billion since we went public in November of 2017.
Notwithstanding our success to date, we are focused on the challenges that lie ahead with market conditions that we expect to remain challenging in the near term. While inflation has had an impact on many of our costs, we are starting to see that abate with some input prices, especially for coal, natural gas and alloys, beginning to turn downwards. Stelco will continue to explore every opportunity to improve our industry leading cost structure and take advantage of the more than $900 million of capital investments we have made into our facilities in 2017. Most recently, during the third quarter, we began to realize the benefits from both our upgraded coke battery and our new electricity cogeneration facilities, which commenced full operations and will provide us with excellent opportunities to improve productivity and reduce both costs and our carbon footprint. During the quarter, we also successfully reached new five year agreements with our unionized employees that will ensure stability in our workforce as we work together to navigate these challenging times. The inflationary environment that is impacting our business is also impacting our employees personally, and I am pleased that we were able to work with the union leadership and members to reach agreements that protect both our workers and their families as well as the company. I look forward to continuing to work together with our valued union partner to keep Stelco the leader in the North American steel industry.
As we move forward, we will not deviate from the successful strategy that has continuously delivered strong results for our business. Our core principles and values are strong. We maintain a strong balance sheet, which will give us operational, strategic and capital flexibility. We will utilize our tactical flexibility model to pursue the highest possible margins across all product lines from pig iron to coated products, and we will deploy our capital in a responsible manner that benefits all of our shareholders. We have worked hard to unlock the potential of our business and establish Stelco as not only a low cost steel maker in North America, but also as an attractive investment for our shareholders and we will continue to work on these principles.
With that, I will turn to Paul and ask that he provide some additional comments regarding our financial performance.
Paul Scherzer
Thanks, Alan, and good morning, everyone. As expected, the third quarter proved to be quite challenging in the face of inflationary pressures and reduced pricing in the market. As a result, we did experienced reduced financial performance compared to the peak we realized in 2021. However, the inherent strength of our business, which is our low cost operating structure, allowed us to generate $357 of adjusted EBITDA per net ton and maintain our position as the North American industry leader with respect to adjusted EBITDA margin. This was achieved despite a reduction in our average selling price of 20% over the previous quarter and a reduction of 36% over the third quarter of 2021. The slight increase in shipments over the second quarter offset some of those price pressures and led to revenue of $846 million and adjusted EBITDA of $245 million. The relative success we achieved allowed the business to maintain a strong cash position and overall liquidity. At the close of the third quarter, we had $250 million availability on our revolving credit facility and cash in the amount of $1.395 billion. In keeping with our desire to effectively deploy our capital to the benefit of our shareholders, subsequent to the end of the quarter, we completed $288 million worth of share repurchase under a substantial issuer bid that was in addition to the share buybacks that were completed during the third quarter.
With the completion of these buybacks, we’ve repurchase approximately 29% of the shares that we are outstanding beginning of this year and still have a cash balance today in excess of $1 billion. As Alan noted in his remarks, our management team remains strongly aligned with our shareholders and we are exceptionally proud of the capital returns we have provided to-date. Following the payment of the dividends announced today, the total capital attributable to shareholders since our 2017 IPO will be in excess of $1.8 billion. By any measure, we view this as a remarkable achievement for our business. Of course we are aware of the challenges that lie ahead. And while we made note of the inflationary pressures and deteriorating pricing that impacted our business through the third quarter, we must also make note that these negative pressures, other than the aforementioned reduction in some of inputs, are likely to abate in the near term. Accordingly, we are again reiterating our guidance for the fourth quarter but assumes that the lower prices and shorter lead times being experienced currently slowly impact results available through the remainder of 2022. However, we will continue to focus relentlessly on costs in order to maintain our industry leadership and so that we can capitalize on any opportunities presented by the market. I remain confident that the strength we have built through strategic capital investments and the creation of an industry leading cost structure will see Stelco persevere and succeed. We’ll continue to take the necessary steps to mitigate and overcome the challenges that face our business and stay true to the core principles that contributed to our success to-date. Thanks for taking the time today to join our call.
Trevor Harris
Thank you, Alan and Paul. And that concludes our prepared remarks for today. I would now like to turn the call back to the operator for Q&A. Reminding callers that they will be limited to one question and one follow up before re-queuing. Operator?
Question-and-Answer Session
Operator
[Operator Instructions]. Our first question comes from the line of David Gagliano with BMO Capital Markets. David, your line is now open.
David Gagliano
I’m going to try and add these into two questions. So first of all, current market dynamics question. Obviously, price is down, demand weak, lead times off, there’s two parts for this one. First, what we see in indices and things like that suggests prices down quite a bit in the fourth quarter versus the third quarter. I don’t want to put a number out there. I just — I’m trying to get a sense as to given where we are in the quarter and your lead times and your order books, what’s a reasonable expectation for quarter-over-quarter decline in realized prices? And then also any indications of life at the end of the tunnel here, given that we’re heading into typically a seasonally stronger period? That’s my first question.
Alan Kestenbaum
David, I don’t think we’re going to provide you like actual prices, I don’t think we can do that. But it is down and you’ll see that in our results. As you know, we were active in an industry here, the indices are — I think, are finally reflective of what’s actually going on, very often there’s a very significant lag. So I think if you refer to the CRU prices, I think you’ll get a pretty good sense of how things have moved quarter-over-quarter. Keeping in mind that it did take them time to catch up and get into a lag. So that’s in terms of that. In terms of an outlook, one of the great things about this business is, you don’t worry about it going out of style. And as long as you’re a producer like us, that’s able to produce constantly with the margin, you keep going. I do see some things shaping up that suggests as we get into Q1, the environment will be better. And a lot of that is driven by scrap. And we’ve seen this now over and over and over again, most recently during the COVID time, during 2021, remarkably, prices of steel went up even at 50% utilization, because scrap became very tight. Scrap is not tight now, by any measure, scrap is continuing to decline. But we’re starting to see the early seeds of the types of things that generally do create scrap tightening, and let me list them.
One, lower prices result in lower collection. Two, slowdown in housing starts means less demolition and therefore, less steel to come back into the steel scrap supply chain. And the other thing that we’re starting to see is a depreciation finally it’s a US dollar. And what that does is it brings back exports. Really, really early signs. Typically this time of the year, you get into the wintertime and collections themselves get hampered by weather conditions and things like that. So I do think that as we move into Q1, we’ll start seeing some better conditions. And that’s kind of our outlook and how we’re playing it. And for Q4, we’re doing really well from a order book perspective. You talk about weakening demand. I think that the macroeconomic statistics definitely show that there would be weakening demand, particularly in construction and other things. But we’re not a giant producer, we make almost 3 million tons a year. So we don’t — we’re not as exposed to — we’re not as sensitive to these types of drops in demand. So we work with our regular customers, their business is, I’d say flat not down, definitely not going up. And so, we’re holding our own, filling our order book and doing what we do. And that’s how we manage the business. It’s a cyclical business. When we get to the lower operating performance periods, like now, we hold our own and we continue to make money and look at what we can do, which is reducing our costs. And as I said, that’s my anticipation but definitely could be wrong. I can see a scenario where interest rates go up, everyone follows the same statistics. As we see a scenario where demand gets weakened as construction goes down further and maybe it hits the auto market, and so we’re ready for that. We know the upturn will come. My crystal ball is telling me to look towards sometime in Q1, but we’re prepared — totally prepared to be wrong about that prediction. And we’ll continue to do what we do, which is to continue to work on our cost structure to stay profitable during the trough of the business.
David Gagliano
And then just another two part question. Just first, on the other part of the business, costs, unit costs, actually, up quarter-over-quarter, but better than what we were looking for and better than what we’ve seen from a number of the other steel producers in the US. So I’m just wondering if there any incremental quarter-over-quarter changes, meaningfully, one way or the other, coming in 4Q? That’s my first part. And the other part on the capital allocation? Right now, we shifted to special dividends. Obviously, we had a nice period of buybacks. Still a lot of cash on the books. What’s the updated thinking on priority of uses of cash on a go forward basis between specials, between buybacks and investment options?
Alan Kestenbaum
So on the question of capital allocation. And well, let me first touch on the first one, about Q4. As I mentioned in my remarks, we definitely are seeing a downturn in input prices in various different places. I’ll highlight the ones that we’re seeing, we’re seeing it more, which is in coal, natural gas and scrap prices. However, like other producers, we do source our coal in advance. And so, we’re not going to be seeing the impact of that during Q4, because we’re still working on some old contracts. But I think unlike a lot of other competitors out there that haven’t pulled back a lot of capacity, there’s a lot of contracts out there that are sitting, that are going to have delay deliveries. And therefore, less near term demand, because they need to fulfill contracts. So from our perspective, as you know, we’re up in the lakes, the lakes freeze, we have our input. So we do get the benefit near term in Q4 from the natural gas, from the scrap, those things do impact right away and continue to impact us right away. And so we’ll see that as a benefit. We do expect to see some lower costs in Q4 as well. And then even further as we move into next year, as we start rolling in some of the lower price other inputs, like alloys, like coal, like other things. And then we continue to negotiate with other inputs as well to see how we can cut costs. So that’s what I think you’ll see, I think you’ll see some moderation in costs in Q4 based on those inputs, and you will continue to see that as we move into next year when we get into some of the new contracts that we have at lower prices.
With regards to capital allocation, I think we’ve done a really good job in being balanced. And when I say balanced, it’s about keeping enough cash around to have operational and strategic flexibility. So we have achieved that. We have taken up 29% of our shares this year. I don’t know how many companies in the world that have done that in any industry in this year, especially at a time where equities for the most part were escalated. Notwithstanding some recent performance, but they were escalated. But we actually waited. If you look at most of our purchases we have done in Q3, Q4, when equity markets were down. So we missed the big boom in the first half of the year. We missed the most recent boom, because we have these done when equity markets were weaker and [indiscernible]. So I was incredibly proud of that, our discipline. I’m not just throwing money when we have nothing else to do with our money and start buying shares back. When you look at most share buybacks they’ve done at the top of the market and because they don’t have better investment ideas and very often management team who are not aligned like we are with shareholders feel that they need to go and prove to the world that they think the stock is undervalued. But here, you got to remember 20% of the stock is in management’s hand. So we think exactly like our managers and timed our buys at a price that we consider very good at that, I think it was $35 on [Indiscernible] [$37] on the one before that.
We have been incredibly disciplined. We didn’t buyback stock when it was $56 a share. We did when it was much lower. So I think patience and waiting and discipline and long term perspective is what drives this management team. So that’s in terms of the buyback. The special dividend, yes, we had some extra cash. We want to keep some extra cash. We certainly could have made the special dividend larger. But we can do another special dividend if we feel that either from a strategic perspective, there are not a great alternatives, so we feel comfortable with the cash accumulation in the business. And so we can do that again and we’ve retained that flexibility. This is our third special dividend since we bought the company, took it public in late 2017. So I think we have now established a track record of willingness to do special dividend. So we will continue to look at that.
And then finally, we think we’re getting into a period where we are going to see some opportunities, let’s say, would be the nicest way I can say it, in our sector. And it’s something that I have spent the career doing, looking for really good price opportunities. And if we find them or we may not, but if we do, we want to be able to be flexible enough to be able to transact on those opportunities. And so I think we are in a really good place right now. As Paul said, we have got about $1 billion of cash, a little bit more than that. We have got an undrawn revolver. We have got a lot of liquidity here. We have gone through some tough times, but tough times are good for us, because it puts us — gives us the ability to be on offense while we continue to generate cash also. So I’m really happy with where we are right now. I think we’ve got a great record, track record on our capital returns and it’s not a surprise. We are aligned with you guys. As I said, management here owns 20% of this company, and so we think like you and we want to do what’s best for the shareholders and sometimes that means keeping some cash on the books to do strategic things and sometimes it means paying phenomenal dividends like we did today, increasing the dividend like we did today and sometimes it means opportunistically buying back stock.
Operator
Next question is from Michael Doumet with Scotiabank.
Michael Doumet
Obviously, nice quarter. First question is on, maybe if you can quantify the impact of the weaker Canadian dollar to your P&L. I’m assuming it helped on the revenue and I’m not sure if there’s a lag on the cost side. So again, anyway you quantify that, maybe the sensitivity from EBITDA or from FX?
Alan Kestenbaum
Actually, there’s not much, because a lot of our costs in US dollars — are in US dollars. So we’re pretty balanced. And we’ve analyzed this over and over again to see do we gain when the Canadian dollar is weak, we gain when the Canadian dollar is strong. And if you look at our cost structure, principally on our inputs, the two biggest ones, iron ore and coal, that’s all US dollar price. And then on the sales side, no one really speaks in Canadian dollars on price, it’s always US dollar price and converted at the exchange rate. So I would say, very little sensitivity or impact to Canadian dollar strength or weakness.
Michael Doumet
And then maybe second question just I guess thinking about cash here. Given the rising cost of debt here, how are you thinking about the inventory monetization agreement into next year? And maybe if I can tack on, any updates you can provide us on the EV recycling JV?
Alan Kestenbaum
On the units for monetization, very satisfied with that agreement, works well and we’ll continue to do that. Keep in mind, we’re also running very large — not very large, I mean, the increased interest on — interest earnings on the cash that we have. So we’re pretty happy with that arrangement. And what’s the second question?
Michael Doumet
Just an update on the EV recycling JV.
Alan Kestenbaum
So we continued to work on that. We’re at the stage now where we’re expecting updated samples from the hub part of this operation, which is in Germany. As you know, they’ve been providing samples and qualifications for the actual end product and that’s what we’re in the process of doing right now to battery makers. We see that as a very important milestone to be reached to make sure it’s a product that’s going to come out of this if the end is fully accessible to very specific battery makers that are willing to commit to the specs, and that process is ongoing and that’s what is [recording] right now.
Operator
The next question is from the line of Alexander Jackson with RBC.
Alexander Jackson
I was wondering if you could maybe touch on potential opportunities that you were talking to earlier, with respect to using that cash. And then as well, are there any other opportunities, maybe internally, other projects, potentially cost saving project or margin enhancing projects that you guys are looking at?
Alan Kestenbaum
So within our CapEx budget, annual CapEx budget, we have a certain amount of growth projects and some of it is normative. And so we’re constantly looking at refinements to the operating model, operating footprint rather that we have to increase and enhance our margins. And so we’ve got a several of those on tap to this year. And then in terms of outside investments, constantly on the lookout, and always engaged in various conversations, and nine out of 10 of those don’t occur and — but you still stay in contact with people in case they can’t occur. And I think where the company is very, very well positioned right now financially is to be able to transact at a time where valuations have come down and are more reasonable and transactable. And so that’s kind of our mindset right now. I’m certainly not going to speak about any specific opportunities, but we’re always in the mix looking at various things that would make sense for us.
And then the other thing, I mean, I don’t know if you guys have seen the announcement on this. But the Government of Canada announced, put us on a list of 10 companies in advanced stages of a — of our request to provide financing for our decarbonization efforts. We’ve not been very vocal yet about what it is that we’re doing. But we’ve got a number of very, very exciting initiatives, which will be involved with large amounts of capital and hopefully from sources that don’t depend on our cash flow. So those are super exciting. We’ve not unveiled them yet, because we’re still refining what that will be. And — but we are — as Government of Canada announced — in increasingly advanced stages of negotiation with them to assess the capital to make those kind of investments. And our goal is to be able to get outside funding for everything that we’re doing, taking advantage of the public and private partnership initiatives that the Government of Canada has shown willingness to do. And I really give the government tremendous amount of — really excited and really proud of being in Canada, because it’s really one of the only governments I can think of that’s actually sitting and taking this decarbonization initiative seriously. And they’re putting their money into it and saying, we’re not just going to dump this on industrial players, we’re going to be in partnership with you. And so it’s also very, very exciting. And if we can achieve what it is that we’re trying to do here, I think it’d be incredible differentiating — differentiated company when it comes to those efforts. So those are the three buckets. There’s the buckets internally, which is part of the CapEx, normal CapEx review, which is ongoing. There is, what I just mentioned on decarbonisation, and then constantly looking for strategic transactions that could change the size and face of the company.
Alexander Jackson
Just maybe one follow-up on that third bucket. Is there any themes that you’re thinking about with respect to those opportunities? Is it within sort of the bread and butter of steel production, or raw materials, or maybe something outside of the box? Just maybe you can answer that or maybe [Multiple Speakers] coming across your desk?
Alan Kestenbaum
No, it’s definitely not all the above. It’s — everything is in the box and not outside the box. And the reason for that is our investors invest in our company, because they want exposure to the steel industry, that’s the first decision they make. And my experience running public companies is when you dilute that at that — the purpose of the company and start moving into other things that might be good investments, you end up creating a confused company that people are not interested to invest in. So we’ve stayed true to our core. And it’s interesting, a lot of people ask us all the time, hey, you guys are — don’t have — you only have spot exposure and the spot market went down and you don’t have this long term contracts and everything else, which I’ve always said those contracts are very one sided. You have buyers out there that don’t take materials when the prices are high or they renegotiate when the prices drop. And my long held belief is those contracts are just one sided contracts. And the best proof I can get for that, because everyone’s always saying to us, you’re exposed to the stock market, you’re exposed, the price is down. Just look at our margins, in a terrible quarter, right?
We were in third quarter, we have by far the highest margins in industry and no long term contracts or spot exposure. So I think we have the winning formula here and we’re going to continue to stay with that formula. It works for us. And I think we’ve just proven it on the ball field. And despite everyone’s questions, you don’t have long term contracts, so what about when prices drop. Our investors want steel exposure, period. They don’t care if you had — they don’t care if you have a long term contracts, they want dividends, they want to share buybacks, they want price and they want exposure to the steel in the street. And so we have stayed firmly in that camp. And one of the things that I love about our third quarter results is the fact that we have shown that even with the declining price the way it is, you are not insulated, because at the end of the day, it’s run by operational footprint and it’s run by smart purchasing and smart selling, and I think that’s the beauty of this company. And I think as we — one of things I love about these down environments, it lets you reestablish the company and reset your costs, and it also lets you operate at a margin and demonstrate that you can operate at a margin despite everybody else’s popular views about what you should and shouldn’t go into. So tactical flexibility is our theme both from a corporate perspective, financial perspective and an operational perspective.
Operator
That concludes our Q&A session, as well as the Stelco Holdings Incorporated third quarter 2022 earnings call. Thank you all for your participation. You may now disconnect your lines.
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