Russel Metals Inc. (OTCPK:RUSMF) Q3 2022 Earnings Conference Call November 10, 2022 9:00 AM ET
Company Participants
Marty Juravsky – Executive Vice President and CFO
John Reid – President and CEO
Conference Call Participants
Michael Doumet – Scotiabank
Michael Tupholme – TD Securities
Ian Gillies – Stifel
Frederic Bastien – Raymond James
Alex Jackson – RBC Capital
Operator
Good morning, ladies and gentlemen. And welcome to the Third Quarter 2022 Earnings Conference Call for Russel Metals. Today’s call will be hosted by Marty Juravsky, Executive Vice President and Chief Financial Officer; and John Reid, President and Chief Executive Officer of Russel Metals, Inc. Today’s presentation will be followed by a question-and-answer period. [Operator Instructions]
I will now turn the meeting over to Marty Juravsky. Please go ahead.
Marty Juravsky
Terrific. Thank you, Operator. Good morning, everyone. I plan on providing an overview of the Q3 2022 results and if you want to follow along, I will be using the PowerPoint slides that are on our website and just go into the Investor Relations section. If you go to page three, you can read our cautionary statement on forward-looking information.
Before I go into detail, let me put a little context around the quarter. We were very pleased with how our business segments performed. There’s obviously been a fair amount of uncertainty in the broader economy of late, but our operating units showed tremendous resiliency as they navigated through the quarter.
Another way that I would describe our results is balanced. Given our broad geographic platform across our three business segments, we are pleased with the breadth of the strong operating performance across the various segments.
So let’s turn to page five to discuss the macro market environment — market conditions. Steel prices have come down, but remain at very healthy levels. As you can see on the left chart, even though there has been price moderation for sheet and plate, the price levels that were experienced in Q3 remain well above historical norms.
The right chart illustrates the recent movements in service center inventories for the industry. Inventory levels in Canada on the top right chart and U.S. on the bottom right chart remain in normal range compared to pre-pandemic levels.
As we look at takeaways from our customer base, demand from our Metal Service Centers customers, which includes industrial manufacturers, fabricators, non-residential construction, ag culture, shipbuilding, infrastructure and Energy remains active in their respective markets.
As a result of seasonality, we did lose some operating days in Q3 due to the Canada Day, 4th of July and Quebec construction holiday periods. Looking forward, the broader economy has some uncertainty because of higher inflation and increasing interest rates.
While these factors typically impact sectors such as homebuilding and retailing more than our customer base, we do expect to see some caution in terms of near-term buying activity amongst our industrial customer base in the coming months. In addition, we do expect to see some seasonal slowdown in Q4 due to normal vacation schedules around U.S. Thanksgiving and the December holidays.
Going to our financial results on page six. Starting at the top from an income statement perspective, revenues of $1.3 billion in Q3 was the highest level that we have ever achieved. Overall gross margins declined to 21.5%, but remained strong.
Our Q3 results were impacted by a few items; one, a positive pickup from the TriMark joint venture. In the quarter, it had a P&L impact of $15 million, being a combination of $13 million equity earnings and $2 million of preferred share dividends.
From a cash flow perspective, TriMark paid dividends in the quarter, which included $2 million of preferred that I just mentioned, plus $12 million of dividends on the common shares for total cash received of $14 million. Going forward, TriMark has already declared and we received $7 million of dividends in Q4 and we expect to receive additional dividends in Q1.
If we look back at the series of initiatives to monetize our OCTG/Line Pipe businesses, including the 2021 liquidation of the U.S. businesses, the cash that was pulled out at TriMark at the time that the joint venture was created in 2021 in combination with the recent and expected dividends from TriMark, we will realize a very profitable exit from our OCTG/Line Pipe businesses.
In the quarter, stock-based comp had no impact on the P&L for Q3 versus a $4 million recovery in Q2. Also, there was an increase in the NRV reserves on inventory, which had a $6 million impact for the quarter.
From a cash flow perspective, we had a $41 million increase in working capital, which was driven by the lag effect between accounts payable versus inventory and AR. More specifically, we had an increase in accounts payable, while inventory and AR were relatively flat. Inventory being flat was a combination of a small increase in tonnage, offset with a small decline in average unit costs.
For inventory, I expect both tonnage and unit cost to come down in the months ahead as we see working capital converted to cash in Q4 and into Q1 of next year. CapEx of $10 million has picked up a bit as we are continuing to advance a series of our value-added equipment projects.
From a balance sheet perspective towards the bottom of the page, our net debt declined from $108 million at the end of June to $92 million at the end of September, as we continue to generate good cash flow. Our liquidity is greater than $500 million and our credit metrics are strong.
One item of note in the quarter is that we annuitized about $35 million of assets and corresponding liabilities from our non-union defined benefit pension plan. The counterparty is a high-rated insurance company. This will close in Q4.
As you will see in our financial statement footnotes, we have a very nice surplus of over $30 million in the pension plans and that surplus can be used to reduce the company’s future contributions into various retirement plans. This annuitization reduces risk for all parties while providing a strong credit counterparty for the benefit of our retirees.
For share buybacks, so far, we picked up a little under $19 million of which around $16 million was accounted for in Q3 at an average cost below $28.
Our capital base grew in the quarter with our book value per share up another $1.81 per share and is now at $24.70 per share. To put that in context, we acquired shares under our NCIB at around 1.1 times book value. Lastly, we have declared a quarterly dividend of $0.38 per share.
We have added a new slide on page seven, if we go to that for a second, to provide a variance analysis between last quarter and this third quarter. In looking at Service Centers, the decline in volumes impacted EBITDA by around $11 million.
As I mentioned earlier, we lost some operating days due to the normal seasonal vacation schedules. The $51 million decline in margins was due to lower prices, while we have not yet seen the offsetting impact of lower cost of goods sold due to the lag effect. We do expect cost of goods sold to come down in Q4. Offsetting this is a $9 million favorable variance in Service Centers due to lower fuel costs and lower variable compensation for that segment.
Energy improved by $1 million in the quarter and Steel Distributors declined by $15 million due to the moderation of steel prices that particularly impacted our U.S. Distributors business. There was an $18 million favorable variance in other, which included the pickup from TriMark and the reduction in variable compensation expense. Somewhat of an offset is the mark-to-market on our stock-based comp that was neutral for the quarter but did a recovery in Q2.
On page eight, we have our segmented P&L information. The Service Centers is continuing to do well amidst the market volatility. Revenues were down versus Q2, but still represented one of our top three quarters. Tons shipped was down 5% versus Q2 due to the summer holiday effect that I previously mentioned but was up 9% versus Q3 of 2021 due to the impact from the Boyd acquisition.
One disclosure item of note is that, starting last quarter, we included in our MD&A tonnage information on a period-over-period comparison. If you go to page 14 of our materials that show a five-year period including quarterly information, we have also included for this quarter, our historical tonnage going back for those five years on a quarterly basis, if you want that for reference. Continuing with Service Centers, average prices were down 6% versus Q2, but up 4% versus Q3 of 2021.
Gross margins were just over 20%, which translates to about $547 per ton. The gross margin per ton and EBIT of $67 million are strong by historical frames of reference and also in the context of the recent steel price declines.
In Energy, we are continuing to see positive market sentiment. Our Energy revenues were up 9% versus Q2. Gross margins came in at 27% and operating profit of $30 million, which are very nice levels compared to the periods before we monetized the OCTG/Line Pipe businesses.
Distributors revenues and operating results came down as they were impacted by the moderation of steel markets. That being said, the bottomline operating profit of $13 million was pretty good compared to historical periods.
On page nine, we have illustrated our inventory turns. This chart shows inventory turns by quarter for each segment, with Energy in red, Service Centers in green and Steel Distributors in yellow. In addition, the black line is the average for the entire company.
A few observations, overall, our inventory turns remained strong at around 4 turns. By sector, our Energy and Service Centers were consistent in that 4-turn to 4.5-turn range. For Steel Distributors, yellow, the inventory turns were around the same level of 2.3 turns in Q2 and Q3.
On page nine, excuse me, on page 10, you will see the impact of the inventory turns on dollars. Total inventory remained at around $1 billion as of September 30th, which is a small increase versus June 30th. The changes within the segments weren’t significant versus June, but we do expect to see some inventory tonnage drawdowns and average cost reductions flowing from both Distributors and Service Centers over the next several quarters.
On page 11, you can see the overall impact on capital utilization and returns. Our capital deployment is up to around $1.6 billion and our LTM returns of 41% remain very strong by both historical comparisons as well versus our competitors.
If we go to page 12, we want to frame up how we see our capital priorities going forward. For investment opportunities, we see average returns of over 15% on average through the cycle and we have delivered well above that over multiple cycles.
The ongoing opportunities for us are threefold; one, value-added projects, which we have talked about a lot in the past are continuing and they are multiyear initiatives for us. We moved forward with several projects in this past quarter and expect to invest around $30 million per year on these discretionary capital projects for several more years. These projects typically have better than three-year paybacks.
Second item is facility modernization. In several cities, we have legacy locations that can be upgraded and consolidated into newer and more modern facilities. These projects will allow for volume growth, increased operating efficiencies and improved health and safety conditions. In a number of these situations, we will also be able to monetize the real estate from our existing locations and thereby reduce the net capital costs for those types of projects.
We recently approved a $7 million net investment related to our Saskatoon operations. This project is underway and should be finished in early 2024. In total, we expect around $50 million to $75 million of these type of investments over the next five or so years.
In terms of acquisitions, we remain committed to our financial and operating criteria as we look at acquisitions. That being said, we expect to remain disciplined yet active in seeking out growth opportunities that fit into our existing business units.
In terms of returning capital to shareholders, we have adopted a more balanced approach to returning capital to shareholders over the last number of months. For dividends, we have maintained our $0.38 per share per quarter dividend, which equates to about $24 million per quarter. In addition, during August and September and into early October, we purchased around 670,000 shares under our NCIB for just under $19 million in total.
In closing, on behalf of John and other members of the management team, I’d like to express our appreciation to everyone within the Russel family. It has been a really tremendous nine months in 2022 so far and is really a direct result of some very strong contributions by our 3,000 plus member teams.
So, Operator, that concludes my introductory remarks. You can now open the line for any questions. Thank you.
Question-and-Answer Session
Operator
Thank you. [Operator Instructions] Your first question comes from Michael Doumet, Scotiabank. Michael, please go ahead.
Michael Doumet
Hey. Good morning, guys.
Marty Juravsky
Hey, Michael.
Michael Doumet
This is the seventh quarter in a row that Russel beats consensus, just in case you guys weren’t already tracking that. Obviously, incremental strength in the Energy side this quarter, but Metal Service Center profitability is down versus last year, but still better than any other quarter before 2021. Can you give us a sense, maybe just breaking out how much value add is helping here just in terms of maintaining margins?
John Reid
Yeah. Thanks for the question, Michael. And we have noticed it, but I appreciate you pointed it out there on the seven straight quarters. But it is helping and it’s an incremental that you see that every time we add equipment and add machinery.
As Marty said, you are seeing less than three-year paybacks on that. So we continue to have that continues to ramp up. So we are seeing that margin impact. Again, we think that we will raise the bar, I think, we have mentioned this before, probably around 2 points over time and so we are moving in that direction and I think you see that as a reflection now in our margin performance.
Michael Doumet
And John, just on the 2 points, presumably, you are comparing that with pre-COVID, pre-pandemic. How much of those — that 2 points do you think you have achieved already?
John Reid
I would say we are halfway to maybe a little over halfway there. Again, this is probably another two-year to three-year window before we maximize the opportunities that are in this value added at the current projects we are looking at. We may expand that further into areas that we are not currently in. We are evaluating those on a day-by-day basis.
Marty Juravsky
And the only thing to supplement is, what’s interesting is, as we have done some acquisitions over the last couple of years, and probably, as we continue to look at those, they also come with embedded opportunities within them.
So we are halfway along within our existing portfolio, but within incremental pieces that come with new acquisitions, there’s also new opportunities that often come with them and we have seen that with the last couple of acquisitions that we have made. So it’s a moving target in terms of the incremental opportunities that are out there.
Michael Doumet
Perfect. Thanks. And maybe just a second question. Nice to see the multipronged capital return and capital reinvestment strategy you laid out. On the reinvestment piece, are you finding M&A today competes a little bit more closely on a return basis versus buybacks?
Marty Juravsky
From an economic perspective, Michael, how do you — what you are referring to?
Michael Doumet
Yeah. From a return basis, like, which one makes more sense in terms of multiple?
Marty Juravsky
They both can make sense is the way I’d characterize it. So in the last quarter, we — as we mentioned, bought back a bunch of our stock as we thought it was fairly cheap and so that was opportunistic.
We have our metrics that apply for acquisitions as well, and if we can buy opportunistically, either internally or through acquisition, both makes sense for us. So it’s not really one or the other, we can do both if they both make economic sense.
What we have seen over the last little while though, probably, going back six months to a year ago, is a lot of M&A opportunities that just didn’t have really good values attached to them. Our expectation or perhaps our hope is that if we have a moderation of the economic conditions.
We will see a more balanced approach to valuation expectations and acquisitions, which kind of lines up for us where we can do both acquisitions and to the extent that opportunistic buybacks makes sense, we can do both.
Michael Doumet
Okay. That’s really helpful. Thanks, guys. Nicely done.
Marty Juravsky
Yeah. Thanks, Michael.
Operator
Thank you. Your next question comes from Michael Tupholme, TD Securities. Michael, please go ahead.
Michael Tupholme
Thank you. Good morning.
Marty Juravsky
Hi, Mike.
Michael Tupholme
I was hoping to start with a couple of questions regarding the Energy Field Stores segment. Strong performance in the quarter and your near-term outlook commentary regarding that segment remains positive. I guess the question is, as we look forward really to next year, can you talk about your expectations for continued growth potential in that segment from a revenue perspective?
John Reid
Again, it looks like there’s a lot of capital to spend in that there is more discipline going on, on the E&P side, but they do have a lot of capital. Backlogs are very strong right now, we are seeing those already well into second quarter, looking at the past breakup and beyond now, so early third quarter. So we feel like the revenue will be steady, potential projects out there could increase revenue for us in the Energy Field Stores and then we are growing market share on both sides of the border.
Michael Tupholme
Okay. So just to clarify, John, you say steady — are you saying sort of the baseline at least steady, but potential for some increases, did I understand that correctly?
John Reid
Yeah. That’s right. I think — again, I think, the Energy will remain very steady at the current price of oil. I think there are potential for some projects that are out there for potential nice size increases going in both Canada and the U.S.
So, again, there may be some potential M&A opportunities for Russel Energy to expand some of our value-added processing there. But, so we will continue to look at that. But on a same-store basis, we think it’s slow, steady increase and then with these projects potentially some nice pops along the way.
Michael Tupholme
Okay. And then just because this segment doesn’t include the OCTG/Line Pipe anymore, just from a seasonality perspective, when we look at it to say next year, can you just help us sort of make sure we understand the seasonality properly?
John Reid
Yeah. The biggest challenge for seasonality, obviously, is in Canada. So when we are looking at breakup, things just slow down, because they can’t get the pipe into the field, and again, that does impact us as far as what projects are going forward. We will deliver some to the pads, but it’s still very difficult transportation.
So that as an industry as a whole just slows down for that roughly six-week period depending on mother nature, whether it’s four weeks or eight weeks, but the industry as a whole will typically slow down, slow down some projects there. There are some maintenance projects, but there is limited transportation opportunities, a large majority of our energy obviously still being in Canada, so we will see that seasonality impact.
Michael Tupholme
Okay. So it’s not materially different going forward than we have seen historically given the change in sort of the composition of the segment?
John Reid
Yeah. That’s right. And keep in mind, field stores would dip down, but they wouldn’t stop whereas your OCTG/Line Pipe would go to no revenue or little to no revenue during those periods.
There is a maintenance. It’s more of an even bandwidth or stable bandwidth of earnings during that cycle in revenue for the Energy Field Stores. There is some maintenance component. There are some things going on, but they don’t just have revenue stop like the OCTG/Line Pipe do.
Michael Tupholme
Got it. And then just last one for me on Energy. It’s not for the segment, but for the TriMark JV earnings. Marty, you said it was $13 million of earnings and $2 million of preferred share dividends in the quarter. Like with the strength you are seeing in Energy markets, is that the sort of level of run rate performance we should expect from that JV quarterly — on a quarterly basis now or how do we think about that going forward?
Marty Juravsky
Near-term it remains strong, but on average, no. This is an above average. This is a well above average level and we are enjoying it while we are having it. And we are reaping the dividends as a result of it, but it’s not a sustainable level at this level.
Michael Tupholme
But I mean, to the extent that things don’t roll over in the sector, like, I understand that this is a cyclical — there is still cyclicality here. So, but for the foreseeable future, assuming there’s no kind of rollover in demand, this is the kind of level we should be expecting?
Marty Juravsky
So let me put you this, in the very near-term, and then, mentioning back to even your question to John about the seasonality and spring break up in Canada. So for the very near-term, we are still at a really good clip for that business. But spring break up will kick in, in Q2 of next year and so that’s on the horizon.
But with what we see today, it remains strong. Absolutely, it remains strong. So there will be some seasonality that kicks in next year and then how the cycle evolves. It will be what it will be, but for the Q4 of this year and probably Q1 of next year, it remains very strong.
Michael Tupholme
Okay. And then just shifting over to Service Centers, you talked about some destocking at your customers in the third quarter and some cautionary — some cautiousness around buying as well here, I think, in the fourth quarter. So I guess when we look at same-store tons, should we be thinking about a sequential change that’s consistent with what you saw in the third quarter, the sort of down 7% sequentially in the third quarter? Is that the kind of order of magnitude we should be thinking in terms of fourth quarter versus third quarter in Service Centers?
Marty Juravsky
Yeah. That’s fair, Mike, that order of magnitude. And I was mentioning on the call, we included some new information in the back now that shows our quarter-over-quarter shipments going back five years.
So you can see that seasonal dynamic that plays out. There’s been a couple of times, so for example, fourth quarter of 2021, we made an acquisition, so the numbers are a little bit apples to oranges.
But if you look back over those five years, you will see that order of magnitude between Q4 and Q3, the seasonal impact and 7% to 10% is probably on average what it’s been over an extended period between Q4 volumes and Q3 volumes, sorry, 7% to 10% down Q4 versus Q3.
Michael Tupholme
Right. Okay. Okay. I will get back in the queue. Thank you.
Marty Juravsky
Okay. Thanks, Mike.
Operator
Thank you. Your next question comes from Ian Gillies, Stifel. Ian, please go ahead.
Ian Gillies
Good morning, everyone.
Marty Juravsky
Hi, Ian.
John Reid
Good morning.
Ian Gillies
In the Metal Service segment, we tend to have a focus on HRC price, because it’s in our face. But can you maybe talk about what’s happening with some of the other products within that segment, whether it would be plate or some of the other upgraded products and how they may be performing better or worse than maybe the spot HRC price?
John Reid
I think spot HRC price has probably been under the most pressure of all the commodities that are out there in that. So if you are looking at long products, be it beams, bars, anything that’s not a product of coil.
I think it’s probably performing a little bit better there. It’s more tied to scrap. It hasn’t had the volatility of the others. But HRCs had the most volatility, again, you have the most supply there, so it’s a supply and demand issue. When you look on the plate side, it’s performed by far the best. It has the most metal spread between scrap and the actual finished good price.
You do have a limitation on the number of producers in North America, there’s five. They have done a good job, kudos to the mills for sustaining discipline to maintain that price. We have seen it drift south, but it’s in a very good place right now historically, it’s all time highs, it’s hovering around that area.
Demand for that product, again, seems to be stable when you look at construction, you look at infrastructure, you look at heavy equipment, ag, all those things or Energy. All those things are going really well in the next year. So those all should bode very well for plate.
So pretty bullish on where plate’s headed. The challenged product, we think, will be the HRC and the product of HRC, again, just due to the supply and demand dynamic, that there’s a lot of supply out there in North America.
Ian Gillies
Yeah. No. I would agree with that sentiment. If we switch over to the energy supply side, given the strength of that market, is there any intention to add more field stores organically over the next 12 months to capture markets you are not in or maybe add geographies that you are not at yet? And I guess, along those same lines, is there any intent for any major expansion at your existing field stores to maybe increase revenue per store?
John Reid
We are always looking at M&A. We think there will be opportunities. We are looking at maybe going out into more of a value-add component in the field stores as well. So we are exploring some of those options on both sides of the border.
Growing with our existing stores, we will move as the rigs and the work moves, but also maybe looking at different products that go into different product lines such as solar, wind. Are there opportunities, we are in the same field, can we supply new product lines there, so we are exploring those opportunities now as well.
Ian Gillies
Okay. Last one for me. The dividend is obviously a Board decision, but is there any — are you able to provide any update around how you are thinking about that given the strength of the cash flow position, the strengthening of the balance sheet, it’s another nice way to return cash to shareholders and you obviously have capacity to do so?
Marty Juravsky
Yeah. It’s a good question, Ian. The way we look at it is, sort of that last slide that I went through, which is a balanced approach and we do have a healthy dividend currently.
Ian Gillies
Yeah.
Marty Juravsky
For the last quarter, it was the first time that we have returned capital to shareholders through a share buyback. And the numbers were almost the same, $24 million worth of dividends, about $19 million worth of share buyback. So kind of having a balanced approach and having the ability to flex where it makes the most sense.
We have revisited dividend with the Board every quarter. So I can’t predict what the future is going to hold, but for purposes of where we are right now, we view it’s a very healthy dividend. And we have capital that we can deploy in a very balanced way across other areas, including the share buyback that we did last quarter for a little bit, as well as some internal investments, as well as probably some M&A opportunities that will continue to emerge in the period ahead.
Ian Gillies
Okay. Thanks very much. I will turn the call back over.
John Reid
Thanks, Ian.
Marty Juravsky
Thanks, Ian.
Operator
Thank you. Your next question comes from Frederic Bastien, Raymond James. Frederic, please go ahead.
Frederic Bastien
Good morning. Just want to build off your comment made about plate and the limited numbers of producers out there. There is new capacity coming on stream I understand. So just wondering how that might impact pricing on a go-forward basis?
John Reid
Yeah. Again, with the number of producers, the number of mills will change with the new Brandenburg mill coming on, but number of producers that will actually still be the same, with Nucor being one of those producers.
I don’t know what the benefit for them is, any of the five producers that are in North America to drop the price, because if they are not going to get another ton. So, again, they have a very disciplined approach, which is the first time in my 32 years I have seen this much discipline. Again, so I applaud the mills there. So I don’t know what they gained by dropping the price.
There could be some volatility as you bring on a new mill if they don’t have the supply — they don’t have the customer buying and the capacity that they want, it could put some of that in, in the first quarter, maybe second quarter of next year. But, again, I don’t foresee it right now, again, with just the limited number of producers out there.
Frederic Bastien
Okay. And then with the midterm elections just passed, is there any risk to the Section 232 tariffs to be removed or like what are your views there? What is the general consensus?
John Reid
Starters, I am still not sure exactly who won. I won’t know exactly to figure it out. They are sorted out. But I don’t see either side of making a change there. Again, I think, it becomes a real — some political upheaval there, some key states, especially Pennsylvania and with the steel workers and so I don’t see there being a change.
There may be some things that move around from the 232 from tariffs to quotas or vice versa. So there may be some object really that moves around from the government to alleviate some pressures in certain products that we have in North America. But I don’t see a whole lot of change in that going forward.
Frederic Bastien
Okay. Cool. I have a question for Marty. You are targeting upwards of $75 million in facility modernizations, which should allow you to sell real estate at legacy locations. How much of value do you reckon is tied up in these locations?
Marty Juravsky
Well, there’s value tied up in locations that were potentially going to modernize in new locations, as well as legacy locations that are in reasonable locations. There’s probably $150 million to $200 million, if not more, in off-balance sheet value attached to current market values for our real estate versus what’s on the books.
I mean we have had some real estate in our portfolio for 50 years, and obviously, completely undervalued in the context of the current market. So orders of magnitude, call it, $200 million plus of off-balance sheet value attached to that real estate.
Frederic Bastien
Great. And then that $75 million in investments is that net of any monetization that you might do?
Marty Juravsky
Yeah. It is. So in using Saskatoon as an example where we announced it, it’s $7 million net and that’s net of the realizations that we are going to have off of the existing real estate, yes.
Frederic Bastien
Okay. So you would be quite active in terms of upgrading your facilities then?
Marty Juravsky
Yeah. Upgrading the facilities is going to be a big focus item for a number of years and sometimes it will involve legacy locations, sometimes it won’t. But to your — to the starting point of your question, we have a fair amount of legacy real estate, some of which we are going to continue to operate under that have pretty significant inherent value in it.
Frederic Bastien
Okay. Awesome. Thank you.
Marty Juravsky
Thanks, Fred.
Operator
Thank you. Your next question comes from Alex Jackson, RBC Capital. Alex, please go ahead.
Alex Jackson
Yeah. Thanks, guys. Most of my questions have been asked. But as you think about acquisition opportunities, I was just curious if there’s been any changes in terms of geographic location or focus on service centers, as well as kind of where we are at in the cycle with maybe some weaker steel prices and demand at least in the near-term?
John Reid
Again, we have said this for years that we continue, the U.S. obviously being a big footprint for us in steel service centers. Again, we will look at energy on both sides and the opportunities with field stores, but our emphasis would be on Service Centers in the U.S., obviously, with a value-added component to build off of our network there is our largest opportunity for growth.
We have a pretty strong network across Canada now, so it’s more of a niche place, similar to our Color Steels acquisition that we did that we have to put, plug-in, in the right place and the right opportunities, but there are some of those out there in Canada as well. So those are the type of things we are looking at for that growth.
Regarding your comment to valuations, we think some of that expectation may be resetting. Again, the economy does come off, it slows a little bit in the future that may bring some valuation expectations of the sellers into a more reasonable arena. We have seen some expectations have just been too high for deals not transacted at all, and not just with us, but with the broader markets that have been out there.
And again, that’s where we shifted back to our NCIB and looking at opportunistically our stock being cheap versus the valuation of buying something at a peak. So we are hopeful that we will see some valuations change. We think there’s going to be a fair amount of opportunities over the next two years out there to look at.
Alex Jackson
Great. Thanks for the color.
Marty Juravsky
Thanks, Alex.
Operator
Thank you. [Operator Instructions] Your next question comes from Michael Tupholme, TD Securities. Michael, please go ahead.
Michael Tupholme
Thank you. Marty, can you provide some more detail on the inventory reserve provision taken in the quarter and what area that was in and where that occurred?
Marty Juravsky
It’s a really granular bottom-up calculation that we do on reserves every quarter, and so for us, it’s not so much done at a macro level, it’s really done at a micro level buildup. It is within — primarily within the service centers, obviously, given the robustness of energy right now, things are in really good shape from that perspective.
But as the analysis is done every quarter, again, it’s done product-by-product, SKU-by-SKU, so it’s literally thousands of line items that build up to that and it just so happens, no surprise that given the environment we have been in for the last little bit, there are some products in some areas that are under water. It’s not a very significant number, the $6 million in terms of the change quarter-over-quarter.
And sometimes, Mike, as you know, you will see that reserve that we have, sometimes it goes up and sometimes it goes down. In terms of specific areas, it’s a little bit in a few different areas. So it’s not isolated to one specific area or one specific product is the way I kind of characterize it.
John Reid
Michael, also just to add a little more color there. If you looked at us, historically, when there were downturns or changes in that, the large majority of those write-offs would come from OCTG and Line Pipe due to the long lead time nature for their items in six month to nine months out. So we have now exited that side of the business and so that risk has come off the table for us.
Michael Tupholme
Yeah. No. That’s all very helpful. Thank you. And part of the reason I wanted to ask and understand where that was, and I appreciate all the detail, Marty, and John, I guess, just wanted to initially be clear on which segment that was impacting. So I guess the next question is just around margins in Service Centers, gross margin of 20.1% in the quarter. I think if you normalized for that $6 million, if we assume it’s all in Service Centers, you are up sort of mid-20% range. How do we think about margins going forward, like there was some, obviously, pressure on HRC prices during the quarter, and then, I guess, we have continued to see some pressure here recently. So, is it sort of a situation where we should assume that level carries on going forward or is there more downside from what you saw in the third quarter?
Marty Juravsky
Yeah. So the way I’d characterize it, there’s obviously two moving pieces in terms of margin; one, revenues; and, two, costs of goods sold. So, as I mentioned earlier, our cost of goods sold per ton were actually flat Q2 versus Q3.
And that is really a function of the timing lag of when stuff comes in and is heading out the door. Cost of goods sold, all other things being equal, probably, going to start moderating down. So there’s some benefit flowing through in Q4 as a result of that. That being said, price realizations are probably off a little bit as well.
So when you put the two things together, we are probably going to be, from a margin perspective, if you do dollars per ton, probably, down a little bit quarter-over-quarter. From a percentage perspective, if you look at that a little over 20% gross margin in Q3, flat to down a little bit is what I’d characterize Q4.
Michael Tupholme
Okay. That’s great. Thank you. And then I guess just shifting over to Steel Distributors, which we haven’t talked about yet, revenues held in pretty well in the third quarter, if we look at where you were in Q3 versus Q2. Given the changes in steel prices we have seen and some of your comments around customer cautious behavior, I know that was more for Service Centers, but nevertheless, if you can help us think about Steel Distributors going forward, both from a revenue and margin perspective?
John Reid
So, again, you will have your normal seasonality of Q4, and obviously, there was some lag effect from just some revenue realization from timing getting things through the port, especially in our Canadian distribution. So that will start to normalize out as well.
In the U.S., you will see a little bit of a pullback, especially in the Texas market, where we have a big Houston base due to their tax that they have at the end of every year, the customers try to go down to zero and then bring everything in January 1 from a tax perspective. But that’s in more historical pattern you would always see from us.
So we think that Q4 revenue will lighten up, earnings will lighten up, although, the distribution revenue and earnings is pretty locked in, in Canada with a back-to-back sales. I think that will pick up again in Q1 as people reverse course, things start to pick back up. We feel like the economy is going to probably gain some momentum in Q1 and I think they will gain momentum on this.
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