Stelco Holdings Inc. (OTCPK:STZHF) Q2 2022 Earnings Conference Call August 11, 2022 9:00 AM ET
Company Participants
Trevor Harris – IR
Alan Kestenbaum – Executive Chairman and CEO
Paul Scherzer – CFO
Conference Call Participants
David Ocampo – Cormark Securities
Seth Rosenfeld – BNP Paribas
Alex Jackson – RBC Capital Markets
Operator
Welcome to the Stelco Holdings Inc. Second Quarter 2022 Earnings Call. My name is Ruby, and I will be your moderator for today’s call. [Operator Instructions]
I will now hand over to Mr. Trevor Harris, Vice President of Corporate Affairs at Stelco to begin.
Trevor Harris
Thank you, operator. Good morning, everyone and welcome to Stelco’s quarterly earnings conference call. Speaking on the call today to discuss our results for the second 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 second 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 website at investors.stelco.com. We have provided a link to the presentation referenced on today’s call on our website as well.
I’d like to inform everyone that the 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 upon 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 today’s call to read the legal disclaimers on Page 2 of the accompanying earnings presentation and also refer to the risks and assumptions outlined in Stelco’s public disclosures, in particular, the second quarter 2022 Management’s Discussion and Analysis sections referring 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 would ask that all participants 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. Good morning, everyone.
The second quarter of 2022 was very busy and productive for Stelco. We have continued to deliver upon our commitments to shareholders with several major milestones achieved. The first one is the completion of the construction and the start-up of our 65-megawatt cogeneration facility at Lake Erie works, that will see us continue to improve on our industry-leading low-cost structure. However, to a large extent, significant increases in energy costs others are experiencing and reducing our overall carbon footprint.
Additionally, during the quarter, we completed a strategic transaction for Stelco that unlock the value of the Hamilton lands with the CAD518 million sale of those lands. Additionally, we entered into a long-term lease that will keep Stelco operating in the community it is called for over 110 years. Operationally, we were able to deliver CAD464 million in adjusted EBITDA and maintain our place as the industry leader with 45% adjusted EBITDA margin.
To show how impressive that is, the combined US and Canadian industry average for all other reporting steel makers was below 30% for the quarter. Moreover, it is our sixth consecutive quarter leading the industry in adjusted EBITDA margin.
We also saw growth in all of our financial metrics over the previous quarter, including revenue, operating income and net income despite the modest reduction in the average selling price in Q2. We had so far in the first six months of this year, generated CAD866 million in adjusted EBITDA, bringing the total adjusted EBITDA for the trailing 12 months to over CAD2.3 billion.
All of these measures have contributed to our business being in a position to continue our tradition of returning capital to our shareholders with whom our senior management team remains closely aligned. We have demonstrated this with what is now over CAD1.1 billion of capital return to shareholders since our IPO in 2017.
In July, we also announced our offer to return up to an additional CAD1.50 billion to our shareholders through a Substantial Issuer Bid. Today, we are furthering our commitment by announcing a CAD0.30 per share dividend for this quarter.
This has positioned Stelco as a leader amongst publicly traded steel makers across North America with respect to capital returns to shareholders relative to market capitalization. The unprecedented alignment of our management team with our shareholder base continues to be a source of unique strength for our company.
Unfortunately, however, we live in a world where test success is not what we as management nor our investor’s gauges on, but rather our future performance. Early in the second quarter, we experienced and continue to see a significant shift in the market with a sharp reversal in pricing trends that has seen the benchmark CRU pricing decline by more than 45% from the recent peak in late April.
On top of deteriorating pricing and demand, our business is being challenged with strong headwinds, including inflationary pressures and some of our key inputs such as natural gas, coal and alloys. We are concerned about this double hit of higher costs and lower prices and are looking at how we can address these challenges. But we have been through troughs before, the particular combination of this double whammy makes this time somewhat different.
Also, as I’m sure you’re all aware, we are in the midst of labor negotiations with our valued employees. We will not be addressing this on this conference call nor will – nor will we respond to any questions on this topic. We consider these discussions with our employees is confidential and we respect the financial well-being of both the company and our employees, and we believe that keeping the discussions in the family is in the best interest of both the company and our valued employees.
With that, I will turn to Paul and ask then provide some additional comments regarding our financial performance.
Paul Scherzer
Thanks, Alan, and good morning everyone.
In spite of the array of challenges we currently face our business, our results for the second quarter were strong. Reported revenue of CAD1.037 billion was up 14% over the previous quarter and 13% year-over-year. Once again, we proved our ability to drive revenue through to the bottom line by capitalizing on our industry-leading low-cost position.
Layering this on top of what was the most successful first quarter in our company’s history. We have generated CAD866 million adjusted EBITDA over the first half of the year, an improvement of 46% over the first half 2021. The continued success has provided the company with substantial liquidity. We ended the quarter with CAD1.503 billion in cash and CAD247 million of availability under our revolving credit facility.
As Alan noted, we will be building on our industry-leading capital returns as our board has approved the continuation of our CAD0.30 per share dividend this quarter. This is on top of the Substantial Issuer Bid, offer we extended earlier this quarter to purchase up to 30 million outstanding common shares for an aggregate amount of over CAD1 billion.
This utilization of our capital is keeping with our long-standing commitment to return value to our share–shareholders. Should the SIB offer be fully subscribed? The company will still have sufficient liquidity to fund all of its obligations and pursue additional capital investment opportunities should they arise.
Of course, we must take note of the challenging environment that we find ourselves in for the balance of this year. While the second quarter began with the continuation of the pricing and volume recovery, we experienced at the end of the first quarter, the market reversed course early in the quarter and we were met with softening demand and substantially deteriorating pricing. Trends that we expect will continue to impact the third and fourth quarters.
As a result, it is expected that adjusted EBITDA in Q3 will be materially below the Q2 level and further weakening is expected in our Q4 results. These expectations assume the lower prices and shorter lead times being experienced currently, fully impact results and prevail through the remainder of 2022.
While these changes in the market are likely to impact our business, I’m confident that the strength we have built through strategic capital investment, the creation of our industry-leading cost structure will see Stelco persevere and succeed. We will continue to take 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.
Thank you for taking time today to join our call.
Trevor Harris
Thank you, Alan and Paul.
That concludes our prepared remarks for this morning. And I’d now like to turn the call back over to the operator for Q&A. Reminding callers that they will be limited to one question and one follow-up question prior to re-queueing.
Operator?
Question-and-Answer Session
Operator
[Operator Instructions] Our first question is from David Ocampo of Cormark Securities. Your line is now open. Please go ahead.
David Ocampo
Thank you. Good morning, everyone. Paul, I was wondering or maybe even Alan can take this. You’ve typically run a book without any hedging for the last a little bit. Does that change now, just given, if you take a look at the futures curve, it’s showing North of CAD900 in the ’23. And just given your commentary that, further weakness is expected, is this something now that you maybe start to change your policies and look to get more aggressive on hedging?
Paul Scherzer
Look, in the past, the problem with what you’re looking at in the future market is that the basis risk is substantial, meaning that they unwinded this is, it’s difficult to do unless you wait for the end of the month and use this CRU average. So, the answer is that our cost structure allows us to operate in the trough and the unwind of these hedges are not easy to do and so we’re going to stay away from hedging. Most likely that can change the circumstances I mentioned change. But if you look at the bid-ask in the – on those future quotes, and liquidity that’s there, it’s no that – it’s not that useful for us at this time.
David Ocampo
Okay, that’s helpful. And then as my second question on the distribution of cash that is sitting at CAD1.5 billion. You do have the – that’s being in place. If you guys don’t get to a fulfill, how should we be thinking about capital allocation because I think you guys mentioned in the past that you’d like to keep around CAD300 million of dry powder available. Does that change that CAD300 million probably change, just given the uncertainty that you guys are seeing in the marketplace?
Alan Kestenbaum
We’re right now focused on the SIB. We’re not – we don’t have any other plans, right now besides the SIB.
Operator
Our next question is from Seth Rosenfeld of BNP Paribas. Your line is now open. Please go ahead.
Seth Rosenfeld
Good morning, thanks for taking our questions today. Two questions, first on demand and second on price realizations. On the demand side, some of your peers through earning season have expressed a somewhat more optimistic outlook for demand, I think into Q3 with the view that there has been an uptick in order intake over recent weeks as the pace of price decline began to slow. Can you comment on your own commercial activity to what extent you might have witnessed in the improvements demand?
And then secondly, please on price realization, given your predominant spot exposure, we know Stelco’s often seen the higher – high in upturns and lower lows in downturn committed CRU benchmark. How big of a risk is that you look ahead to Q3 price realizations and where do you see the current market leveling out? Thank you.
Alan Kestenbaum
Well, first of all, we don’t see, use term optimistic. I think some of our peers are always optimistic. In Stelco, we try and be realistic. I don’t think it’s a surprise to anybody that the interest rates are – impact in construction and the auto market, that’s widely publicized. So, we’re comfortable with the assessment we’ve given out with certainly as good as anybody else in terms of getting orders.
But we shouldn’t be surprised anybody that the macroeconomic things that are going on specifically impacted by interest rate increases are having an impact on those key sectors. The one sector that is resilient to that at the moment is energy because of what’s going on in the energy space.
So, hey, it’s great to be optimistic, we try and report things as things are actually happening. It’s not a sharp fall-off, I want to emphasize that also. There is no disaster in terms of demand itself, it’s more of a pricing issue. But, there’s no doubt that the key end-markets that pushes back also to be the service centers themselves, that has an impact on order entry. As they see prices fall, they don’t want to get stuck holding onto material especially in the phase of weakening economic performance.
In terms of pricing, it’s hard to tell, we are definitely feeling the impact of our cost inflation. You might have seen yesterday a couple of producers announced price increases. We have always maintained that we’re not price leaders. We’re – we’re not the biggest steel company out there. We’ve always felt that the – that the steel pricing environment is impacted directly by scrap and so, the fact that one of our EAF competitors decided to raise price, that’s probably a good sign from a pricing perspective. And we’ll have to see.
So we – it just happened yesterday, things have been a really, really sharp decline. We’ve seen no bottom yet. But certainly, as a welcome sign that we saw from one of our competitors and hopefully the market follows.
Operator
Our next question is from Alex Jackson of RBC Capital Markets. Your line is now open. Please go ahead.
Alex Jackson
Thanks guys for taking my question. I guess, just wanted to follow-up and confirm or re-ask what the sort of minimum cash balances that you guys will be comfortable carrying going forward after capital returns? Thanks.
Alan Kestenbaum
Well. I mean we – including have more cash than we need right now. I don’t think, we think of things in terms of an absolute number like that. A lot of it – it’s a moving target. In a period of time where there’s a lot of free cash flow generation, the cash-on-hand is lower and the opposite is also true. So, I think consistent with our remarks, we do think that we are entering a weakening period here, in line with the economic forecasts that are out there, that are widely – I think widely accepted by most people. And therefore, our absolute number that we like to keep might be a little bit higher to – for two reasons. One, to allow ourselves breathing room in the event things get tougher.
And secondly to be opportunistic, if the right things come along. I want to emphasize we don’t typically see anything right now, that looks exciting to us that we would pursue. But that number is not an absolute number. That’s definitely is related to what we see going on out there and as I said before, as the moment notwithstanding the price increase yesterday that was announced by a different producer, even at the moment we’re seeing things on the weakening side. And so we’ll probably be a little bit more cautious on cash – on cash balances than we might be in a period where we’re generating hundreds of millions of dollars per quarter.
Alex Jackson
Got it. That’s helpful. And then I guess just as a follow-up, you guys alluded to doing things to help mitigate some of the cost inflation you’re seeing. I’m curious is that really sort of talking to the cost savings program that was mentioned back with Q4 results or is there other things that you guys are considering as well? Thanks.
Alan Kestenbaum
Well. We’re always working, no matter what’s happening on cost savings. And unfortunately in our business, if you look at the key cost inputs, it’s raw materials and energy, and labor. And in all these, there is cost increases in the work that we do to reduce costs. I cannot possibly offset with types of cost increases that come from those sectors. So reduction, of course, is a continuing effort. It helped us to try and offset all the other increases that I mentioned, but that’s a continuing effort and stands by itself.
You know, we’re trying to have a good job on buying raw materials in troughs and not buying in peaks. We’ve done that over the last few years, and you don’t always get it right. And so I think, we do expect that in line with weaker economic performance, many mill shutdown in Europe because of energy issues, that these raw materials will have to find their way at lower levels as sooner or later.
Then, and that’s what we expect. But as you know from being in the commodities business for a long-time, you can’t always – you can’t always get it exactly, right. And you don’t always know exactly when that’s going to happen. So, there is not much we can do about things we don’t control like those costs.
So, we’re going to have to do our best to ride it out. Also, of course, our competitors faced similar cost pressures and so you would think that that would result in some of the higher cost producers shutting back some capacity or raising prices or something to offset that. So we did not no magic wanted, we can wave when it comes to higher natural gas prices for instance. I mean it is, what it is. We don’t know what’s going on with that.
And so, some of it is just a waiting game, waiting for things to – your things to normalize. And we’ve seen that already, we’ve seen some of these energy prices go down. But of course, we know where living a very volatile geopolitical world right now. Anyone should sit there or the worst is behind us and can say, yesterday the market reacted.
Inflation is over and because July is only whether what they say, 0.5% instead of 9% or whatever was. I mean, kind of ridiculous like in the August report could be higher again in the same thing with natural gas. So, I think we’re in a period of time now, where we’ll continue to reduce our costs and it’s challenging for metal producers, you’re seeing it around the world.
We’re better than most because we start from a much lower platform. And so I would think that overtime, supply and demand will also impact a correction to allow front-end of the cost curve like us to be able to return to the types of large margins that we’ve had. And fortunately, we’re also able to function in a down market than the trough at a relatively reasonable profitable way.
Operator
Thank you. We have no further questions, so I’ll hand back to Alan Kestenbaum for any closing remarks.
Alan Kestenbaum
Okay, well. Thank you very much everyone for being here today. Again, very pleased with some of the things we were able to accomplish in Q2. Q3 as we’ve told you is that our work cut out for us. And we’re going to get back to work and start digging in the market.
So, thank you very much and we’ll talk to you on next call.
Operator
This concludes today’s call. Thank you for joining. You may now disconnect your line.
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