Stelco Holdings Inc. (OTCPK:STZHF) Q4 2021 Earnings Conference Call February 24, 2022 9:00 AM ET
Company Participants
Trevor Harris – Investor Relations
Alan Kestenbaum – Executive Chairman and Chief Executive Officer
Paul Scherzer – Chief Financial Officer
Conference Call Participants
David Gagliano – BMO Capital Markets
David Ocampo – Cormark Securities
Alex Jackson – RBC Capital Markets
Michael Doumet – Scotiabank
Seth Rosenfeld – BNP Paribas
Operator
Good morning. Thank you for attending today’s Stelco Holdings Fourth Quarter 2021 Earnings Call. My name is Quida. I will be your moderator for today’s call. [Operator Instructions] I would now like to pass the conference over to your host, Trevor Harris with Stelco. Trevor, please go ahead.
Trevor Harris
Good morning, everyone and welcome to Stelco’s quarterly earnings conference call. Speaking on the call today to discuss our fourth quarter and full year results for 2021 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 fourth quarter and full year of 2021. 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 2021 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 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 and good morning everyone. I am extremely proud of our team for leading Stelco to our most successful year on record. Over the past 4.5 years, we have worked around the clock to reduce and control our costs while also investing strategically in our business. Today, I am pleased to report that our tireless efforts to build the business with an industry leading low cost position, has delivered these remarkable results. We have taken full advantage of the opportunity presented by favorable market conditions throughout the majority of 2021 and continue to allocate our capital in the way to benefit our shareholders with whom we are directly and uniquely aligned. As a result of our continued success, we have continued to return capital to our fellow shareholders, including $562 million via share repurchases just in the last 6 months, bringing our total capital return to shareholders to almost $1 billion since our IPO in 2017.
Relative to our market cap, we have returned by far, the largest amount of capital to our shareholders of any reporting steelmaker or downstream steel company in North America and more than 4x the amount raised in our IPO. We are very proud of this return of capital record. We ended the 2021 calendar year with over $2 billion of adjusted EBITDA, resulting in an industry leading adjusted EBITDA margin of 50% and a cash balance of $955 million. This achievement goes beyond taking advantage of the exceptional price levels we saw through much of the year and speaks directly to our ability to employ our model of tactical flexibility and utilize our low-cost structure to drive revenue through to the bottom line.
To this point, for the second consecutive quarter, we were able to generate adjusted EBITDA of more than $1,000 per ton. Furthermore, we continue to convert almost 80% of our EBITDA into net income in the fourth quarter and we converted 83% of our EBITDA into net income overall of 2021. However, like the entire industry, we have seen our costs creep up due to inflationary pressures. As a result, for 2022, we are committed to lowering our costs and attacking the impact of these inflationary pressures. First, we will complete the final stages of our $700 million strategic capital plan that commenced in 2018 with the completion of our Lake Erie Works coke battery, rehabilitation upgrade and the commissioning of our new 65-megawatt electricity cogeneration facility. Additionally, we have identified additional significant cost savings of approximately $75 million, which will come from operational changes and other initiatives that don’t require capital expenditures.
Consistent with our philosophy of low to no debt, I want to remind everyone that all of these investments and massive return of capital have been made while keeping our commitment to a strong balance sheet and utilizing our free cash flow and without incurring any restrictive long-term debt or equity issuances. In 2022, we expect to see downward pressure on margins due to lower steel pricing, softer demand and the previously mentioned inflationary pressures. Our key concerns relate to the lack of visibility and also uncertainty evidenced by the recent significant shortening of lead times industry-wide and the falling benchmark CRU hot-rolled coil price index.
Until the auto sector begins to again produce to its capacity, we anticipate continued weak visibility of the supply-demand balance in the flat-rolled steel industry. These recent poor dynamics of the steel market will only deepen our resolve and make us more relentless in managing our costs. Our team has proven that they are capable of responding and adapting to changing market conditions and deploying the full strength of our tactical flexibility strategy, deepening our core competitive advantage and achieving our goal of remaining profitable through every point of the market cycle.
Moreover, it underscores the importance of our principles of avoiding friction creating outside forces such as the impact of restrictive debt and unending legacy costs. As we chart our course through the next year, a year which has started with oversupply and weak demand, we will of course remain committed to our core principles by keeping our balance sheet strong. By pursuing opportunities to improve our industry leading cost position and by deploying our capital in a manner that affords as much upside as possible for our investors considering current market conditions.
With that, I would ask Paul to provide some additional comments regarding our financial performance.
Paul Scherzer
Thanks, Alan and good morning everyone. While the third quarter of 2021 was the high point of what was a record year for our business, the fourth quarter, although strong on a relative historical basis was impacted by declining market conditions starting in November, which accelerated throughout the fourth quarter and continued through to today. However, looking back on 2021, we exceeded $4 billion in revenue for the year and generated adjusted EBITDA of more than $2 billion.
As Alan mentioned in his remarks, the 50% adjusted EBITDA margin we achieved over the full year of 2021, was the highest margin of any of our reporting peers in North America. This type of continued success is testament to every employee’s focus on controlling our costs and maximizing our productivity. Despite the reduced shipments that we noted in our guidance issued in early January, we did benefit from a modest increase in selling prices quarter-over-quarter and generated almost $1.2 billion in revenue in the fourth quarter. Our shipping volume for the full year of just under 2.7 million tons is the highest volume we have seen since acquiring the business in 2017 and is a clear demonstration of the value we are extracting from the upgrade of our smart blast furnace and other strategic capital investments.
Looking forward to the first quarter, we continue to believe that the weaker demand conditions being experienced currently as well as increased COVID-19-related disruptions with respect to labor force availability, which has impacted this quarter’s production, logistics and customer demand, will result in shipments that are even lower than those of the fourth quarter. An additional challenge we face is the recent decline in pricing. Since the start of the fourth quarter, we have seen hot-rolled pricing fall by approximately USD 900 from historic highs achieved last year. However, we are confident in our strategic approach and in our ability to keep our costs low and compete at every point in the market cycle. Our business is structurally sound, and we are prepared to respond to whatever challenges the market brings.
Our investments to date and further cost reductions that we anticipate from our coke battery rehabilitation and upgrade and our electricity cogeneration facility will certainly assist in reaching that goal. In addition to the almost $1 billion we have returned to shareholders since 2017, which includes the $164 million deployed for share buyback through the recently closed substantial issuer bid, we have also strategically invested $700 million into our business without incurring any restrictive long-term debt. At the end of 2021, we continue to maintain an undrawn revolving credit facility with $240 million of availability and we closed the year with $955 million in cash.
Continuing that stellar track record of capital returns, our Board has authorized a continuation of our $0.30 per share quarterly dividend and authorized further share repurchases via a newly filed normal course issuer bid for up to an additional 4.4 million shares, representing 6% of the total shares outstanding currently. We will repurchase these shares opportunistically over the next 12 months if and when we see the share price trade at a level that we think is advantageous for the company to execute on.
We are certainly pleased with our overall results for 2021. While we recognize we benefited greatly from a robust market and exceptional pricing, our ability to convert that opportunity EBITDA and then to the bottom line validate our commitment to the fundamentals and form the backbone of our business. Going forward, we will not deviate from those fundamentals. As a management team, we remain very closely aligned with the interest of our investors, and that alignment will serve our business well as we navigate whatever challenges we face in the upcoming year.
Thank you all for taking the time to join our call.
Trevor Harris
Thank you, Alan and Paul. That concludes our prepared remarks for today. And I would now like to turn the call back over to the operator for Q&A. Operator?
Question-and-Answer Session
Operator
Certainly. [Operator Instructions] The first question is from David Gagliano with BMO Capital Markets. You may proceed.
David Gagliano
Hi. Great, thanks for taking my questions. So I appreciate the prepared remarks but they went pretty quickly. So I apologize if I missed some of these things that were covered. But just first of all, on the near-term outlook commentary, I didn’t quite catch. I know you said down quarter-over-quarter in shipments. What are you seeing from your customers and in terms of nature of these continued weakness into the first quarter one volumes? Is it destocking or is it end market demand being weak? And then again – this is my first question. And then if you can talk a little bit about, obviously, spot price is down $900 a ton. What does that translate to a realized price decline in the first quarter for you given lags are all over the place and factoring in that it’s basically two-thirds of the way through the quarter. So I’m assuming you already know what the price is for the end of this quarter? That’s my first question.
Alan Kestenbaum
Sure. With respect to the end markets, we can go one at a time. But as everyone knows, the auto sector remains extremely weak. So in terms of – because of the chip shortage and other types of issues there, there was the recent border issues. And so that pushes up the entire supply chain. It goes all the way through the Tier 1s, the service centers, and so those companies that have been in the midst of destocking now for several months continue to destock with no end in sight. OEM orders that we have, again, same thing. As they cut production, those orders get pushed back. So you’re seeing a very significant chunk of the demand side of things be impacted by the auto industry.
And the same with the construction industry, there are numerous construction sites that are down because of worker absences due to COVID, that might change soon. Interest rates are going up. I think people are getting a little bit leery about holding too much inventory, anticipating interest rate increases, which has a direct impact always on the real estate market. So we’re seeing that. The oil market and drilling a little bit of signal light over there, but not much, and has also been slow, and I think there is also a significant amount of inventory in the pipeline. By way of example, my son is a pipe distributor. And he’s sitting on inventory and his suppliers are sitting on inventory of many, many months. So what we’re seeing here is a dramatic destocking and just a wait and see from the customers. And also, frankly, a lot of panic from steel mills, including us to some degree, I think if you go back a few months ago at the time I alerted the market to what was happening, at that time, CRU is quoted at $1,490 today, it’s a bit over $1,000. And at that time, people were saying, no, it didn’t – it’s not really falling that much. Well, it did. It fell by over 35%. The CRU is out there right now. At that time, CRU was probably 20% over the real market and that has not changed. It doesn’t actually reflect the real market that’s going on right now. So, there is a lot of oversupply, overcapacity. The last few days, we’ve seen a little bit of retrenchment there, but it doesn’t really move the needle. And so we’re playing it really cautious. You asked about price realizations. Frankly, we’re not sold out for the quarter yet. So I can’t even give you a good guidance on price utilizations because like every mill, our lead times, we still have plenty of availability for March. So to give you some sort of a real type of view on where prices are going to be, we just don’t have that visibility just yet.
David Gagliano
Okay. That’s helpful. Thank you. And then on the capital return, the commentary there, obviously, things have changed quite a bit. The company did generate, I think, what, $570 million of free cash flow just in the fourth quarter alone, that’s 23% of the equity market cap, I think. So still quite a bit of cash. So can you talk through a little bit more about your current thinking on how you plan to deploy the capital in the near-term, the cash in the near-term if you do plan to deploy it? And if you could also comment on the inventory monetization which I believe is coming due in 4 days or 5 days, it’s a $400 million number. What’s the plan there? Thanks.
Alan Kestenbaum
So a couple of things. Just so with respect to capital return, I mean, we’ve made two announcements today that should be reflective of our capital return policies, which are to continue the dividend. And also, we announced the NCIB, which is a continuation of share buybacks. So that’s responsive to the capital deployment question. And in terms of the inventory monetization agreement that will be – that will continue, it’s a very, very good arrangement for us and that will continue.
David Gagliano
Okay, thanks.
Alan Kestenbaum
You are welcome.
Operator
Thank you. The next question is from David Ocampo with Cormark Securities. You may proceed.
David Ocampo
Thank you. Good morning, everyone.
Alan Kestenbaum
Good morning.
David Ocampo
When we take a look at your cost per ton for the balance of the year or even into next quarter, should we expect this to trend lower with scrap prices coming off their highs and all the internal initiatives that you guys cited on the call like the coke battery have and your cogen facility or will inflationary pressures keep a lid on any of those improvements?
Alan Kestenbaum
Yes. I mean there is a lot of cross currents. First of all, we’re not really seeing scrap prices drop all that much yet. And with the recent tensions overseas, we’re not sure that scrap prices really going to retreat, so not too confident about seeing any kind of dramatic change in scrap prices. When you look at some of the other costs, whether it’s alloys, ferroalloys, like ferrosilicon and stuff like that. I mean that stuff has been going up in price. And we really don’t see that changing, again, turning towards events overseas just this morning that potentially could get worse. So not seeing a natural gas price is another one. We saw a little bit of relief a couple of months ago. Again, world events may push that higher as well. So we’re fighting. There are certain things we can’t control, the items like I’ve just mentioned, the things we can’t control. The things that we do have in our control, I think we’ve got the best COO in the business. I mean this man is – just is relentless, finding every single dollar to take down. So we’re going to fight like hell to try and offset those inflationary pressures. But I don’t see the input side of things changing very much. If anything, with world events, it could potentially get worse. But as I mentioned, we do have – we have identified $75 million in cost savings that do not involve reduction in cost of raw materials. And so we think that – we think we’re going to be able to go after those and get those as the year draws on. So as I mentioned in my remarks, those inflationary pressures are definitely there and will have an impact on our cost structure in the near-term, and we need to keep fighting it. We face it like everybody in the industry. We’re not different. We bought the same stuff everyone else buys. So we will probably have, I think, shown and demonstrated to our margins that we’ve got a lot more room before it starts hurting us. And so I think I’m pretty confident that we will be able to do a good job offsetting part of the inflationary pressures, but part of it is simply out of our control.
David Ocampo
That makes sense. And then as a follow-up, can you remind us how much the cogen and the coke batteries take out of your cost structure? And then the time line on the $75 million when that flows through to the income statement?
Alan Kestenbaum
So I think you can look at that coming in pretty evenly over the course of the year, the $75 million. As far as the cogen, we believe we’re going to save about $18 million a year. And that $18 million a year is not in the $75 million, so that’s additive. And as far as the coke battery, it’s about $7 a ton. We expect to be able to save on that, also not in the $75 million.
David Ocampo
Perfect. I will hand the line over. Thanks so much, guys.
Alan Kestenbaum
Thank you.
Operator
Thank you. The next question is from Alex Jackson with RBC Capital Markets. You may proceed.
Alex Jackson
Yes. Thanks for taking my question, guys. I guess just in terms of operating costs, the impact of inflation, are you able to quantify some of that maybe on a quarter-over-quarter basis from Q4 into Q1 here?
Alan Kestenbaum
I can’t. I don’t know, Paul, do you have any insight on that?
Paul Scherzer
Yes. Alex, I mean as you know, we typically don’t give guidance, which – and I think that’s starting to get pretty close to it. But as Alan said, we are definitely seeing inflationary cost pressures in Q1.
Alex Jackson
Okay, got it. Thanks guys. That’s all for me.
Operator
Thank you. The next question is from Michael Doumet with Scotiabank. You may proceed.
Michael Doumet
Hi, good morning guys. Just a couple of follow-ups to some of the questions. I guess for the Q1 shipments, what I am trying to figure out here is what the main driver would be for the shipments there to get a little bit more close to the Q4 shipments, that $625 or how far behind it could fall if my interpretation of the main driver there being demand or other issues? And just any sort of way to think about how shipments could bounce back through the year would be helpful as well.
Alan Kestenbaum
So, when we put out guidance a couple of months ago, and we said that we expected Q1 to be level with Q4 that was under the assumption – that was based on production capability. So, the production capability is back to where we need it to be. We did get to some of those outages that we accelerated into Q1. So, those are going well. It’s all demand right now. We are in a situation where in order to ship in this quarter, we need orders in the next week or two weeks. So, a lot’s going to depend. We are not seeing the order flow like we would expect in order to get to Q4 shipment levels. And that’s why, as Paul indicated, they will probably be a little lower than Q1. As far as the outlook, I have been saying this now for a couple of months. I mean what we lack right now is visibility, which means that we run our business. We have a tactical flexibility model. We respond instantly to changes in demand, both up and down. And right now, visibility is our biggest challenge, and we are fighting a fight every day to get what we can get. But we just don’t – we don’t – we are not in a position at this point to make any predictions. And so I think that’s where our tactical flexibility model really works because we don’t sit and build inventory. We don’t sit in with our hands up and saying, but what do we do next, we go out, we fight, we move quickly. We get orders as much as we can. And I think we have got the benefit of a low-cost position and the healthy balance sheet to carry us through. But I mean I really wish I could give you some better view on if and when things might turn around, we just don’t see it.
Michael Doumet
That’s helpful, Alan. And I guess the second question, back to the cost per ton, the cost per ton and the way I calculated is about $100 more in 2021 when compared to 2018 and 2019. And obviously, it’s understandable and you commented on some of the inflation and where that’s coming from. But if I start to think about the cost per ton longer term, what would be the main drivers to reducing costs towards the historical average and presumably even below the historical average given some of Stelco’s structural cost improvements.
Alan Kestenbaum
Yes. I mean, so a couple of things. In the number that you have cited, there is a few things going on. Does the inflationary pressures including increases of price of scrap, we never – we like increases in price of scrap because it raises the cost for everybody else. So, we never look at that as a bad thing. So – but in that number is some increases in costs and some of the inflationary pressures that you cited. And – but the other thing that you don’t get really is mix. I think if you look on a brighter note, we have continued to improve our percentage of value-added products, downstream products. A lot of that has to do with our continued penetration into the auto industry and other industries. And so as you see mix shift, that’s also going to impact the cost per ton. So, those are the factors that go in it. And so, some of it is good news like the scrap price going up, like our increased penetration into downstream markets and some of it is bad news like the inflationary pressures. The things that we can control on the things where we are focused right now in terms of operational improvements and when you look at the efficiencies of our blast furnaces, we are tops in the industry. So, if scrap prices do go down, then you will see that impact and then the implementation of our cost reductions. That’s the single biggest thing we can do. It’s selling product, being quick on our feet to our customers and being able to lower our costs. And that’s where we – we are really good at that. But you are correct, our costs have gone up and a lot of it has to do with the inflationary pressures that are continuing.
Michael Doumet
Thanks and helpful comments.
Operator
Thank you. The next question is from Seth Rosenfeld with BNP Paribas. You may proceed.
Seth Rosenfeld
Good afternoon. A couple of questions, please, starting out with pricing strategy and then secondly, on pig iron. When it comes to our sales and pricing strategy, your comment strike me as being much more cautious we have heard from many of your peers through earnings season. With that in mind, and given the history of hedging, why has Stelco decided to not hedge in the current pricing environment? I think you commented earlier that even CRU benchmark is perhaps 20% above the real market. Why is now not a good time to be hedging? I will start there, please.
Alan Kestenbaum
Yes. I mean if you look at the technical – my background is trading, and we went the route of hedging about a year ago, and hedging is a complete fool’s game, why, because if you look at the CRU, and I don’t know why this happens, but it does happen. The CRU is significantly higher than the forward curve, which means if you hedge and then you have to buy back under your position based on the CRU, I mean just take it right now, if you wanted to hedge forward, you would be hedging it like $900 a ton. And if you want to buy CRU, it’s 10 whatever. And this has been consistent in tray down, anyone that hedged got totally screwed. It’s – I don’t know who is playing around with it, but the CRU is the benchmark, but you undo the hedges. And we don’t feel like giving up a couple of hundred bucks a ton because a few traders want to play around with this market.
Seth Rosenfeld
Okay. Understood. Just to clarify on that point with regard to the disparity, can you comment on the gap between current CRU and where you see volumes being transacted in the spot market, please?
Alan Kestenbaum
Consistently, it’s been over 20%, and that has not changed. And these are historic gaps. I mean it used to be $50 a ton. But of course, that’s when CRU is at $500, $600. When at $1,490, it was outrageous. It was 25% off. Now, it’s maybe the other side of 20%, but it’s significant.
Seth Rosenfeld
Okay. Very interesting. I guess one last question with regards to product mix. Stock is quite well positioned right now from a mix or optionality perspective, given the pig iron caster. I think you recently completed building, but I don’t believe it’s been actually fully ramped up or utilized with the concern over pig iron supply out of Russia and Ukraine now. Under what price or demand environment would you consider selling pig rather than steel? Obviously, spot HRC following a great deal, but with the spot HRC price north of $900, is pig attractive, or would you prefer to stick with finished steel grade for now?
Alan Kestenbaum
Listen, the situation just broke this morning. It’s really too early for us to see what the impact. I think we have seen over time these sanctions that come out, people expect all kinds of things. I will take the oil price, for instance, the oil price shot up this morning. I don’t know, Russia has got a lot of borders, and why wouldn’t they put more oil into the market break with OPEC or whatever. No one knows what’s going to happen. It’s way too early for us to make decisions that are longer term. We have customers that we need to serve, and we have to see. But I mean we just spoke this morning. We are just not in a position yet to make decisions like that just on a win.
Seth Rosenfeld
Okay. Thank you very much.
Alan Kestenbaum
Thank you.
Operator
Thank you. There are no questions waiting at this time. I would like to pass the conference back to the management team for closing remarks.
Alan Kestenbaum
Go for it, Trevor.
Trevor Harris
I would like to thank you all for joining the call today. It’s very appreciative for you taking the time and everybody have a great day. Thank you.
Alan Kestenbaum
Thank you. Bye.
Operator
That concludes the Stelco Holdings fourth quarter 2021 earnings call. Thank you for your participation. You may now disconnect your lines.
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