Russel Metals Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
August 1, 2024

There are 7 speakers on the call.

Operator

Good morning, ladies and gentlemen, and welcome to our 2024 Second Quarter Results Call for Russell Metals. Today's call will be hosted by Marty Jurafsky, Executive Vice President and Chief Financial Officer and John Reed, President and Chief Executive Officer at Russell Metals Inc. Today's presentation will be followed by a question and answer period. And I would like to turn the meeting over to Marty Jurafsky. Please go ahead, sir.

Speaker 1

Great. Thanks very much, operator. Appreciate it. Good morning, everyone. I'll provide an overview of the Q2 2024 results.

Speaker 1

If you want to follow along, I'll be using the PowerPoint slides that are posted to our website. And all you just need to do is go to the Investor Relations section, and it's located in the conference call submenu. If you go to Page 3, you can read our cautionary statements on forward looking information. So let me start with a little bit of perspective on Q2 as I think that there's just probably 3 or 4 summary observations that I'd like to start off with. One, we performed exceptionally well, not just this quarter, but relatively consistently over the past several quarters, even though there's been a lot of steel price volatility.

Speaker 1

Over the past quarter alone, the benchmarks for sheet and plate have come off by 17% and 12%, respectively, compared to Q1. But our consolidated revenues are in fact up. I think this is the most recent example of how we've taken a lot of volatility out of the business. 2nd, there's been a lot of behind the scenes work by the company in preparing for the Samuel acquisition, which is expected to close in mid August, and I'll discuss that in more detail in a few minutes. But a big thank you to the internal team who've worked exceptionally hard to get us through the Competition Bureau process as well as some heavy lifting in terms of integration planning.

Speaker 1

3rd item, there have been a lot of behind the scenes initiatives in addition to the Samuel acquisition that provide us with a springboard for our other initiatives. 1, we've got a whole bunch of CapEx and facility modernizations underway, and I'll go through those later in the discussion as well. We've also made a bunch of changes to our capital structure, our debt structure with the new secured unsecured bank deal and the redemption of our legacy notes. So again, puts us in a very good position going forward. Lastly, we are fairly active in the quarter on our share buyback program as we have the capital structure flexibility to both invest in the business as well as opportunistically return capital to shareholders.

Speaker 1

So with that being said, let me start with the details of the materials here and we can start on Page 5. As said earlier, we've seen a lot of underlying steel price volatility over the past while as both sheet and plate prices came down during the quarter. That said, there appears to be a floor for sheet with the recent price hike in the past day or so. And when we take the price environment into account with our business, it appears that Q3 will be a bit of a transitionary quarter as the price and margin compression that occurred in the early part of Q3 along with having fewer operating days in Q3 due to summer holidays will negatively impact our Q3 margins and bottom line results, but with margin recovery expected into early Q4 and then into 2025. On the supply chain inventories, they bounced around a bit but remain in a similar zone over the past few months.

Speaker 1

In addition, there are a number of producers who have scheduled maintenance is coming up over the next couple of months and that should moderate production for the industry. Lastly, demand has been steady across our businesses. On Page 6, we have a snapshot of our historical results. The key takeaway for all these charts and these metrics is that over the past few quarters, we've generated pretty steady results. If we look across some of the various charts going from the top left, revenues were up a bit versus Q1, had been running at around that $1,100,000,000 per quarter mark for several quarters.

Speaker 1

EBITDA was $86,000,000 EBITDA margin was 8% and EPS was $0.84 a share. All of these were similar to up slightly versus Q1. Our annualized return on invested capital came in at 19% again. In looking at the public comps that have already reported, we remain an industry leader on that metric. Lastly, in terms of capital structure, we have net cash of $237,000,000 versus net debt of almost $500,000,000 at the end of 2019.

Speaker 1

So plenty of dry powder as we look at continuing with our various initiatives. Going into more detail with our financial results on Page 7. From an income statement perspective, I covered several high level items on the previous page, but a few other items to note. Revenues of $1,100,000,000 was up 1% from Q1. This in spite of the downward pressure on steel prices.

Speaker 1

Gross margins both in dollars and percent were down 1% from Q1, but EBITDA, EBIT and earnings were all up slightly as it reflects the variable cost nature of our expense profile. Our Q2 results were impacted by a few non operational items. Stock based comp was an $9,000,000 recovery versus nil in Q1. The Samuel acquisition integration cost, legal costs were another $1,000,000 and we had a $1,000,000 in non recurring non cash charge for the write off of the deferred financing costs on the redeemed 6% notes. From a cash flow perspective in Q2, we generated $6,000,000 from working capital.

Speaker 1

We did increase in inventory, which is mostly a timing issue with an inventory pickup in our steel distributor segment, and I'll go through that in a little bit more detail in a few minutes. And that was offset by a decline in AR and an increase in accounts payable. Share buybacks were active with 1,500,000 shares for $56,000,000 before tax. That being said, this was the Q1 where the federal government's buyback tax came into effect and that cost was a little over $1,000,000 We increased our dividend in June to $0.42 per share and that equated to $25,000,000 for Q2 and we've just declared the next quarterly dividend to remain at $0.42 and is payable in mid September. CapEx of $24,000,000 was in line with our tracking to be around $100,000,000 for 2024 as our key discretionary projects continue to advance.

Speaker 1

From a balance sheet perspective, we are in a net cash position of $237,000,000 In the quarter, we redeemed $150,000,000 of the 6% notes. In July, we put in place a new unsecured bank facility with no borrowing base restrictions and investment grade financial covenants. The remaining $150,000,000 of notes, the 5.75% notes become par callable in October. Our liquidity is $768,000,000 at the end of June, which is before the completion of the new bank deal in July, which added another $150,000,000 to our available liquidity. Our book value per share continued to go up in spite of the share buyback program and is now $28.22 per share at the end of June.

Speaker 1

On Page 8, we show our EBITDA variance analysis between last quarter and this quarter. For the service centers, the volumes were up from Q1, but our margins were down. There was also a $5,000,000 reduction in operating costs, which is a function of our variable compensation that toggles up and down with our financial results. Energy field stores was down slightly as was steel distributors. In the other bucket, there was an $8,000,000 favorable impact from lower mark to market on stock based compensation and also the seasonal recovery at our Thunder Bay Terminal operation.

Speaker 1

If we go to Page 9, there's our segmented P and L information. For service centers, revenues declined slightly as prices were down, but volumes were up. And I'll go through some of these metrics in a little bit more detail on the next page. In our energy field stores, we are continuing to see really solid performance. Q2 revenues were up.

Speaker 1

Margins came down slightly resulting in earnings being down slightly, but the business remains pretty steady and as you can see and as the margins have remained at around that 25% level. Distributors revenues were up, margins and operating profit were down. The logistics improved for product coming in from overseas suppliers, which led to higher volumes and revenues in the quarter, but that higher activity was offset by lower margins in parts of that business. On Page 10, we are showing a deeper dive on the metrics specifically related to our metal service center business. The top right graph is the past 5 years of tons shipped.

Speaker 1

And in Q2, our volumes were up 2% versus Q1, reflecting pretty steady takeaway. And as we benchmark ourselves against the volume from our other publicly traded comps on a same store basis, our 2% growth in volume demonstrates market gain in the quarter. On the bottom left graph, we have the revenue and cost of goods sold per tonne. On revenue per tonne, our price realization decreased by 4%, while cost of goods sold decreased by 1%, which resulted in a decline in margins that is showing on the bottom right chart. Going into Q3, as I mentioned earlier, we expect average margins to be down versus Q2 as the margins at the end of the quarter were lower than the average for Q2.

Speaker 1

And this should self adjust as we get that price stabilization as I was talking about earlier. On Page 11, we have illustrated our inventory turns. This chart shows the inventory turns by quarter for each segment, energy in red, service centers in green and steel distributors in yellow and the black line is the average for the whole company. Overall, our inventory turns remain pretty steady at the 3.9. By sector, our service centers remained strong at 4.6.

Speaker 1

Our energy field stores came up to 3.6 from 3.2, while steel distributors declined slightly to 2.3 from 2.4. On Page 12, we have the impact inventory turns on inventory dollars. Total inventory was up slightly compared to March as there was a pickup in our distributor segment due to overseas logistic issues that I previously mentioned. This should continue to streamline through the early part Q3 as product arrives into Canadian ports and then moves on to our customers. On Page 13, we have the overall impact on capital utilization and returns.

Speaker 1

Our capital deployment remained at just over 1 point $4,000,000,000 More importantly, our returns continue to be industry leading with last 12 month return on invested capital of 19%. Page 14, just provide an update on our capital structure. And there have been a number of changes during Q2 and also subsequent to quarter end. In July, we closed on our revamped bank deal. Our bank group has recognized the significant evolution in our credit profile, and we now have a more traditional investment grade type bank structure that has no borrowing base formula, is unsecured and has flexible financial covenants.

Speaker 1

The new bank deal was up sized by $150,000,000 from the previous deal and this gives us ample liquidity to call the $150,000,000 of 5.75% notes that become par callable in October. With the redemption of those notes, the already completed redemption of 150 of 6% notes in Q2 and the modernization of our bank structure will have removed all the legacy elements of our former debt structure and we now have a very clean slate going forward, which gives us significantly more flexibility. Lastly, our equity base per share continues to grow, as you see on the right hand chart, in spite of our share buybacks. And this chart on the right shows our book value per share of $20.22 which is $1.81 per share increase since this time last year. On Page 15, we have an update on our capital allocation priorities going forward.

Speaker 1

And some of these I'll dive into in more detail in a second. But given our strong balance sheet, it really remains a multipronged approach to do a variety of things that make good common sense and good economic sense. From an investment perspective, we're seeking average returns over the cycle greater than 15% as already discussed and we've delivered well above that target. The ongoing opportunities are threefold. We are continuing to identify the value added project opportunities, facility modernizations.

Speaker 1

We have 5 underway that are tracking for completion at various times towards the end of this year. And I'll go through a bit of an update on this front in a few minutes. And then in terms of acquisitions, we are targeting close the Samuel acquisition on August 12, and we are continuing to explore other growth opportunities from acquisitions. For turning capital to shareholders, we adopted a flexible approach. In May, we announced the 5% dividend that will be payable in September.

Speaker 1

For the NCIB, we are very active in the quarter with 1,500,000 shares acquired for $56,000,000 That equates to $38.08 per share for this quarter. And if we roll back to August of 2022 when we first put our share NCIB in place, Since that time, we've acquired about 5,000,000 shares, which equates to about 8% of our shares outstanding at an average price of 36 $0.30 We expect to continue to utilize the NCIB on an opportunistic basis. On Page 16, just given a longer term context around some of those topics returning capital to shareholders. Top left graph, you can see the dividend profile over an extended period of time with just announced $0.42 per share per quarter that will be payable in Q3 and we'll continue to regularly revisit the appropriate dividend level to take into account our capital structure earnings profile as was done when we lifted the dividend in both May of 2023 and in May of 2024. On the bottom left chart, that's where we have the quarterly NCIB activity since we put it in place in mid-twenty 22.

Speaker 1

It does illustrate that we don't have a hardwired or fixed approach to the program, but view it as an opportunistic way to buy back shares. And we've been more aggressive at certain price points than others including this past quarter. On the bottom right chart, the impact of the NCIB has been a gradual reduction of our shares outstanding over the past 2 years that has resulted in that 8% reduction in our share counts. On the top right chart, the aggregation of the dividends versus the NCIB over the past year shows a relatively balanced approach, not the same quarter to quarter, but over an extended period of time, it's been relatively balanced. Over the past 12 months, we've acquired a little over $100,000,000 of our shares and the current run rate for our dividends tracks to around $99,000,000 per year.

Speaker 1

Note that also what's interesting is the cash outflow for our dividends has remained consistent around $24,000,000 offset the per share increase in our dividends. On Page 17, I have a bit of an update on the Samuels acquisition. As I said earlier, we have a targeted close date of August 12, so it's not too far away. And again, I just really like to repeat John and my appreciation to all the folks internally and frankly the coordination with the folks at Samuel as well in getting ready for this transaction closing. It's a complicated transaction in terms of transitional planning and there's been an awful lot of effort from a whole series of folks at Russell in getting ready for this position.

Speaker 1

So the deal structure itself has remained unchanged, but there are 2 updates. One, since we announced the deal, Samuel's inventory has come down by about $40,000,000 and you can see that into the chart below where it went from $154,000,000 at September 23 to $114,000,000 which was the latest balance sheet at June 30 this year. And the deal structure was set up, so the purchase price moved up or down on a dollar for dollar basis with any changes in working capital. As a result of the sizable reduction in inventory, there will be a direct reduction in that element of the purchase price and moves us forward in terms of our goal of trying to right size the capital invested in this business. For administrative simplicity, we also elected to not assume most of the accounts payable component of working capital.

Speaker 1

Again, it's really an administrative and not an economic impact. As illustrated on the chart, at September 30, 2023, that represent about $46,000,000 Therefore, closing will not take over that liability and it will be in a position to then just rebuild that accounts payable in normal course, which will be a source of cash flow for us in the 1st few months. Again, it's really an administrative reason that we've done that and it really doesn't have any impact from an economic standpoint. On Page 18 and 19, I want to provide an update of our facility modernization CapEx projects. And we've historically talked a lot about the value added projects that we're doing, but a big part of our CapEx investments is also related to these facility modernizations.

Speaker 1

And in some ways, not are they only going to be facility modernizations that enhance our product flow, improve logistics, provide health and safety benefits, but they also give us the space as we want to put in more and more value added equipment into some of these facilities that were space constrained in the past. On Page 8 excuse me, Page 18, there's some recent pictures of the Greenfield project in Saskatoon. It's well underway and we expect to be moving in later this summer. The project involves relocating our business to a new industrial park in Saskatoon that has much better logistics, improved facility layout than our previous locations in the city. But equally important, it will also be freeing up some value from the real estate at our at our legacy location.

Speaker 1

And this type of scenario is sort of illustrative of some of the other alternatives we are considering with our legacy real estate in other locations. On Page 19, there are 4 facility modernizations in our U. S. Operations. Each example is taking an existing footprint and adding a sizable expansion to accommodate the growth in volumes as well as accommodate the opportunity to add some of the value added equipment.

Speaker 1

It's also interesting to note that 2 of these 4 projects are locations that came by the Boyd acquisition. And one of the important things that we look for in acquisitions is the opportunity to strategically deploy incremental capital to growing those acquired businesses. And the example in Joplin and Little Rock are perfect examples of growth that came through those acquisitions. Page 20 is a chart that we've not shown before, but I think it illustrates the significant change in our portfolio over the last couple of years. And we've discussed in the past how our actions have reduced the volatility of our operating results and have raised the floor through the cycle.

Speaker 1

In the top graph, it's a little bit busy. So let me walk you through it in a second. And it's snapshot from 2020. And each of those dots represented each of our business units that we had at that point with one axis being gross margin and the other axis being return on net assets. And what's also interesting is 2020 was a very difficult year from an economic perspective being at the front end of COVID.

Speaker 1

So it was a really great year to test how businesses can perform. All businesses do reasonably well in up years. It's really a question of how they're doing in a down year. So that's why when we look at stuff from 2020, it provided us a frame of reference for how challenging some of our businesses were. The red dots represents the business units that had experienced challenges and were frankly a drag on our results and where remediation was required.

Speaker 1

And all of those business units, those underperforming business units have been fixed or monetized in one way or another. So there was an awful lot of listing attached to it. But when we talk about the changes in our business, it was a whole series of actions. And again, using this snapshot back to 2020, you can see the impact of what those did to drag our results in 2020 and have since been course corrected. In addition, we've invested in our core operations through acquisitions like Sanborn, Boyd, Alliance and Short Samuels as well as the CapEx initiatives that we've talked about many times in the past.

Speaker 1

And so it's continuing to reinvest in those opportunities that add to our green dots at the same time that we've dealt with those problematic business units as illustrated by the red dots. The impact of all those initiatives is somewhat illustrated in the bottom chart where this past cycle has resulted in stronger earnings during the upcycle, modest use of working capital during the upcycle and lower earnings downside in situations where steel prices encountered the volatility that they've encountered over the past few quarters. So in closing, on behalf of John and other members of the management team, I'd like to express our appreciation to everyone within the Russell family for your contributions. In particular, many people have really stepped up and provided significant leadership and demonstrated the commitment and teamwork as we continue to make inroads in advancing the business. So operator, that concludes my introductory remarks.

Speaker 1

If you'd now please open the line up for questions.

Operator

Certainly, sir. And your first question will be from James McGarrigle at RBC Capital Markets. Please go ahead.

Speaker 2

Hey, good morning and appreciate you having me on.

Speaker 1

Thanks, James.

Speaker 2

Just looking at the results sequentially at your service centers, I mean, you talked about some potential pressure on margins, given the weak deal price environment, you gave us some good color on the volumes. But that seems to imply potentially some pressure on earnings into Q3, but then we also have the same deal posing in the quarter. So just kind of like given all those moving parts, can you just give us some color on how we should be thinking about sequential earnings trends into Q3?

Speaker 1

Yes. Look, it's a fair observation, James, because there are a series of moving pieces. And maybe it's easier to start with the Samuels acquisition. So it's going to close halfway through the quarter. But as is typically the case, there's always lots of noise and transitional costs associated with it.

Speaker 1

So even though it will probably add a half a quarter's worth of revenues and a half a quarter's worth of volumes, there's always noise in some of those operating costs and how that flows through and accounting for acquisitions. So for all intents and purposes, it shouldn't show much impact from a bottom line result because of the relatively short contribution period for Q3. The more impactful item will be, as I talked about and you mentioned in your questions, is some of the margin dynamic that was evolving through Q2 and into the early part of Q3, which is appears to be self correcting over the next little bit and then into Q4. So sequentially, Q3 margins and Q3 results for the service centers are expected to be down versus Q2.

Speaker 2

Thank you. And just a longer term question on how you're thinking about 2025. I'm not asking for guidance because I understand lots of things can happen between now and then especially within your industry, but it seems like steel prices starting to pick up potentially, a lot likely a lot more some positives from these modernization programs. Samuel integration could be a big positive. So, if three things that could drive some significant growth in 2025, so can you just maybe help frame the opportunity around each of those and how we should be thinking about that into 2025?

Speaker 1

Yes, well, look, it's a great question, James. And frankly, I think you framed it up probably better than I could, because all of the stuff that's going on right now, it provides a really nice springboard into 2025. We already talked about Q3 and it's a sort of transitionary quarter. And then when we get into Q4, there's just a seasonal slowdown that occurs of holidays around U. S.

Speaker 1

Thanksgiving, Canadian Thanksgiving and the Christmas holidays. So you lose some operating days. But all the stuff that has happened and we're continuing to work on provides a really nice springboard. So at a macro level, conditions within the industry are set up for improvement, because I think we've hit a floor and then with recovery bouncing back from there. And again, that usually takes a couple of months to work itself through the system.

Speaker 1

And so it bodes well for 2025. And then the things that are within our control, we're really excited about. The Samuels acquisition is a meaningful part of what we're trying to do. It is a significant opportunity for us to both grow in the Northeast U. S.

Speaker 1

As well as integrate what we're doing within the Western Canadian business. That being said, there's a lot of heavy lifting that our team is going to be doing to be putting their business together with our business. Is a lot of really unsexy stuff related to systems and back office and being organized so that we can be efficient as a platform. But it really is going to set up very well for 2025. And as those things start coming to the table, the good news is on Samuels, we've already seen a sizable reduction in their capital deployment, which was part of our game plan, but we inherit a lower invested capital base coming in given what's happened with the business over the last little bit.

Speaker 1

And then our other internal initiatives that we're working on, when I went through those couple of pages on the facility modernizations, those are all slated to get done in 2024. So going into the New Year, those are operational. So that capacity flexibility that we have, they will be in place. The new equipment projects that we talk about, we're constantly green lighting new opportunities, But we'll have made really good progress on a bunch of the stuff in 2024 that will start having recognizable impact on top line and bottom line in 2025. So it's a long winded way to say, I think your question was really spot on, on all the things that are out there for us, which is why it's interesting for us, with all the initiatives that we have underway and the springboard effect that it should play out for 2025.

Operator

Next question will be from Michael Tupholme at TD Cowen. Please go ahead.

Speaker 2

Thank you. Good morning.

Speaker 1

Hi, Mike. Good morning.

Speaker 3

First question is just regarding steel prices. You noted in your outlook in the release and the comments today that you expect to see steel prices stabilize. And I guess you mentioned, it looks like we may be seeing some stabilization in HRC, but did see plate or have seen plate continue to trend a little bit lower here, I think down again yesterday. Wondering if you could just talk about the differences you're seeing in those two markets?

Speaker 4

Thanks, Michael. And you're exactly right. We've seen increases come out from 2 significant mill players in North America. We've also seen the index come up this week on HRC. So, we're starting to see that market move back up.

Speaker 4

It does appear to have stabilized. Marty mentioned in his comments, we also will see some mill closures for typical maintenance during the quarter. So several mills will take that supply out of the market. So we think that will further help cement that supply demand relationship. Plate typically follows maybe about 30 days HRC, it's not always there'll be some intermittent moments, but it typically will follow.

Speaker 4

So it may drift just a little bit further, but we think it's coming to a bottom. The typical spread historically had been $180 to $200 a ton with the inflationary pressures at the market seeing it to mill level. My understanding that's now moved up about $100 so call it $2.80 $300 a ton. HRC coming up, coming down a little as you referenced yesterday. We're starting to get close to that number again.

Speaker 4

So, it feels like we're getting to that point as well with plate probably very shortly.

Speaker 3

Okay. That's certainly helpful. Thank you. Switching over to the margins, you noted that we should expect to see some a little bit of margin deterioration in Q3 versus Q2 on a sequential basis before recovery begins to set in later in the quarter and into Q4. It sounded like that was quite a specific comment around Service Centers.

Speaker 3

So I guess the question would be just to confirm that. And then if there's any way to kind of help us understand how we should be thinking about Q3 margins

Speaker 1

in terms of actual levels given the various moving pieces here? Yes. So you're right, Mike. It was specifically to the service centers, but it also spills a little bit over into steel distributors as they have similar cycles. A couple of nuance differences in our case, but I'll come that in a second.

Speaker 1

But as it specifically relates to the service centers, we'd characterize as probably the end of quarter margins versus the beginning of quarter and Q2 quarter gross margins were about 75 basis points difference. So it kind of gives you a frame of reference of what happened during the quarter and the orders of magnitude going into Q3. If I flip it over to energy, it's more of the same. Not a lot of variation of what we're seeing, pretty good steady. So don't expect to see a whole lot of change in terms of our activity level or margin on the energy side of it.

Speaker 1

The 3rd segment, steel distributors, as I said earlier, there is a dynamic where directionally the margins will follow what's going on in the broader steel market. We do have though the dynamic of some top line debottlenecking that occurred at the end of Q2 and is continuing to Q3 for our Canadian business that brings product in from overseas markets. It was a little bit of log jamming going on, on the overseas logistics in late Q1, early Q2 and some of that will spilled over into the end of Q2 and into Q3. So we should be okay on the top line perspective in steel distributors in Q3, but the margins will flow similarly to what happens in the broader steel market.

Speaker 3

Okay. That's all helpful. Maybe just two clarifications. I guess, first off, when we're thinking about service centers margins, it sounds like most of what you're describing in terms of the changes in margin in Q3 versus Q4 and then where we go from there is really being driven by, I guess, fluctuations in steel prices and the way they've been trending as opposed to really a discussion around the impact that Samuel is going to have. Is that fair to say?

Speaker 3

Like do we need to take what you're suggesting and then sort of layer Samuel in on top of that?

Speaker 1

Correct. Yes, exactly. It's spot on. I was looking my comment was more on a same store equivalent basis and then the Samuels is a layer on.

Speaker 3

Okay. And then just on energy, to your point, I mean, quite stable in that business, the margin performance. But we did see margins sort of dip down a little bit below the 25% level in the second quarter. What is the driver for that? I mean, I guess, again, fairly stable, but just a little bit lower than we've seen in recent quarters.

Speaker 3

Just wondering what caused that?

Speaker 1

Yes. It didn't move by that much, Mike. And I think, I mean, at the end of the day, there's always a bit of a range, and it's still operating within that range, plus or minus 25%, maybe it's a shade higher, maybe it's a shade lower, but that is sort of give or take the range. So there wasn't any big driver in and of itself other than it's still operated within that normal zone.

Operator

Next question will be from Frederic Bastien at Raymond James. Please go ahead.

Speaker 5

Good morning. Apologies if you have touched on this before because I just hopped in here. Marty or John, are you in a position to comment on your expectations for the Samuel assets once you integrate them into your operations? Are they any different from what they were in December when you first announced the transaction?

Speaker 1

At a really high level, Fred, it's exactly as we expected. The benefit of the only benefit of the passage of time and how long it's taken to get through the regulatory process is we've had the opportunity to do more planning, being more thoughtful, working especially over the last couple of months with our counterparts over at Samuels. And it's exactly as we are expecting it to be. The opportunities are exactly as we expected them to be. The specific game plans are pretty much tracking to what we were expecting them to be.

Speaker 1

So as advertised is the way I'd characterize it. And the only real change, as I mentioned earlier, is we benefited from the fact that we're inheriting a lower invested capital base going in and that's an adjustment to our purchase price down. And so one of the things that we had expected coming out of the gate is to focus on reduction of working capital, specifically inventory, but most of that has already taken place with the passage of time and what Samuels has done on their own over the past number of months. But beyond that, John, I'm not sure if you have anything incremental, it's we're pretty excited about the opportunity because it's exactly what we thought it was going to be.

Speaker 4

And I agree with Marty, Fred. It's as advertised. A lot of work has gone on both sides and it's been very pleasant to work with. As Marty mentioned, a lot of the lifting was done by Samuels bringing the inventory in line. It's still not quite to our level of turn, so there's still some room to go there, but a lot of that's been done upfront.

Speaker 5

Cool. And are your like key customers in Western Canada happy to hear that you're emerging? Are there any issues that you have brought up or anything like that?

Speaker 4

Yes. So far, we're hearing overall from everyone that we've talked to is they look at this as something that will be good for the market, maybe a little more stabilizing for the market long term. And so they seem to be very positive to that.

Speaker 5

That's great to hear. Okay, that's all I have. Thanks.

Speaker 1

Great. Thank

Operator

you. Your next question will be from Ian Gillies at Stifel. Please go ahead.

Speaker 6

Good morning, everyone.

Speaker 1

Good morning, Ian.

Speaker 6

When I look at the Q2 results and the relative outperformance of your average selling price versus HFC in place, I'm just curious whether you would attribute that to some of the value added processing investment you've done over the last few years, and whether we could expect to see further stability in that number with more investment as time passes?

Speaker 4

Okay, Ian. Really astute observation there. And interestingly enough, we were touring one of our facilities yesterday with the Board and we were showing the difference in the value add and the as is material there and as that continues to grow on a percentage basis, how that does create that stability. And so you will see steel prices go up and down, but again that margin component of the value add does not. And so it's a real opportunity for us and we just continue to add to that incrementally.

Speaker 4

I think we've talked about this in the baseball references, a lot of singles are chipping away and it just continues to get better. We still have a lot of those initiatives on the go. Some will come to fruition through the last half of this year, 1st part of next year. So, we'll continue to chip away and grow that portion a a more normalized bandwidth.

Speaker 6

That's helpful. Maybe switching gears a little bit. We've obviously seen the steel M and A cycle heat up on the producer side. You've done the Samuel deal earlier this year. Are you getting any sense that maybe on the distributor side that it's going to get perhaps a little easier, a little looser to get deals done over the next 12 to 18 months?

Speaker 1

It's hard to handicap getting things over the finish line, but we are seeing a lot a fair amount of activity. And we have it's not like there's been a shortage of things that we've looked at over the last year, 2 years, 3 years, and we're continuing to see that deal flow. I think what is helpful though as there was sort of a period of time where there wasn't a lot of stuff that was transacted because I think there were probably fair amount of disconnects between buyer expectations and vendor reality. There's just a value disconnect. And so there wasn't an awful lot of transactions.

Speaker 1

But there's been a couple of things that have come over the finish line in the industry as there's some broader themes that are occurring within the industry. I think that just bodes well for having buyer and seller expectations becoming more in line. And we're pretty value conscious. So like we care a lot about what we pay for stuff, whether internal investments or through acquisitions. So I would expect there's going to be more opportunities that fall into the criteria that works to us, both from an operational perspective, but also from a value perspective.

Speaker 1

And yes, so we're optimistic that over the next little bit, there'll be more opportunities.

Speaker 6

And then lastly, if you look at the presentation, there's obviously been a natural decline in the return on capital employed as steel prices have rolled off. But as Russell thinks about where they'd like to see the return on capital employed stabilize, do you have a range you'd be willing to put out there of where you'd like to see that or something you'd be comfortable with?

Speaker 1

Well, we still use 15% as our target return over the cycle. Now again, that's over the cycle and some years will be better and some years will be worse. But overall, we're trying to get to the 15%. So the target for us remains the same. We've generally generated more than that on average over the last couple of years.

Speaker 1

And obviously, a lot of that has been driven by the very favorable market. But it's still the way we look at internal investments, it's the same way we look at acquisitions. So that remains the target we look for. That being said, there'll be some things that some initiatives might have a 2 or 3 year payback attached to them and some might be longer. On average though, that's what we're trying to achieve is that 15% -ish type of turnover the cycle.

Speaker 6

Understood. Thanks very much. I'll turn the call back over.

Speaker 1

Thanks, Ian.

Operator

Next is a follow-up from Michael Tupholme at TD Cowen. Please go ahead. Thanks.

Speaker 3

Marty, can you provide an update on intended plans for integration activities, let's say, over the balance of 2020 4 once you close on the Samuel acquisition?

Speaker 1

Lots is, I guess, the short answer. And maybe I'll turn it over to John because John is in the crosshairs of that in a lot of ways. But it really is it's across the board. It's operational. It's systems, it's a whole series of initiatives.

Speaker 4

Michael, again, we'll look at the systems and bringing those over very systematically. They're on 2 separate systems, both in Canada and the U. S. So we'll bring those over. They'll operate within our regions that we have already established.

Speaker 4

Williams McCall would handle the United States that's coming over for Samuels on a separate computer system versus what we'll have in Western Canada under the Russell Metals and Broadal that's already there provincially. So those individual divisions will go under those regions. And so there'll be a lot of integration there, again with 2 separate systems, obviously with payroll systems and HR systems coming over to ours initially. So those will be put in place, then we will start to look at operational opportunities that are out there between the two businesses and how we can maximize what's out there. It's our capacity utilization on equipment.

Speaker 4

We've done some of that homework now. We'll continue to do that. Ideally, that works better when you're on the same computer system. So, there will be a lot of moving parts in the first year. As Marty mentioned, there'll be some costs associated with that, but we see that moving fairly quickly over the 1st 12 months.

Speaker 4

And

Speaker 1

in some ways, John, and Mike, this goes back if you recall the maps that we have shown in the past related to their footprint and our footprint, every facility sort of has a different story of what the opportunity is. In the Northeast U. S, it's an extension of our platform into Buffalo and Pittsburgh where we don't have current operations in that region. So the integration planning in that region is different than it is in Manitoba or Alberta or BC where we have different locations, different products, different equipment. So it really is highly tailored and there are very specific game plans in each particular location and each particular location has a very, very different game plan of how to achieve those benefits.

Speaker 3

That's helpful and I appreciate there's a lot going on and so do appreciate the color there from both of you. Maybe just one other question on Samuel. Marty, you called out some of the changes in non cash working capital accounts that have occurred. But if we just think about the expected purchase price on closing that you will actually be paying? If I'm understanding this correctly, to me, it seems like it's similar to what you'd originally announced, but if you can just clarify that.

Speaker 1

Yes. So cash out the door on closing will be similar, but it's a little bit of an artificial number because we're not inheriting any accounts payable that would be the normal course part of working capital. So over the next 2 months, we'll be rebuilding it. So on closing, it'll be around that $225,000,000 mark, but we won't have any cash going out the door to pay trade payables for the 1st 2 months. So it's the economic equivalent of more like $180,000,000

Speaker 3

Okay. And I was just going to ask the you had intended to bring investment working capital down, but the payables number that you're not inheriting, we should assume you will ramp it back up to a similar level to what it was when you announced the deal?

Speaker 1

Yes, like well, yes and no. It ebbs and flows. A big part of a pounds payable is trade payables, which is also driven off of steel prices that ebb and flow. But directionally, if it was September 30 all over again, it would be close to that $45,000,000 number, yes.

Speaker 3

Okay. I'll leave it there.

Speaker 1

There's another way, Mike. Another way, Mike, that $45,000,000 equivalency will be a cash benefit in the 1st 2 months as it as that accounts payable builds back to a normal level as opposed to having to deal with trade payables and cash going out the door day 1, day 2, day 3. There's no cash going out the door for those first, call it, 2 months as we rebuild that level.

Operator

And at this time, gentlemen, we have no other questions registered. Please proceed.

Speaker 1

Great. Thanks, operator. Look, everybody, really appreciate joining our call. I know it's really busy this time of year, in particular yesterday and today with a variety of things going on. If you have any follow-up questions, please feel free to reach out at any time.

Speaker 1

Otherwise, we look forward to staying in touch during the quarter and into Q3. Thanks very much. Bye bye.

Operator

Thank you, sir. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. At this time, we ask you to please disconnect your lines.

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Earnings Conference Call
Russel Metals Q2 2024
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