Schnitzer Steel Industries Inc (SCHN) 2017 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Schnitzer Steel Third Quarter 2017 Earnings Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Ms. Alexandra Deignan. Ma'am, you may begin.

Thank you, Kailey. Good morning, everyone. I am Alexandra Deignan, the company's Vice President of Investor Relations. Welcome to Schnitzer Steel's Third Quarter Fiscal 2017 Earnings Presentation.

In addition to today's audio comments, we have prepared a set of slides that you can access on our website at www.schnitzersteel.com or www.schn.com.

Before we get started, let me call your attention to the detailed safe harbor statement on Slide 2, which are also included in our press release of today and in the company's Form 10-Q, which will be filed later today.

As we note in Slide 2, we may make forward-looking statements on our call today, such as our statements about our outlook and targets for growth. Our actual results may differ materially from those projected in our forward-looking statements. Additional information concerning factors that could cause actual results to materially differ from those in the forward-looking statement is contained in Slide 2 as well as our press release of today and our Form 10-Q.

Please note that we will be discussing some non-GAAP measures during our presentation today. We've included a reconciliation of those metrics to GAAP in the appendix to our slide presentation.

Now let me turn the call over to Tamara Lundgren, our Chief Executive Officer. She will host the call today with Richard Peach, our Chief Financial Officer and Chief of Corporate Operations.

Good morning, everyone, and thank you for joining us on our fiscal '17 third quarter conference call. This morning, we issued our press release, which is posted, along with our slides, on our website.

On our call today, I'll review our third quarter results, the market and macroeconomic trends underlying our quarterly performance and progress against our strategic priorities. Richard will then provide more details on our segment performance and our capital structure. I'll wrap up with some closing remarks, and then we'll take your questions.

So let's start on Slide 4. Earlier this morning, we reported fiscal third quarter earnings per share of $0.60 and adjusted EPS of $0.56, representing significantly stronger performance versus last year and versus the second quarter of fiscal '17. Through the first 9 months of fiscal '17, we have delivered our best reported earnings per share since fiscal 2012. And at the same time, we have continued our trend of consistent cash flow generation, which has enabled us to invest in our business, reduce our debt and return capital to our shareholders.

Our results this quarter were primarily driven by our Auto and Metals Recycling division, which, as you can see on this slide, delivered better performance across the board. AMR's operating income reflects its best third quarter in the last 5 years.

Our Steel Manufacturing Business achieved slightly better than break-even operating income on higher sales volumes, which were up sequentially and year-over-year. However, the pricing and margin benefits of the stronger volumes were tempered by the continued impact of low-priced rebar imports into the West Coast.

As of the end of the third quarter, we've now achieved substantially all of the $30 million of cost savings and productivity initiatives we announced in April of last year, which, so far, has brought the total benefits of our multi-year plan to $160 million. Our execution on these initiatives and our culture of continuous improvement and operational efficiency is providing sustainable benefits to our organization and our stakeholders.

Last quarter, we announced our 3-year organic volume and margin objectives. As our Q3 performance illustrates, we have made a strong start towards achieving these targets. In addition, during the quarter, we announced our intention to integrate our Steel Manufacturing Business and our AMR-Oregon Metals Recycling Business into a new operating division, which we have named Cascade Steel and Scrap. We are undertaking this transformation in order to improve product quality, to enhance customer service and to generate operational synergies. We'll cover this organizational change in more detail later on our call.

Now let's turn to Slide 5 to review metal market pricing trends. As we entered the third quarter, ferrous market prices were peaking just above $300 per ton, marking their highest level in almost a year. Mid-quarter prices dropped about $25 a ton and have remained relatively stable through June. The relative stability of the scrap market compares to the iron ore and met coal markets, where we saw more volatility during the quarter. However, scrap has remained competitive against alternative products, such as billets, for a number of reasons, including relative price, the broad-based demand for scrap, and the increased focus on the environmental benefits of scrap usage.

Similar to the ferrous market, pricing in the nonferrous market during the quarter was also relatively stable, with prices for copper and aluminum trading within a tight range.

Let's move to Slide 6 to review our ferrous sales trends. One of our strategic priorities is to increase and diversify our ferrous sales volumes, both of which are illustrated on the right-hand side of this slide. Compared to last year's third quarter, our ferrous sales volumes have increased by 14%. And through the first 9 months of this fiscal year, our ferrous sales volumes have increased by 11%. We have also been able to significantly diversify our shipments, selling into 12 countries through the first 9 months of fiscal '17 versus 7 countries for the same period last year. There are several drivers underpinning our year-over-year higher volumes, including improved market conditions, broad-based demand for scrap, stronger supply flows and improvement in U.S. economic indicators and the reduction in China's finished steel exports.

In recent earnings calls, we've highlighted a number of trends worth following with respect to China's excess steel manufacturing capacity and overproduction, and their impact on scrap prices and volumes. Although capacity in China has been reduced with the closure of induction furnaces, along with production curtailments to lower emissions, China's reported production is up 4.4% through the first 5 months of 2017 after a 1% increase in 2016. However, this increased production apparently is being absorbed by internal demand as China's finished steel exports are down 26% year-over-year, which has helped to return some stability to the market.

On a longer-term basis, we anticipate demand for scrap to continue to increase. Industry experts expect that there will be increased global demand for scrap as EAFs become a larger component of the global steel sector. The attraction of a lower, more flexible cost base, together with increased environmental compliance requirements, has the potential to increase the proportion of EAFs from approximately one-third of global capacity today towards 50% over the longer term.

These expectations show signs of becoming a reality even in China. A number of recent reports highlight China's increased scrap usage last year, along with their initiatives to continue to increase the amount of recycled scrap used in their steelmaking processes. All of these trends support an improved market for the scrap industry.

Let's move now to Slide 7 to review key domestic macroeconomic trends influencing our markets. On this slide, we illustrate many of the key leading indicators for the generation of scrap and the demand for steel, all of which continue to display positive momentum. The U.S. industrial production index, which includes, among others, the energy, automotive and construction industries, has continued its positive trend for the last 6 months, and during our Q3, hit its highest point in over 2 years. Growth in personal consumption expenditures, consumer confidence and housing starts have all maintained momentum, with each measure continuing to trend up year-over-year.

Other key indicators supporting the recycling pipeline are white good appliance shipment trends, light vehicle sales, including used vehicles, and the average age of vehicles on the road. All are good indicators and reflect the steadier and stronger flows into the recycling pipeline that we see across our platform.

Let's move to Slide 8 to review progress against our strategic priorities. Last quarter, we announced key organic volume and margin growth objectives. As we indicated then, we believe we can grow our ferrous sale volumes by approximately 25% to 30% over the next 3 years from the base of 3.3 million tons in fiscal '16.

In addition, we anticipate the benefits from the operating leverage that we have created through our $160 million multiyear cost savings and productivity initiatives should enable these additional tons to be added at higher incremental margins, enabling AMR to deliver operating income per ton margins of at least $35 per ton, which is an increase of more than 40% over the trailing 12-month average we reported at the end of Q2.

We are very pleased that through the third quarter of fiscal '17, our volumes and margins have substantially improved from last year and moving positively and steadily towards the achievement of our 3-year growth objective.

Now of course, while macroeconomic and industry indicators are showing positive trends, political and economic uncertainties could impact the timing and trajectory of this growth.

So let's now turn to Slide 9 to discuss the formation of our new segment, Cascade Steel and Scrap. As I mentioned earlier, we have integrated our Steel Manufacturing Business and AMR's Oregon Metals Recycling Business to form a new division, which we have named Cascade Steel and Scrap. The strategic rationale underlying this new platform is based on 4 principles: improving product quality; enhancing customer service; increasing operational flexibility; and more effectively managing logistics.

The CSS platform will include our steel mill in McMinnville, Oregon, our metals recycling and export operations in Portland, 6 recycling feeder yards and 1 distribution center. Our newly integrated platform will enable CSS to continue to serve both Cascade and third-party domestic and export markets with more flexibility and agility. This integration represents a new phase of productivity initiatives we have underway to achieve process improvements and cost efficiencies and follows on from our multiyear $160 million program.

Now let me turn it over to Richard for a review of our segment performance and our capital structure.

Thank you, Tamara. I'll start with a review of the operating trends for the Auto and Metals Recycling business. On a sequential basis, average ferrous selling prices improved by 4% and were up by 20% compared to the prior year quarter. As Tamara referenced earlier, ferrous sales volumes were up by 12% sequentially and by 14% year-over-year.

For the first 9 months of fiscal '17, ferrous sales volumes have increased year-over-year by 11%. Among a variety of factors, these strong trends reflect better market conditions relative to last year and the success of our sales diversification strategy. Improved supply flows support these trends with car purchase volumes for our retail stores reaching a quarterly record of 108,000 cars. These volumes are up by 32% for the first 9 months of fiscal '17 compared to the same period in the prior fiscal year.

Nonferrous selling prices were up by 2% sequentially and by 12% year-over-year, and sales of nonferrous were up 32% on both these comparisons. This increase in volume came from the combination of improved supply flows, higher shredder production and also from the timing of sales. For the first 9 months of fiscal '17, nonferrous sales volumes are up by 18% year-over-year.

Moving to Slide 11, I'll review AMR's operating income and operating income per ton. AMR achieved its best third quarter operating income in the past 5 years. Adjusted operating income was $29 million, which excluded a $1 million gain on the sale of a surplus asset. Excluding the impact of average inventory accounting, AMR's third quarter performance was a sequential increase of $7 million and was up by $5 million from the prior year quarter. On the same basis, adjusted operating income per ton increased sequentially by $5 to $31 per ton.

Operating leverage on higher sales volumes is the main reason for our increased profitability. Performance in the third quarter also reflected seasonally higher parts sales and increased admissions to our Pick-n-Pull retail stores. The trend of higher sales volumes and of operating income per ton indicates our ability to achieve our long-term targets for growth.

Moving to Slide 12, I'll cover operating trends in our SMB segment. SMB's adjusted operating income was slightly above breakeven at $400,000. This was an improvement sequentially from higher average selling prices and from increased volumes. Sales volumes were 141,000 tons, which was a sequential increase of 33%, and compared to last year, an increase of 6%. Sales volumes have benefited sequentially from seasonally higher construction activity.

SMB's average selling prices were up by 5% sequentially and by 9% year-over-year. This reflected a combination of higher raw material costs and a product mix improvement. However, price pressure from low-cost imports continued to limit increases in selling prices and led to compression in operating margins for SMB.

Looking ahead to the fourth quarter and consistent with our previous practice, we will provide preliminary results in late September. These will include our new Cascade Steel and Scrap reporting segment and comparative information will be revised accordingly. While still early in the fourth quarter, we currently expect to achieve continued year-over-year growth in ferrous sales volumes. We also expect that in the fourth quarter, the combined operating income of our two operational segments will be significantly better year-over-year, and compared to the third quarter, will be in the same range as the aggregate performance of our existing two operational segments.

Moving on. Let's proceed to Slide 13 to review our capital structure. Quarterly operating cash flows were $45 million. This strong cash flow was generated from a combination of increased profitability, which contributed around two-thirds of the total, and from lower working capital, which produced the remainder. For the first 9 months of fiscal '17, our operating cash flow is comparable year-over-year at $51 million. And similar to last year, we aim for a strong finish to the full year performance period. As a consequence of our cash flow, net debt at the end of the third quarter was $169 million, a sequential reduction of $31 million. Net debt leverage was reduced to 25%.

The trend of increased profitability and also the reduced leverage is notably observed in our net debt-to-adjusted EBITDA ratio. This ratio is now at 1.6, demonstrating the combined benefit of improved financial performance and the increased strength of our balance sheet.

In the third quarter, we invested $10 million in capital expenditures, which mainly included equipment replacement and environmental projects. For the fiscal year as a whole, we expect total CapEx to be in the range of $45 million.

We paid our 93rd consecutive quarterly dividend and our priorities for capital allocation remain balanced among investing in our business, reducing our debt and returning capital to our shareholders.

Now I'll turn the remainder of our presentation back over to Tamara for her summary remarks.

Thank you, Richard. Over the last several quarters, we've highlighted favorable industry trends and leading economic indicators that are creating conditions for improving scrap and steel markets.

Combined with our successful operational transformation, we're delivering growth as evidenced in our strong quarterly performance. We are well on our way to our best year in the last five as we benefit from our cost savings and productivity initiatives as well as our strategic initiatives to increase our volumes and expand our margins. We continue to focus on growing our market share, increasing our profitability and investing in technologies and systems to enhance our products, increase our service offerings to our customers and operate our company even more efficiently.

Our ability to consistently generate positive cash flow and our strong balance sheet provide the foundation for our growth, for our disciplined reinvestment in our business and for our continued ability to return capital to our shareholders.

In closing, I'd like to thank our employees, many of whom I know are listening into our call this morning. Our financial and operational performance illustrates your ability to successfully execute our strategy and drive best-in-class results without wavering from our core values of integrity, safety, environmental stewardship, quality and customer service. My thanks go to each of you as you've truly demonstrated why we have continued to be a leader in the recycling industry for well over a century.

Now operator, let's open up the call for questions.

(Operator Instructions) Our first question comes from the line of Evan Kurtz with Morgan Stanley.

So I guess my first question is just on the targets that you laid out for 2019, the 4.1 million tons to 4.3 million tons. How much of that is internal initiatives versus market? And what are those initiatives exactly?

Sure. Well, our focus is clearly on increasing our volumes profitably, so expanding our margins along with that. And what you can see from the last several years when we've undertaken a multi-year cost reduction and productivity initiative program, we have reduced our cost base so that we can create operating leverage and benefit from both improving supplies, improving demand, but also being able to be more responsive to customers, expand our supply channels and drive more volumes through our system. So to date, it has been a combination of internal initiatives, a very high focus on increasing our supply channels as well as market conditions. And as Richard was mentioning, you can see some significant improvement in our supply channels through our Pick-n-Pull activities. We see it through customer service on our metals recycling side. You see a better overall market environment. Although recognize, prices are still historically low. They've been averaging mid-$200s for the last 12 months or so. And while they are high $200s at this point, these increased volumes of plus 10% year-over-year plus 11% year-over-year are being achieved in a relatively low price environment.

Great. Okay. And then maybe just putting a couple of things together you said on the call. You talked a little bit about how scrap's holding up well relative to iron ore and coking coal. And it sounded like you expected that to continue. So just kind of want to confirm that. And then also, just back onto the guidance here. You kind of said that operating profit will be relatively flat sequentially. Is that -- I'm assuming based on a relatively flat scrap price because you don't expect the scrap to correct with iron ore and met coal. Is that -- am I getting that right?

So let me focus you on looking back because obviously, we don't comment on forward prices. But if your question is regarding the movement of iron ore versus scrap, if you just look at Q3, the scrap market did not run up as significantly as iron ore, and that iron ore increase was probably driven by a lot of speculative trading. And you don't see that type of activity in the scrap market. So there was a divergence in that run-up. But I think what's important to take away is that scrap usage is up globally. And particularly in China, both in BOFs and EAFs fundamentally because of the government's commitment to improving the environmental impact to steel mills and associated with a lot of their overall commitment to be more environmentally friendly. So I think that the sustained demand for scrap is what has kept it relatively steady, and we saw broad-based demand for scrap over the quarter as well across Southeast Asia as well as off the East Coast.

Okay. So safe to assume that flat scrap is underlying the flat guide for the sequential quarter?

So on the outlook going forward, what we've indicated is volumes up significantly year-over-year. And because we're splitting the CSS -- or creating CSS and splitting up AMR Oregon from metals recycling, we'll give you that breakdown in September. But on an aggregate basis, we assume that it will be in the same range as Q3.

And our next question comes from the line of Andrew Lane with Morningstar.

First question, huge growth in nonferrous shipment volumes. Could you just provide some commentary or some backdrop as far as what's driving that massive growth for nonferrous volumes?

Andrew, it's Richard. Well, the growth in nonferrous volumes is really supported by our very strong supply flows. Our ferrous supply is up. And of course, we gain additional nonferrous from the shredding process. Our supply flow of nonferrous itself has increased. And as we mentioned, our car purchase volume of 108,000 cars (corrected by company after the call) is at a quarterly record. So the combination of these 3 together helped drive an extremely strong nonferrous quarter.

Great. And then based on your 2019 ferrous volumes outlook, I'm curious what your thinking is as to the mix of that volume contribution might be between domestic and export. Clearly, export -- or I should say, domestic volumes have accounted for a larger share of your total company-wide ferrous volumes, 42% this quarter. Just kind of curious, of that 4.1 million to 4.3 million tons in 2019, broadly, what do you expect the mix to look like?

I would say roughly the same. I think with our flexible operating platform, we're fortunate that we can sell to wherever demand is greatest. So that is a mix of export and domestic, but roughly the same as where we're trending at the moment.

Thank you. And I am showing no further questions at this time. I'd like to turn the call back to management for closing remarks.

Thank you, operator, and thank you all for joining us on our call today and for your interest in our company. We look forward to speaking with you again in October when we report our fourth quarter results. Thank you.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a wonderful day.