Steel Dynamics Inc (STLD) 2018 Q3 法說會逐字稿

Good day, and welcome to Steel Dynamics' Third Quarter 2018 Earnings Conference Call.

(Operator Instructions) Please be advised this call is being recorded today, October 18, 2018.

Your participation implies consent to our recording this call.

If you do not agree to these terms, please disconnect.

At this time, I would like to turn the conference over to Tricia Meyers, Investor Relations Manager.

Please go ahead.

Thank you, Sherry.

Good morning, everyone, and welcome to Steel Dynamics' Third Quarter 2018 Earnings Conference Call.

As a reminder, today's call is being recorded and will be available on the company's website for replay later today.

Leading today's call are Mark Millett, President and Chief Executive Officer of Steel Dynamics; and Theresa Wagler, Executive Vice President and Chief Financial Officer.

We also have our leaders from the company's operating platforms, including our Metals Recycling operations, Russ Rinn, Executive Vice President; our Steel Fabrication operations, Chris Graham, Senior Vice President, Downstream Manufacturing Group; and our Steel operations, Glenn Pushis, Senior Vice President, Long Products Steel Group; and Barry Schneider, Senior Vice President, Flat Roll Steel Group.

Some of today's statements, which speak only as of this date, may be forward-looking and predictive, typically preceded by believe, expect, anticipate or words of similar meaning.

They are intended to be protected by the Private Securities Litigation Reform Act of 1995 should actual results turn out differently.

Such statements involve risks and uncertainties related to our steel, metals recycling and fabrication businesses as well as to general business and economic conditions.

Examples of these are described in our annually filed SEC Form 10-K under the heading Forward-Looking Statements and Risk Factors found on the Internet at www.sec.gov, and if applicable, in any later SEC Form 10-Q.

You will also find any referenced non-GAAP financial measures reconciled to the most directly comparable GAAP measures in the press release issued yesterday, entitled Steel Dynamics Reports Record Third Quarter 2018 Financial Results.

And now I'm pleased to turn the call over to Mark.

Well, thank you, Tricia.

And good morning, everyone.

Welcome to our third quarter 2018 earnings call, and we certainly value and appreciate your time and interest in our company.

We're excited to share that the Steel Dynamics team delivered another tremendous record performance this quarter.

Our underlying growth and market positioning during the last 4 to 5 years is showing its power in this strong demand environment.

I think it affirms our perspective that SDI is a very different company today relative to the last market peak.

And I'd like to take a moment to specifically thank the leadership group here today and along with the respective teams for an absolutely extraordinary job, not just their execution this past quarter, but over the last several years as we intentionally positioned the company for long-term prosperity and superior shareholder return.

Our growth, expanded product diversification and market positioning will continue to achieve higher highs and just as importantly, higher lows, driving a considerably higher through-cycle cash flow generation capability.

So team, hats off to you.

You're the best team on the planet.

But to begin this morning, Theresa, would you provide some clarity into our financial results?

I'd be happy to.

Good morning, everyone.

It's great to be with you here today.

Our third quarter 2018 net income was a record $398 million or $1.69 per diluted share, which includes fair value purchase accounting adjustments of approximately $13 million or $0.04 per diluted share associated with our recent Heartland acquisition, and all of those additional charges are actually in our cost of goods sold line on the income statement.

And we -- it also included a discrete tax benefit of $10 million or $0.04 per diluted share related to a change in tax accounting methodology, which is a onetime pickup.

Excluding these 2 items, our adjusted results remain unchanged at $1.69 per share, and we're above our guidance of between $1.64 to $1.68, as steel results came in above expectations.

For the third consecutive quarter, we've achieved record revenues, hitting $3.2 billion in the third quarter.

Higher sales reflected improved average realized product pricing across the steel platform.

We achieved record quarterly operating income of $532 million and adjusted EBITDA of $626 million, a continued tremendous performance by everyone, with our steel operations leading the improvement.

As a reminder, we acquired Heartland, a flat roll steel processing company, on June 29 of this year.

Therefore, this quarter represents the first impact from an earnings perspective.

Integration is going well, and the teams are executing.

The plan remains to maximize galvanized steel sales of approximately 360,000 tons while building cold rolls and P&O sales during the next 6 to 9 months to reach an average annualized total run rate of around 800,000 tons by midyear 2019.

On our last call, we noted that we believe that through-cycle EBITDA estimate for Heartland is between $50 million and $60 million per year at run rate.

Given the geographic location and optionality of production that Heartland brings to our Midwest flat roll group, we believe there are also additional benefits to be derived.

Our early estimates for those group synergies are in the range of $10 million to $15 million per year at run rate.

Regarding our steel results for the third quarter 2018, steel shipments improved slightly to a record 2.8 million tons.

For the third consecutive quarter, steel metal spreads expanded meaningfully across the platform as our average quarterly realized sales price increased $56 per ton to $988 in the third quarter and our average scrap cost consumed only increased $4 per ton to $352.

The result was record operating income of $577 million, a 7% sequential improvement for steel.

For our metals recycling platform, third quarter operating income was $18 million, an $8 million decline from last quarter.

Nonferrous shipments and metal spreads were negatively impacted from declining nonferrous commodity prices as well as the actions from China to ban certain recycled material imports through their Green Sword policy.

We continue to effectively leverage the strength of our vertically connected operating model, which benefits both the steel mills and the scrap operations.

The metals recycling group shipped 65% of their ferrous scraps to our own steel mills, increasing scrap quality, melt efficiency and reducing company-wide working capital requirements.

Achieving record high shipments in the third quarter, our fabrication operations continue to see strong demand and customer optimism moving into 2019.

Order activities have been strong, and our fabrication backlog was at a near record high moving into October.

However, average steel input costs continued to rise and outpaced improved selling values, resulting in a slight decline in third quarter earnings.

Operating income from our steel fabrication platform was $13 million in the quarter.

During the third quarter of 2018, we generated record cash flow from operations of $420 million.

Operational net working capital grew $53 million in the third quarter due to the overall market improvement, which resulted in higher customer account balances and inventory value.

So far this year, we've generated cash flow from operations of $924 million, another record result.

Year-to-date capital investments were $176 million.

We currently estimate fourth quarter capital expenditures to be in the range of $50 million to $75 million.

An early estimate for 2019 capital investment is approximately $350 million.

We may update that, or generally, we will update that on the fourth quarter conference call.

But right now, we're looking at sustaining capital, which includes environmental and safety initiatives, of about $150 million for next year.

We have some spending on the Columbus' announcement for the third galvanizing line.

That's about $100 million spend next year.

And then the remaining $100 million will be other expansionary and efficiency growth projects.

Regarding shareholder distribution, after our 20% increase in first quarter of this year, we maintained our cash dividend at $0.1875 per common share, and we also repurchased $193 million of our common stock during the first 9 months of 2018, completing our $450 million program authorized in October of 2016 and initiating a new $750 million program in August.

Our liquidity increased to $2.2 billion at September 30, representing $999 million in cash and short-term investments and $1.2 billion of available funding under our revolving credit facility.

The strength of our through-cycle cash generation, coupled with a strong credit and capital structure profile, provides meaningful opportunity for continued growth and continued shareholder distribution through our positive dividend profile and our share repurchase program.

We are squarely positioned for the continuation of sustainable optimized value creation.

And finally, for those that request more details concerning our flat roll shipments, we had hot rolls and pickle and oil shipments of 901,000 tons in the quarter.

We had cold-rolled shipments of 138,000 tons and coated shipments of 819,000 tons.

And then I would also note that in our supplemental financial data, this quarter, given the increase in the amount of what I'll call processed tons with the addition of Heartland, we actually broke out flat-rolled shipments so that you can see Heartland and The Techs combined, and then you can see Butler and Columbus combined.

Mark?

Super.

Thank you, Theresa.

Well, safety is and always will be our #1 priority and fortunately, we reversed the uptick in recordable incidents we experienced in the second quarter.

But unfortunately, year-to-date, our recordable incident rate is still lagging last year's results.

But I think, commendably, our lost time rate still continues its year-over-year downward trend and is significantly better than industry average.

Nothing surpasses the importance of creating and maintaining a safe work environment, and while our performance remains significantly better than the industry averages, it's certainly not enough.

We must continually be aware of our environment and not -- of those around us.

I challenge all of us to be focused and to keep moving toward our unmet goal of 0 incidents.

The steel platform continues to perform exceedingly well.

We achieved record quarterly steel earnings and continue to reach numerous production milestones.

With the addition of Heartland this quarter, we also have record high steel shipments as their volume offset lower shipments from our Butler Flat Roll Division.

Underlying demand remained strong, but customers took a temporary purchasing hiatus in anticipation of lower transaction prices and scrap pricing dipped a little and imports moderated some.

It's important to remember domestic steel inventory levels appear to be balanced and virtually every domestic steel consuming sector is already in good shape or continues to improve.

We believe domestic steel consumption has reason for growth in 2019.

We continue to position Steel Dynamics for the future through new investment in our existing operations.

In June, we announced the new $140 million galvanizing line at our Columbus Flat Roll Division.

This investment is yet another step of further diversification into higher-margin products.

The 400,000 ton line is expected to begin operating mid-year 2020.

In recent years, Columbus has transformed its product offerings through the addition of painting and Galvalume coating capability and through the introduction of more complex grades of flat-rolled steel, some of which serve the automotive sector.

The diversion of product to these value-added outlets has reduced the amount of volume available to our existing galvanized customer base.

So the addition of a third galvanizing facility will allow Columbus to serve these existing customers along with new customers in the region.

This expansion will also reduce Columbus' exposure to the more cyclical hot-rolled market, which will result in higher and less volatile through-cycle earnings.

Additionally, during the next 2 years, we plan to make additional investments at Columbus to upgrade certain processing lines and hot strip mill capability to further enhance and stabilize profitability with further product diversification and process efficiency gains.

The investments will increase Columbus' range of complex grade capabilities and will improve the process control needed to produce the best high-strength steel grades used in the automotive industry and also in the energy markets.

These investments extend Columbus' strategy to diversify into advanced premium value-added capabilities.

We're also investing in our Long Products steel operations.

These projects, coupled with the improving construction and industrial markets, have already resulted in increased capacity utilization.

As an example, we have 2 primary organic initiatives to increase the utilization of our Structural and Rail Division, which operated about 75% of its capacity in 2017 and, in contrast, has been operating at over 90% of its capacity this year.

First, we have grown the production of SBQ quality blooms for internal supply to our Engineered Bar Division.

They need blooms to fully utilize their rolling capability.

This improves through-cycle utilization at both facilities.

With over 47,000 tons of blooms shipped in the third quarter, we're achieving our anticipated annual run rate of transferring over 200,000 tons from Columbus to [Pittsboro].

Second, we're investing over $80 million to utilize excess mounting and casting capability at the Structural and Rail Division through expansion of product diversification through the addition of an annual production capability of 240,000 tons of rebar, including spooled, custom cut-to-length and smooth bar.

Our unique rebar supply chain model is expected to substantially enhance customer optionality and flexibility, providing meaningful logistics, yield and working capital benefits.

In addition, we will be the largest independent rebar supplier in the Midwest region.

We strongly believe that these innovative, cost-effective products can provide a material improvement in future through-cycle utilization and profitability at this facility.

The expansion also complements the recent growth at our Roanoke Bar Division.

We invested approximately $38 million to also utilize their excess melting and casting capability, planning for about 200,000 tons of rebar volume annually.

We started operations a few months ago and commission is ongoing.

I think the steel team should stand proud.

And with the addition of the Heartland acquisition, we now have almost 12.5 million tons of annual shipping capability.

Historically, Heartland was operated at low utilization rates, and they focused on galvanized steel.

We plan to focus on a full breadth of products, including very light gauge sheet.

Our operating expertise, product market familiarity and the geographic proximity of our existing Midwest flat roll operations allows for meaningful value creation.

Consistent with our strategy to differentiate and grow through product diversification, Heartland provides wider and lighter gauge product capability.

We're familiar with their market and customer base.

Due to the continued addition of value-added capabilities at our Butler Flat Roll Division, we've displaced some of our customers that can now be served by Heartland.

Heartland will also provide pull-through volume.

We plan to supply at least 300,000 tons of steel substrate from our Butler Flat Roll Division, thereby increasing through-cycle profitability at both locations.

Heartland should also improve Butler's cold mill productivity.

We plan to reduce lighter gauge flat roll orders at Heartland, which should increase Butler's cold mill productivity.

Lighter gauge products require more time to run, so to speak, and Heartland is better equipped to make these gauges.

We believe the Heartland acquisition will result in numerous future earnings synergies, both at Heartland's current operations and to our broader Midwest flat roll group.

As Theresa explained, we believe annual synergies could be in the range of $10 million to $15 million.

In whole, Heartland provides a unique margin-enhancing opportunity for Steel Dynamics, and we're excited to continue the integration and realize the value creation.

While our metals recycling earnings decreased sequentially, the platform delivered a solid performance in a complicated freight environment.

Nonferrous shipments and metal spreads decreased due to declining commodity prices and the changing export market environment during China's recent ban on certain recycled materials.

Also, the ferrous scrap exports picked up a little more than expected last month, and the market recovered some of the price drop manifested in August and September.

We'd expect seasonal tightness to keep the market firm for the rest of the year.

Long term, we're committed to the premise that scrap supply will outgrow anticipated demand, even the expectations of higher steel mill utilization rates and associated scrap needs.

The steel fabrication team achieved record shipments in the quarter, and I'd like to congratulate them for an incredible job.

Our order backlog remains strong.

Similarly, our customer backlogs are extremely strong, with some having to turn business away.

The ongoing strength of the business and customer optimism is a solid indicator that nonresidential sector strength will continue well into next year.

Based on strong underlying domestic steel demand fundamentals and customer optimism throughout all market sectors, we believe steel consumption will continue to be seasonally strong and grow into 2019.

In combination with our expansion initiatives, we believe there are firm drivers for our continued growth.

Furthermore, the actions the U.S. federal government has recently made to develop a healthy domestic steel industry should provide sustainable long-term support to the U.S. manufacturing base and continue to erode import volume.

We also believe the USMCA negotiations will result in a constructive outcome for our industry.

Specific to Steel Dynamics, our unique culture and execution of our long-term strategy continues to strengthen our competitive position through strong cash flow generation and long-term value creation.

And it clearly demonstrates our sustainability and differentiates us from our competition.

Customer focus, coupled with market diversification and low-cost operating platforms, support our ability to maintain our best-in-class performance and differentiation.

The company and the team are poised for continued organic and transactional growth.

Our team provides the foundation for our success, and I thank each and every one of them for their hard work and commitment to excellence in all we do and remind them, safety is the first priority.

We are committed to providing exemplary long-term value to our employees, to our communities, customers and shareholders alike and look forward to creating new opportunities for all of us in the years ahead.

So once again, thank you for your time and interest in our company.

And Sherry, we'd like to open the call up for questions now.

Thank you.

(Operator Instructions) Our first question is from Matthew Korn with Goldman Sachs.

So I had 2. One is a little -- so I had a couple of questions.

One is a little bit more short term, the other one is a little bit more long term.

First, you highlighted this temporary backing off of orders that you saw among your buyers as the imports of hot-rolled coil grows.

I wanted to ask, was this hesitancy in orders, was it really centered in hot-rolled coil?

Or did you see any similar behavior across the longs?

And then second, has this normalized since then?

Are you seeing a tick back up as you had expected this season and as you've seen prices somewhat stabilize here in the mid-800s or so?

Look, I think the -- certainly, the hiatus has reversed itself in the last couple of weeks, and we've seen on the flat-rolled side very, very strong order intake.

And I think on the long product side, it wasn't quite as pronounced.

I think the order rate just continued at a reasonably strong pace through that period.

Okay.

So really, I'm focused on that particular product.

Let me then ask -- let me ask a more longer-term one a little bit more thematic.

There's been a lot of announced steel expansion projects year-to-date, your own, your established competitors, some new entrants.

So even if you handicap for the normal discount of what's been announced versus what gets executed, it seems like a lot of metal coming in, especially if we're going to keep aiming for this 80% capacity utilization.

Does this concern you?

Or do you feel comfortable that all this new supply could be absorbed without much disruption?

And if so, why?

I think the -- firstly, the market remains incredibly strong, as I said, in every market sector, and we continue to see and believe strongly that that's going to go into 2019.

And so demand will be strong and increase, maybe incrementally, but it will continue to increase.

At the same time, imports are going to dissipate.

I think the actions the government had made are starting to take place with the slight retraction in market pricing after the highs we saw a couple of months ago.

The arbitrage, the import pricing has dissipated to some degree.

And I think imports are going to erode further.

And if you look at the imports per ton, so just a regular normal historical rate, I think there's plenty of demand to absorb the increased supply.

And the only other thing I would add, Matthew, is that if you look at the greenfield capacity expansions that have potentially been announced, I mean, those wouldn't come into the market for probably 2 to 3 years at the earliest.

So there's that part of the equation as well.

Got it.

So between timing, import reduction and continued strength in demand, you feel pretty confident.

Yes.

Our next question is from Chris Terry with Deutsche Bank.

Mark and team, yes, I just had a question on the fabrication margins.

Based on the order of backlogs, do you think that margins have bottomed?

And should we see recovery going forward?

Or is it still a couple of quarters out, given the seasonality?

I think you make a good point.

This is Chris.

We think that seasonality will hide it or mask that a little bit, but we do think that we will continue to -- we will begin to start seeing spreads improve.

Okay.

Okay.

And just maybe one for Mark on the M&A pipeline.

Has it changed at all over the last few months?

Are you still looking for sort of smaller scale?

How are you thinking about the size and the opportunity set since we had the call last time?

Well, our preference is certainly not small scale, as you appreciate and we certainly appreciate.

It seems to take just as much time and effort and distraction on a small deal as it does a big deal.

But we certainly have a pipeline that's still very active and active across a breadth of scales, in all honesty.

And I think perhaps on the downstream pull-through volume side opportunities, they are smaller scale, just the Vulcan push that we made some time ago, but there are other larger opportunities as well.

We remain, I would say, disciplined.

Obviously, given the market euphoria out there, valuations are pretty strong, and we're working through those issues in our sort of negotiations and discussions.

Our next question is from David Gagliano with BMO Capital Markets.

I think you may have just covered off -- one of them, but -- so I'm just going to ask one near-term.

Based on your visibility in the order books, what's a reasonable range of assumptions for changes in your steel operation volumes quarter-over-quarter and in the fourth quarter?

That's my first question.

Look, I mean, as you know, Dave, based on seasonality, the holidays and customer base looking to realign inventories at the end of the year, the steel shipments are always lower in the fourth quarter, and that goes back to as long as I've been doing this for the last 20 years.

So that would be our expectations as well.

But I don't think it's been -- have anything that is unique to this market environment.

It's just normal seasonality.

Okay.

That's helpful.

And then just on -- strategic question, in -- just in -- kind of in generic terms, when you peruse the landscape of acquisition opportunities that you're seeing out there right now, how do the valuations that you see compare to the other options in terms of, for example, getting even more aggressive on buying back more of your own stock and that kind of thing?

Well, I think the -- I guess on a broader perspective, it's our cash allocation strategy, in general.

Obviously, we evaluate, I wouldn't say daily but frequently, the best use of our cash.

And we've always, I think, at least in the past, used -- you've seen us use all the tools in our toolbox there.

We have both the financial strength and basis to be able to not have to direct it to one or another.

So I believe the positive dividend stream profile will continue as our through-cycle cash generation profile continues to increase as well.

You've seen the completion of the initial share repurchase program.

We've got another one in place for $750 million.

And I think we believe fervently, even more strongly today, that our shares, our market cap is undervalued and there's great value there.

So I think you'll see us aggressively pursue that program as we continue to evaluate further organic growth and transactional opportunities.

So I think we look at all those mechanisms, there -- we believe the opportunities have good value on the transaction side, yes.

And certainly, obviously, our organic internal projects are absolutely the best place to spend them on.

Okay.

That's helpful.

That sounds somewhat similar to previous comments.

But what I'm kind of trying to get to is right now, in the current marketplace, your stock where it is, opportunities are out there right now, what do you think is a better opportunity for you?

Is it buying back your stock or is it -- are there good, sizable acquisition opportunities available?

I think we have the opportunity to do both.

If you look, Dave, at the profile that we have and if you -- I mean, I know you do.

So if you look at the cash on the balance sheet and the generation pace that we're heading in, we have -- definitely have the capability to both maximize the repurchase program as well as look at the deal sets that we're looking at, and it wouldn't jeopardize our credit profile, nor our ability to grow in the next downturn as well, which is always something that we like to do.

We find great value in doing that.

Our next question is with Curt Woodworth with Crédit Suisse.

Two questions.

The first is just looking at your cost structure in the third quarter, it seemed like conversion costs increased pretty significantly year-on-year.

I know there's a lot of sort of moving pieces within that between variable labor, power and maintenance, maybe some Heartland inventory impact.

But can you just comment on that?

Because it looked like it was up close to $500 million annualized this quarter versus last quarter in the mill segment.

Curt, I'll take that.

I saw your note last night, so -- and one that I'd be able to comment on.

Thanks for asking the question.

Actually, if you look -- I'm going to address quarter-over-quarter before year-over-year.

But if you look quarter-over-quarter, our conversion costs are actually lower if you back out -- remember I purposely mentioned that, that $13 million was going to the cost of goods sold line for Heartland.

But more impactfully is the fact that now, if you look at Heartland and The Techs and it's recently breaking out their volume, they make up about 11% of our total steel shipments.

And you have to look at conversion on total steel shipments or you miss the cost compression.

You can't look at it based on external.

So because it's now about 11% of our volume versus when it was just The Techs, it was somewhere between, call it, 5% to 7%, there's a bigger impact because we can't get as much.

There's a higher conversion cost that it looks like it's having because we're buying our substrate outside of the company, and so that steel cost input is getting mixed up.

If you just look at straight conversion costs to steel operations in the sequential quarters, they actually decreased.

If you look at it year-over-year, there has been an increase but not as sizable as you've mentioned.

The increase is closer to $10 to $15, and that's related to electrodes, refractories.

Our operations, they're still performance-based from an incentive perspective.

There's higher bonuses as well because the profitability is higher.

So there's nothing that is significant for us to point out, and I'm happy to walk you through it later as well.

Okay.

So that reported figure this quarter, that is a reasonable baseline to use going forward then?

As you look at your model, I would encourage you to try to separate The Techs and the Heartland volume from the other steel mill volume, and there's going to be an impact.

So as you look at it, the only thing I would tell you, you do need to change is your denominator.

It's going to be in actual shipments.

It really needs to be total shipments.

Yes, we're running it off total shipments, so -- yes, that's fine.

We can catch up online.

I don't know if the arithmetic would necessarily change.

But that's fine.

Okay.

Second question is just around -- maybe for you, Mark, just kind of communication with commerce or sort of trade, people you speak to in Washington.

Do you feel -- there's that article in AMM about, I think, the AISI presidents have potential resolution of Canada in November on tariffs.

Do you have a sense of sort of what that negotiation looks like?

Have the steel managements kind of communicated what they would like to see happen with respect to Canada?

Well, I think the negotiations are playing out reasonably well for us, generally, in the steel industry.

And again, I'm very glad that the administration has been able to find common ground with Canada and Mexico.

As a block, we need to be working together and not against ourselves.

But trade, in general, the 232 program, I think is working incredibly well.

It's created a much -- sort of a level of playing field and has given relief to the industry and is going to support, I think, pricing in the market into next year.

And I think as I said earlier, imports generally are going to continue to erode, I believe.

Relative to Mexico and to Canada, the so-called USMCA, I guess, we're going to be calling that in the future, might be the same actor, but nonetheless, it's going to be a benefit to us, primarily as the sales of autos and auto parts, which now will have a minimum content requirement and minimum wage component favoring more U.S. parts production and more North American steel inputs.

And we've seen, actually, just recently since the announcement, a resurgence in orders and order inquiries from Mexico.

There was a lot of uncertainty there for a while when no one knew exactly what was going to come out.

But as clarity has come to the forefront, again, our customer base in Mexico has been pretty strong.

But generally, I think no one knows and one can only speculate as to the final details, but I think prudence will rule the day, and it's going to be a benefit for us.

Our next question is from Timna Tanners with Bank of America Merrill Lynch.

I was wondering if you could talk us through Q4 pricing at current market conditions, just because it's always helpful to get a reminder about how much of your business operates on a CRU kind of lag and how much would be exposed to the spot price.

And granted I know you're not just flat-rolled, but if you could just remind us like what percentages would be exposed to spot and what percentages might see a lag and help us think about that, again, considering current conditions.

Timna, the only real significant contract business that we have to date still is within the flat rolls.

And generally, about 50% of it is contractual where you're going to get a lag that's going to be based on the CRU Index.

And that lag, generally, is probably about 2 months.

And so you're going to have 50% that will be subject to spot and the other 50% subject to that contract.

On the long product side, generally, there is no contractual business.

There's a very small amount in the SBQ side of the business but not enough for you to try to model.

Okay.

Appreciate that.

And then I was wondering separately if you could talk about the rebar expansion and the Columbus plans in a little more detail.

So Columbus is already a really strong asset, really strong profitability, and so I'm curious like what further -- if you could detail a little further what you can do to enhance that.

Is it more product?

Is it cost?

Or both?

And on the rebar side, you're new entrants into that market somewhat, or I know you dabbled it in the past, I believe, but how are the customers receiving your product?

How are you finding that market acceptance so far?

Timna, on the Columbus plant, bringing the new galvanized line allows us to make galvanized products for general consumption.

So as we've grown our automotive business down at that plant as well as our painting business, it really put pressure on regular galvanized customers.

So this additional galva line allows us to put more of our product mix into value-added products.

It also allows us to fully kind of exploit the paint line down there and as well as some of the more demanding products in the automotive side that we've taken.

So some of those have much more difficult process parameters to control.

So this allows us to grow our business and keep the quality in mind for our customer base.

So we're really looking forward to get this line online and continue to take care of the customers we have as well as grow the business.

That line is a 400,000 ton line, and it's expected to be sometime in the first half of 2020.

And so if you think about it, also substantially reduces the amount of exposure that Columbus has of just straight hot roll, which should be through-cycle much higher margin.

Glenn, do you want to...

Yes.

Glenn Pushis here.

On the rebar project at Columbia City, we plan on starting that project [up here] and commissioning it at the end of the fourth quarter this year.

And you asked about reception in the marketplace.

Obviously, we've not made anything yet, but the reception that we're hearing from our potential customers and independent fabricators has been very strong, a lot of interest in that facility with the spooled coils and the custom cut-to-length, as Mark said earlier.

Okay.

So I was referring to the operation that you said you had just started up in Roanoke, and also on the Columbus side, I was referring to Mark's comments about over the next several years, even further expansion.

Sorry I wasn't clear on that.

No problem.

In Roanoke, we've started up the rebar bundling area, and that's running much better than it did 6 months ago as we first started the recommissioning process.

We had some equipment problems from our supplier there, but we're through those, and that facility is up and running at a much better pace now.

We anticipate that being in full operation at full time at the 200,000 ton per year level by the end of this year.

And Timna, at Columbus, a couple of things.

Obviously, as Barry mentioned, the $140 million galvanizing line is going to be a growth when that comes online in 2020.

We are spending about $90 million to $100 million on, I would say, a variety of enhancements at Columbus.

It's going to give us further product diversification.

It allows us to get to higher-strength auto grades.

It allows us to get to higher-strength, heavier-gauge energy pipe and tube grades.

And then thirdly, you have the paint line and although that's been running for some time and it's well utilized, obviously, they're going through product evaluation and the product -- the margin will be enhanced as they get into more HVAC and appliance-type applications.

Our next question is from Seth Rosenfeld with Jefferies and Company.

Just to dig in a little bit more for Kentucky Electric Steel.

Can you just give us a bit more color on the plan to ramp up trajectory of that facility?

Which of the mills we should expect to be leading the substrate in?

And when you think about this asset and the product mix, how should we consider the margin contribution compared to the baseload across the division?

It's Glenn Pushis here.

The Kentucky Electric Steel asset that we just purchased, we'll be starting that facility up in 2 to 3 weeks.

We've got employees hired.

We've got our first order of billets showing up for the materials to run.

We've got about a 4,000, or 5,000 ton backlog right now.

It's about 12,000 tons total that we've got earmarked to start the facility up on.

Really, the play there is for us to be able to supply our own billets.

Three of our facilities will supply those: Steel of West Virginia will be supplying Kentucky Electric some of the sizes.

Roanoke Electric Steel in Roanoke, Virginia, will be supplying some, and then some of the alloy SBQ grade will come straight out of our Pittsboro facility.

So really those 3 facilities will be feeding that new rolling mill asset, and that will supplement Steel of West Virginia.

So Seth, from a high level, there will be some margin contribution from the asset itself, but the strong advantage is that pull-through volume through cycle from those other divisions to allow a high utilization rate there.

Our next question is from Phil Gibbs with KeyBanc Capital Markets.

I had a question, Mark, just on the automotive strategy and if you could update us on that in terms of where we are this year, perhaps in terms of volume and where you expect to be in the next couple of years as some of your platforms take off.

I think the -- in Butler, we remain pretty steady at around about 30% or so of -- 32% of its output is going to automotive, principally through processes.

Columbus, where we focus more on direct sales to the automotive clients, particularly in Mexico, they are continuing to gain market share.

We are on platforms to take that up to 450,000 tons or so by the end of '19.

So I think it's going very, very well.

And just to frame, where do you see Columbus now?

And how much of your engineered bar business should we think about being automotive as well?

Columbus is kind of just the year about...

250,000 tons this year.

250,000, yes, or thereabouts.

And SBQ is around about 15%.

Yes, 20% right now, Mark, and that's growing because we're starting up our new inspection in our bar turning line.

A lot of that automotive SBQ, Phil, needs to be inspected, so we're kind of bottlenecked right now in that finishing area.

So with this expansion project that we're putting in right now and starting up, that helps us to delve more into automotive.

So we need to grow that from 15%, 20% now, let's say, to 25% to 30% in the future.

Okay.

That's helpful.

And I just have one more, Glenn, on the engineered bar business, if I could.

What are you seeing on the energy side?

It certainly looked like there's been a mix shift in the market to more seamless product away from welded, given some of the demands of the E&Ps.

And has there been any positive stress or strain on your business to supply that more so for today and greater needs in the future, if some of these import restrictions play out?

I'd say, from that market right now, we're seeing order entry at historical highs, both in the third quarter and fourth quarter.

And we anticipate that, that's going to continue into 2019.

You're saying broadly or for the energy piece?

Just the -- well, broadly, and I'd say the energy piece, for certain.

Yes, as we said in the past, our engineered bar is kind of our bellwether to the general steel consuming industry or market.

And it is literally across the board incredibly strong.

This group has the highest backlog it's ever had for the fourth quarter.

And although we will -- as Theresa pointed out, we'll see a little seasonal impact on shipments in the fourth quarter, we expect things to really, really open up in the first quarter next year.

Perfect.

And Theresa, I do appreciate the color you provided on the mix straightaway.

And is Heartland about 50-50 as well in terms of contract and spot?

Yes.

Yes.

Our next question is from Andreas Bokkenheuser with UBS Securities.

Just a quick question on the tariffs.

You always had mentioned that you think the tariffs are working quite well and we're seeing that in the prices as well.

Do you have a preference for tariffs over quota or the other way around?

Obviously, there's been a little bit of a talk about replacing some of the tariffs with quotas on Mexico and so on and so forth.

What in your view is -- maybe thinking about a framework of the quotas that are in place right now for South Korea, do you have a preference of what you think is healthier for the industry, what gives you the most pricing power, a tariff versus a quota going forward?

Well, I think, long term, quota is probably a preference from our perspective because it allows the support of the manufacturing base.

And it's -- long term, the Section 232 tariffs, I do believe, is a good stopgap, but one has to recognize that we're going to continue to have global overcapacity for some time to come that virtually every economy that's matured and/or emerged since World War II are all based on exports, their export economies.

And so there has to be some long-term sort of moderator or moderation of the flow of imports on to our shores.

As a country, we're still short, one of the few countries that is.

So we need imports on manufacturing base.

We need that product, and I think quotas tends to be the better way of controlling them.

Our next question is from Derek Hernandez with Seaport Global.

Just want to touch on additional growth opportunities that you had mentioned beyond ongoing growth projects.

Which sort of product lines do you see opportunities in at this time?

Well, our focus is -- well, we have 3 sort of growth areas of focus.

One is just continue to look at steel assets, underperforming steel assets that we can infuse our culture and our business model to turn around.

Secondly, our teams have got an expertise in the processing -- downstream processing lines, whether it be coated, whether it be painted, so there's opportunity, I think, for that.

On the fabrication side, continued growth in the deck offerings.

And then lastly, pull-through opportunities that we feel they would add and improve our margin profile, but more importantly -- or as importantly, would allow a higher through-cycle utilization rate.

And not to be redundant, but we really are focused long term, we're focused on making sure that our future highs are much, much higher than they are today, but as importantly, our future lows are higher.

And we think pull-through volume allows us to achieve that.

And my second question being, where do you see potential for cost savings, given the current environment is a bit leaning towards a bit of inflation there?

Where might you target opportunities to keep margins strong despite this?

Well, I guess I'll kick off first.

But I think if you actually look at most of our operating sort of lines or processes, over time, conversion costs remarkably stayed somewhat stable, and it's because the teams are continually innovative and creative to become more efficient.

But more importantly, they seem to have an incredible aptitude to push more tons through.

And so the increased effectiveness of our operations seems to offset any sort of inflationary cost of materials or commodities.

Our next question is from Sean Wondrack with Deutsche Bank.

Apologies if you've touched on this, but can you talk about what you're seeing in the scrap market and kind of what your expectations are moving into year-end?

This is Russ.

As we look at the scrap market, I think we are seeing a relatively firm market through the year-end and probably into the first month or 2 of next year.

Again, seasonal factors, as weather comes in.

But again, in my opinion, this reaffirms this is just going to depend on what happens on the coast and exports, if exports pick up to a higher level, it will become firm.

If they remain at the level they are at right now, it will be a steady increase but not a dramatic one.

Right.

That's helpful.

And then just more kind of big picture, can you talk about a little what the impact of tax reform has been on your customers?

Do you find some of this optimism is related to that?

Or do you think most of that has worked its way to the system?

If you could touch on that, I'd appreciate it.

I would not say that it's worked its way through the system because the impact from the tax reform, obviously, the biggest impact was noted in the first quarter of this year.

However, let's say that, that's gone through the systems, you have additional projects, additional fixed asset investments, which translate into higher steel consumption, I think that would be probably incorrect only because there hasn't been sufficient time.

And in addition to that, with the repatriation of funds coming into the U.S. from global companies, that as well just wouldn't have had time to translate from bringing the money in to building the factories, to having additional investments in the U.S. in totality.

So my expectation is that tax reform actually gives legs to what some think is an economy that's already been on the up-float for too long.

They try to measure it in years, and I don't think that's probably appropriate for this time because I think with tax reform, it allows it to have more legs and to last even further.

So my personal view, our view is that no, there's still more to come.

Theresa, in support of that, the fabrication group would note that coat activity in retail and hotels is now just starting to increase.

And to your point, that will take some time to get through the system, but we do assume that some of that might be from the effect of lower taxes on consumer spending.

And then just one last one.

You obviously have a large revolver outstanding.

I apologize, can you remind me, if you were to get upgraded, would that go unsecured?

Or have you had any thought about potentially moving to an unsecured revolver there?

So the treasury team did an excellent job in that the revolver has a provision that it's our choice to execute.

Now if we were to get an upgrade in any one of the agencies, we would have the ability to actually spring into an automatic unsecured revolver, which then could allow the other agency to upgrade us as well.

So is that in our election?

But yes, it's already there, so we don't have to make a change in the revolver structure today.

Our next question is from Brian Lalli with Barclays.

Maybe if I could follow up on actually a couple of Sean's questions.

Maybe first, on just the investment-grade side, Theresa, have you -- do you have any additional thoughts?

Or are we kind of in that same place of your positive outlook at both and if you get there, great, but you're obviously clear on your goals in terms of shareholder returns and M&A?

I would say that our goals are still the same on the shareholder distributions, on wanting to grow transactionally and organically.

That being said, just the strength and where we believe the steel markets are going and the strength that we think we have internally for levers to be pulled, to Mark's point, both in kind of the high markets and in the low markets, I think we're probably heading toward that IG rating more quickly than what we may have anticipated, and we may start talking a little bit more about it kind of in the coming months.

Got it.

Okay.

That seems like a little bit of a change, so that's good to hear.

And then, I guess, the second question I have relates to -- it relates to the scrap side of things.

But we're starting to hear more, obviously, Cliffs, for instance, talking about building an HBI facility.

I guess, where do you see kind of your iron content?

I know this is a longer-term question, but is this something where as you want to compete more with the blast furnace producers, you see that there's a greater need for higher iron content?

And I guess, where do you see that in your mix right now?

That would be helpful.

I don't believe we see a need, some need to increase iron content from a quality standpoint necessarily.

We certainly, obviously, are very aware of the costs or the best mix to get the most economic cost of raw materials into the furnace and at the same time, maintain a high level of productivity.

So you'll see that in Columbus, we're probably 0.5%, Barry, or thereabouts pig iron.

And in Butler, we're around about 15%.

And that's purely an economic decision so we can get pig iron into the Columbus mill at a lower rate, sort of [lower].

Obviously, the Cleveland-Cliffs project and any other project, and Nucor's project down south, but the more iron units coming into the marketplace, the better off we and everyone in the electric arc furnace community is going to be.

Our next question is from Matthew Fields with Bank of America Merrill Lynch.

Appreciate the updated thoughts on the IG outlook.

Sort of a bigger picture question, we've kind of seen some small M&A transactions with Heartland and some other ones.

Just wondering maybe why we haven't seen bigger, large-scale M&A transactions and more consolidations in the steel sector.

Is there a valuation gap between buyers and sellers?

Is there kind of an expectation that 800, 900 hot-rolled is kind of the future forever from a seller's point of view but the buyers are kind of holding -- sellers -- sorry, buyers are kind of holding the line?

Well, I would say that folks are pretty proud of their assets right now.

So yes, valuations generally are, as you would expect, sort of at the high-end.

If you actually reflect, as we reflect on the deals that we have done, even going back to the Columbus deal, there have always been other factors in our successful transaction, whether it be folks wanting their employees to be in the SDI family, whether they want some clarity and speed of transaction.

There are other things that can perhaps play a role and get you an asset, perhaps as not top valuation, but it's certainly [benefiting the industry], for sure.

Do you see anything changing with that?

Do you see the pace of consolidation picking up?

Or kind of is this what it is from your outlook?

And I obviously appreciate you can't predict the future.

Well, I certainly can't predict it.

I can only say -- and I can't speculate as to the outcome.

All I can say is that the pipeline is very, very active.

There are a lot of assets out there.

At some point in time, they're likely to, I guess, be transactive but it's a slow process, I would say.

That concludes our question-and-answer session.

I would like to turn the call back over to Mr. Millet for any closing remarks.

Well, thanks, Sherry.

And again, thank you for taking time to listen to us today, listen to our story.

We're pretty happy with the performance.

Like I said at the very beginning, I can't be prouder of the team in this room and the other 7,700 employees that we have across the nation and in Mexico.

So from us, we're going to keep doing what we do best, provide the greatest shareholder value in our space.

So have a great day and be safe.

Bye-bye.

Once again, ladies and gentlemen, that concludes today's call.

Thank you for your participation.

Have a great and safe day.