Reliance - Earnings Call - Q2 2017
July 27, 2017
Transcript
Speaker 0
Greetings, and welcome to Reliance Steel and Aluminum Company's Second Quarter twenty seventeen Earnings Conference Call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal It is now my pleasure to turn the conference over to your host, Brenda Miyamoto. Thank you. You may begin.
Speaker 1
Thank you, operator. Good morning, and thanks to all of you for joining our conference call to discuss our second quarter twenty seventeen financial results. I'm joined by Greg Mullins, our President and CEO Carla Lewis, our Senior Executive Vice President and CFO Jim Hoffman, our Executive Vice President and COO and Bill Sales, our Executive Vice President of Operations. A recording of this call will be posted on Investors section of our website at investor.rsac.com. The press release and the information on this call may contain certain forward looking statements, which are based on a number of assumptions that are subject to change and involve known and unknown risks, uncertainties or other factors, which may not be under the company's control, which may cause the actual results, performance or achievement of the company to be materially different from the results, performance or other expectations implied by these forward looking statements.
These factors include, but are not limited to, those factors disclosed in the company's annual report on Form 10 ks for the year ended December 3136, under the caption Risk Factors and other reports filed with the Securities and Exchange Commission. The press release and the information on this call speak only as of today's date, and the company disclaims any duty to update the information provided therein and herein. I will now turn the call over to Greg Mullins, President and CEO of Reliance.
Speaker 2
Good morning, everyone, and thank you for joining us today as we discuss our second quarter twenty seventeen results. Continued steady demand along with strong execution by our managers in the field resulted in a gross profit margin of 28.4%, driving our second highest quarterly gross profit dollars in the company's history of 702,100,000.0 Current pricing levels are higher than both the first quarter of twenty seventeen and the second quarter of twenty sixteen, which positively contributed to our earnings. However, mill prices were pressured somewhat in the second quarter of twenty seventeen, especially for carbon and stainless steel products, which prevented us from enhancing our gross profit margin as we did in both the first quarter of 'seventeen and the second quarter of twenty sixteen when multiple price increases were announced by the mills. In a period of rising prices, we are typically able to increase our gross profit margin as we obtain the higher prices from our customers before we receive the higher cost metal into our inventory. The absence of meaningful price increases and our receipt of higher cost metal during the second quarter of 'seventeen, along with the added elements of a competitive landscape due to continued uncertainty around possible Section two thirty two action and increased imports in the market, collectively pressured our gross profit margin more than we had anticipated.
In addition, the positive momentum we experienced during the first quarter of twenty seventeen for both demand and metal pricing trends did not meaningfully accelerate into the second quarter as confidence around infrastructure spending and tax reform stalled. Because of this, in June, we announced updated guidance for the second quarter that reflected our expectation of a lower gross profit margin, although still strong and within our range of 27% to 29%. Demand was at the low end, and our average selling price slightly exceeded the top end of our original guidance range of flat to 2%. Recently, there has been a great deal of uncertainty in the marketplace, much of which we believe stems from the pending Section two thirty two investigation by the United States government. Uncertainty impacts demand momentum as customers change their inventory buying patterns and hold back on capital investments.
In addition, imports increased during the quarter as we believe metal buyers were bringing in foreign metal before any steel import restrictions, which may result from the Section two thirty two investigation. Higher inventory levels along with pricing uncertainty increased competition and pressured our gross profit margin. Although we were able to increase our average selling price for the second quarter of 'seventeen by passing through the higher prices that were in effect at the end of the first quarter, mill prices for carbon and stainless steel products experienced downward pressure during the second quarter with some relief for carbon steel products near the end of the quarter. Our average selling price was up 11.3 from the second quarter of twenty sixteen and up 2.4% from the first quarter of 'seventeen. Overall, customer sentiment remained positive, which translated into continued healthy customer demand in the second quarter of twenty seventeen, with our tons sold roughly flat with the first quarter of twenty seventeen.
We continue to anticipate customer demand levels will hold with the potential for improvement in the second half of twenty seventeen, subject to normal seasonality and into 2018 with even more meaningful upside if the administration's infrastructure plans are implemented. Beyond pricing discipline, our managers in the field continued their strong execution in terms of inventory management, helping us achieve an inventory turn rate of 4.5x based on tons, consistent with our 2016 inventory turn rate. We are very comfortable with our current inventory level. Turning to capital allocation. Our strategy remains consistent, made possible by our effective working capital management and solid earnings levels providing cash flow from operations.
We will continue to grow our business through a balanced combination of organic investments and acquisitions while also returning cash to our stockholders. The majority of our 2017 capital expenditure budget of $200,000,000 will be spent on growth activities. We continue to work with our customers to determine which value added services are most beneficial to them as well as to proactively identify areas in which we can provide additional services. We believe our gross profit margin improvement over the past two years compared to historical levels directly demonstrates the return on these capital investments. On the M and A front, we have not completed any acquisitions so far in 2017.
The pipeline remains active, and we will continue to evaluate opportunities to grow through acquisitions of well managed metal service centers and processors with end market exposures that complement our diversification strategy. From a stockholder return perspective, quarterly cash dividends and share repurchases remain core to our capital allocation philosophy. While we did not repurchase any shares of our stock during the quarter, we will continue to be opportunistic in our approach. We increased our regular quarterly cash dividend by 6% in the first quarter of 'seventeen, marking the twenty fourth increase since our 1994 IPO. We have consistently paid regular quarterly cash dividends for fifty eight consecutive years.
In summary, we are very pleased with our success in raising our sustainable gross profit margin range through targeted growth of our value added processing capabilities and specialty products, coupled with our focus on pricing discipline and inventory management. In the first six months of twenty seventeen, we increased our pretax income by $60,100,000 or 23% over the first half of twenty sixteen. We remain optimistic about the potential for increased infrastructure and equipment spending, which we believe should improve both metal demand and pricing that will support our efforts to drive earnings even higher. I will now hand the call over to Jim to comment further on the operations and market conditions. Jim?
Speaker 3
Thanks, Greg, and good morning, everyone. Before I begin, I would like to take a moment to thank our folks in the field for their continued hard work and dedication. They did a tremendous job navigating through the market uncertainty in the quarter, and I'm very proud of their achievements. Now I'll discuss demand and pricing of our carbon steel and alloy products as well as our outlook on certain key end markets we sell those products into. Bill will then address our aluminum and stainless steel products and related end markets.
Demand for automotive, which we service mainly through our toll processing operations in The U. S. And Mexico, remained robust throughout the second quarter. Our growth continues to be driven by the increased usage of aluminum in the automotive industry. Over the past year, we have expanded our facility to support automotive demand for both carbon and aluminum processing.
I am pleased to announce that during the second quarter, we finished construction on our new U. S. Facility in Kentucky, which was completed on time and on budget. We began shipping product from this facility late in the quarter, and so far, it has been operating in accordance with our expectations. In addition, our facility in Monterrey, Mexico, which became operational in the third quarter of twenty sixteen, has also been performing well.
Second quarter demand in heavy industry, which includes railcar, truck trailer, shipbuilding, barge manufacturing, tank manufacturers and wind and transmission towers was in line with levels experienced in the first quarter of twenty seventeen. During the quarter, we saw positive signs of activity, specifically with the lighter agriculture equipment, which was encouraging, as well as a slight uptick in construction equipment spending. We expect demand in heavy industry to remain at similar levels throughout the remainder of the year, subject to normal seasonality. Demand in nonresidential construction market, including infrastructure, continues to experience steady growth, though volume remains far below peak levels. During the quarter, we experienced increased uncertainty in the marketplace in anticipation of the outcome and resolution
Speaker 0
decisions, including the Section two thirty two investigation, tax reform and domestic infrastructure spending.
Speaker 3
Of We remain cautiously optimistic that domestic infrastructure spending will improve, which we believe bodes well for Reliance. As a result, we are continuing to invest in value added processing equipment for businesses that sell into nonresidential construction, and we will remain well positioned to absorb increased volumes in our existing footprint and cost structure as this end market improves. Demand for energy, which is mainly oil and natural gas, continues to improve with both rig counts and drilling activity increasing, though completion activity remains low. Quoting and overall activity improved during the quarter and mill lead times are extending. Importantly, beginning in the first quarter of twenty seventeen, our businesses servicing the energy market are once again contributing positively to our earnings.
The increased activity in this market is an encouraging sign, and we are well positioned to support demand growth as energy continues to recover. Mill pricing for almost all of the carbon steel products we sell into these end markets was under pressure during the second quarter due to the more competitive environment resulting from uncertainty over Section two thirty two and increased import levels. In mid June and again in July, however, mills announced price increases for certain carbon steel products that are now in effect, and we anticipate further price increases if the two thirty two investigation results in restriction on steel imports. Pricing for alloy products has been steadily improving, and further improvement in activity levels in the energy market should support increased pricing going forward. Thank you for your attention.
I will now hand the call over to Bill to comment further on our nonferrous markets.
Speaker 4
Bill? Thank you, Jim. Good morning, everyone. First, I too would like to thank our folks in the field for their solid operational performance during the second quarter. We appreciate your continued hard work.
I'll begin today by reviewing pricing and demand for our aluminum and stainless steel products as well as key industry trends in the markets for these products. Aerospace continued to perform well during the quarter and remains one of our strongest end markets. Today, lead times continue to be about nine to ten weeks for aluminum aerospace plate. The backlog for orders of commercial planes remains healthy, and we expect build rates should continue to improve modestly in the second half of twenty seventeen, led by single aisle planes. On our last conference call, we noted increased activity from many of our defense customers, and that trend continued in the second quarter.
Further, we continue to ramp production in regard to our participation in the five year $350,000,000 Joint Strike Fighter program. We are extremely pleased with our strong position in the aerospace market and look forward to increasing our market share as overall demand continues to grow. On that note, our entry into the aerospace market in India through our all metal services subsidiary in The U. K. Remains on track to become operational by the end of the year.
We are maintaining our positive outlook for the aerospace market. Turning to the semiconductor market. Activity remains strong, especially in The U. S. And Pacific Rim regions.
We maintain our positive outlook for the balance of this year as well as into 2018 based on solid demand trends. Moving on to pricing. The majority of our sales into the aerospace market consist of heat treated aluminum products, especially plate, as well as specialty stainless steel and titanium products. Most notably, a 5% increase for heat treated aluminum plate was announced during the first quarter and went into effect in April. Since then, pricing and demand have remained stable.
We expect this trend to continue in the third quarter. Most of our common alloy aluminum products are sold to sheet metal fabricators that support a variety of end markets. Demand for common alloy sheet in the second quarter was stable and in line with the first quarter trends. From a pricing standpoint, the conversion price increase announced for April has full domestic support and we believe the recently announced increase for the fourth quarter will also be supported domestically. We are also seeing less aggressive import offerings, which we believe relates to the Section two thirty two aluminum investigation.
Lastly, demand for our stainless steel flat products, which are primarily sold into the kitchen equipment, appliance and construction end markets has remained solid. That said, we experienced some pricing pressure during the second quarter as the price increase announced in April has been rolled back. As a result, we experienced some downward margin pressure on sales of our stainless steel products during the quarter. Thank you for your time and attention today. With that, I'll now turn the call over to Carla to review our second quarter twenty seventeen financial results.
Speaker 5
Thanks, Bill, and good morning, everyone. Our net sales in the second quarter of twenty seventeen were very strong at $2,480,000,000 up 12.3% from the second quarter of twenty sixteen with our tons sold of 1.4% and our average selling price per ton sold up 11.3%. Compared to the first quarter of twenty seventeen, our net sales were up 2.3 on steady tons sold with our average selling price per ton sold up 2.4%. Our gross profit margin in the second quarter of twenty seventeen was 28.4%, down from 31.1% in the second quarter of twenty sixteen and 29.8% in the first quarter of twenty seventeen. As Greg mentioned, there were multiple mill price increases in the first quarter of twenty seventeen and the second quarter of twenty sixteen, which allowed us to temporarily expand our gross profit margin as we pass through the higher mill price before we receive the higher cost metal in our inventory.
Given the absence of mill price increases in the second quarter of twenty seventeen and our receipt of higher cost inventory that reflected the mill increases announced in the first quarter, in addition to the downward pricing pressure on carbon and stainless steel products due to uncertainty in the marketplace and increased competitive pressure, we are very proud of our second quarter gross profit margin of 28.4%, which is solidly within our estimated sustainable range of 27% to 29% and produced $702,100,000 gross profit dollars, the second highest in Reliance's history. Consistent with the first quarter, as a result of higher metal prices compared to year end 2016, we recorded a net LIFO inventory valuation charge or expense of $10,000,000 for the second quarter of twenty seventeen or $09 earnings per diluted share. We continue to estimate a net LIFO inventory valuation expense of $40,000,000 for the full year of 2017. We did not record a LIFO inventory valuation adjustment in the second quarter of twenty sixteen. As a percentage of net sales, our SG and A expenses were 19.2% compared to 20.7% in the second quarter of twenty sixteen and nineteen point seven percent in the first quarter of twenty seventeen.
The decrease as a percentage of net sales was primarily due to higher selling prices, which increased our sales. Interest expense decreased by $3,200,000 in the second quarter of twenty seventeen compared to the second quarter of twenty sixteen, mainly due to the refinancing of our 6.2% senior notes with bank debt in November 2016. Our effective income tax rate for the second quarter of twenty seventeen was 31.2% compared to 32.7% in the second quarter of twenty sixteen. We currently estimate that our full year 2017 effective income tax rate will be approximately 32%. Net income attributable to Reliance for the second quarter of twenty seventeen was $103,000,000 or $1.4 per diluted share, up from $1.38 in the second quarter of twenty sixteen and down from $1.52 in the first quarter of twenty seventeen.
Although our earnings benefited from higher selling prices in the second quarter of twenty seventeen, the reduction in our gross profit margin from the elevated levels in the second quarter of twenty sixteen and the first quarter of twenty seventeen offset this improvement. Turning to our balance sheet. As a result of our effective working capital management, we generated $35,900,000 in cash from operating activities during the second quarter of twenty seventeen. We spent $38,700,000 for capital expenditures and paid $32,800,000 in cash dividends to our stockholders in the second quarter of twenty seventeen. At June 3037, our total debt outstanding was $2,080,000,000 and our net debt to total capital ratio was 30.7.
As of the end of the second quarter, we had $740,500,000 available on our $1,500,000,000 revolving credit facility. Our effective working capital management along with our solid earnings enables us to fund our increased activity levels with significant liquidity available to continue to grow the company and return value to our stockholders. Turning now to our outlook. We remain cautiously optimistic with regard to business activity levels in the third quarter of twenty seventeen subject to normal seasonal patterns. Given our expectation that current demand will remain steady except for the typical third quarter decline in shipping volumes due to customer shutdowns and vacation schedules, in addition to one less shipping day in the quarter, we estimate that our tons sold will be down 3% to 5% in the third quarter of twenty seventeen compared to the second quarter of twenty seventeen.
Given the recent increases in carbon steel pricing and the potential for fewer imports, we believe metal pricing momentum is positive. Therefore, we expect our average selling price in the third quarter of twenty seventeen will be flat to up 3% from the second quarter of twenty seventeen. As a result, we currently expect earnings per diluted share to be in the range of 1.15 to $1.25 for the third quarter of twenty seventeen. In closing, we are pleased with our overall financial performance in the second quarter due to the solid operational execution by our managers in the field in a competitive environment. We're excited to demonstrate the increased earnings capacity that exists in our company if and when market conditions improve and we look forward to updating you on our continued success in the coming quarters.
That concludes our prepared remarks. Thank you for your attention. And at this time, we would like to open the call up to questions. Operator?
Speaker 0
Thank you. Our first question comes from Seth Rosenfeld with Jefferies. Please proceed with your question.
Speaker 6
Good afternoon. Thanks for taking my question. Starting out, I'd like to get bit more update on current order activity. How are your customers positioned you think ahead of any potential further trade measures within The U. S?
You noted earlier in your prepared remarks that with the policy uncertainty customers are perhaps delaying purchases, but with perhaps more confidence over trade restrictions in the back half of the year, I guess I would think that that would perhaps drive more willingness to rebuild inventories at current lower price levels. Is that just not what you're seeing from your own downstream customers right now? And then second question on the stainless market. We've heard from two of your biggest suppliers talking about continued market headwinds and expected further destocking, perhaps base price weakness through Q3, but painting a much more positive outlook for Q4. Is that in line with your own expectations?
Or do you still see more potential for destocking in The U.
Speaker 0
S? This
Speaker 2
is Greg. I'll take question number one and give Bill the opportunity to respond to two. I think with the trade cases, there definitely has been some uncertainty in the marketplace with our customer base, and they're just being cautious. That doesn't mean that they don't have business, okay, that they need to buy material to support that business that they have on their book. But I think they still have maintained a level of cautiousness.
And frankly, I think most of us have. We fall into the same boat. But on the other hand, our demand for in the second quarter on a tonnage basis was basically flat as compared to the very first quarter. So we're really not complaining about the demand situation. It would be better if infrastructure was the bill was funded and we saw more activity in that regard.
But as businesses today, we're really not having much complaints on that. The uncertainty is always problematic. But at the end of the day, our customers do have business on their books and they do need to buy metal. And I think the results speak for themselves themselves on on tonnage being flat in the second quarter as compared to first quarter, which was a good quarter.
Speaker 4
Bill? Yes. And Seth, on I think your what you said is exactly correct. In our comments where the April increase was rolled back on stainless, I think we've seen a very competitive market. We expect that market to continue to be competitive in the third quarter.
And there is some speculation and talk about maybe pricing starting to stabilize, improve as we get into Q4. So I think from our point of view, we're hearing the same thing, and we hope that is the case.
Speaker 6
Okay. Thank you very much.
Speaker 2
Thank you.
Speaker 0
Our next question comes from Phil Gibbs with KeyBanc Capital Markets. Please proceed with your question.
Speaker 7
Morning, Greg, Carla, Jim, Bill.
Speaker 3
Morning, Bill.
Speaker 7
Question on the guidance, the pricing outlook of flat to up three percent for the third quarter versus the second quarter. Are you seeing that based on your realizations thus far in July? Or are you expecting pricing to get better in August and September to meet that?
Speaker 2
Well, so far, the Phil, the price increases that were announced in the June and also very recently, some flat rolled products, they've helped. The mills are not negotiating, at least as far as we're concerned. And they're pretty set in their ways on the mill price increases. So we feel pretty good about that. Section two thirty two has been a question in everybody's mind.
It looks like there's going to be a delay in that. How that's going to impact the pricing market is anybody's guess. But so far, the announcements that have been made in the June and just recently in the last week, they have held, and we're optimistic that they will continue to hold and hopefully improve at some point in time depending on a number of things, February as well as just imports in general. So we're hoping that the imports will start to decline a little bit, especially from the second quarter of this year.
Speaker 7
Yes. I guess my question was more along the lines of whether or not you need to see prices improve from relative to what you realized in July to get to that flat to 3% range?
Speaker 2
Well, I think those increases that were announced in June and July would put us in that 0% to 3% increase range.
Speaker 5
Yes. Because there were some price declines during the quarter, Phil, I think, which is what you're getting to. So to get back up to that average, we would need prices to improve a little bit from where those that were in effect when we ended the second quarter. But to Greg's point, the recent announcements we think helps get us up to flat and then we see potential upside of potentially more price increases for certain products through the quarter.
Speaker 7
Okay. And then next question here is just on inflationary pressures that you may be seeing in the marketplace, whether that be a tighter labor market and or a tighter freight market or anything else you may be seeing out there? Because I think starting to see or have been seeing just general inflation start to creep back into the fold? Anything you could comment on there would be helpful.
Speaker 5
I think if you look at our SG and A line, Q2 was pretty consistent with Q1. However, this year we are up a bit from last year somewhat because of those inflationary factors. We put most of our wage increases in effect at the beginning of the year. So we had some impact from that, just kind of normal inflationary factors, healthcare, etcetera. So we've kind of seen that across there.
From the freight side, we run primarily our own trucks at the majority of our locations. So we would have had the driver wage increases. Freight comes up a little bit just with the cost of gas and things, but probably not the level of inflation that some people who are using more third party carriers are experiencing.
Speaker 7
Okay. And then just a sub question to the labor piece, would just be are you in the mode to be hiring more folks right now? Or are you looking to sort of maintain or pare back what you have for productivity sake? Thanks. Bye.
Speaker 2
I think where we are from an employee standpoint, headcount, I think we're fine where we are right now. I don't anticipate unless we get a little bit of a bump on some of the infrastructure or some of the other industries that we support, we're in pretty good shape where we are today.
Speaker 7
Ladies
Speaker 0
and gentlemen, we've reached the end of question and answer session. I would now like to turn the call back to Greg Mullins for closing. Oops, excuse me, someone jumped into the queue. Our next question comes from Lee McMillan with Clarksons Capital Markets. Please proceed with your question.
Speaker 8
Hi, everyone. Good morning. Good morning. Just had a follow-up to Phil's first question. I want to make sure I'm getting this right.
It sounds like the price increases from June and July are embedded in your guidance. If I think about those as possibly being somewhat February related and then since then we've gotten the delay. I'm trying to balance that. You said that the recent increases get us up to flat. So I'm sort of wondering what drives prices higher from here, if I'm thinking about that correctly?
Thanks.
Speaker 5
Yes. I think, Leigh, overall, as Greg commented earlier, we think demand is still good and we'll hang in there subject to the normal seasonal patterns in the quarter. Mills are busy, so we anticipate that the prices will hold even without February. And with that continued kind of steady demand, we believe there will more than likely be fewer imports arriving during the third quarter than we saw during the second quarter, which also leads towards pricing support.
Speaker 8
Okay, got it. Thank you.
Speaker 0
Our next question comes from Naved Rosselli with Cowen and Company. Just
Speaker 9
on that what you just said, Carla, the fewer imports. I wanted to see what is giving you guys the confidence that we will see fewer imports? And if there's any products that you could single out that you think will decrease going into 3Q?
Speaker 2
Well, we think that there's a potential for that because we saw quite a bit. I think June was the highest import month that we've had since early twenty fifteen. We think we're going to see a gradual decline beginning in July, getting more reduced in the month of August, September. And even with the two thirty two delay, if people were to start increasing their purchases of imports today, that wouldn't be landing for another ninety days. So we think there's a period of time here where there's going to be reduced imports.
And with that, with mills running on flat roll at roughly 90% of capacity, which is big, and the other products running in the 75% capacity range, that there is a potential for further increases moving into the future.
Speaker 3
No, we just basically go by the offerings that we get. You got to remember, 95% of what we sell is domestic product. We prefer to deal with our domestic friends and partners. And even the offers that we do get because we get offers, they're not that great. There's not that many of them, and the spread isn't anything to write home about.
Speaker 9
Got it. Okay, that's very helpful. And then you guys have not made any acquisitions thus far in 2017. I just want to see if there are any specific reasons why? Are there deals out there that nothing looks attractive?
Or if you can just give us a little bit more color into your thought process there.
Speaker 2
Well, there's been some activity, okay? But very honestly, some of it is a little bit out of our realm of responsibility. So we've chosen not to pursue it. We think that there's been some reluctance from some sellers to get into the marketplace today based on tax reform potential out there. So we think that some people that would maybe not be sitting on the sidelines are sitting on the sidelines in anticipation of some tax level that will help them personally.
So but recently, we've seen a little bit of an increase in activity, which is encouraging for us. But as you know, we're pretty particular in the companies that we acquire. They have to be well run, well managed, immediately accretive to earnings. And that criteria that we have, we're going to stick with. It's served us well over the years, and we're going to stick with that going forward.
But we have, just in recent weeks, seen a little bit more activity than we did in the balance of the first half of the year.
Speaker 5
And I think, Naved, as you're aware, and as we've done consistently for years, we're opportunistic when the right opportunities are out there. So it's not a decision by reliance to not complete any acquisitions so far this year. It's just based upon the opportunities that are out there that fit our criteria that we have that Greg just talked about.
Speaker 9
Got it. Thanks guys.
Speaker 2
Thank you.
Speaker 0
Our next follow-up question comes from Phil Gibbs with KeyBanc Capital Markets. Please proceed with your question.
Speaker 7
My question has been asked and answered. Thank you.
Speaker 4
Thanks, Phil.
Speaker 0
Ladies and gentlemen, we've reached the end of the question and answer session. I'd like to turn the call back to Greg Mullins for closing comments.
Speaker 2
Thank you. Thanks again for your support and for participating in today's call. We'd like to remind everyone that in September, we will be in Boston presenting at KeyBanc's Basic Materials Conference. We hope to see many of you there. Thanks again for joining us, and have a great day.
Speaker 0
This concludes today's conference. You may disconnect your lines at this time. We thank you for your participation.