Commercial Metals Company (NYSE:CMC) Q1 2023 Earnings Call Transcript

Commercial Metals Company (NYSE:CMC) Q1 2023 Earnings Call Transcript January 9, 2023

Operator: Hello, and welcome, everyone, to the First Quarter Fiscal 2023 Earnings Call for Commercial Metals Company. Today’s material, including the press release and supplemental slides that accompany this call can be found on the CMC Investor Relations website. Today’s call is being recorded. And after the Company’s remarks, we will have a question-and-answer session and we will have a few instructions at that time. I would like to remind all participants that during the course of this conference call that the Company may make statements that provide information other than historical information that will include expectations regarding the economic conditions, effects of legislation, U.S. steel import levels, U.S. construction activity, demand for finished steel products, the expected capabilities and benefits of new facilities, the Company’s future operations, the time line for execution of the Company’s growth plan, the Company’s future results of operations, financial measures and capital spending.

These and other similar statements are considered forward-looking and may involve certain assumptions and speculation and are subject to risks and uncertainties that could cause actual results to differ materially from these expectations. These statements reflect the Company’s beliefs based on the current conditions that are subject to certain risks and uncertainties, including those that are described in the risk factors and forward-looking statements section of the Company’s latest filings with the Securities and Exchange Commission, including the Company’s annual report on Form 10-K. Although, these statements are based on management’s current expectations and beliefs, CMC offers no assurance that these expectations or beliefs will prove to be correct, and actual results may vary materially.

All statements made only of this date, except as required by law. CMC does not assume any obligation to update, amend or clarify these statements in connection with future events, changes in assumptions, the occurrence of anticipated or unanticipated events, new information or circumstances or otherwise. Some numbers presented will be non-GAAP financial measures and reconciliations for such numbers can be found in the Company’s earnings release, supplemental slides, presentation or on the Company’s website. Unless otherwise stated, all references made to the year or quarter end are references to the Company’s fiscal year or fiscal quarter. And now for the opening remarks and introductions, I would now like to turn the call over to Chairman of the Board, President and Chief Executive Officer of Commercial Metals Company, Ms. Barbara Smith.

Barbara Smith: Good morning, everyone, and thank you for joining CMC’s first quarter earnings conference call. I hope each of you had a wonderful holiday season. As we reported in our press release issued this morning, fiscal 2023’s first quarter was another outstanding period, marking the second best core EBITDA performance in our company’s history. I would like to thank CMC’s 12,000 employees who made these results possible. Your hard work and focused efforts are appreciated and are driving €“ the driving force behind CMC’s success. I will start today’s call with a few comments on CMC’s first quarter performance, then discuss our key strategic growth investments and sustainability efforts before providing an update on the current market environment.

Paul Lawrence will cover the quarter’s financial information in more detail, and I will then conclude with our outlook for the second fiscal quarter, after which we will open the call to questions. Before starting my prepared remarks, I would like to direct listeners to the supplemental slides that accompany this call. The presentation can be found on CMC’s Investor Relations website. As I noted, CMC’s first quarter fiscal 2023 earnings were among the strongest in our company’s 108-year history. We achieved net earnings of $261.8 million or $2.20 per diluted share on net sales of $2.2 billion. Excluding the impact of mill operational start-up costs incurred at our Arizona 2 project, adjusted earnings from continuing operations were $266.2 million or $2.24 per diluted share.

CMC generated core EBITDA for the quarter of $425 million, an increase of 30% from a year-ago, which produced an annualized return on invested capital of 23%. Results for our North America segment were again exceptional, as our team capitalized on strong demand. Segment adjusted EBITDA was within 1% of its record, excluding the impact of our second quarter 2022 California land sale. We continue to experience strong margins on sales of steel and downstream products during the quarter, which drove meaningful year-over-year earnings growth. Our Europe segment performed well despite a challenging economic backdrop, generating adjusted EBITDA more than double the past 10 years’ quarterly average. Facing well-publicized economic headwinds associated with the ongoing energy crisis, our team in Poland leveraged their excellent cost structure to profitably win share and maintain strong volume level.

Reflecting on the quarter as a whole, CMC encountered sharply different market environments within its two segments with tailwinds in North America and headwinds in Europe and demonstrated that we are capable of performing well in both environments. Our business model and well-aligned strategies have provided us the ability to fully capitalize on opportunities when they are available or adapt and adjust quickly when challenges arise. I would now like to discuss CMC’s strategic growth investments, specifically our exciting greenfield mill projects. Our Arizona 2 Micro Mill project is on track for a start-up later this spring. As I mentioned previously, we incurred start-up costs during the first quarter as we train and build our crews and begin to commission the new equipment.

We are excited to begin commissioning and look forward to providing updates as the process evolves. Once AZ2 is ramped up, CMC will be operating one of the most unique steelmaking complexes anywhere in the world. Not only will we achieve another industry first by producing merchant bar on a micro mill, but we will also have co-located two of our micro mills in a unique configuration. We expect this arrangement of the two steel plants will provide synergies, including shared staff support, production optimization, improved production scheduling and shared site infrastructure. Arizona 2’s commissioning looks to be well timed with the Infrastructure Investment and Jobs Act, which should begin to increase public infrastructure construction later this calendar year.

We intend to focus initially on ramping up rebar production with the commissioning of merchant products to follow soon after. Currently, we expect to produce a mix of approximately two-third’s rebar and one-third merchant bar on an annual run rate basis. Of course, as we have mentioned previously, Arizona 2 will have the operational flexibility to seamlessly adjust its production mix based on market demand. Turning to CMC’s other organic growth projects. We announced in early December that our fourth micro mill will be located in Berkeley County, West Virginia. The site selection process took longer than anticipated, but we are confident that CMC has chosen an excellent location within a state that is supportive of manufacturing innovation.

I’d like to thank Governor Jim Justice and the entire West Virginia economic development team and the dedicated Berkeley County staff for their support during the site selection process and their ongoing assistance as we become an important member of the community. During the planning phase, we have been referring to this growth initiative as MM4. I’m happy to say that after formalizing our site choice, we will now rebrand our mill as CMC Steel West Virginia. The mill is expected to have an annual capacity of approximately 500,000 tons and will be capable of producing both straight length and spooled rebar. The new plant will feature the latest productivity-enhancing technologies for micro mill steelmaking including Danieli’s Q-One power system that we first deployed in Arizona, making CMC Steel West Virginia one of the cleanest and most energy-efficient mills in the world.

The planned site location on West Virginia’s Eastern Panhandle will provide excellent access to the dense rebar consuming markets of the Northeast and Mid-Atlantic. Nearly 60 million people live within a standard shipping radius of this site, providing a variety of commercial opportunities across a number of major metropolitan areas. As can be seen on Slide 6 of the supplemental presentation, the site is also ideal for optimization of CMC’s existing operational network in the Eastern United States. We expect to generate synergies through reduced logistics cost, optimized production mix across mills, lower levels of safety stock and improved customer service capabilities. The project is budgeted to have a net cost of approximately $450 million.

Based on anticipated time lines for permitting and construction, plant is scheduled to begin operation in late calendar 2025. These two projects strongly advance CMC’s strategy of leadership in early phase construction reinforcement. We also believe they will provide meaningful value accretive earnings and cash flow growth for our investors. In addition to our organic growth projects, we continue to be very encouraged with the integration process of our Tensar acquisition and Paul will discuss the financial contributions a little later. During the quarter, we acquired two scrap recycling facilities and we are happy to welcome these employees to CMC. Both acquisitions support our captive scrap strategy to provide an economic supply of metallics for our mills.

Before I turn to commentary, I would also like to take a moment to emphasize the advancement of CMC’s sustainability efforts. Our fiscal 2022 sustainability report published last month illustrates CMC’s leadership position in environmental performance and our ongoing commitments for continued improvement. In fiscal 2022, CMC’s Scope 1 and 2 greenhouse gas emissions stood at just 0.413 tons of CO2 per ton of steel produced, representing a 14% reduction from a 2019 baseline and a decline of 7% from fiscal 2021 levels. These Scope 1 and 2 emissions in intensity levels are nearly 80% below the global industry average. It may surprise some to learn that despite the heightened focus on ESG, the global steel industries emissions per ton have actually increased steadily over the last several years.

However, CMC is going in the opposite direction using innovation, process improvements and energy sourcing to make greener steel with less impact on the environment. CMC’s micro mill projects will further improve our environmental footprint as this technology consumes 32% less energy and emits 30% less greenhouse gas compared to standard mini mills. Once AZ2 and Steel West Virginia are fully ramped up, roughly one-third of our products will be produced using the world’s cleanest steelmaking technology. These investments are yet another example of how at CMC good business decisions and good environmental stewardship go hand in hand. As you can also read in our 2022 sustainability report, CMC is poised to meet its or exceed its 2030 environmental goals related to Scope 1 and 2 greenhouse gas emissions intensity, water usage and energy consumption intensity and renewable energy sourcing.

Soon, we will be reevaluating these goals and setting new targets. I would now like to turn to CMC’s market environment starting with North America. Hopefully, it will be encouraging that my comments sound very similar to our recent updates as we continue to experience strong market conditions and see signs that strength will remain. We are well aware that recessionary concerns are growing in the investment community and being reported in the financial press, and we are monitoring conditions closely. However, looking at our business, we see no meaningful signs of a slowdown. Demand in the first quarter was stable at strong levels across our product lines and major geographies. Most key indicators that lead rebar consumption by nine to 12 months point to growth ahead.

These indicators include both external and internal metrics that have been historically reliable in our indices we’ve referenced in past market commentary. Let me review several of these key external indicators. The Dodge Momentum Index, which measures the value of non-residential projects entering the planning phase, reached a record high in November. The reading highlighted strong growth in both the commercial and institutional components of the index, rising 28% and 21%, respectively, from the prior year. We recently began monitoring a separate Dodge indicator that tracks the value of infrastructure projects entering the pre-design and design phases. The value of these projects is up significantly from the prior year, likely signaling that federal funding is working through the pipeline and will soon began to impact on the ground construction activity.

To give a sense of magnitude, the value of projects tracked by Dodge’s Design Phase Index over the last three months was double the prior year and was 12 times higher than two years ago. CMC’s own internal view also gives us confidence going forward. Our downstream bidding activity remained at historically high levels during the first quarter, driven by a broad range of project types in both the public and private sectors. As can be seen on Slide 9, our downstream backlog continues to grow on a year-over-year basis when measured in terms of both value and quantity. Beyond the near-term, we believe there are structural trends underway that will support strong domestic construction activity. The first, which I’ve already mentioned, is the federal infrastructure package signed into law a year ago.

At full run rate, this plan is expected to increase federal funding for core rebar consuming projects such as highways, bridges and related structures by 65% compared to the FAST Act that it replaced. We estimate the impact will be 1.5 tons of incremental annual rebar demand within a domestic market of roughly 9 million tons, representing an approximately 17% increase in consumption. Spending is expected to ramp up over five years and assuming typical time frames for project approvals, bidding and awarding, we should begin to see some impact on construction activity in calendar year 2023. The Dodge data I discussed earlier supports this view. Another meaningful structural trend is the reassuring of critical industries. We have previously mentioned the massive scale and pace of construction of new semiconductor facilities.

Currently, there are at least 11 facilities planned to be constructed with related total investment of over $275 billion. CMC is already shipping to several of these projects, but most are yet to break ground and impact rebar consumption. Semiconductor chip and wafer plants are the highest profile examples of reshoring, but other industries are also experiencing increased activity or project planning. These include LNG facilities for the export of natural gas, chemical and plastic plants as well as the automotive supply chain with a particular focus on electric vehicles and battery production. The last three years have exposed the vulnerabilities of concentrated global supply chains structured to operate under stable conditions and cooperative political regimes.

The pandemic and geopolitical turmoil have reminded us of the need for a more distributed set of sourcing options, ensuring reliability and flexibility in securing critical materials and equipment. Eventually, we expect reshoring to extend well beyond the areas we just discussed. Turning briefly to merchant bar, underlying demand conditions and end use OEM markets are generally stable. Following the destocking event that occurred during our fiscal fourth quarter, shipments to service centers stabilized at improved levels during the first quarter. We would expect real underlying demand to continue at a steady rate in the quarters ahead. As I indicated, market conditions in Europe are more challenging. Overall, construction activity continued to grow on a year-over-year basis during the first quarter.

However, residential activity, which has been strong for more than a year, is now showing signs of a slowdown due to the impact of rising mortgage interest rate. New mortgage origination has declined meaningfully over the last several months. However, programs are being developed to support first time homebuyers, which should attract more market activity by mid-calendar 2023. In addition, as a result of the ongoing energy crisis, industrial activity in Central Europe has been in contraction since the summer of 2022. This has impacted demand for merchant bar and some wire rod products. On the other hand, energy prices have moderated somewhat from recent market peaks and the current mild temperatures should also provide some relief. As illustrated on Slide 10 of the supplemental presentation, the European energy crisis, combined with trade sanctions, have has impacted historical trade flows in the region, which has benefited Poland on a relative basis.

Poland has recently moved into a net rebar export position compared to a fairly large net import position a year ago. Electricity price volatility relative to the broader EU has tended to be less extreme in Poland over the last year due to a variety of factors, which has created a favorable cost dynamic for Polish producers. Energy costs have been both lower and more stable, providing some protection from imported materials originating from other European Union countries. With regard to rebar trade with countries outside the EU, little foreign material has entered the Polish market to offset the loss of Russian and Belarusian rebar. Imports have increased into the broader EU, but this material has gone to countries that are more logistically accessible and are experiencing higher energy costs.

So while European demand is challenging at the moment, the supply side of the economic equation is helping to offset much of the detrimental impact. Within this environment, CMC has leveraged its strong relative cost position and operational flexibility to profitably win market share. Shipments of rebar, merchant bar and wire rod in the first quarter were all well above the long-term quarterly average despite a lackluster demand backdrop. We would expect these advantages to continue to favor CMC. Finally, as stated in our press release, our Board of Directors declared a quarterly cash dividend of $0.16 per share of CMC common stock for stockholders of record on January 19, 2023. The dividend will be paid on February 2, 2023. This represents CMC’s 233rd consecutive quarterly dividend, with the amount paid per share increasing 14% from Q1 of fiscal 2022.

With that as an overview, I will now turn the discussion over to Paul Lawrence, Senior Vice President and Chief Financial Officer, to provide some more comments on the results for the quarter. Paul?

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Paul Lawrence: Thank you, Barbara, and happy New Year to everyone on the call. As Barbara noted, we reported fiscal first quarter 2023 net earnings of $261.8 million, or $2.20 per diluted share compared to prior year levels of $232.9 million and $1.90, respectively. Results this quarter include a net after-tax charge of $4.4 million, which was related to start-up activities at CMC Arizona’s project. We expect to continue to incur start-up costs for the balance of fiscal 2023. Excluding the impact of this item, adjusted earnings were $266.2 million, or $2.24 per diluted share. Core EBITDA was $425 million for the first quarter of 2023, representing a 30% increase from the $326.8 million generated during the prior year period.

Slide 13 of the supplemental presentation illustrates the strength of CMC’s quarterly results. Our North America segment drove the significant year-over-year earnings growth, while Europe experienced some pullback. Core EBITDA per ton of finished steel reached its second highest rate ever coming in at $273 compared to $223 per ton a year ago. Now I will review the results by segment. CMC’s North American segment generated adjusted EBITDA of $378 million for the quarter, equal to $348 per ton of finished steel shipped. Segment adjusted EBITDA improved 41% on a year-over-year basis, driven significantly by increased margins on downstream and steel products over their underlying scrap costs. Downstream products were a particularly impactful contributor on a year-over-year basis as the average selling price improved by over $300 per ton compared to the first quarter of fiscal 2022.

Partially offsetting these benefits were lower margins on sales of raw materials as well as higher controllable costs on a per ton of finished steel basis due primarily to increased unit pricing for alloys, energy and freight. On a sequential quarter basis, controllable costs per ton were relatively unchanged with signs of pricing on some key consumable inputs have peaked and could begin declining in the quarters ahead. As we look forward, we have a number of planned maintenance outages that will not impact shipment volumes, but will result in higher controllable costs in coming quarters. Selling prices for steel products from our mills increased by $44 per ton on a year-over-year basis, but declined $84 per ton from the prior quarter. Margin over scrap on steel products increased $147 per ton from a year ago.

Comparison to our fourth quarter, metal margin decreased by $22 per ton as a decline in average pricing outpaced the reduction in scrap costs. Shipments of finished product in the first quarter were virtually unchanged from a year ago and followed a typical seasonal pattern compared to the fourth quarter. End market demand for our mill products remained healthy. Rebar consumption as tracked by the Steel Manufacturers Association is growing on a year-over-year basis. They are likely still moderated by constrained supply of labor and material in certain geographies. Demand for merchant bar is stable at good levels. Turning to Slide 15 of the supplemental deck. Our Europe segment generated adjusted EBITDA of $64.5 million for the first quarter of 2023, which included the receipt of an annual energy credit that totaled approximately $9.5 million.

The first quarter results compared to adjusted EBITDA of $79.8 million in the prior year period. The decline was driven by higher costs for energy, the negative P&L impact of selling higher cost inventory into a contracting price environment; a reduced energy credit, which was over $15 million last year as well as the weakening of the Polish Zloty relative to the U. S. dollar. CMC’s energy hedge position once again paid significant dividends as actual costs were well below the levels that would have been paid had we purchased solely on the spot basis. Europe volume increased 30% compared to the prior year due to the market share gains mentioned by Barbara, as well as the impact of a planned major maintenance outage taken during the comparative period of the first quarter of fiscal 2022.

Demand conditions within Central Europe are challenging. However, the Polish construction market continue to grow by mid single-digit percentages, while industrial production has entered into contractionary phase as a result of the ongoing energy crisis. We believe CMC is well positioned for this current period of volatility in Europe. We are a low-cost industry leader with operational flexibility to adjust to and serve changing market conditions. Tensar generated $11.4 million during the first quarter, yielding an EBITDA margin of 18.9%. Margins were temporarily hampered by production issues encountered at our Morrow, Georgia geogrid plant. These issues have been addressed with equipment upgrades. However, during the first quarter, we incurred increased logistics costs and slower delivery time as a result of bringing product from our overseas operations.

As a reminder, Tensar performance is included within CMC’s existing segments. Of our $11.4 million of EBITDA, $8.1 million was included in CMC’s North American segment, with the remaining $3.3 million recorded in our Europe segment. Turning to the balance sheet. Moving as of November 30, 2022, cash and cash equivalents totaled $582 million. In addition to cash and equivalents, we had approximately $915 million of availability under our credit, term loan and accounts receivable facility, bringing total liquidity to $1.5 billion. During the quarter, CMC took a few financing actions worth noting. First, we repurchased $115.9 million of CMC’s 2023 senior notes through a tender offer process, leaving $214.1 million outstanding, which will mature in May.

Second, our revolver was upsized to $600 million and concurrently, we canceled our U.S. accounts receivable program, which resulted in a net $50 million increase in availability. And lastly, CMC established a $200 million term loan facility that can be utilized to refinance the maturing notes if we so choose. During the quarter, we generated $372.4 million of cash from operating activities, with working capital being relatively neutral factor. Our free cash flow amounted to $239.3 million defined as our cash from operations less $133 million of capital expenditures. Our leverage metrics remain attractive and have improved significantly over the last several fiscal years. As can be seen on Slide 19, our net debt to EBITDA ratio now sits at just 0.4x.

While we believe our robust balance sheet and overall financial strength provides us flexibility to finance our strategic organic growth projects and pursue opportunistic M&A while continuing to return cash to shareholders. CMC’s effective tax rate was 22.7% in the first quarter. Looking ahead to fiscal 2023, we currently expect a full-year effective tax rate of between 23% and 25%. Turning to CMC’s fiscal 2023 capital spending outlook, we expect to invest between $500 million and $550 million in total. The $50 million increase to the range compared to prior guidance is driven by spending related to CMC Steel West Virginia that we now view as likely to occur this year. Lastly, CMC purchased roughly 1.3 million shares during the fiscal first quarter at an average price of $38.53 per share.

Transactions since the initiation of the buyback program through Q1 have amounted to roughly $211 million, leaving $139 million remaining under the authorization. This concludes my remarks. And I’ll turn the discussion back to Barbara for comments on our outlook.

Barbara Smith: Thank you, Paul. We remain confident that fiscal 2023 will be another year of strong financial performance. Downstream backlog and bidding activity are at historically high levels and should support volumes over the near-term. Additionally, we look forward to the start-up of our newest micro mill, Arizona 2, in the spring, which will greatly enhance CMC’s ability to capitalize on the strength we see in construction markets. We anticipate good financial results in the second quarter compared to historical standards, though seasonally down from the first quarter. We expect healthy demand for our products to continue in North America, while conditions in Europe are more challenging and could be impacted by customer pessimism and general uncertainty.

However, as I discussed earlier, CMC’s operations in Poland are very well positioned to compete given their cost leadership position and operational flexibility. While we anticipate margins over scrap in both North America and Europe to remain elevated in relation to historical levels, they are likely to compress from the first quarter levels. Once again, I would like to thank all of our CMC employees for delivering yet another quarter of outstanding performance.

Q&A Session

Operator: Thank you. And at this time we will now open the call for questions. And our first question today will come from Emily Chieng with Goldman Sachs. Please go ahead.

Emily Chieng: Good morning, Barbara and Paul. Thank you for the update this morning. I’d like to start off by asking around the Europe segment there. Volumes were certainly much higher than anticipated. Perhaps could you share how much of that is taking share versus some of the still steady Polish construction market strength that you’re seeing? And then perhaps if you’ve got a sense of what volume expectations could look like there for the remainder of the year?

Barbara Smith: Yes. Thank you, Emily. Happy New Year. So I would say the following. If you look at our strategy in Europe, we’ve had a deliberate strategy over time to strengthen our Polish operations by creating a situation where we have tremendous operational flexibility and expanding the product range of products that we have to offer. So if you go back 10, 15 years, we were highly dependent upon construction products, rebar and wire rod. And there’s been a deliberate investment strategy to invest in merchant and even into some SBQ ranges. And what that does for us is it gives us the flexibility as market conditions change to shift the product mix to the markets with good demand or better demand. In addition, we’ve worked really hard to have a cost structure that is advantaged relative to other options in the region.

And those two factors combined have really allowed us to shift to the markets that have the strongest demand. So I would say we are encouraged, as I said earlier, about the construction fundamentals in Poland going forward, albeit some reduction in residential, but still good growth and good €“ there’s positive GDP in Poland as compared to other parts of the region. There’s €“ as I indicated, the trade flows have changed as a result of the war. That has created opportunity for CMC to step in and fill demand that was filled from Russia and Belarus. So all those factors combined, we’re going to continue to take advantage of our low-cost structure and take advantage of our operational flexibility to shift to where the best market opportunities are.

And that will allow us to have good operational results going forward.

Emily Chieng: Great. That’s very clear, Barbara. And as a follow-up, would love to sort of dig deeper around the cost commentary that was provided. It sounds like things may be peaking and you might be starting to see some early signs of certain costs coming down, presumably some of the warmer weather might have brought down the energy cost structure as well. But could you perhaps share what you’re seeing in each of the different components in the controllable cost calculation? And then maybe when we should be expecting that maintenance activity to hit this year? I’ll leave it at that. Thank you.

Barbara Smith: Let me make a couple of broad comments, and then I’m going to let Paul give some more specifics. If you look at €“ and you go back and look at what happened when COVID hit, there was just a severe supply chain disruption and severe economic reaction because there were so many unknowns. If you fast forward to when the war broke out between Russia and Ukraine, you saw a similar situation where €“ in the example, I’ll use energy just skyrocketed because there was all this uncertainty around how Europe would source their energy and what would the price be. You also saw a massive increase in a number of raw materials, alloys and other things that were a result of that disruption. And much the same as we saw during COVID after supply chain started to readjust and things calm down, there was an abatement in that supply chain disruption.