Algoma Steel Group Inc. (NASDAQ:ASTL) Q3 2023 Earnings Call Transcript

Algoma Steel Group Inc. (NASDAQ:ASTL) Q3 2023 Earnings Call Transcript February 14, 2023

Operator: Hello and welcome to today’s Conference Call to discuss Algoma Steel’s Fiscal Third Quarter 2023 Financial Results. My name is Shamali and I am your operator for today’s call. At this time, I’d like to hand the call over to Mike Moraca, Treasurer and Investor Relations Officer for Algoma. Mr. Moraca, please go ahead.

Mike Moraca: Good morning, everyone and welcome to Algoma Steel Group, Inc.’s financial and operating results conference call for the fiscal third quarter ended December 31, 2022. Leading today’s call are Michael Garcia, our Chief Executive Officer; and Rajat Marwah, our Chief Financial Officer. As a reminder, this call is being recorded and will be made available for replay later today in the Investors section of Algoma Steel’s corporate website at www.algoma.com. I would like to remind you that comments made on today’s call may contain forward-looking statements within the meaning of applicable securities laws, which involve assumptions and inherent risks and uncertainties. Actual results may differ materially from statements made today.

In addition, our financial statements are prepared in accordance with IFRS, which differs from U.S. GAAP, and our discussion today includes references to certain non-IFRS financial measures. Last evening, we posted a presentation on our financial and operating results to accompany today’s prepared remarks. The slides for today’s call can be found in the Investors section of our corporate website. With that in mind, I would ask everyone on the call to read the legal disclaimers on Slide 2 of the accompanying presentation and to also refer to the risks and assumptions outlined in Algoma Steel’s financial statements and management’s discussion and analysis for the full year ended March 31, 2022. Please note that our financial statements are prepared using the U.S. dollar as our functional currency and the Canadian dollar as our presentation currency.

Our fiscal year runs from April 1 to March 31, and our third quarter financial statements have been prepared for the 3 months ended December 31, 2022. Please note all amounts referred to on today’s call are in Canadian dollars unless otherwise noted. Following our prepared remarks, we will open the call to conduct a question-and-answer session. I will now turn the call over to our Chief Executive Officer, Michael Garcia. Mike?

Michael Garcia: Thank you, Mike. Good morning and thank you for joining us today. As we always do, I would like to begin my remarks by addressing Algoma’s top priority, which is the safety of our employees. At Algoma, safety is nonnegotiable and is firmly rooted in our corporate values, where with every decision, every action and every day, we will work safely with teamwork, integrity and a deep care for our people, their families and the environment. Our continued dedication has led to a significant improvement in our lost time injury frequency rate over the past decade. We will continue to work diligently as we relentlessly pursue our goal of achieving 0 workplace injuries. Next, I’ll cover key events and milestones during our fiscal third quarter and subsequent to its end.

I will then turn the call over to Rajat for a deeper dive into the numbers before closing with an update on market conditions and our strategic investments set to deliver long-term value for all of our stakeholders. Our performance in the third quarter was largely in line with our preannouncement on January 9, 2023. Shipments of 458,000 tons were sequentially higher, though still below our normal run rate as we completed commissioning of our plate mill modernization Phase 1. Our overall financial results also reflected lower pricing in the third quarter. Steel prices for hot-rolled coil have recovered meaningfully since early November, and plate pricing has maintained a significant price premium. While commissioning of the plate mill modernization Phase 1 was a challenge in the second half of calendar 2022, it’s important to highlight the reasons for the project and the value delivered from it.

Our plate mill is the only discrete plate mill in Canada, and it produces a full range of high-quality rolled and heat-treated plate products, including the widest plate manufactured in Canada. Our products can be tailored for high-strength abrasion resistance and military applications among a wide range of other end uses. Completion of Phase 1 will now deliver enhanced capabilities, including improved surface quality and shape. Importantly, plate shipments returned to normalized levels by the end of the third quarter, and we expect shipments in calendar 2023 to be consistent with historical production levels. The next phase of our plate mill modernization project, Phase 2, will focus on increasing mill throughput and is expected later in 2023.

As we outlined on our last quarterly call, we will be mindful of market conditions before commencing Phase 2, and we will be laser-focused on utilizing lessons learned from Phase 1 in its implementation. Looking forward on the cost side, we expect a quarter-over-quarter improvement on cost of goods sold per ton as we return to normal production levels. It should be noted that we continue to experience some headwinds on account of higher-priced purchased coke. Our demand for coke at the blast furnace outstrips our production capacity, requiring us to supplement with purchased coke. In an effort to mitigate this, we are focused on operational improvement initiatives at our coke-making facilities to increase throughput. We anticipate to complete these improvements over the next few months, providing additional internal coke production by the end of fiscal Q1 2024.

As previously disclosed, we have a long-term contract with a third-party coke producer, which provides us with the coke needed to maintain steel production at normalized levels. The fiscal third quarter was also characterized by a volatile market for steel and raw material inputs, which continued to impact realized prices and costs. Pricing reached 2022 lows in early November before recovering through the end of the quarter and into 2023. During the quarter, we continued to advance construction of our transformative electric arc furnace project, which remains on budget and on time for our planned mid-2024 startup. Piling and foundational work is largely complete. Cranes are in position, and the first structural steel components are being raised as we speak, an exciting milestone in the project.

On the capital allocation side, we declared our regular quarterly dividend of $0.05 per share, and we remained active on to our normal course issuer bid program. Now I will pass the call over to Rajat to go over the financial results of the third quarter. Rajat?

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Rajat Marwah: Thanks Mike. Good morning and thank you all for joining the call. Our fiscal third quarter results, while challenging for the operational reasons Mike alluded to, came in line with our guidance for shipments and EBITDA provided in January. I will remind you again that all numbers are expressed in Canadian dollars unless otherwise noted. However, our functional currency is the U.S. dollar. For the third quarter, we reported a net loss of $69.8 million or $0.64 per diluted share compared to net income of $123 million or $0.92 per diluted share in the prior year quarter with the decline attributable to weaker steel market conditions as well as lower-than-expected shipments due to the commissioning delays at the plate mill.

Now let me summarize the key drivers of our performance. We shipped 458,000 net tons in the quarter, down 17% as compared to the prior year quarter. As we previously disclosed, delays experienced during the commissioning of our plate mill modernization project had the largest impact on shipments. Net sales realization averaged 1,116 per ton, down 38.9% versus the prior year period. The decrease versus the prior year level primarily reflects weaker market conditions during the quarter relative to record pricing levels seen during the prior year period. This resulted in steel revenue of $512 million in the quarter, down 49.3% versus the same quarter of last year. On the cost side, Algoma’s cost of goods sold averaged $1,157 per ton in the quarter, up 22.3% over the prior year period.

This includes approximately $100 per ton of cost attributed to previously disclosed operational challenges flowing through inventories. Further cost pressure comes from higher prices for key inputs, including metallurgical coke, natural gas, alloys and scrap as well as the impact of lower shipments. Adjusted EBITDA for the quarter was a loss of $35.9 million as compared to $457.3 million in the prior year comparable quarter. The year-over-year decrease was driven primarily by a decline in realized steel pricing and lower shipment volumes. From a cash flow perspective, cash flow from operating activity was a use of $128.6 million in the quarter compared to cash generation of $318.4 million in the prior year comparable quarter. The main drivers include lower EBITDA and a significant investment in the working capital in the quarter as we continue to build both raw material and work-in-progress inventories given seasonal inventory build and lower-than-normal production volumes.

For context, our inventory position as at December 31, 2022, stood at 912 million versus 616 million in the same quarter of the prior year. This nearly 300 million increase in inventory was partially attributable to higher prices and exchange variation. However, approximately 55% of the variance relates to higher inventory quantities. We expect to gradually release this excess inventory in the coming quarters, which will add to our liquidity levels. We finished the quarter with $245 million of cash and equivalents on the balance sheet. And our asset-backed credit facility was undrawn with $239 million in availability. As an update to year project spending through the end of the third fiscal quarter ended December, we have spent approximately $220 million on the EAF project and issued letters of credit of $48 million, securing fabrication and delivery of key components.

While this aggregate spending level is lower than originally anticipated for the quarter end, it is primarily due to timing differences in fabrication and erection of EAF building and the delivery of offshore equipment. These timing differences do not affect the critical path of the completion of the project. And we remain on time and on budget for a mid-2024 start-up. To-date, approximately 70% of the total EAF investment amount has been contracted with fixed price commitments with the balance still to be contracted. Supporting the remaining items to be contracted, we maintain approximately $50 million of available contingency. We expect to spend approximately $70 million to $80 million on the EAF project in the fourth fiscal quarter. Putting this altogether, I would like to highlight a few points.

As at December 31, Algoma’s net working capital plus cash totaled $1.15 billion, and we have full access to our undrawn ABL facility. We have a conservative and prudent approach to our balance sheet with virtually no long-term debt, except for attractive government financing. We have access to an additional $168 million of funding available on the SIF facility, which is supporting the development of the EAF. All this together puts us in a strong position to advance on our strategic capital initiatives, including the transformation to EAF, which we expect to deliver improved operational performance, enhanced cash flow and EBITDA through the cycle and reduce earnings volatility. I’d now like to turn the call back to Mike for a market update and closing remarks.

Michael Garcia: Thank you, Rajat. Now turning to the North American steel market, 2022 was marked by significant volatility in pricing. Highs that were reached in March around the start of the Ukraine war quickly reversed, testing various support levels through the summer and fall before bottoming in November. We are encouraged by the recent price improvements in hot-rolled coil and continued robust plate pricing. Key market indicators including extended lead times and a strengthening forward curve, support our expectation of improved performance in calendar 2023. Our order book supported by a significant portion of contract sales, shows consistent demand for our product, including sales to the automotive, construction, oil and gas and other steel-intensive industries.

And from a global perspective, price dynamics and trade measures continue to reduce the attractiveness of imports into our North American markets. For the fiscal fourth quarter, we expect sequentially higher shipments, more consistent with our normal operating levels. And in combination with current steel pricing, we expect sequential improvement in net sales realizations and EBITDA performance. That said, we continue to experience pricing pressure on our key inputs, including metallurgical coke, coking coal, alloys and general inflationary increases on other goods and services, which will have an effect on margins for our products. In calendar 2023, we expect to benefit from normalized and consistent operating performance, labor stability, a strong and flexible balance sheet and great support from our government partners and our community.

We expect this year to yield a combination of improved operational results and accelerating progress on our transformative EAF investment. As the market is showing signs of greater stability, we expect to generate significant free cash over the longer term, which supports our two main capital improvement program: the second phase of the plate mill modernization and the EAF investment. Our focus remains on prudent financial discipline, maintaining full operating capabilities and completion of our EAF project, ushering in the next era for Algoma Steel and providing long-term value creation for our stakeholders. As the world transitions towards a more sustainable future, it will continue to need steel for decades to come. At Algoma, we are building on our proud 120-year-plus history to serve our customers today while simultaneously becoming one of the lowest cost producers of green steel in North America.

We are very excited for our company and employees, and look forward to what the future holds. Thank you very much for your continued interest in Algoma Steel. At this point, we would be happy to take your questions. Operator, please give the instructions for the Q&A.

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Q&A Session

Operator: Our first question comes from the line of David Ocampo with Cormark Securities. Please proceed with your question.

David Ocampo: Thank you. Good morning, everyone. Rajat, I was wondering if you could €“ Rajat, I was hoping we could touch a little bit on the working capital, particularly as it relates to the inventory. You called out that 55% of it is due to higher inventory levels. I was wondering if you could break that down between potentially how much of it is related to unfinished slabs versus, say, higher inventory levels of iron ore?

Rajat Marwah: So on a very high level, let’s say 40% will be in €“ within finished, and the balance will be in rest of the raw materials, so roughly 40%, 60%.

David Ocampo: Okay. And then on the work-in-process €“ in-progress, is there potentially a catch-up in shipments that we could expect that sort of unwinds in calendar €˜23?

Rajat Marwah: Yes, we should €“ as we start reducing and finish, we should expect that to flow into the shipments over the next, let’s say, couple of quarters.

David Ocampo: Okay. That’s good. And then on the plate mill modernization Phase 2 component of it, should we expect any downtime if you guys do decide to go forward with this for the end of the year? Or how should we think about any disruptions to your production levels as you move forward with that next phase?

Michael Garcia: Yes. David, this is Mike. So the Phase 2 implementation of the plate mill modernization project involves two components. One component is to bring online the new in-line high-capacity shear that will replace a small undersized shear that’s there currently and replace most of the gas flame cutting that we need to do in the facility anything under 2 inches. That portion of Phase 2 does not require any mill downtime. So as we’re doing that, we can continue to produce both plate and strip the small amount of cutting that would be done on the small shear we will do with an outside processor. The other component is the replacement and the upgrade of drives on the four-high stand in the hot mill. That does require an outage.

Currently, that outage will be approximately 40 days of production or you can think about roughly it’s 60,000 tons of both plate and strip. And that’s kind of what that outage looks like currently. And again, the timing for the outage is the shear work and the finishing end work will begin in May, take approximately 5 months. Again, no impact to ongoing operations and then the 40-day mill outage for the drive upgrade has not been scheduled with a final implementation date and that will depend on both market conditions and our readiness for the down. Does that help?

David Ocampo: That’s extremely helpful. That’s all the questions I had. I’ll hop back in the queue. Thanks.

Operator: Our next question comes from the line of Ian Gillies with Stifel. Please proceed with your question.

Ian Gillies: Good morning, everyone.

Michael Garcia: Good morning, Ian.

Ian Gillies: I just wanted to start on the volume side. As you think about it from a business planning perspective, are you anticipating pretty standard volumes across all the quarters this year? Do you think €“ should we be thinking about it as a build through the year, given that there is still a little bit of ancillary repair and maintenance work left to be completed?

Michael Garcia: Yes. Thanks, Ian. So we anticipate it to be pretty standard. Other than the plate mill outage that I spoke about, which we haven’t decided when exactly we will take that, it should be relatively standard and somewhat equal across the four quarters with maintenance kind of spread evenly throughout the steelworks.