Algoma Steel Group Inc. (NASDAQ:ASTL) Q4 2023 Earnings Call Transcript

Algoma Steel Group Inc. (NASDAQ:ASTL) Q4 2023 Earnings Call Transcript June 22, 2023

Operator: Hello, and welcome to today’s Conference Call to discuss Algoma Steel’s Fiscal Fourth Quarter and Full Year 2023 Financial Results. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] 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 fourth quarter and full year fiscal 2023 earnings conference call. 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 is — which differs from U.S. GAAP and our discussion today includes references to certain non-IFRS financial measures.

Last evening, we posted an earnings presentation 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 today’s call to read the legal disclaimers on slide two of the accompanying earnings presentation and also refer to the risks and assumptions outlined in Algoma Steel’s fourth quarter fiscal 2023 Management’s Discussion and Analysis. 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 1st to March 31st, and our financial statements have been prepared for the three months and 12 months ended March 31, 2023.

Please note, all amounts referred to on today’s call are in Canadian dollars unless otherwise noted. Following our prepared remarks, we will 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. Welcome and thank you for joining Algoma Steel’s earnings call to discuss our fiscal fourth quarter and full year results. I will start my comments, as we always do, by addressing what truly matters most to us, the safety of our employees. At Algoma, we believe in safety without compromise. As disclosed last week, a subcontracting company performing specialized maintenance work at our site sustained a fatality of one of their employees, who succumbed to his injuries despite the prompt and professional response of Algoma’s Emergency Services team and assistance from the Sault Ste. Marie Fire and Paramedic Service. This tragic loss of life has impacted us all at Algoma and our prayers go out to the family, friends and colleagues of the individual.

Now turning to our results and highlights. Our fiscal 2023 was a very busy time at Algoma, one marked by volatile commodity prices, operational improvements to our plate mill and exciting progress on our transformative Electric Arc Furnace or EAF project. We overcame a challenging fiscal second quarter and third quarter, while commissioning Phase 1 of our plate mill modernization project, followed by our plate and strip production returning to normal levels at the start of the new calendar year. Our results for the fiscal fourth quarter and our guidance for fiscal Q1 2024 reflects solid operational momentum, which we expect to continue throughout the fiscal year even as activity ramps at our EAF project, which I will give additional color on in a moment.

Relentless execution by the entire Algoma team helped overcome commodity price volatility and operational challenges to drive the strong results we achieved in our fiscal year. Those results included shipments of 2 million tons, revenues of almost $2.8 billion, adjusted EBITDA of $452.3 million and cash generated by operating activities of $177 million. We recently strengthened our liquidity through an upsized and extended ABL facility, which, when combined with cash on hand and strong cash flows, we expect to deliver in fiscal 2024 positions us well to deliver on our goal of exceptional operations at our current facilities, while advancing the later stages of our EAF project construction. Regarding Phase 2 of our plate mill modernization project, I am pleased to report that the inline shear installation is currently progressing ahead of schedule and the company expects to be able to begin increasing plate production in the third calendar quarter of 2023.

This higher production will allow us to capture market opportunities and to build inventory ahead of the planned Phase 2 hot mill outage to upgrade the hot mill drives currently scheduled in April of 2024. Now I’d like to spend a few minutes updating you on our progress and outlook for the transformational EAF project. The completion of this initiative will see a shift from roughly 2.8 million tons per year of liquid steelmaking capacity by conventional means today to employing dual Electric Arc Furnaces that are designed for a combined annual liquid steel production throughput of 3.7 million tons. This increased output will match our expanded downstream finishing capacity, as we increase our capacity at our plate mill, while simultaneously lowering our carbon emissions by approximately 70% when fully operational.

We recently achieved two important milestones related to securing the power supply necessary to support dual furnace operations. First, we received conditional approval of the System Impact Assessment from Ontario’s Independent Electricity System Operator, confirming that we may connect our EAFs to the current 115-kilovolt electricity grid in Northern Ontario in combination with Algoma’s on-site Lake Superior Power combined cycle natural gas power plant. This SIA was conducted by the IESO to gauge the impact of the project on the reliability of the Ontario grid for large-scale projects. Dedicated reliable electricity supply is critical to successful EAF operations and the upgrades to support our project will take place in three phases. Phase 1 is comprised of the existing 115-kilovolt transmission connection supplemented by LSP on-site generation, Phase 2a includes the development of a new local 230-kilovolt transmission line providing access to more power on the current grid, and Phase 2b represents full power with the enhancement of the Northern Ontario electricity grid expected to be completed by 2030.

Our second milestone was the successful on-time and on-budget installation of two new GE LM6000 turbines and all control systems at our Lake Superior Power Plant, which we expect to give us 115 megawatts of internally generated baseload capacity, enabling us to start production at our EAF steel facility. Our original budget for the EAF project set in 2020 was approximately CAD700 million, with an expected commissioning start date of calendar mid-2024. Our start-up plan includes normal production from our existing steelmaking facility, while ramping up steel production from our EAFs in calendar 2025, followed by a complete switch to EAF production. The project advanced through fiscal 2023 with approximately 80% of the budgeted project costs contracted and the remainder uncontracted at the fiscal year-end.

As is typical for an undertaking of this scope, the remaining portion of project contracting was subject to achieving final detailed designs, a milestone recently reached as expected. Not surprisingly, many of the inflationary and logistical factors that have weighed on large capital projects for other industrial companies since 2020 have come into play as we move into the next phase of this project. The company now estimates that the project will exceed its original budget by $125 million to $175 million due to various emerging factors, including general market pressures impacting the cost of materials, along with higher costs for skilled labor and currency fluctuations. Additionally, supply chain disruptions with certain micro processing chips is expected to delay the start of commissioning of the first furnace to calendar year-end 2024.

Management remains fully committed to addressing these challenges proactively to mitigate their impacts and to ensure the successful execution of this project. The company expects that the completion of the EAF project will be funded with cash on hand, cash generated through operations and available borrowings under the company’s existing undrawn and recently upsized and extended ABL credit facility. While the date for the start of commissioning has now moved to the end of the calendar year 2024, our revised start-up plan will not materially impact shipping performance in calendar year 2025. These are busy times at our site in Sault Ste. Marie and it’s a testament to the execution by our team that we are able to operate our existing portfolio of assets normally without being operationally impacted by the advancing construction of this transformational project.

Now I will pass it over to Rajat to go over our financial results for the quarter and the fiscal year. Rajat?

Rajat Marwah: Thanks, Mike. Good morning and thank you all for joining the call. I’ll remind you again that all numbers are expressed in Canadian dollars unless otherwise noted. We had a solid quarter to close out our fiscal year end March 2023. Our fourth quarter results included adjusted EBITDA of $47.9 million, which reflects an adjusted EBITDA margin of 7.1% and cash generated from operating activities of $95.4 million. We finished the quarter with $247 million of unrestricted cash and $279 million of undrawn capacity on our revolving credit facility, representing total liquidity of approximately $526 million. Subsequent to quarter end, we upsized our ABL credit facility by US$50 million and extended the maturity five years, further enhancing our available liquidity.

As a reminder, the only remaining long-term debt on our balance sheet is in the form of government loans linked to our capital projects. I will provide additional color on the ABL later in my remarks, but first I’ll dive into the key drivers of our performance. We shipped 572,000 tons in the quarter, up 24.7% sequentially and up 4.5% as compared to the prior year quarter. On our last call, we highlighted how our plate and strip operations were running normally at January 1st, and that continues through today as evidenced not only by our fiscal fourth quarter shipment, but also in our fiscal first quarter 2024 guidance. Net sales realization averaged $1,066 per ton, down 4.5% sequentially and down 33.7% versus the prior year period. The decrease versus the prior year level reflects overall soft market conditions.

Plate pricing continued to enjoy a significant premium relative to hot-rolled coil during the quarter, driven by resilient demand, particularly from spending on infrastructure projects and durable goods. As a reminder, we are the only discrete plate mill in Canada. This resulted in steel revenue of $609 million in the quarter, up 19% sequentially, but down 30.8% versus the same quarter of last year. On the cost side, Algoma’s cost per ton of steel products sold averaged $934 in the quarter, down 19.3% on a sequential basis and down 1.4% versus the prior year period. The main drivers of the modest decrease versus the prior year period include, higher volume more than offsetting the cost of replacing internally produced coke with purchase scope and higher cost for other key inputs.

Cash flow from operations totaled $95.4 million for the quarter. The main drivers of cash flow beyond EBITDA included a release of inventories totaling $189 million, offset by increase in accounts receivables and a reduction in payables. As mentioned in our last call, we expect to continue to release inventories throughout the year as quantities normalize with consistent production. Looking at our fiscal 2023 full year results. We shipped 2 million tons for the year, down 12.8% as compared to the prior year. The drivers of the year-over-year decline included commissioning challenges at the plate mill following Phase 1 of the modernization project and production issues related to staffing. Net sales realization averaged $12.74 per ton, down 17.6% versus the prior year, reflective of soft market condition.

This resulted in steel revenue of $2.6 billion, down 28.1% versus last year. On the cost side, Algoma’s cost of steel products sold averaged $1,004 per ton for the year, an increase of 17% over the prior year. The main drivers of this increase versus the prior year period were the replacement of internally produced coke with purchase coke and increases in the purchase price of key inputs such as metallurgical coke, coal, natural gas and alloys, in addition to ratifying the collective bargaining agreement, which resulted in increased pension and post-employment benefit expenses. Next, I’ll touch on the financing activity we completed last month. As a normal course, with our previous ABL credit facility set to expire in November of 2023, we engaged our lender group to amend and extend the facility.

Given our financial strength and cash flow profile through market cycle, we were pleased to expand and extend our ABL credit facility on favorable terms to Algoma. We upsized the ABL credit facility to US$300 million from US$250 million previously with an extended maturity date to May of 2028. All told, with cash on hand and undrawn capacity available, we had total available liquidity at fiscal year-end of $526 million, which has been increased by US$50 million considering the ABL upsizing. Now turning to outlook for the first quarter of fiscal 2024. Steel prices have been volatile year-to-date, with another spike in March to near $1,100 per ton for Midwest hot-rolled coil, followed by a retreat to approximately $850 per ton. The forward curve is relatively flat around $850 per ton for the next several months.

However, recent mill announcements provide cautious optimism that market conditions are improving. Based on our operations to-date in the quarter, our order book and our expectations for shipments through the end of the month, we expect to deliver strong fiscal first quarter adjusted EBITDA in a range of $170 million to $180 million and total shipments of steel of 550,000 to 560,000 tons. I’d now like to turn the call back over to Mike for closing comments. Mike?

Michael Garcia: Thank you, Rajat. Looking at the state of the North American steel market, pricing levels in the fiscal fourth quarter saw a significant increase, followed by greater stability near current attractive levels, which we expect to drive solid cash generation in fiscal 2024. While we saw prices fall off through the first fiscal quarter, it has been encouraging to see announcements of price increases from several North American producers in recent weeks. We run our business with a diverse customer base that provides selling opportunities across Canada and the U.S., traditionally servicing roughly 150 customers in a calendar year and we target a high percentage of contract sales. These volume commitments provide stability to our order book and operations, and the lagging price mechanics helped to smooth some of the volatility experienced when prices shift up or down quickly.

Our primary focus is on delivering prudent financial discipline and operational excellence to ensure our ability to execute our EAF project, ushering in the next phase of our company that provides the foundation for long-term value creation for our stakeholders. That endeavor defines the future of Algoma and solidifies our leadership position at the forefront of green steel production in North America. The fiscal fourth quarter was a solid end to a very exciting year at Algoma. As we continue to ramp through the later stages of our EAF project construction, be assured that we will continue our relentless focus on safe, reliable, efficient operations of our existing facilities to enjoy the benefits of strong markets. We will continue to build upon this and position Algoma as a compelling value proposition for all of our stakeholders.

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

Q&A Session

Operator: Thank you. [Operator Instructions] Our first question comes from the line of Katja Jancic with BMO Capital Markets. Please proceed with your question.

Katja Jancic: Hi. Thank you for taking my questions. Starting off with the CapEx the — for the EAF project, I think there’s $590 million left to be spent. How much of that is going to be spent this year, so in fiscal 2024?

Rajat Marwah: Yeah. So we will be spending around $300-odd million, $300 million to $350 million during this fiscal, which is fiscal 2024 and the balance will follow.

Katja Jancic: And then what is — can you update us on the remaining CapEx outside of EAF, how much is that for this year?

Rajat Marwah: Sure. So the remaining CapEx, normally for us, based on all the maintenance activity that’s happening, we spend around $80 million to $90 million with the inflationary pressure that’s out there for labor, as well as construction, I think, that will be a little over $100 million. So that’s all on the maintenance side. And we are also completing our EAF project — our plate mill project during this year, by early next year we should be done with our outages. So there will be another $30-odd million spent in that area. So it will be in the range of $110 million to $150 million for the remaining CapEx other than Electric Arc Furnace.

Katja Jancic: And just on the plate mill, the $30 million, is that for the Phase 2?

Rajat Marwah: Exactly. That’s for the Phase 2.

Katja Jancic: And that’s all going to be spent this year, fiscal 2024, right?

Rajat Marwah: Yeah. Yeah. That’s all going to be spent this year.

Katja Jancic: And then just going to the plate mill modernization. I know you mentioned the Phase 2 hot mill outage will be done in April 2024. Can you update us on when is the second phase going to be fully complete and are you still expecting to increase capacity by 350,000 tons to around 700,000 tons and how should we think about the ramp-up following the completion?

Michael Garcia: Sure, Katja. This is Mike Garcia. So as we announced in our remarks, we are commissioning our inline shear, which was part of the plate mill modernization project. We’re going to start cold commissioning that in August, which is actually early in the schedule. So we believe that once that commissioning is in place as soon as October, we will start to see more shipments and capacity through that plate mill. And over the balance of the third fiscal quarter and the fourth fiscal quarter, we would expect to see 15% to 20% more plate mill shipments. But the one caveat on that is some of that incremental plate production will be going into stock as we prepare for our 40-day outage in April of calendar year 2024. So that’s what the profile will look like the balance of this fiscal year.

And then once we come out from that plate mill outage next April, we would look to factor in the increased plate mill capacity fully into our annual plan and commercial strategy and try to get as many of that — as much of that high-margin play into our order book as practical. Does that help?

Katja Jancic: Yeah. Just one follow-up, sorry. The 15% to 20% increase, I guess, in the second half of this fiscal year. Is that based on the current level, so quarterly levels or how should we think about that?

Michael Garcia: It’s based off of a current quarterly level of 70,000 tons to 75,000 tons of plate per quarter.

Katja Jancic: Okay. Perfect. Thank you so much.

Rajat Marwah: You’re welcome.

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

Ian Gillies: Good morning, everyone.

Rajat Marwah: Good morning.

Michael Garcia: Good morning, Ian.

Ian Gillies: I wanted to go back to some of the financing comments made and ask in a different manner. Can you just confirm that there’s no intention to use external equity to help finance the remainder of the EAF and that you believe it can be funded through credit facilities cash and operating cash flow?

Michael Garcia: That’s correct. Yes. There’s no intention to fund it through issuance of securities or equity.

Rajat Marwah: And just to follow-up on that, Ian. There is — when you look at the cash profile that we have right now, the liquidity profile, we’ve got $250 million of cash. There is roughly $300 million plus of ABL availability that we have. We will be drawing down our inventories. We did a huge draw in the March quarter, but our March end inventory is still elevated compared to historical numbers and it’s elevated to the extent of $250-odd million, but we know that there is some bit of a disprice, but still the volume part of it around $100 million to $150 million will get released over the next several quarters. So when you take all of that into account, there is enough liquidity available to manage this EAF CapEx and we are not even taking into account the good quarter that’s just getting behind us, which is the first fiscal quarter and how our profile looks for the balance of the year and you know that there’s no debt on the balance sheet in any case.

So we are pretty confident about funding the EAF.

Ian Gillies: Okay. That’s helpful. And I led to my next question, with respect to the inventory, the absolute releases are helpful, but given we all tend to run different models and different strip. Could you maybe — is there any way you could frame that in the way of where the target is for inventory days? I mean, historically, it’s been sub-$80 million or you’re around $100 million last quarter. Do you have any context you can provide on where you’re targeting to get that to by the end of the year?

Rajat Marwah: I think it should come down if — it should come down below 80s. So by — let’s say, by end of the fiscal year, you should see a release — we should see a release of $100 million to $150 million. Now this is from the current levels that you’re seeing, so from March getting down to next March, we should see it in that range and that doesn’t release the entire extra tonnage that we are carrying. And as I mentioned last time that with our — with the fixed tonnage contracts that we have, it takes a little longer to get those inventories down. So we should get down to below $80 million, but in absolute dollar terms, $100 million to $150 million of inventory reduction over the year and further reduction happening in 2025 as well.

Ian Gillies: Okay. And then the last one for me with respect to shipments. There was some focus on plate in the prior question set. As you get into the back half of this fiscal year, do you think shipments can push into that 600,000-ton to 650,000-ton range or is that a bit aggressive?

Michael Garcia: Ian, I think, that would be a bit aggressive. I think our run rate for the year should be similar to the volumes we demonstrated in the quarter that we’re talking about, as well as the quarter that we’re currently in. I think there’s always some opportunity from upside, but I would say, north of $600 million is probably a bit aggressive.

Ian Gillies: Okay. That’s helpful. I’ll turn the call back over. Thanks very much for the detail.

Rajat Marwah: Thanks, Ian.

Operator: And our next question comes from the line of David Ocampo with Cormark Securities. Please proceed with your question.

David Ocampo: Thanks for taking my questions. I guess my first one is just on the CapEx creep there. If I look back at the last quarter, you guys had, call it, 70% of the CapEx locked in at fixed rates, so call it, $210 million, but you still had a contingency. So it does look like that lasts a little bit that you guys have to contract out has increased by roughly 100%. I was just hoping you guys could drill into that a little bit was just so we can understand it a little bit better?

Michael Garcia: Sure, David. So, as we initiated the project, you can think about it in a series of major construction packages for the project. The initial ones, which are the most significant, which we locked in on fixed price and fixed duration where the Danieli contract, obviously, for the equipment and then the Walters contract for the building construction. At that point, it was too early in the project life to award some of the more — some of the other significant packages that needed detailed engineering to be completed before those bid packages could go out and get priced by the market. Those — that detailed engineering was wrapped up around six weeks to seven weeks ago. When those bid packages went into the market is when we saw a pretty different market for construction costs than we were seeing when the early large bid packages were going out in the market in 2021.

So those packages involved the construction — the installation of the equipment, the fume treatment plant, the electrical install, the piping. We started to see an emerging risk in those packages coming back higher than the original budget and as we went through an iteration with the contractors to make sure they fully kind of had all the details they needed. We started thinking of how to take costs out. It was at that point where we started seeing the increase of the total cost beyond the $700 million budget and to the number that we’re — we disclosed today, which is the result of a lot of work and we’re very confident about. But that’s kind of how the evolution of the cost increase transpired.

David Ocampo: And just out of curiosity, is there any contingency built into that $75 million like at the top end? Just kind of wondering if there could be additional cost creep beyond this?

Michael Garcia: Well, I think, the contingency is that, we’re giving a range and so that top end of the range would be reflective of creeping into that contingency.

David Ocampo: Okay. That makes sense. And then Rajat, just out of curiosity, it does seem like the maintenance CapEx have — has also creeped up with inflationary pressures. What’s the thought process behind the maintenance CapEx when you are finally EAF, because I think before you’re talking about $20 million lower than the CapEx would be if you’re a blast furnace. So does that put you at $80 million?

Rajat Marwah: Yeah. So it will be US$20 million to US$30 million lower. So if we are spending around $110 million on the CapEx, we should be around $80 million, $70 million to $80 million on the CapEx in Canadian dollars after the full year is running and the blast furnace and coke batteries are closed.

David Ocampo: Okay. That’s perfect. I’ll hand the line over. Thanks a lot guys.

Operator: And our next question comes from the line of Ahmad Shaath with Beacon Securities. Please proceed with your question.

Ahmad Shaath: Hi, guys. Maybe just one for me on the guidance front. We’re noticing a trend that you keep, I guess, beating the guidance. When you talk about thought process when you provide the guidance and maybe some of the challenges or the moving parts. Just to help us pay more thinking once you release those guidance numbers in our modeling?

Rajat Marwah: Sure. So there is — we are a single site. So there is always that variability on the material moving out of the facility and the big variability we normally see is on movement through waters, the barges that move out and there are a number of barges that go out during the month and we see some variability in those situations. That’s why we provide guidance also towards the end of the quarter or closer to the end of the quarter so that we are at least closer to the numbers and things relative to that keeps changing. So it’s mostly on the shipment side as we see and as we close the books, there are a few variabilities that happens on the pricing side, as well as on the cost side. So we have been beating except for a quarter where we had a coke fire, which was unexpected, and that led to — and the plate mill that led to certain issues.

But we’ve been consistent in providing a reasonable guidance, and based on how the quarter ends, it’s normally closer to the higher end.

Ahmad Shaath: Fair enough. That’s very helpful. And maybe — and this could be a disclosure and if I missed this, I apologize guys, but talk to us about the revolver. It’s back to the receivables and the inventory you’re talking about some release of that. So how is that going to work, as you guys plan to finance some of the CapEx using that facility as well. So maybe talk to us about the moving parts there, I mean, how is that — if there is any potential impact on your liquidity from the revolver?

Rajat Marwah: Sure and good question. There is a lot of unused availability that we have under our revolving credit facility and that’s just given by the amount of inventories and receivables that we have on the balance sheet. So the amount that we can borrow under the revolver is US$300 million, let’s say, it’s CAD400 million and when you look at our balance sheet, we’ve got $700 million of inventories and $300 million roughly million of receivables, almost $1 billion. And even after reducing the inventories that I’m suggesting, we will still have enough capacity under our ABL to borrow the entire amount. So that’s how it will play out. So we will be able to release a lot of inventory and create liquidity there, but it should not impact our revolver from that perspective.

Ahmad Shaath: That’s very helpful. Thanks, Rajat, and I’ll get back in the queue.

Operator: And we have reached the end of the question-and-answer session. I’ll now turn the call back over to Michael Garcia for closing remarks.

Michael Garcia: Thank you. Thank all of you again for your participation in our fourth quarter fiscal 2023 earnings conference call and for your continued interest in Algoma Steel. We look forward to updating you on our results and progress when we report our fiscal fourth quarter results later this summer.

Rajat Marwah: Thank you.

Operator: And this…

Michael Garcia: Thank you.

Operator: And this — I am sorry, and this concludes today’s conference and you may disconnect your lines at this time. Thank you for your participation.