MRC Global Inc. (NYSE:MRC) Q4 2023 Earnings Call Transcript

MRC Global Inc. (NYSE:MRC) Q4 2023 Earnings Call Transcript February 14, 2024

MRC Global Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Greetings and welcome to the MRC Global’s Fourth Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Monica Broughton, VP, Investor Relations and Treasury. Please go ahead.

Monica Broughton: Thank you, and good morning. Welcome to the MRC Global fourth quarter and full-year 2023 earnings conference call and webcast. We appreciate you joining us. On the call today, we have Rob Saltiel, President and CEO; and Kelly Youngblood, Executive Vice President and CFO. There will be a replay of today’s call available by webcast on our website, mrcglobal.com, as well as by phone until February 28, 2024. The dial-in information is in yesterday’s release. We expect to file our annual report on form 10-K later this week, and it will also be available on our website. Please note that the information reported on this call speaks only as of today, February 14, 2024, and therefore, you are advised that the information may no longer be accurate as of the time of replay.

In our call today, we will discuss various non-GAAP measures. You are encouraged to read our earnings release and securities filings to learn more about our use of these non-GAAP measures, and to see a reconciliation of these measures to the related GAAP items, all of which can be found on our website. Unless we specifically state otherwise, references in this call refer to EBITDA refer to adjusted EBITDA. In addition, the comments made by the management of MRC Global during this call may contain forward-looking statements within the meaning of the United States federal securities laws. These forward-looking statements reflect the current views of the management of MRC Global. However, actual results could differ materially from those expressed today.

You are encouraged to read the company’s SEC filings for a more in-depth review of the risk factors concerning these forward-looking statements. And now I’d like to turn the call over to our CEO, Mr. Rob Saltiel.

Rob Saltiel: Thank you, Monica. Good morning, and welcome to everyone joining today’s call. I will begin with a discussion of notable achievements in 2023, review our fourth quarter results at a high level, and address some of the key business drivers underpinning our 2024 outlook. I will then turn the call over to Kelly to provide a detailed review of the quarter and 2024 guidance before I deliver a brief recap. For the full-year 2023, we had many accomplishments that I want to highlight, including setting several new MRC Global records for profit margins, balance sheet strength and working capital efficiency. First, we generated $181 million in operating cash for the year, well above the $110 million that we previously expected.

This translates to a robust 18% levered free cash flow yield for the year. We are very bullish on the cash generation potential of the company going forward. We also set a company record for full-year adjusted gross margins at 21.5%, which is the second year in a row where we exceeded 21%. Some of our investors have expressed concerns that we might not be able to maintain margins at this level, but I am happy to report that we have now had seven quarters in a row with 21-plus-percent margins. This is a transformational change from the high teens level of margins throughout most of our company’s history. Adjusted EBITDA margins were 7.3% for 2023, the second year in a row above 7%. This is a result of both higher adjusted gross margins along with our discipline on cost management.

We’ve been very focused on working capital efficiency over the last few years, as evidenced by another record set in 2023 with our net working capital as a percentage of sales coming in at 15.5%. Since 2018, we have improved this metric by 490 basis points, which is helping us to consistently generate positive cash flow irrespective of the business cycle. Our balance sheet has never been stronger with ample liquidity and the lowest leverage ratio in our public company history at 0.7 times. We expect this metric to improve even further in 2024. Revenue grew for the third straight year in 2023 to $3.4 billion, with year-over-year growth in our PTI and DIET sectors partially offset by a slowdown in our gas utilities sector. Our PTI sector grew by 6%, driven by increased activity and market share gains in the Permian Basin, partially offset by reduced sales in California and Canada.

The DIET sector improved 5% in 2023, driven by various LNG, chemicals and refining projects. Our international business grew 13% in 2023, and is poised for double-digit improvement in 2024, supported by a healthy backlog that was 55% higher at year-end compared to the beginning of 2023. I will now make a few comments about the fourth quarter results and then turn to our outlook. Despite a revenue pullback in the fourth quarter, we maintained strong profit margins and cash generation that exceeded our expectations. For the quarter, adjusted gross margins were 21.9% and adjusted EBITDA was $48 million, or 6.3% of sales. In addition, we generated cash flow from operations of $89 million in the fourth quarter, aided by excellent stewardship of our working capital that allowed us to achieve $181 million for the full-year.

Turning to our outlook, I will now provide some early perspectives on 2024. First of all, we have seen a meaningful improvement in our backlog and our new orders over the first few weeks of 2024. This gives us optimism that our business is stabilizing, and we expect to return to growth in the coming quarters. From a sector perspective, for our gas utility sector, we expect our customers to continue their destocking efforts in the near term, which could cause capital spending for the first half of the year to lag the levels we saw in the first half of 2023. However, we expect to see an inflection point around mid-year for gas utility spending to improve once the destocking targets have been met. In addition, we expect moderation of inflation and interest rates as we move through 2024, which should improve the overall investment climate for this sector.

Despite the near-term headwinds, the long-term market fundamentals and growth potential of our gas utilities business remain very positive. We continue to expand our market share and wallet share with gas utilities, and we are competing for new utility contracts in 2024 that should expand our presence further. Most of the work we perform with our gas utilities customers is based on multi-year programs where they evaluate and implement measures to improve their local distribution networks and, in some cases, their transmission pipelines to ensure the safety and the integrity of these systems. Since approximately 35% of the U.S. gas distribution network today is over 40 years old or of unknown origin, this creates a steady backlog of work due to the need to upgrade and maintain these networks as they age.

Additionally, as new housing starts improve with lower interest rates, this should result in further growth opportunities for this sector. In the DIET sector, we are optimistic that we will experience modest revenue growth this year from a strong level of refinery and chemical plant maintenance activities, supplemented by a growing slate of projects. We remain excited about energy transition growth opportunities and expect that most of the revenue in 2024 for this sub-sector will occur in the renewable fuel space. We expect a lot of new project bidding activity this year, but we will likely see most of the benefits in 2025 and beyond. Turning to our PTI business, recent industry reports have signaled some potential risk of declining oil prices and customer spending levels in 2024.

However, larger public E&P companies are expected to drive a higher percentage of the activity in 2024 in the U.S. oil field, which bodes well for our company as our revenue for this sector is driven primarily from this customer base. Recent announcements of consolidation by our PTI customers are expected to be beneficial to MRC Global, once completed. We partner more extensively with the acquirers than we do the targets, and the value we bring is generally better recognized by the larger operators who procure higher quality, longer life products for their oil and gas development projects. Another positive for the PTI sector is our international oil and gas market is expected to expand, and we should benefit from our strong position in growth markets such as Norway, the UK and Middle East.

For our international segment, we expect another strong year aided by favorable fundamentals in both the PTI and DIET sectors and a healthy revenue backlog that has grown each of the last five quarters. Our international backlog at the end of the fourth quarter increased 14% over the third quarter. We have lined up exciting projects in both PTI and in DIET and we expect another year of double-digit growth for international in 2024. Given the slower business environment in the US segment, we are laser-focused on improving the things we can control, such as our cost structure. We are working to lower our absolute SG&A cost this year after experiencing an increase in 2023, which will support our ability to maintain healthy adjusted EBITDA margins.

We are implementing a number of cost optimization initiatives, including slower wage growth and reductions in professional fees, overtime, travel and entertainment expenses and logistics costs. We have made significant progress elevating our adjusted gross margins and EBITDA returns over the last few years, and we are committed to not losing this momentum in 2024. In summary, we expect 2024 to be a transitional year for the company in terms of revenue, but it is clear that we have never been a stronger company than we are today. We remain optimistic about the fundamentals of all three business sectors and their long-term outlook, given our strong market position and the expectation of demand for our products and services for decades to come.

With the recent improvements in our cost structure and our working capital efficiencies, we are well-positioned to generate significant earnings and cash flow across the business cycle. We are targeting to generate approximately $200 million in operating cash flow in 2024, which will make us an even stronger company with minimal debt at the end of this year. This will provide us with a lot of flexibility to pursue a capital allocation strategy that is focused on the highest return opportunities for our shareholders, including investing in our growth drivers and distributing capital to our shareholders. I will now hand it over to Kelly.

Kelly Youngblood: Thanks, Rob, and good morning, everyone. My comments today will primarily be focused on sequential results comparing the fourth quarter of 2023 to the third quarter of 2023m unless otherwise stated. Total company sales for the fourth quarter were $768 million, a 14% sequential decline and 12% lower than the same quarter a year ago. From a sector perspective, gas utility sales were $253 million in the fourth quarter, a $61 million or 19% decline. As expected, we continued to see gas utility customers focused on reducing their product inventory levels due to more certainty in supply chain and associated lead times. End of year seasonality, along with higher interest rates and inflation in construction cost, also caused customers to delay project activity.

The DIET sector fourth quarter revenue was $258 million, a decrease of $21 million or 8%, due to the conclusion of various projects in the third quarter and lower year-end turnaround activity in the US. As we have mentioned before, this sector has a significant amount of project activity which can create substantial variability between quarters. The PTI sector revenue for the fourth quarter was $257 million, a decrease of $38 million or 13% sequentially, primarily due to seasonality and lower year-end customer activity in the US. From a geographic segment perspective, U.S. revenue was $633 million in the fourth quarter, a $112 million or 15% decrease from the previous quarter, driven by the gas utilities sector which was down $59 million, followed by the PTI sector which was down $34 million, and finally the DIET sector which was down $19 million.

International revenue was $107 million in the fourth quarter, up $2 million or 2%, driven by improvement in both the PTI and DIET sectors. The PTI sector increase was driven by increased activity in Norway, the Middle East and the U.K. The DIET sector increase was driven by energy transition activity as well as project activity in Europe. We remain very optimistic about the outlook for our international segment, which has experienced a 55% increase in backlog since the beginning of 2023, with double-digit growth in both the PTI and DIET sectors. Canada revenue was $28 million in the fourth quarter, down $10 million compared to the prior quarter, due to year-end budget exhaustion and year-end curtailment in customer spending. Now turning to margins.

Adjusted gross profit for the fourth quarter was $168 million or 21.9%, a 60 basis point improvement over the third quarter. Although we have experienced deflation in our line pipe business this year, along with inflation stabilization across most other product lines, we have been successful maintaining adjusted gross margins in excess of 21% of sales due to a higher margin product mix and a higher contribution of revenue from our international segment, which is accretive to overall company gross margins. This marks the seventh consecutive quarter with adjusted gross margins exceeding 21%. Reported SG&A for the fourth quarter was $125 million or 16.3% of sales as compared to $126 million, or 14.2% for the third quarter. This quarter includes $1 million of pre-tax charges related to activism response, legal and consulting cost.

Excluding these costs from our SG&A or adjusted SG&A for the quarter of 2023 — for the fourth quarter of 2023 is $124 million. Adjusted EBITDA for the fourth quarter was $48 million or 6.3% of sales, a 160 basis point decline from the third quarter due to the lower sales activity. Tax expense in the fourth quarter was $2 million with an effective tax rate of 9% as compared to $14 million of expense in the third quarter. The fourth quarter was favorably impacted by a net reduction in a foreign valuation allowance provision. For the fourth quarter, we had net income attributable to common shareholders of $15 million, or $0.17 per diluted share. And our adjusted net income attributable to common share — stockholders on an average cost basis, normalizing for LIFO adjustments and other items was $20 million or $0.23 per diluted share.

In the fourth quarter, we generated $89 million in cash from operations and a net $181 million for the full-year. This is a 65% increase over our previous guidance, due to exceeding our year-end working capital targets, resulting in an 18% levered free cash flow yield for the year. And as Rob pointed out, we also achieved our best net working capital to sales ratio in our history at 15.5%, a significant improvement over our historical trend. Turning to liquidity and capital structure. Our current availability on the ABL is $610 million and including cash, our total liquidity is $741 million. Our leverage ratio based on net debt of $170 million was 0.7 times, a record low for the company. With the cash we expect to generate in 2024, we believe our liquidity and the leverage ratio will continue to show significant improvement.

Based on our current projections, we believe we can comfortably pay off our Term Loan B on or before its maturity date in September of 2024 with a combination of excess cash and our ABL facility. As such, we are now classifying our term loan as current debt. Also, this reduces our ongoing interest expense burden by 150 basis points for any balance that remains on our ABL. I would also like to highlight an exciting initiative we are undertaking this year. We recently launched a project to replace and modernize our North America Enterprise Resource Planning or ERP system. Currently, we are running on a mainframe system which is at the end of its useful life. We will be moving to a modern cloud-based ERP system over the next two years. I am personally the executive sponsor of the project and have the utmost confidence that we will be successful in meeting our budget and timeline goals.

We have spent the past year planning, evaluating software packages and implementation partners, and building a stellar blue ribbon team of some of the company’s best resources to implement this ERP system. The new ERP is expected to provide leading-edge functionality, including AI capabilities, allowing us to automate and streamline our processes and systems to improve reporting, forecasting and controls. It will also reduce IT maintenance costs by approximately $2 million a year. The CapEx investment is expected to be approximately $50 million spent over the next two years, and we expect to be fully implemented and running on the new system in the second half of 2025. We are excited about the multitude of opportunities this new cloud-based system will provide to our organization.

Now I’ll cover our outlook for the first quarter and full-year 2024. For the first quarter, we expect sequential revenue to be flat to modestly lower for the total company, with PTI and gas utility revenue flattish with the fourth quarter and DIET declining modestly due to the timing of various project deliveries. We expect 2024 to be a transitional year and currently believe total company revenue will come in flat to a potentially modest decline of low to mid-single digits compared to 2023 levels. From a sector perspective, we expect DIET to be modestly higher for the year, PTI to be modestly lower, and gas utilities to also be down for the full-year, but showing a recovery in the second half of 2024. It’s noteworthy and encouraging that recent trends in our 2024 year-to-date sales, new order intake and backlog are providing optimism that we are seeing stabilization in the business.

For example, the backlog at the end of January is up $47 million, or 6.8% since December 31, with gains across all sectors and all segments. Also, January sales have improved by about 1% over December. And finally, January’s new order intake is up over 30% compared to December, a significant improvement. In 2024, we will also target the following key metrics: average adjusted gross margins of 21% or better; average adjusted EBITDA margins of 7%; average SG&A cost as a percent of revenue below 15%. And for cash flow from operations, we expect to exceed the cash we generated in 2023, targeting to hit $200 million in operational cash generation. Capital expenditures are expected to be elevated this year due to our ERP initiative. We estimate total capital spend in the $40 million to $45 million range in 2024, higher than our normal run rate of approximately $15 million.

And finally, we expect our effective tax rate in 2024 to be in the range of 26% to 28%. And with that, I would like to turn it back to Rob for closing comments.

Rob Saltiel: Thanks, Kelly. It bears repeating that our company is in a very strong position. And despite the pullback in activity in the second half of 2023, we achieved key milestones in profit margins, working capital efficiency and balance sheet strength, setting us up for future success. As we continue to execute our strategy and generate consistently strong levels of free cash flow, we will have ample financial flexibility to deliver shareholder value through an opportunistic shareholder returns focused capital allocation strategy. These are the highlights I want to summarize before opening for Q&A. We are targeting $200 million of cash from operations in 2024. With the working capital efficiencies we have achieved, we are well-positioned to consistently generate cash regardless of the business cycle, which is a transformational change.

We expect average adjusted gross profit to remain in the 21% range in 2024 and are targeting average EBITDA margins of 7% for the full-year. We intended to pay off our Term Loan B on or before its maturity date in September of 2024 without requiring any additional financing. We expect to exit 2024 with a minimal net debt position and be in a positive net cash position in 2025. And lastly, before we open the call for Q&A, similar to last quarter, I want to acknowledge the rumors and speculation about one of our shareholders. As I’m sure you can appreciate, we don’t discuss the specifics of our interaction with any of our existing or potential shareholders and we won’t be able to comment. As such, we kindly ask that you keep your questions in the Q&A session focused on our results.

And with that, we will now take your questions. Operator?

See also 35 Biggest Football Clubs in the World and Top 20 Chocolate Companies in the World by Revenue.

Q&A Session

Operator: Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] First question comes from Nathan Jones with Stifel. Please go ahead.

Nathan Jones: Good morning, everyone.

Rob Saltiel: Yes. Good morning, Nathan.

Kelly Youngblood: Good morning, Nathan.

Nathan Jones: I just wanted to start off with cash flow, given — you know, I’m sure you guys had trouble getting out of your office, just crawling over it all this morning. There’s been a significant reduction in receivables inventories and offset a little bit by reduction in payables. I think the cash flow guidance for 2024 would imply a pretty significant further reduction in working capital and receivables inventories payables? Can you talk about, you know, kind of what you’re expecting there? I would say, probably, you would acknowledge that $200 million of CFO might not be sustainable over the long run at these levels of revenue. So any color you can give us on what you think the sustainable cash flow level of the business is?

Kelly Youngblood: Yes, Nathan, this is Kelly. I’ll start off and Rob can jump in, if he likes, but — no, listen, you know, we’ve been consistent here over the last couple of years, you know, saying to the market that with our working capital efficiency that we’ve maintained or we’ve improved over the last couple of years, that we think we can consistently generate cash, you know, regardless of what the market conditions are. And so, I think this year is a very good example of that. You know, that up slightly, not huge improvement, but up slightly on revenue. But having $181 million of cash generation, we’re very proud of that. Our working capital efficiency, I think we put in our press release, it’s a new record of 15.5%. If you go back to 2018, that was around a 20% number.

So we’ve made drastic improvement there. To answer your question, though, the sustainability, we think, as we’ve guided to $200 million in 2024, we’re going to have some working capital influence there. You know, we think we have room to improve our turn rates on inventory, and we’ve made a lot of progress on our receivables, past due receivables and things like that. But we think we can maintain and even continue to improve that in 2024. The majority of the cash flow generation, I would say two-thirds to three quarters of it, is still going to be cash flow from operations before working capital changes. But we’ll still get the benefit from working capital changes to get us up, make up that other one-third to 25% to get us up to the $200 million number.

And then I think, you know, going forward, Nathan, we’re not guiding to anything right now, but we think easily we can have 100-plus, maybe even 150-plus million of cash generation per year in a, call it, a single-digit type growth market. You know if you get into, like we were in 2022, where we had a 26% revenue growth, it’s harder to achieve that kind of cash flow number. But with moderate growth, whether we’re up or down, we think easily $100 million, $150-plus million is very achievable.

Nathan Jones: Thanks. I’ll follow up with, I guess, cash priority. You obviously have this term loan that you have to deal with in September. It seems counterproductive for your preferred shareholder to be blocking refinancing of that. Is there any update you can give us on any of the negotiations you’ve had there that might allow you to refinance that rather than have to use cash plus the ABL to pay it off, which would clearly give you guys some more financial flexibility to do some M&A or to do some share repurchase in the nearer term, rather than have to wait a little bit longer for that? So if there’s any commentary you can make on that or how you’re thinking about deploying capital once we resolve this issue.

Rob Saltiel: Yes, Nathan, I’ll jump in here. Look, we’ve talked about this before that we’ve had the disagreement previously on the previous attempt to refinance the term loan, and we continue to remain in discussions about the opportunities to get through that if, in fact, we decide to go to the market for a refinancing. I think one of the things that we’ve been pleasantly surprised with is how much cash generation we’ve actually been able to deliver. As Kelly said, we’ve talked about this for quite some time that we need to be able to demonstrate we can generate cash across the cycle, and to do so in, I would say, pretty large amounts, given the comment you made when we opened the call. And I’m really proud of the fact that our team has been able to do that.

It’s obviously a combination of profitability of the business. Our team has done a great job on collections and reducing our day sales outstanding, and making sure as well that we’re more efficient with our inventory, that we can generate more revenue and more profitability with less inventory, which is a key metric when you’re in the distribution business. So all those things lining up have really demonstrated we can generate a lot of cash. And in fact, we’re generating so much cash that we can basically pay off the term loan with a combination of cash and pulling on the ABL without any necessity of refinancing. Now, opportunistically, to the extent that we have a resolution with the disagreement with the preferred shareholder, we could consider doing exactly what you say, which is taking out an additional financing vehicle to do some other things, potentially with returning cash to shareholders.

But at this point in time, the base case is we use a combination of the ABL and cash to retire the Term Loan B in September.

Nathan Jones: Thanks. Go ahead, Kelly.

Kelly Youngblood: Hey, Nathan, I was just going to add one more thing to what Rob said. When we saw how much cash we generated closing out ’23 and what we’re projecting for 2024, we saw pretty quickly that if we went out to the market to do a refi of the term loan, we were going to be putting a lot of cash just immediately on the balance sheet, right? I mean, like, literally, like a couple of hundred million of cash on the balance sheet. And we can always go back out to the market. You know, there’s no — there is nothing that says we have to do it right now. We always have that flexibility. And so, you know, time is on our side. We got, you know, very good projections ahead of us. As Rob said in his prepared comments and I think I mentioned it too, we’re going to have minimal net debt at the end of the year. So we think we’re very well-positioned.

Nathan Jones: Yes, I think you’re in a good spot for that. Just on the ERP system, I guess the implication is about $30 million of CapEx in ’24 on that. Can you talk about how long the total roll-out is and what the total cost of the ERP system is going to be, and then what you expect to be the financial and operational benefits that you can generate from that new system?

Kelly Youngblood: Yes. Absolutely, Nathan. A good question. We said in the prepared comments, the total project cost, we’re estimating around $50 million. We think we’ll incur $25 million to $30 million of that here in 2024 with the remainder in 2025. We think we’ll be fully up and running on the new system in the second half of ’25. So this doesn’t go on for many years. It’s really just kind of an 18-month period that we’re going to be doing, the implementation. And so, you know, that’s on top of our normal run rate of CapEx, around $15 million to get you to the guide that we have this year of $40 million to $45 million. The benefits we expect to receive, we’re kind of really just in the early days of the design phase right now.

But let me tell you, we’ve been working on this for over a year. We spent the first six months of last year going through software selection to make sure we were getting the best fit tool for our business. And then we spent really the second half of the year making sure we got a best-in-class implementation partner to take us through the whole process. And some of the benefits we think we’re going to get. If you look at just the maintenance cost we have on the existing system versus the new, it’s $2 million annual savings from that alone. Being on a mainframe system, which is what we are right now on the North — for North America, there’s just a lot of compatibility issues, integration issues with other equipment, software, industry standards.

So that system has served us very well for many decades, but it just becomes more and more challenging to maintain an old system like that. And even just hiring employees and contract resources to maintain, support and operate the system becomes very difficult. And so, it really is time for us to move on to something new. And, you know, as far as you know — I know there’s always concern about the level of risk of a new system like this. But let me tell you, as I mentioned, we spent the last year doing our homework. We’ve selected a first class team of MRC employees to work on this. Many of them, this is not their first ERP project. They’ve worked on other ERP implementations, and so they’re not new to this. This is a North America-only implementation, which I think is very important.

We’re not dealing with a lot of, you know, countries around the globe which can introduce different risk. If you look at our footprint here in North America, between our service centers and our RDCs, we have a very standardized approach and processes and the way we run the business. And then we really intend to have very little to no customization. That introduces risk when you do that. And with the cloud-based systems you have today, off the shelf, they give you virtually all the functionality that you need. I mean, off the shelf functionality, there’s hundreds or even thousands of companies that are using the software package already. And so, it’s not like you’re having to program things from the ground up. It’s already been proven and in use for many years now.

And so, we feel pretty comfortable. And then on top of that, we’re going to have multiple, what we call, conference room pilot testing before we go live with the system to make sure that everything’s working correctly. So we’re very excited about it. I think this is going to be a game changer for the company. It’s going to help us with our reporting, our forecasting. We’ve made a lot of improvement in working capital efficiencies, but I think this new system is going to take us even to the next level in-demand forecasting’s and better inventory management and things like that.