Steel Dynamics, Inc. (NASDAQ:STLD) Q3 2023 Earnings Call Transcript

Steel Dynamics, Inc. (NASDAQ:STLD) Q3 2023 Earnings Call Transcript October 19, 2023

Operator: Good day and welcome to the Steel Dynamics Third Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the management remarks, we will conduct a question-and-answer session and instructions will follow at that time. Please be advised this call is being recorded today, October 19, 2023 and your participation implies consent to our recording this call. If you do not agree to these terms, please disconnect. At this time, I would like to turn the conference over to David Lipschitz, Director, Investor Relations. Please go ahead.

David Lipschitz: Thank you, Holly. Good morning and welcome to Steel Dynamics third quarter 2023 earnings conference call. As a reminder, today’s call is being recorded and will be available on our website for replay later today. Leading today’s call are Mark Millett, Chairman and Chief Executive Officer of Steel Dynamics and Theresa Wagler, Executive Vice President and Chief Financial Officer. The other members of our senior leadership team are joining us on the call individually. Some of today’s statements, which speak only as of this date maybe forward-looking and predictive, specifically preceded by believe, expect, anticipate or words of similar meaning. They are intended to be protected by the Private Securities Litigation Reform Act of 1995 should actual results turn out differently.

Such statements involve risks and uncertainties related to integrating or starting out new assets in the aluminum industry, the use of estimates and assumptions in connection with anticipated project returns and our steel metal recycling and fabrication businesses as well as to general business and economic conditions. Examples of these are described in the related press release as well as in our annual filed SEC Form 10-K under the heading Forward-Looking Statements and Risk Factors found on the Internet at www.sec.gov, and if applicable, in any later SEC Form 10-Q. You also find any referenced non-GAAP financial measures reconciled to the most directly comparable GAAP measures in the press release issued yesterday entitled Steel Dynamics Reports Third Quarter 2023 Results.

And now, I am pleased to turn the call over to Mark.

Mark Millett: Thank you, David. Good morning, everybody. Thank you for being with us on our third quarter earnings call. As you saw in the release, once again, our teams achieved a solid financial and operational quarter. Almost 80% of our facilities had zero safety incidents, and our company-wide trailing 12-month incident rate is running at an all-time low. So congratulations to everyone, but more importantly, thank you for all your work to make that happen. It takes each and every one of us to get there. Cash from operations was a healthy $1.1 billion, and with the adjusted EBITDA generation of $876 million. I think this performance truly affirms the cash generation resiliency of our diversified value added product portfolio.

Seeing significant momentum in our aluminum flat rolled investments, both current and prospective customers are excited by our market entry and the new and differentiated supply chain solutions we can provide. They’re actually very, very surprised by the speed and completeness of our execution so far. Sinton mill has proven its nameplate production capacity rate, and full product capability, but does remain challenged by equipment reliability issues. We’re confident we can resolve the majority of these issues by the year-end. Successes cannot be achieved without the best metals team in the industry. I am incredibly proud to the whole SDI family. Their passion and spirit form the foundation of our company. They drive our success and it’s an honor to work among them.

In fact, in this world of turmoil with the human catastrophe happening in the Ukraine, the atrocities in Israel, the suppression of the Palestinian people and even closer to home, the anger and divisiveness within America and our political structure really is inspiring to come to work each and every day and be surrounded by very, very positive people that think right, they get it, they treat people right and a focus on what we do each and every day. As such, our greatest leadership commitment is to our SDI family. Not only our colleagues that come to work, but also their partners in life and their kids. They remind our team’s great financial performance of no importance without keeping everyone safe. We continue to be focused on providing the very best for the health, safety, and welfare.

Today, the SDI family, when you include everyone, we have over 45,000 people that are reliant on the decisions that we make each and every day and we’re focused. We truly are focused on that. Together, we’re actively engaged in safety at all times and at every level, keeping safety top of mind and an active conversation. Before I continue, Theresa would you like to give us some details?

Theresa Wagler: Good morning, everyone. Thank you, Mark. Add my sincere appreciation to our teams for a really solid performance in the third quarter. Our third quarter 2023 net income was $577 million or $3.47 per diluted share with adjusted EBITDA of $876 million. Third quarter 2023 revenues of $4.6 billion and operating income of $734 million were lower than sequential second quarter results driven by lower realized steel and steel fabrication pricing. We see solid industry fundamentals for the rest of this year and beyond, and we’re focused on our continued transformational growth initiatives. Our steel operations generated operating income of $474 million in the third quarter lower than sequential second quarter results due to flat rolled steel pricing metal spray compression as realized pricing declined more than average scrap costs.

Our steel shipments remain steady at 3.1 million tons, excluding the lost volume of approximately 90,000 tons related to Sinton’s unplanned July outage. We expect our four new flat rolled coating lines to begin operating in the first quarter of 2024 at both Sinton and Heartland increasing our value added mix by additional 1 million tons making so that our total coating capacity will be 6.9 million tons going forward. For those that track our detailed flat rolled shipments, in the third quarter, we had hot rolled and P&O shipments of 858,000 tons; cold rolled shipments of 132,000 tons; and coated shipments of 1,202,000 tons. Operating income from our mills recycling operations was $19 million, significantly lower than second quarter results due to non-ferrous and ferrous metal spray compression.

Ferrous scrap demand was also reduced as numerous domestic steel mills had maintenance outages in the quarter. We are the largest North American metals recycler, processing and consuming ferrous scrap and non-ferrous aluminum, copper, and other metals. The team continues to lever our circular manufacturing operating model, providing higher quality lower cost scrap to our still mills, which improves furnace efficiency and reduces company-wide working capital requirements. Our steel fabrication operations achieved operating income of $330 million in the third quarter lower than sequential second quarter results, yet historically strong as average realized pricing declined 11% and volumes declined 16,000 tons. Our steel joist and deck demand remains solid with good order activity.

Our backlog extends through the first quarter of 2024. The backlog has contracted from record highs experienced in 2022 as shipments have outpaced spot order activity. Forward backlog pricing remains very strong and spot pricing resilient. Based on our backlog, customer sentiment and manufacturing momentum, we expect steel fabrication earnings to remain solid in the fourth quarter, but below third quarter levels based on seasonally lower volumes. Infrastructure, Inflation Reduction Act, Department of Energy decarbonization support and manufacturing onshoring are expected to support domestic fixed asset investment in related steel and joists and deck consumption in the coming years. Our cash generation continues to be strong based on our differentiated circular business model and variable cost structure.

During the third quarter of 2023, we generated strong cash flow from operations of $1.1 billion and generated $2.7 billion on a year-to-date basis. At September 30th, we achieved record liquidity of $3.7 billion inclusive of cash, liquid investments and our unsecured $1.2 billion revolver. Year-to-date of 2023 we’ve invested $1.1 billion in capital investments. For the fourth quarter, we estimate capital investments will be in the range of $500 million to $550 million, of which around $350 million is related to our aluminum flat rolled investments. Much of the remaining capital is related to the completion of our four new value added coded lines. In February, we increased our cash dividend 25% to $0.425 per common share. Year-to-date 2023 we’ve also repurchased $1.1 billion of our common stock, representing almost 6% of our outstanding shares.

At September 30th, $278 million remained authorized for repurchase under our existing $1.5 billion authorized plan. Since 2017, we’ve increased our dividend per share by 174% and repurchase $5.2 billion of our common stock, representing over 40% of our outstanding shares. Our capital allocation strategy prioritizes high return growth with shareholder distributions comprised of a base positive dividend profile that’s complimented with a variable share repurchase program. We remain dedicated to preserving our investment grade credit designation at the same time. Our free cash flow profile has fundamentally changed over the last five years, generating from an annual average of $540 million to $2.6 billion today. We’ve placed ourselves in a position of strength to have a sustainable capital foundation that provides the opportunity for meaningful strategic growth and strong shareholder returns while maintaining investment grade metrics.

Our aluminum growth strategy is consistent with this philosophy. We will readily fund our flat rolled aluminum investments with available cash and cash flow from operations. We also plan to continue strong and responsible shareholder distributions as we’ve clearly demonstrated, we’re squarely positioned for the continuation of sustainable, optimized long-term value creation. Sustainability is also a significant part of our long-term value creation strategy, and we’re dedicated to our people, our communities, and our environment. We’re committed to operating our business with the highest integrity. In that regard, we remain excited about our joint venture with Aymium, a leading producer of renewable biocarbon products. We believe our first joint venture facility could decrease our still scope one greenhouse gas emissions by as much as 35%, and we currently expect to have the facility operating in the second half of 2024.

A machinist inspecting a freshly-cut steel beam, ready to be shipped to its intended destination.

We have an actual path toward carbon neutrality that is more manageable and we believe considerably less expensive than may lay ahead for many of our industry peers. Our sustainability and carbon reduction strategy is an ongoing journey, and we’re moving forward with its intention to make a positive difference. And again, before I turn the call back over to Mark, I just want to thank the teams for a great performance. Mark?

Mark Millett: Super. Thank you, Theresa. As you saw, the steel fabrication platform continues to perform well and it turned in another solid quarter. We continue to have high expectations for the future earnings profile of this business. We believe non-residential construction markets will be strong in the coming years. Some residential starts and build rates are forecast to remain strong into 2024, and related spending has been higher in 2023 compared to the last year at this time. So political dysfunction has delayed the awarding of public monies likely into the first quarter of next year, the infrastructure spending and fixed asset investment related to the IRA programs, along with the reshoring and manufacturing should provide momentum for additional construction spending through 2024 effectively extending the construction cycle.

And customer commentary has, as I talked to lot of folks out there, has confirmed our positive outlook. Deal of fabrication order backlog has certainly shortened from its historical high of over 12 months achieved in 2022, but it remains strong from a historical perspective, standing through March, 2024 with strong forward pricing. Current order entry pricing remains resilient. Not only a significant contributor unto itself, our fabrication platform provides meaningful pull-through volume for our steel mills, particularly important in softer markets, allowing for higher through cycle steel production utilization rates compared to our peers, adding to the resiliency of our through cycle cash generation. Furthermore, it provides an effective natural hedge to lower steel prices.

Our metals recycling platform had a challenging quarter. Its demand from domestic steel mills softened and realized ferrous scrap prices declined. Scrap prices pulled back in the third quarter with bushing prices falling some $80 a ton. The North American geographic footprint of our metals recycling platform provides a strategic competitive advantage for our electric arc furnace steel mills, and our scrap generating customers. In particular, our Mexican locations competitively advantage our Columbus and Sinton and raw material positions. We also strategically support aluminum scrap procurement for our future flat rolled aluminum investments. Our metals team is partnering even more closely with both our steel and aluminum teams to expand scrap separation capabilities through process and technological solutions, enhancing margin, increasing the availability of low residual ferrous scrap.

This will mitigate prime ferrous scrap supply issues in the future. It’ll also provide us with significant advantage to materially increase the recycled content for our aluminum flat rolled products and increase our earnings opportunities on that platform. Our steel operations achieve strong shipments of 3.1 million tons and solid financial results in the third quarter. Steel production utilization rate when you exclude Sinton was 90% compared to a domestic industry rate of some 76%. The higher utilization rates have been clearly demonstrated throughout all market cycles driven by the value added diversified product offerings, which are amount to 70% of our sales. And this, as Theresa mentioned, will increase further with the addition of two galvanizing and two paint lines that will be commissioned in the first quarter of 2024.

Differentiated supply chain solutions driving customer preference and mitigating price volatility and support of downstream internal pull-through manufacturing volume are all contributors. Our higher through cycle utilization rate is a key differentiator and supports our strong and growing through cycle cash generation capability and best-in-class financial metrics. Looking forward, steel backlogs are strong and customer order entry is good. Customer inventories are also at historically low levels. Auto production estimates for 2023 remained around 15 million units, but obviously with the ongoing strike, the outlook for the remainder of the year is somewhat opaque. So positively, dealer inventories remain below historical norms, which will be further reduced by the ongoing strike.

[Indiscernible] demand there is still strong and with tight supply, the auto build rate will likely be higher than the already anticipated 16 million unit plus for 2024. In the meantime, unfortunately, our auto direct flat rolled exposure is more concentrated toward European and Asian producers, which so far has mitigated the strike impact on our flat rolled auto volume. Although not a significant impact to overall earnings, we are seeing greater impact at our engineered bar division as their 15% — 20% auto exposure is mostly consumed by domestic auto producers. Non-residential construction remains solid. Our long product steel backlogs are good and customer inventory levels are low. General market is estimated to be off 8% of some due to seasonality, but should rebound as infrastructure spending provides meaningful support in the first half of 2024.

The turn down in residential construction seems to be abating with a depletion of available home inventory. Oil and gas activity is strong driving improved orders for OCTG products and still continues to grow at a rapid rate. In total aggregate, long product demand remains solid and in flat rolled lead times are extending. We’re seeing excellent order entry. Supply chain inventory is low, and pricing is certainly in an upward trend. We certainly anticipate further meaningful strength once the strike is concluded. Turning to Sinton. After the unplanned July outage related to the caster shear, the Sinton team produced over 290,000 tons in the quarter. The mill has clearly demonstrated its production rate capability and achieving 36 heat sequence lengths, and it’s exceeded its hourly nameplate run rate.

However, as I said, the constrained production is manifest from a low utilization rate caused principally by equipment reliability issues. That said, we expect to progressively ramp up to about 70% total run rate by the end of 2023, reaching a production of 2.4 million tons for 2024. Despite our challenges, the team has demonstrated the key competitive advantages of the Texas steel mill. We have completed full product dimensional capability. It’s proven up to one inch thick, down to 053, I do believe out to 84-inch width. Customers are reporting exceptional surface quality and the hot strip mill design has allowed for thermal mechanical rolling, allowing production of higher strength grades, tough grades with lower alloy content and thus lowering costs for those value added products.

We’ve achieved grade 80, 100 and already been approved for some API grades. I think just generally, it affirms our technical and process choices, and there’s no doubt that in my mind it’s the next generation of electric arc furnace flat rolled steel technology of choice. We have gained strong market acceptance and we can sell every pound of steel we make. Our exceptional through cycle operating and financial performance continues to support our cash generation and our growth investment strategies. Relative to our expansion into aluminum, as I said the responses from existing and new customers across all markets is absolutely incredible. We are developing the site. We purchased some 2,600 acres, I do believe, but we’re developing it for the colocation of customers with the rolling mill as we successfully did in Sinton.

We’re seeing a number of customers who are already indicating strong interest in that model because it provides a sustainable, competitive model for all of us. To recap the project, the 650,000 metric ton flat rolled facility, the rolling mill will be located in Columbus, Mississippi, state-of-the-art facility, serving the sustainable beverage and packaging, automotive and industrial sectors. Approximately 300,000 metric tons will be canned, 200,000 tons auto and 150,000 industrial. We have onsite mill and cast slab capacity in Columbus of around 600,000 metric tons and the project will be supported by two satellite recycled aluminum slab casting centers one in central Mexico and one in Arizona to capture scrap close to its source. We’ll have two cast lines, coating lines, and downstream processing and packaging lines to fully support our customer base.

Startup plans are still anticipated for mid-2025 start for the rolling mill. Mexico slab center should start up late 2024, perhaps January 2025, and the Arizona slab center in the first quarter of 2025. So the project cost, including all recycled slab centers, is around $2.5 billion, 100% to be funded with cash. As we stated in the past, we expect a through cycle annual EBITDA of around about $650 million to $700 million from the aluminum portion, and the support of OmniSource will draw another $40 million to $50 million for them. I think the market from an investment premise perspective, what excites me is the market environment is very similar to the domestic steel industry when we started SDI 30 years ago. The industry generally has older assets, had a tough time earning its cost of capital.

There’s been little reinvestment over the last 45 years. It has heavy legacy costs, tends to be inefficient in high cost operations. Again parallels the situation we saw within the steel industry 30 years ago. According that we see a definite deficiency in supply that is exists in North America. And that deficiencies expected to grow even with our and second competitor’s new facility. From our perspective, it is an adjacent industry to us. It leverages our ability to design and build commission ramp up the large capital assets and operate those assets very effectively, efficiently, at low cost through our performance and incentivized innovated and very effective culture. In closing, we’re excited and impassioned and we always are, and we continue to be by our future growth opportunities as they will continue to the high returning growth momentum we have consistently demonstrated over the years.

Culture and business model continue to positively differentiate our performance leading to best-in-class financial metrics, allowing a balanced cash allocation strategy that has rewarded our shareholder by top-notch in class returns. We’re no longer a pure steel company, but an integrated metals business providing an enhanced supply chain solutions to the industry. In return [ph], mitigating volatility and cash flow generation through all market cycles. Our teams are a foundation. I thank each and every one of them for their passion and their dedication. We’re committed to them. As I remind those listening today, that safety for yourselves, your families, and for each other is the highest of priorities, but competitively position and continue to focus on providing superior value for our company, our customers, team members, our shareholders alike.

Thank you. Thank you for joining us again today. And Holly, we would love to turn it over to questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] Your first question for today is coming from Martin Englert at Seaport Research Partners.

Martin Englert: Hello. Good morning, everyone.

Mark Millett: Good morning.

Martin Englert: Within the Steel segment, steel conversion costs, which do include some substrate costs increase I think to around about 576 per ton in the quarter from 522. Is there any additional color that you can share regarding the portion of substrates, and maybe some positives and negatives when you think about these sequential change in contributions between true conversion costs and substrates, as well as if there was any material impact from the Sinton outage on that conversion cost.

Theresa Wagler: Good morning, Martin. It’s Theresa. Great question and observation. It really didn’t have anything to do with the change in substrate mix, but that can have an impact. But there’s two things that I would point to. One is the fact that because Sinton didn’t operate all of July, the way that you’re calculating your conversion costs, that lack of volume does have a pretty significant impact. It’s not that there was additional costs, the costs were pretty de minimis. It’s just that lost volume affecting the denominator. It’s really affecting your conversion costs on a per ton basis, a little bit on an outsized way. The second thing is that we are preparing to start the value added lines in Heartland and then Sinton will follow thereafter in the coming months. And there’s some additional costs related to that as well. But nothing to point to that would be systemic of higher conversion costs going forward.

Martin Englert: Okay. So there’s certainly a one-off that seemed material for the quarter and then some lingering, kind of transitory as you’re working on ramping the other value added assets that will — how long do you think that will persist for — through the fourth quarter and then in the first quarter of next year? Any idea?

Theresa Wagler: No. So Martin, with the advent of Sinton now operating and not being a part of that outage, you’re going to have that incremental volume, which is going to really make that conversion cost get back in line with what you’re used to seeing. But the value added line, there is some incremental cost. It’s nothing that is necessarily significant that you’ll have to try to figure out for the fourth quarter. We have two of the lines coming line maybe even before the end of the year with the remaining two for the first, probably first couple months in the first quarter.

Martin Englert: Thank you for that. If I could one last one here, excluding 2020, looking at seasonality in 4Q total steel shipments, they tend to decline around 5% sequentially. Is there anything you’re seeing this year that would suggest something different? And I imagine comparing the sequential with the Sinton outage and then Sinton backup probably might have an impact here on a sequential basis.

Theresa Wagler: Yeah. So you’re spot on, Martin. We would expect to see normal seasonality within the steel operations, but as you have now Sinton ramping up and operating for the full fourth quarter, you will see some benefit from that additional volume.

Martin Englert: And you’re aiming for 70% utilization on exit for the year with Sinton, correct?

Theresa Wagler: That’s correct.

Martin Englert: Okay. Thank you very much. Congratulations navigating the downward market on and the continued growth investments.

Theresa Wagler: Thanks Martin.

Operator: Your next question is coming from Carlos de Alba at Morgan Stanley.

Carlos de Alba: Yeah. Thank you very much. Good morning. Just continue on Sinton. I wonder if you can give us a little bit of color on the EBITDA generated by the operation, and how you see that going forward.

Theresa Wagler: Martin, I’m sorry. You cut out.