Schnitzer Steel Industries Inc (NASDAQ: SCHN) Q2 2023 earnings call dated Apr. 05, 2023
Corporate Participants:
Michael Bennett — Vice President, Investor Relations
Tamara Lundgren — Chairman, President and Chief Executive Officer
Stefano Gaggini — Senior Vice President and Chief Financial Officer
Analysts:
Emily Chieng — Goldman Sachs — Analyst
Presentation:
Operator
Good day, and thank you for standing by, and welcome to Q2 Fiscal 2023 Earnings Call. [Operator Instructions]
I’d now like to hand the conference over to your host, Michael Bennett, Investor Relations. Please go ahead.
Michael Bennett — Vice President, Investor Relations
Thank you, Justin, and good morning. I am Michael Bennett, the company’s Vice President of Investor Relations. I am happy to welcome you to Schnitzer Steel’s earnings presentation for the second quarter of fiscal 2023. In addition to today’s audio comments, we have issued our press release and posted a set of slides, both of which you can access on our website at schnitzersteel.com.
Before we start, let me call your attention to the detailed Safe Harbor statement on Slide 2, which is also included in our press release. As we note on Slide 2, we may make forward-looking statements on our call today, such as our statements about our targets, volume growth and margins. Our actual results may differ materially from those projected in our forward-looking statements. Additional information concerning factors that could cause actual results to materially differ from those in the forward-looking statements is contained in Slide 2 as well as our press release of today. Please note that we will be discussing some non-GAAP measures during our presentation today. We’ve included a reconciliation of those metrics to GAAP in the appendix to our slide presentation.
Now, let me turn the call over to Tamara Lundgren, our Chairman and Chief Executive Officer. She will host the call today with Stefano Gaggini, our Chief Financial Officer.
Tamara Lundgren — Chairman, President and Chief Executive Officer
Thank you, Michael. Good morning, everyone, and welcome to our fiscal ’23 second quarter earnings call. Before we begin with our formal presentation, I’d like to address the devastation that occurred in Turkey, due to the earthquake in February, and more recently the series of natural disasters in the US. Our new cycles are short these days. And I’d like to take a moment to remember the tens of thousands of people who lost their lives or loved ones, homes or livelihoods as a result of these natural disasters. Our relationships in Turkey go back decades and we have sold millions of tons of recycled metals to our valued Turkish customers over that time.
Here at home, we have employees, customers and suppliers in many of the communities impacted by tornadoes, storms and floods. I know that I speak for all of us, when I say that our thoughts and prayers continue to be with those impacted by these disasters. I’d also like to recognize our employees for their generosity and humanitarian spirit, whether providing support to Turkey or more recently providing aid and assisting in cleanup efforts connected with natural disasters and rail accidents in the US. Our company and our employees have stepped up to offer many forms of in-kind and financial support. Thank you.
Today on our call, I’ll review our quarterly financial results, the trends affecting our business and progress on the strategic activities we have underway, to address evolving industry dynamics and create long-term value through the cycle. Stefano will then provide more detail on our financial performance, our capital structure and our capital investments. I’ll wrap up, and then we’ll take your questions.
So let’s turn now to Slide 4, to get started. Earlier this morning, we announced our results for our fiscal ’23 second quarter, which reflected adjusted EPS of $0.14 and adjusted EBITDA of $32 million. Our strong sequential improvement benefited from the resolution of the shredder operating disruptions that affected our Everett and Oakland operations in the first quarter, and the strengthening of both ferrous and nonferrous prices.
The significant sequential increase in our ferrous sales volumes of nearly 50% was primarily underpinned by several shipments in December that have been delayed from the first quarter. Our nonferrous sales volumes were up slightly and finished steel sales volumes as expected were down about 7% due to seasonality and softer demand for wire rod products.
While ferrous scrap prices increased during the quarter to relatively strong levels on an historical basis, lower industrial and consumer activity led to tighter than expected scrap flows, tempering our margin expansion. We’ve generated strong free cash flow during the quarter and our results benefited from the productivity initiatives and cost savings that we implemented earlier in the fiscal year. And we continued our uninterrupted record of returning capital to our shareholders through the issuance of our 116th consecutive quarterly dividend.
Let’s turn now to Slide 5. Ferrous export prices strengthened during the quarter amid increased global steel demand, tight availability of scrap and strong rebar demand in Turkey. Ferrous prices increased about 35% from their November trough with about half of that uplift occurring in February, which should benefit our Q3 shipments. Since the end of the quarter, ferrous export prices strengthened before flattening and currently remain in the mid to high $400 [Phonetic] per ton delivered depending on the region.
Recently, the Turkish government announced the country’s need for 5 million tons of steel to support those efforts in the Iskenderun region. This implies a need for around 6 million tons of ferrous scrap. We expect that even accounting for Turkish domestic scrap generated by earthquake cleanup activities, Turkey scrap imports should rise materially to meet this need.
In the US domestic market, ferrous prices increased in each month of Q2 and in March, following seven months of consecutive price declines. Higher scrap prices were driven by mill — steel mill restocking, tighter scrap flows and higher auto production. In the nonferrous market, demand and prices for recycled copper, aluminum, and zorba products increased for most of Q2, driven by low inventories and stronger demand from China and Southeast Asia.
Turning to finished steel. While demand in prices came off their near record highs, metal spreads continue to be robust during Q2. Although higher interest rates and tighter credit conditions could lead to softer demand, there are a number of offsetting trends. We expect lower steel imports into the US from Turkey due to Turkey’s increased domestic demand associated with its rebuilding activities.
In addition, we expect increased rebar demand supported by the Biden administration’s infrastructure bills and the Buy Clean directive. Our Oregon steel mill with its range of low carbon long products, including our net zero carbon emission GRN Steel product line is well positioned to meet this rising demand.
Let’s turn now to Slide 6. Decarbonization is a powerful structural driver of demand for recycled metals, which require less carbon to produce than mined metals. Many low carbon technologies are widely acknowledged to be more metal intensive. Maximizing the environmental benefits of decarbonization will require increasing use of recycled metals versus virgin materials.
An example of one of the many actions we’re taking to capture value from this rising demand is our acquisition of ScrapSource LLC last quarter. ScrapSource is an asset light business focused on providing metals recycling management services and solutions to over 500 customers, including manufacturers, fabrication facilities and service centers across North America. This lean business model will enable us to scale our national accounts platform, enhance services to our national manufacturing and retail customers, increase supply flows to our operations, and create expansion opportunities in new regions.
The integration of ScrapSource with our National Accounts platform is well underway. And we are launching our integrated recycling services activities under our trademark 3PR brand. 3PR stands for Third Party Recycling. 3PR involves activities where Schnitzer is providing recycling services, including among other activities, scrap management and recycling solutions for our customers’ reverse logistics processes.
Our 3PR brand reflects a rapidly growing and important service and supply chain solution for industrial, manufacturing, and retail customers that enables greater recycling rates and value recovery, improved manufacturing and retail efficiency, reductions in material going to landfill, and improved carbon footprint, and enhanced sustainability reporting.
So now let’s turn to Slide 7 to review additional strategic actions we have underwent. We are focused on four strategic priorities. First, technology investments in advanced metal recovery systems at our major recycling operations to enable us to extract more nonferrous metals from our shredding activities, increase throughput and improve our margins, expand our product offerings and customer base, and reduce material going to landfills.
Second, volume growth. We’re highly focused on increasing our ferrous and nonferrous volumes through a combination of organic growth and recent acquisitions such as ScrapSource, Encore Recycling and Columbus Recycling. Our multi-year focus on the strategic priority has led to an annual 6% volume growth rate between fiscal ’16 and fiscal ’22. Third, expansion of our products and services to meet the evolving demand for recycled metals, such as our net zero GRN Steel products and the 3PR services we provide to manufacturers and retailers.
And fourth, productivity initiatives that we undertake as part of our continuous improvement culture and which are particularly important in the face of significant inflationary pressure. In Q2, we achieved nearly the full run rate of benefits from the cost reduction and productivity initiatives that we announced earlier in this fiscal year.
So now let me turn it over to Stefano for a more detailed review of our financial and operating performance.
Stefano Gaggini — Senior Vice President and Chief Financial Officer
Thank you, Tamara, and good morning. I’ll start with a review of our consolidated results and provide an update on our ferrous sales and the market dynamics. Adjusted EBITDA in the second quarter was $32 million, a significant increase from the $8 million achieved in the first quarter. Adjusted EBITDA per ferrous ton was $25. Performance benefited from higher demand and prices for recycled metals as well as from the resumption of full operations at the Everett and Oakland facilities in mid-November.
Ferrous volumes were up by 48% sequentially. The expansion in metals spreads for recycled metals in the higher price environment was limited by the tightness in supply flows due to a combination of lower economic activity and winter seasonality. In addition, we experienced a compression of metal spreads on shipments contracted before the increase in market prices during the second half of the quarter. This substantially offset the benefit from average inventory accounting of approximately $8 per ferrous ton in the quarter, resulting from the increase in market prices.
The contribution from our rolling mill remained a significant driver of our consolidated performance, although it decreased sequentially on lower net selling prices and volumes. Our second quarter results also included approximately $3 million in SG&A expense for various legal matters. We continue to focus on finding ways to mitigate and offset inflationary pressures we are experiencing on operating costs, including for labor, energy, logistics and waste disposal.
During our second quarter, we successfully implemented the initiatives targeting a reduction of SG&A expense by approximately $20 million annually, which we announced in January, focused on a combination of reduction in force, lower professional and outside services, decreased lease cost and reductions in other discretionary expenses. We achieved approximately two-thirds of the targeted quarterly run rate of $5 million in the second quarter and expect to achieve the full run rate by the fourth quarter of fiscal ’23. These initiatives are in addition to the $40 million in targeted annual benefits from measures we announced and implemented in the first quarter, focused on production cost reductions, operating efficiencies and yield improvements.
Turning to the ferrous dynamics in the quarter. Average net selling prices were up 8% sequentially. Due to selling ahead, the realized prices on shipments made in the second quarter did not fully reflect the increase in market prices in the period. Our ferrous sales volumes were up 48% sequentially. This increase was driven by three factors: first, over 100,000 tons associated with the resumption of full operations in Everett and Oakland; second, the delivery of several bulk cargos delayed at the end of the prior quarter carrying approximately 100,000 tons; and third, a drawdown of ferrous inventories at other facilities into normal ranges to meet strengthening demand.
Our top sales destinations for ferrous exports in the quarter were Vietnam, Turkey and India. The share of export sales was 65%. Shipments to Turkey made up 17% of our total sales volumes. We did not experience disruptions to our shipments to Turkey following the earthquake in early February and rebuilding efforts are expected to lead to more demand for recycled metal in the country.
Now let’s move to Slide 9 for an update on nonferrous sales and the market dynamics. We saw stronger demand for nonferrous products during the quarter, including from global restocking as China’s strict COVID lockdowns were lifted in the latter part of calendar ’22. Together with a weaker US dollar, this resulted in market prices for copper, aluminum and other nonferrous products increasing during the quarter. As a result, our average net selling prices for nonferrous shipments were 10% higher sequentially.
Nonferrous sales volumes were substantially flat on a sequential basis and we sold our nonferrous products to 15 countries with the major export destinations being Malaysia, India and China. The share of export sales of nonferrous was 54% in the second quarter, down sequentially from 60% due to increased shipments into the domestic markets of furnace ready products recovered by our nonferrous systems.
Our product mix is highly diversified with sales of Zorba, twitch, aluminum and copper, representing approximately 80% of our nonferrous volumes. Our investments in advanced nonferrous recovery technologies give us the ability to produce more furnace ready materials, which create optionality to meet changes in market demand for nonferrous products while maximizing margins.
Now let’s move to Slide 10 to provide an update on our technology investments. We continue to advance our technology program focused on increasing metal recoveries of nonferrous material from shredding operations and generating more furnace ready higher value products. In March, we began commissioning of a major copper recovery system in Massachusetts with an additional primary recovery system on the West Coast targeted to do so by the end of our third quarter.
We will complete our investment program with two additional major copper recovery systems targeted to begin commissioning by the end of the summer 2023, subject to construction, equipment delivery and permitting timelines. Once fully operational, we expect nonferrous volumes recover from shredding to increase by approximately 20%. As a reminder, the main drivers of the projected increase in recover volumes are the seven primary nonferrous recovery systems. Three of them are major aluminum and four are major copper systems.
Our initiative although includes aluminum separation systems on each coast that are already operational, and four supplemental copper separation systems of which one is still in its ramp-up phase. The contribution to performance from these technologies in the second quarter was positive, although not yet material to results after consideration of the costs incurred on several systems that are undergoing commissioning and ramp up activities. We expect the net benefits from these investments to gradually expand and to deliver approximately half of the targeted full run rate of benefits by the fourth quarter of fiscal ’23.
We continue to target substantial achievement of the estimated run rate benefits to EBITDA of $10 per ferrous ton by the end of calendar year 2023, upon completion of commissioning and ramp up for all systems. We expect the overall capital investment for these projects to be in the range of $130 million of which approximately $125 million have been spent to date leaving $5 million to complete the projects in fiscal ’23.
Now let’s move to Slide 11 to discuss our steel mill performance in West Coast markets. Demand for finished steel in the second quarter in our West Coast markets was lower sequentially, driven by seasonality on construction activity, including the impact of prolonged periods of rain in California. Average net selling prices for finished steel decreased 7% sequentially. Finished steel sales volumes of 109,000 tons were down 7% sequentially, but up 3% year-over-year.
Our average mill utilization was 75%, which was higher than the US average of approximately 73% for the period. While metals spreads at our mill were down from the record highs experienced during calendar ’22, they remain robust and the mill stands to benefit from the demand support to be provided by the US infrastructure bills.
Now let’s move to Slide 12, and discuss cash flow, capital structure and our outlook for the third quarter. Operating cash flow in the second quarter was strongly positive at $88 million driven by profitability and the benefit to working capital, primarily associated with a drawdown of inventories. Year-to-date, we achieved positive operating cash flow of $26 million. As the chart on the top left shows, we have a multi-year track record of generating strongly positive annual operating cash flows through the cycle.
Capex spend in the second quarter was $27 million, down from $48 million in the prior quarter. For fiscal ’23 as a whole, we now project our capex to be in the range of $110 million to $120 million, slightly less than a third of the fiscal ’23 capex will be for growth projects, including the completion of our technology initiatives with the remaining for maintaining the business and environmental related capital projects. Excluded from this annual range is capex associated with the repair and replacement of the shredder enclosure building at our Everett facility during fiscal ’23, as these expenditures are expected to be substantially recovered through insurance over time.
Net debt decreased $55 million to $299 million at the end of the second quarter, reflecting the strong generation of free cash flow. Availability under our credit facility remains sizable with a borrowing capacity of $800 million in a maturity of August 2027. Net leverage was 24% at quarter-end, down from 28% sequentially and the ratio of net debt to adjusted EBITDA was 1.5x. We returned capital to shareholders through our quarterly dividend. While we did not repurchased shares in the second quarter, buybacks remain part of our balanced capital allocation strategy and we repurchased approximately 2.7% of our outstanding stock in the last 12 months.
Our effective tax rate on adjusted second quarter results was 14%, lower than expected due to the beneficial impact of certain tax items. Although there are still almost two months left in the quarter, I’ll now turn to our outlook for the third quarter of fiscal ’23, which is based on market conditions and information we have today. Taking into account that ferrous volumes were up nearly 50% in the second quarter as they benefited from an inventory drawdown effect from delayed cargos. We expect our ferrous volumes for the third quarter to be down approximately 10% from that strong level supported by spring seasonality.
Nonferrous sales volumes are expected to be up 15% sequentially. Finished steel sales volumes are expected to be up 25% sequentially due to seasonally higher construction demand. We expect our consolidated adjusted EBITDA per ferrous ton to significantly improve from the second quarter and approximate $45. Looking at some of the underlying dynamics, there are various factors contributing to the expected improvement in sequential performance.
First, metal spreads for ferrous and nonferrous recycle metal are anticipated to expand as our contracted shipments for delivery in the third quarter fully reflect the increase in market prices that occurred earlier in the calendar year. However, this expansion in spreads continues to be constrained by tightness in scrap flows. Second, we expect a higher sequential contribution from our steel mill driven primarily by higher sales volumes. And third, retail parts sales at our Pick-n-Pull auto stores are expected to increase due to seasonality.
We expect our effective tax rate in the third quarter to approximate 27%, and to be in the range of 25% for the full fiscal year subject to company performance. We expect the average inventory accounting effects to be neutral. And lastly, we anticipate interest expense to be slightly more than the previous quarter, due to the increase in short-term interest rates. And our operating cash flow in the third quarter to be positive based on higher profitability.
And with that, I’ll turn the call back over to Tamara.
Tamara Lundgren — Chairman, President and Chief Executive Officer
Thank you, Stefano. As I often say, sustainability is at the core of what we do and how we operate and it has been since our founding in 1906. Since our last earnings call, we’ve been recognized by several well-respected organizations for various aspects of our sustainability program. Corporate Knights ranked us number one on their Global 100 list of the World’s most sustainable companies, highlighting the increasingly critical role of our work in the global transition to a low carbon future. And Ethisphere named as one of the World’s Most Ethical Companies for the 9th consecutive year. Our multi-year people, planet and profit goals underpin our sustainability frameworks. I encourage you to visit our website to view our latest sustainability report, which describes our goals in more detail.
Now let’s conclude by turning to Slide 14. As we hit the halfway point in fiscal ’23, our strategic growth investments and our productivity and cost reduction initiatives are expected to deliver additional benefits in this fiscal year and beyond. We have a strong balance sheet, a track record of delivering positive operating cash flow, an ability to invest in the growth and productivity of our company, and an uninterrupted record of returning capital to our shareholders through our dividend. We are well positioned to benefit from the global focus on decarbonization, the increased metal intensity of low carbon technologies and the continued growth in US and global EAF steelmaking capacity.
Before closing, I’d like to congratulate our employees for their excellent safety performance in the first half of the year. While we still have work to do to keep achieving improvement in our safety performance, our team’s commitment to safety continues to be reflected in our results. Thank you for your dedication to working safely, while continuously serving our customers and communities, supporting our suppliers and demonstrating the critical and essential role of our business and industry in the economy. You’ve demonstrated once again why we have continued to be a leader in the recycling industry for over a century.
And now, operator, let’s open the call for questions.
Questions and Answers:
Operator
And thank you. [Operator Instructions] And our first question comes from Emily Chieng from Goldman Sachs. Your line is now open.
Emily Chieng — Goldman Sachs — Analyst
Good morning, Tamara and Stefano, and thank you for the time this morning. My first question is just around the metal spread outlook that you’ve been outlining there. Certainly seems like average selling prices have moved in the right direction. But to your point, are there any real-time impacts that you’re seeing to scrap flows as it relates to the changes in industrial and consumer activity following increasingly uncertain macro there? How should we be thinking about the metal spreads relative to 2Q levels triangulating those prices — those higher prices and the title flows [Phonetic]?
Tamara Lundgren — Chairman, President and Chief Executive Officer
Sure. Good morning, Emily, and thanks for your questions. So, although broadly speaking scrap remains tight and US manufacturing is near a three-year low. There are nascent signs of improved inbound flows that are primarily related to seasonality. And I think that the outlook of that increasing supply flows aligns with the higher margins that Stefano was referring to in his outlook — in his prepared remarks.
Emily Chieng — Goldman Sachs — Analyst
Okay, understood. And so real-time following the regional banking crisis there has not been enough impact to I guess industrial order book activity that’s necessarily causing concern for you guys at this point?
Tamara Lundgren — Chairman, President and Chief Executive Officer
So we haven’t seen any impacts from the banking situation. Clearly, credit contraction could impact the demand for finished steel, but there are offsetting trends. We do anticipate lower imports into the US. We do anticipate funding provided through the Biden administration’s infrastructure bills. And then just generally and longer-term, the higher metal intensity associated with low carbon technologies and the clean tech reindustrialization are all long-term trends that are supporting demand.
Emily Chieng — Goldman Sachs — Analyst
Understood. That’s very helpful. My second question, shifting gears a little bit. Just on the advance metals recycling. So looks like we’ve made some good progress to getting most of the construction complete before the end of the summer. But can you remind us what are the remaining construction equipment delivery you’re permitting, pieces that remain outstanding before getting to that endpoint there?
Stefano Gaggini — Senior Vice President and Chief Financial Officer
Yes. Good morning, Emily. This is Stefano. I’ll take that one. So as you said, we continue to progress and advance our program. We began commissioning of a major — commissioning the major copper recovery systems in Massachusetts in March. And then we expect to have another one coming online at the end towards the end of our third quarter. They will leave only two additional major copper recovery systems that are targeted to begin commissioning at the end of the summer. And with that, we would have completed the construction.
Obviously, as you mentioned, this timeline is subject to a equipment delivery. At this point, we don’t expect any issues that supply kind of constraints as more subdued. There is one system that is still subject to permitting, but at this point this is our targeted and expected timeline. And as I mentioned during the call, based on that timeline, we then expect to be able to achieve the full run rate benefits from those systems once they’re fully operational by the end of the current calendar year and that remains unchanged compared to the past.
Emily Chieng — Goldman Sachs — Analyst
All right. Thank you, Stefano.
Operator
And thank you. And I am showing no further questions. I would now like to turn the call back over to Tamara Lundgren, [Technical Issues] now available.
Tamara Lundgren — Chairman, President and Chief Executive Officer
Thank you, operator, and thank you for your time today everyone. I look forward to speaking with you again in June, when we report our third quarter results. In the interim, stay safe and stay well.
Operator
[Operator Closing Remarks]