Q1 2023 Reliance Steel & Aluminum Co Earnings Call

Participants

Arthur Ajemyan; CFO & Senior VP; Reliance Steel & Aluminum Co.

Karla R. Lewis; President, CEO & Director; Reliance Steel & Aluminum Co.

Stephen P. Koch; Executive VP & COO; Reliance Steel & Aluminum Co.

Emily Christine Chieng; Associate; Goldman Sachs Group, Inc., Research Division

Martin John Englert; Senior Analyst; Seaport Research Partners

Philip Ross Gibbs; Director & Equity Research Analyst; KeyBanc Capital Markets Inc., Research Division

Timna Beth Tanners; MD of Equity Research; Wolfe Research, LLC

Kimberly Orlando; SVP; ADDO Investor Relations

Presentation

Operator

Greetings, and welcome to the Reliance Steel & Aluminum Company First Quarter 2023 Earnings Call. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Kim Orlando with ADDO Investor Relations. Please go ahead.

Kimberly Orlando

Thank you, operator. Good morning, and thanks to all of you for joining our conference call to discuss Reliance's first quarter 2023 financial results. I am joined by Karla Lewis, President and Chief Executive Officer; Steve Koch, Executive Vice President and Chief Operating Officer; and Arthur Ajemyan, Senior Vice President and Chief Financial Officer. A recording of this call will be posted on the Investors section of our website at investor.rsac.com.
The press release and the information on this call may contain certain forward-looking statements, which are based on a number of assumptions that are subject to change and involve known and unknown risks, uncertainties or other factors, including the impacts of inflation, geopolitics and the COVID-19 pandemic and related economic conditions on our future operations. Which may not be under the company's control and may cause the actual results, performance or achievement of the company to be materially different from the results, performance or other expectations implied by these forward-looking statements.
These factors include, but are not limited to, those factors disclosed in the company's annual report on Form 10-K for the year ended December 31, 2022, under the caption Risk Factors, disclosure in our press release this morning and other documents, Reliance files or furnishes with the Securities and Exchange Commission. The press release and the information on this call speak only as of today's date and the company disclaims any duty to update the information provided therein and herein.
I will now turn the call over to Karla Lewis, President and CEO of Reliance.

Karla R. Lewis

Good morning, everyone, and thank you all for joining us today to discuss our first quarter 2023 financial results. I'll begin with an overview of our performance and capital allocation strategy. Steve will then speak to our operating results and demand trends by end market, and Arthur will conclude with a review of our financial results and outlook for the second quarter of 2023.
Beginning with our first quarter performance. We started the year off strong as our highly diversified business model continued to yield favorable results in an uncertain business environment. Our first quarter net sales of $3.97 billion increased approximately 10% from the fourth quarter of 2022. Our sales benefited from solid demand in the vast majority of our end markets, with our tons sold up 17.7% from the fourth quarter of 2022 which were partially offset by a lower average selling price. This was the highest sequential increase from the fourth quarter we've seen in our tons sold in the last decade.
Our strong volumes which benefited from our investments in organic growth, a robust gross profit margin of 3.9% and disciplined expense control helped drive pretax income of $508.5 million and diluted earnings per share of $6.43, well ahead of our expectations. Our strong profitability along with effective working capital management enabled us to generate significant first quarter operating cash flow of $384.6 million.
Turning to capital allocation. Our consistent cash generation continues to fuel our strategy of investing in growth activities and returning capital to our stockholders. Our capital expenditure budget for the full year 2023 remains a record $500 million, with spend of $102.9 million in the first quarter and an expected total cash outlay of approximately $400 million to $450 million this year. We expect approximately 2/3 of this budget will be invested in growth projects up from roughly 50% historically as we continue to invest in various facility upgrades, efficiencies and expansion into new markets.
Our investments include new cutting-edge equipment to expand our value-added processing capabilities to further bolster our market position and margin profile as well as investments to provide safer working environments for our employees. While we did not complete any acquisitions during the first quarter, the pipeline remains healthy. We continue to evaluate a wide variety of prospective opportunities and remain well positioned to pursue those that meet our disciplined criteria for high-quality growth. Concurrent with our growth initiatives, we returned $100.9 million to our stockholders in the first quarter through a combination of dividends and share repurchases. Since 2018, we have allocated over $2 billion of capital towards organic growth and acquisitions and nearly $2.8 billion towards stockholder returns in the form of dividends and share repurchases.
In summary, we are very pleased with our first quarter performance, both operationally and financially. We continue to execute our strategy in a dynamic environment with metal pricing volatility, ongoing inflationary headwinds, recessionary concerns, supply chain disruptions and labor shortages. Nevertheless, our managers in the field continued to do an excellent job upholding our superior levels of service and providing increasing levels of value to our customers. We maintain our belief that Reliance remains very well positioned to capitalize on opportunities resulting from the Infrastructure Bill, the CHIPS Act and the Inflation Reduction Act in an environment with relatively higher metal pricing versus historical levels.
Thank you to our extraordinary team at Reliance for your commitments to working safely and successfully executing our model. Thank you all for your time today. I'll now turn the call over to Steve, who will review our first quarter operating results and demand trends.

Stephen P. Koch

Thanks, Karla, and good morning, everyone. I'd also like to express my gratitude to our dedicated team at Reliance for their outstanding operational execution and ongoing commitment to safety. I'll now turn to our first quarter demand and pricing trends.
Our tons sold increased 17.7% compared to the fourth quarter of 2022, surpassing our expectations of up 11% to 13% and vastly exceeding the typical seasonal recovery. Compared to the prior year period, our tons sold were up 7.2% higher than the service center industry increase of 5.5% as reported by the MSCI. The performance was supported by our organic growth activities we've invested in over the course of the past several years, along with our end market and product diversification, broad value-added processing capabilities and ability to service quick turnaround orders.
Continued strength in the nonresidential construction, general manufacturing and aerospace end markets further contributed to our strong shipment levels in the quarter. Additionally, rising metal cost trends incentivized many customers to reenter the market ahead of further price increases, which led to strengthened demand for our carbon steel flat-rolled products. Shipments for the other carbon steel products we sell also increased both sequentially and year-over-year. Our first quarter average selling price per ton sold of $2,623 declined 6.3% compared to the fourth quarter of 2022, exceeding our expected decrease of 3% to 5%, largely due to shifts in product mix.
Relative to the fourth quarter, the increase in carbon steel product shipments, which have a lower average selling price than stainless steel and aluminum products contributed to a shift in our product mix, resulting in a lower realized sales price per ton sold. While our overall quarterly average selling price per ton sold decreased, pricing for most products we sell stabilized during the first quarter. It's also important to note that announced carbon steel flat-rolled price increases were only partially realized during the first quarter, with more to come in the second quarter. Arthur will cover our second quarter 2023 outlook in more detail.
On a non-GAAP FIFO basis, which is how we monitor our day-to-day operating performance, our gross profit margin increased by 190 basis points to 30.5% compared to the prior quarter due to the -- due to better alignment of inventory cost on hand with replacement costs.
I'll now turn to a high-level overview of the trends we saw within our key end markets. Notably, shipments improved both year-over-year and quarter-over-quarter in nearly every end market with continued strength in non-res construction, general manufacturing, auto through our tolling operations, aerospace and energy. While sales to the semiconductor industry declined sequentially and remained at elevated levels compared to the first quarter of 2022. And our long-term outlook for this market remains positive and we will continue to make investments to increase Reliance's capacity in the semiconductor space to support the significant expansion of semiconductor fabrication underway in the United States.
Separately, we will also continue to make investments in our businesses that sell into infrastructure and clean energy to support anticipated higher activity in these areas. Please refer to our earnings release for additional commentary on our end markets. Overall, we remain confident underlying demand will remain healthy across the majority of the end markets we serve in the second quarter of 2023.
I'll now turn the call over to Arthur to review our financial results and outlook.

Arthur Ajemyan

Thanks, Steve. Good morning, everyone, and thank you for joining us today. As Karla highlighted, ongoing strong demand contributed to non-GAAP earnings per share of $6.37, well ahead of our guidance of $5.40 to $5.60 per share. The stronger-than-anticipated 17.7% sequential increase in our tons sold also exceeded our guidance and accounted for the majority of the earnings per share outperformance, while our overall quarterly average selling price per ton declined from the previous quarter due to the entry point into Q1 being lower than the prior quarter average and a shift in our product mix. Our selling prices remained relatively stable throughout the first quarter.
In an environment of relatively flat pricing for the vast majority of the products we sell, we improved our transactional or FIFO gross profit margins that's without the impact of LIFO adjustments from the fourth quarter of 2022 as our inventory turn rate accelerated and costs on hand continued to better align with lower replacement costs. Additionally, we realized a significant amount of operating leverage on the incremental tons we shipped, these factors collectively contributed to the better-than-expected results for the first quarter.
We recorded LIFO income of $15 million in the first quarter of 2023 and compared to $99.1 million of LIFO income in the fourth quarter of 2022 and LIFO expense $37.5 million in the first quarter of 2022. Our current estimate of $60 million of LIFO income for fiscal 2023 remains unchanged from our previous outlook. As a result, we currently expect to record $15 million of LIFO income in the second quarter of 2023.
Consistent with historical practice, we will update our expectations quarterly to account for actual inventory cost and metal pricing trends. As of March 31, 2023, the LIFO reserve on our balance sheet was about $729 million, which will generate LIFO income and benefit future period operating results to mitigate the impact of potential declines in metal prices.
Moving on to expenses. Our first quarter non-GAAP SG&A expenses increased $43.2 million or 7% compared to the fourth quarter of 2022. Due primarily to higher incentive compensation associated with higher profitability as well as higher variable warehousing and delivery expenses associated with higher tons shipped. On a year-over-year basis, non-GAAP SG&A expenses increased $43.3 million or 7.1% primarily due to incremental variable costs associated with higher tons shipped and inflationary wage adjustments, which were partially offset by lower incentive-based compensation resulting from lower FIFO profitability.
Turning to cash flow. Despite about $100 million of working capital investment in the first quarter, we generated cash flow from operations of $384.6 million, supported by our strong earnings. Our inventory turn rate based on tons improved in the first quarter of 2023 to 4.9x or 2.4 months on hand, up from 4.4x or 2.7 months on hand for all of 2022 and exceeding our company-wide turn goal of 4.7x. Our days sales outstanding was approximately 40 days in line with our historical range of 39 to 43 days. Our operating cash flow funded $102.9 million of record quarterly capital expenditures and the return of $100.9 million to our stockholders in the form of $62 million of cash dividends and $38.9 million of share repurchases. As of March 31, 2023, approximately $641.8 million remained available on our $1 billion share repurchase authorization.
I'll now turn to our second quarter outlook. While we expect underlying demand will remain healthy in the second quarter of 2023, we expect our tons sold will be flat to down 2% in the second quarter of 2023 compared to the first quarter of 2023 due to one less shipping day in the second quarter of '23 and the absence of the demand pull forward experienced in the first quarter of 2023. We anticipate overall pricing to remain fairly stable with slight upside from recently announced carbon steel price increases. Accordingly, we estimate our average selling price per ton sold in the second quarter of 2023 will be flat to up 2% compared to the first quarter of 2023. Based on these expectations, we anticipate non-GAAP earnings per diluted share in the range of $6.40 to $6.60 for the second quarter of 2023.
In closing, we are very pleased with our solid start to the year with strong shipment levels, earnings and cash flow despite continued macroeconomic uncertainty. This concludes our prepared remarks. Thank you for your attention. And at this time, we'd like to open the call up to questions. Operator?

Question and Answer Session

Operator

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions) Our first question comes from Emily Chieng with GoldmanSachs.

Emily Christine Chieng

I wanted to ask around the shipment levels in 1Q and then the outlook for 2Q. So I know you mentioned that there was some demand pull forward in the first quarter. Perhaps could you give us a sense as to if there wasn't this pull forward, what would shipments have been? And then as you look into the second quarter, if there's no demand pull forward there, are you getting a sense that there's a sign -- there's any indications of perhaps demand being pushed out given the macro uncertainty?

Karla R. Lewis

Hi Emily, thanks for joining the call today. So on the demand side, we were very pleasantly surprised a bit with the strength of the demand pull forward. And -- or sorry, of our shipments during the first quarter, it was higher than our typical seasonality bounce back. Part of that, we mentioned that related to some of our organic growth activities. So we had a couple of our newer plants that are on campus with some of our good mill partners. And with their ramp-ups, we also benefited from more shipments out of those locations that contributed.
But even without that and the pull forward we had guided to a slightly stronger-than-normal seasonal bounce back and really because our customers continue to be busy they're still struggling to find the labor they need, which extends some of the strength in their businesses for continued shipments. So we're pleased with what we see. Q2 guidance, really, we've got 1 less shipping day that's the majority of the guide. We're typically -- our Q1 and Q2 are generally pretty flat historically, and we had good, strong shipments in Q1. And we're looking for something similar to that in Q2, minus the 1 day and a little bit of demand pull forward we had with the dynamics on the carbon steel flat-rolled pricing in the quarter.

Emily Christine Chieng

Great. That's very clear. A second question just around the end markets then. Has there been anything that has been impacted by some of the credit tightening that we're seeing? And have there been any signs of project delays or cancellations? It's been good to see some inflow from the infrastructure side, but curious if there's anything that you're seeing a little weakness there?

Karla R. Lewis

Yes. So we certainly understand that people have concerns and there's speculation that we're seeing that. We haven't seen it yet. We're not saying that we might not see some of it later in the year. But going into Q2, our customers have strong backlogs and projects are continuing.

Operator

Next question comes from Timna Tanners with Wolfe Research.

Timna Beth Tanners

I wanted to ask to follow-up Emily's question, we've heard from some of the smaller service centers that they're struggling with higher interest rates. So could you be perhaps gaining share if some of your competitors are having a harder time accessing capital. And because it doesn't sound like that's an issue for you. So just wondering about that competitive dynamic.

Karla R. Lewis

Yes, Timna. So we are not aware of that. We have heard some comments by people that some of the service centers may be struggling. For us, that is an environment where it is typically favorable for us and where our customers still seem healthy as well. But if they're trying to manage their credit limits more tightly, that's usually favorable for us because of our smaller -- we're able to service smaller order sizes on a frequent basis. So it does create a favorable environment for us, and we do pick up some market share sometimes in those types of environments.

Timna Beth Tanners

Okay. That's helpful. Alongside your mix, you mentioned the higher sheet prices. There's also been some big plate increases. I know you're decent in plate. But on the flip side, for long products on the carbon side, with scrap retreating a bit here, that could be an offset. I mean, is there anything I'm missing in terms of the moving parts because of flat to up 2% pricing number seems to temper some of that enthusiasm we've seen on the flat-rolled side. So any other color on the components of that pricing guidance would be great.

Stephen P. Koch

Timna, it's Steve. I'd have to say there's not really much to report there. Our long product business has been steady. Prices have been steady. Demand has been strong, and we've not seen a pullback in demand or pricing.

Karla R. Lewis

Yes. And our mix too, Timna, can also impact that. Semiconductor, we're seeing a little weakness there right now. And our pricing on those products is pretty high compared to a lot of the other products, including like carbon flat rolled or plate. And so the product mix can make a bit of a difference as well.

Timna Beth Tanners

So that would be offsetting some of the sharp increases in flat rolled second quarter over first quarter is what you're saying?

Karla R. Lewis

Yes. Well, we saw some of it in the first quarter and would expect that to continue in the second quarter, yes.

Timna Beth Tanners

Okay. And then for my final question, and I'll take a stab at LIFO here. I was kind of surprised with the lack of change in the $60 million annual guidance. Given the stronger price environment, at least of late. Can you walk us through -- I mean, is that really a function of year-over-year lower prices? Does that reflect any thoughts on inventory year-over-year? If you could just talk us through why that didn't change despite some of the more positive dynamics you've laid out? And -- because I would have expected that could have converted to a LIFO expense.

Arthur Ajemyan

Yes. Sure, Timna, this is Arthur. So from our perspective, I mean, you have to look at our product mix as well. Karla just alluded to that earlier, carbon flat rolled combined as a percentage of sales in the first quarter, less than 20%. And you have certainly some prices on the carbon side, plate and flat rolled, that have come up, but there's some headwinds on the non-ferrous side.
So all in all, there wasn't anything sort of story changing, so to speak, from an annual cost forecast perspective. And also when you step back and you look at a $60 million LIFO on nearly $3 billion worth of inventories and that's FIFO basis, it's a relatively small number. So essentially, what we're saying is kind of relatively flat pricing, right, for the year. At least for cost on hand from the beginning of the year to the end of the year.

Operator

(Operator Instructions) Our next question comes from Phil Gibbs, KeyBanc Capital Markets.

Philip Ross Gibbs

Can you guys hear me okay?

Karla R. Lewis

Yes.

Philip Ross Gibbs

All right. Perfect. Some pretty strong comments on aerospace in the release. Maybe give us some color in terms of what you all are thinking for the balance of the year because the rebound in Q1 sounded very strong.

Karla R. Lewis

Phil, so we've been seeing continued improvement in our aerospace business throughout 2022 and then coming into the first quarter of this year. Commercial aerospace build rates have been improving. And so we've benefited from that. That's probably -- commercial is probably about half of our aerospace exposure and then space, private jet, defense have continued at strong levels. So overall, we've been really pleased with what we've seen and our customers continue to be busy and we expect that to continue throughout the year.

Philip Ross Gibbs

And then I may have missed it because I did miss a portion of the script, but your CapEx expectations for the year on a cash basis. I think Q1, you did a little over $100 million, but what's the expectation for the full year there?

Karla R. Lewis

Yes, Phil. So we do still have some catch-up from our spend over the last year or 2 because of extended lead times and a lot of the equipment manufacturers and just constructing new buildings and things. So we estimate that we'll spend cash of about $400 million to $450 million in 2023. We did have $100 million, as you mentioned, spend in the first quarter. We are seeing some of those lead times start to come in a little bit. So we're anticipating some improvement in that area as we progress through the year.

Philip Ross Gibbs

And then just lastly, I know Timna asked the question on share gains. I think you did intimate that there were some of that in your first quarter in your release. Maybe talk a little bit about that more. And if it's something that could be meaningful to you all this year in the sense that, hey, is it a couple hundred basis points? Is it more than that? Is it less than that? Anything that you could provide there would be helpful.

Karla R. Lewis

Yes. So we mentioned that we -- we do have a couple of new facilities, some of our organic growth that have been ramping. And so we're seeing some higher shipments based on that activity. Our tons shipped were higher than the MSCI industry average. So that would imply that we are taking a little share. We've got great people out there throughout our organization who are hungry and they like to sell metal. And we're -- we may be taking some share. We don't have a specific plan. We haven't quantified anything, but we've got the capability to ship more tons if we get reasonable profits on it.

Operator

Next question comes from Martin Englert, Seaport Research.

Martin John Englert

I wanted to get your thoughts on -- you spoke about underlying demand looking into 2Q here. But looking past that, do you have any thoughts or expectations in the back half of the year and maybe how that compares to the prior year. Any color, commentary maybe from some of the customer base on their expectations or their budgets?

Karla R. Lewis

Martin, our customers, I don't know if we look that far out, 40% of our orders, the customer calls today, we ship tomorrow. The sentiment from our customers are that they continue to be busy. They're not getting as much labor, that their workforces are down a bit. So they still have orders that they're working to fulfill.
Beyond Q2, we're not sure. There are a lot of uncertainties out there. We do think, though, and we mentioned in our comments, you've got the combination of reshoring of some manufacturing business. You've got the Infrastructure Bill, which sounds like a lot of the mills are starting to see some activity from that we typically trail the mills a bit. So we think that's a positive indicator for us, along with activity on the Inflation Reduction Act and the CHIPS Act. We're expanding some of our capacity to be able to meet that demand as we just commented, aerospace has been strong. Our toll processing for the automotive business has been strong. So no quantified outlook for the second half, but we feel good about 2023.

Martin John Englert

Okay. And I guess kind of along the same lines and you did touch on that sort of there was maybe some pull forward as buyers stepped up the sidelines in 1Q here. But any other color on how buying activity among the customer base when you think across different metals, products is today versus how it transpired in 1Q? And are there any differences or divergent trends when you think about that activity, carbon versus other metals?

Karla R. Lewis

Yes. So Martin, there was the pricing dynamic for carbon flat rolled during Q1 with the price increases. There were quite a few increases. They're pretty significant. As mentioned, there have been some plate increases. So we think some customers may have bought ahead a bit. So we commented on that as a factor in Q1. But it seems like prices are stabilizing a bit now, and we expect kind of normal buying patterns in the second quarter.

Martin John Englert

Any indication that this would pivot from the restock to a destock across the supply chain? Or rather, I guess, what you're saying -- in my read on what you're explaining is not necessarily that it's more so, yes, there was some prebuying and maybe some restocking, but now just kind of stabilized. Is that right?

Karla R. Lewis

Yes. I mean, Martin, we don't really -- we don't run our business to restock or destock. We run our business to focus on our customers needs. And as I mentioned a few minutes ago, a lot of our business is next-day type delivery. So and our inventories are in very good shape. And we think throughout the industry inventories are in pretty good shape. So we don't anticipate any big changes in buying patterns as we move into the next quarter for us or for our customers or competitors.

Martin John Englert

If I could, one more. Any additional color on the semiconductor weakness, mix shift there?

Karla R. Lewis

Yes. I think we're seeing a bit. Shipments are still at strong levels, we're still higher than year-ago levels. The industry had been at record levels, and there's been a little bit of a pullback. We think there was maybe a little bit of a glut. Some customers maybe had more inventory than they needed for the slowdown that has been seen. And that's really for us related to selling metal into the equipment manufacturers feeding into the semiconductor industry.
From a semiconductor kind of infrastructure, so to speak, which is the other part of our semiconductor business with all the spending that's been announced in the U.S. We see that business continuing to be steady to stronger. So we think it's just a temporary situation long term, both from the expansion of the chip making capabilities in the U.S. and just the demand for chips, we think is going to be very strong on a long-term basis.

Operator

Since there are no further questions, I would like to turn the floor back over to Karla Lewis for closing comments.

Karla R. Lewis

Thank you. And thanks again to all of you for your time and attention today. Before we close out the call, I'd like to remind everyone that we'll be in Boston in late May, attending the KeyBanc Industrials and Basic Materials Conference. And in Chicago in mid-June, presenting at the Wells Fargo Industrials Conference. We hope to see many of you there. And thank you again to our team at Reliance for your continued strong performance so far in 2023. And thank you to all of you for your continued support of and commitment to Reliance. Thank you.

Operator

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a great day.