Reliance Steel & Aluminum Co. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; comparisons are with the three months ended March 31, 2016 unless noted. The filing presents unaudited consolidated results.
Business context
Reliance distributes and processes metals, including carbon and stainless steel, aluminum, and alloy products. Management attributed improved results primarily to higher metals prices, modestly higher volumes, improved demand, and continued emphasis on value-added processing. The 2016 acquisitions of Alaska Steel, Best Manufacturing, and Tubular Steel contributed to reported results.
Key financial metrics
| Metric | Q1 2017 | Q1 2016 |
|---|---|---|
| Net sales | $2,419.3 million | $2,162.7 million |
| Gross profit / margin | $721.6 million / 29.8% | $636.7 million / 29.4% |
| Operating income / margin | $190.2 million / 7.9% | $131.1 million / 6.1% |
| Net income attributable to Reliance | $111.7 million | $92.2 million |
| Diluted EPS | $1.52 | $1.27 |
| Operating cash flow | $(20.7) million | $155.4 million |
| Capital expenditures | $34.1 million | $34.4 million |
Sales increased 11.9%; tons sold rose 2.5% and average selling price per ton rose 9.7%. Gross profit and gross margin are non-GAAP measures as presented by the company because they exclude depreciation and amortization associated with sales. Cash and cash equivalents were $133.8 million at March 31, 2017, versus $122.8 million at year-end 2016.
Material changes and drivers
- Operating income rose 45.1% and net income attributable to Reliance rose 21.1%. Management cited stronger pricing, improved demand, higher gross profit, and a lower S,G&A percentage of sales. Same-store S,G&A was 19.6% of sales versus 20.6% a year earlier.
- Carbon and stainless steel prices increased year over year; alloy prices declined. Energy-market tons sold increased for the first time since Q3 2014, while heavy-industry demand remained subdued and non-residential construction continued a slow recovery.
- Operating cash flow swung to an outflow, mainly reflecting higher receivables and inventory as working-capital needs increased. Inventory turns were about 4.7 times, compared with 4.9 times in Q1 2016.
- Investing cash outflow fell to $32.0 million from $331.5 million, which included $290.9 million of acquisition spending in Q1 2016.
- Total debt was $2,038.3 million, up from $1,945.0 million at December 31, 2016. Net debt-to-total capital was 30.8%, versus 30.3% at year-end.
Liquidity, outlook, and risks
Reliance reported $785.5 million available under its $1.5 billion revolving credit facility, after $652.0 million of borrowings and $62.5 million of letters of credit. It reported compliance with debt covenants: interest coverage of approximately 8.2 times against a 3.0-times minimum, and a credit-agreement leverage ratio of 33.0% against a 60% maximum. Management believes liquidity will be sufficient for operating needs and debt repayment, and expects to continue acquisition and other growth activities. No specific earnings or revenue guidance was provided.
Management plans to keep focusing on working capital, profitability, and growth. Principal market exposures include interest rates, economic conditions, competition, foreign exchange, metals prices, and demand and availability. The company said market-risk exposures had not changed significantly since year-end and that there were no material changes to the risk factors in its 2016 Form 10-K.
Unusual items and contingencies
- The Q1 2016 effective tax rate of 14.4% included a $17.6 million benefit from remeasurement of a previously uncertain tax position. Q1 2017’s effective tax rate was 32.7%, making the year-over-year earnings comparison affected by this prior-period benefit.
- Q1 2017 cost of sales included a $10.0 million LIFO inventory reserve expense; Q1 2016 had no LIFO expense or income.
- An environmental remediation matter relates to former EMJ manufacturing operations. Insurance has covered costs to date and is expected to cover most related costs; management does not expect a material adverse impact. Other disclosed litigation is routine and not expected to be material.
- The company adopted pension-cost presentation changes retrospectively; the 2016 comparison was reclassified, with no material impact on the financial statements. New lease accounting is expected to materially increase reported assets and liabilities, but not materially affect net income or equity.
Important facts for investors to verify
- Whether improved metal pricing and demand persist, and how changes in product prices, mix, and imports affect gross margins.
- Whether receivables and inventory growth converts to operating cash flow and whether inventory turns recover.
- Debt levels, variable-rate borrowing costs, available revolver capacity, and continued covenant compliance.
- The effect of the Q1 2016 tax benefit and the Q1 2017 LIFO charge when assessing sustainable earnings.
- Developments in environmental remediation, acquisition purchase-price allocations, and impairment risk for goodwill and intangible assets.