Algoma Steel Group Inc.

Algoma Steel Group Inc. (Algoma) operates as a fully integrated steel producer of hot and cold rolled steel products, including coiled sheet and plate, with its active operations located entirely in Canada. The company's core business model revolves around manufacturing and selling these steel products primarily in North America, serving a diverse customer base across multiple sectors such as automotive, construction, energy, defense, and manufacturing. Revenue is generated through the sale of these steel products, with a significant portion of sales being spot-based, and a strategy to increase the share of contracted revenue above 65% while maintaining flexible pricing mechanisms. The company's competitive advantages include its cost-efficient Direct Strip Production Complex (DSPC) asset, its strategic location on the Great Lakes providing economical access to raw materials and markets, and ownership control of the port of Algoma. Additionally, Algoma benefits from an on-site 70MW Co-Gen power generation facility, which provides approximately 49% of its power needs at favorable prices ¹⁰⁰.

For the fiscal year ended March 31, 2022, Algoma reported total revenue of C$3,806.0 million ¹¹, a significant increase from C$1,794.9 million in fiscal year 2021 ¹². The company achieved a net income of C$857.7 million ¹³ for fiscal 2022, a substantial improvement from a net loss of C$76.1 million ¹⁴ in fiscal 2021. Gross profit is not explicitly stated, but cost of sales was C$2,054.6 million ¹⁵, implying a gross profit of C$1,751.4 million. Operating income for fiscal 2022 was C$1,411.0 million ¹⁶, compared to C$84.8 million ¹⁷ in fiscal 2021. Diluted EPS for fiscal 2022 was C$1.45 ¹⁸. Cash generated by operating activities was C$1,263.4 million ¹⁹, while cash used in investing activities was C$165.7 million ²⁰, and cash used in financing activities was C$198.7 million ²¹. As of March 31, 2022, cash and equivalents stood at C$915.3 million ²². Total debt is not explicitly aggregated, but long-term governmental loans were C$136.5 million ²³, and bank indebtedness was C$0.1 million ²⁴.

Year-over-year, total revenue increased by C$2,011.1 million [11, 12], or 112.0%, from fiscal 2021 to fiscal 2022. Steel revenue increased by 119.7% ²⁵, and steel shipment volumes increased by 9.3% ²⁶. Net income saw a C$933.8 million [13, 14] increase, moving from a loss to a profit. The average net sales realization (NSR) on steel sales per ton shipped increased by 101.2% to C$1,545 ²⁷ in fiscal 2022 from C$768 ²⁸ in fiscal 2021. Cost of steel products sold increased by 45.0% to C$1,968.5 million ²⁹ in fiscal 2022 from C$1,357.7 million ³⁰ in fiscal 2021, primarily due to increased steel shipments and higher purchase prices for key inputs such as iron ore, scrap, alloys, and natural gas, as well as an increase in employee profit sharing expense of C$132.9 million ³¹. Non-steel revenue increased by C$54.9 million ³² to C$84.3 million ³³ in fiscal 2022, mainly due to the sale of royalty rights for C$20.0 million ³⁴ and increased by-product sales.

During the fiscal year, Algoma's Board of Directors authorized the construction of two new Electric Arc Furnaces (EAFs) to replace existing blast furnace steelmaking operations ³⁵. The company also entered into a joint venture with Triple M Metal LP, establishing ATM Metals Inc. to source prime scrap metal and other iron units ³⁶. Additionally, Algoma is undertaking a two-phase plate mill modernization project (PMM Project) with a total investment of approximately C$120 million ³⁷, partly funded by government loan facilities totaling approximately C$50 million ³⁸. The first phase of the PMM Project is expected to be completed by May/June 2022, and the second phase by November/December 2022 ³⁹.

Algoma has not provided specific revenue, margin, or EPS guidance ranges for the upcoming period in the filing.

A major growth area for Algoma is its transformation to Electric Arc Furnace (EAF) steelmaking. The company's Board of Directors authorized the construction of two new state-of-the-art EAFs to replace its existing blast furnace steelmaking operations ³⁵. This transformation is expected to reduce Algoma's carbon emissions by approximately 70% ⁴⁰ and has a goal of eliminating all coal use in steelmaking operations over time ⁴¹. The EAF steelmaking facility is planned to be built adjacent to the current steel shop, utilizing existing downstream equipment and facilities to reduce capital expenditure requirements ⁴². The EAF is anticipated to improve product mix, reduce fixed costs, provide significant carbon tax savings, and increase production capacity ⁴³. The company expects a 30-month construction phase, with completion projected between April 2024 and June 2024 ⁴⁴. Funding for this project includes up to C$200.0 million ⁴⁵ in the form of a loan from the Federal Strategic Innovation Fund (Federal SIF) and up to C$220.0 million ⁴⁶ in loan financing from the Canada Infrastructure Bank (CIB). Key milestones include the selection of Danieli & C. Officine Meccaniche S.p.A. as the sole technology provider ⁴⁷, a contract with GE Gas Power for an upgrade to the natural gas combined cycle power plant ⁴⁸, and a structural building contract awarded to Walters Group Inc. ⁴⁹.

Another significant growth area is the Plate Mill Modernization (PMM) Project, with a total planned investment of approximately C$120 million ³⁷, partly funded by government loan facilities totaling approximately C$50 million ³⁸. This two-phase project is expected to be completed by November 2022 ³⁹. The PMM Project aims to enhance the capacity and quality of the company's plate product line, which is identified as a key source of competitive advantage ⁵⁰. It will allow Algoma to meet higher product quality requirements, increase high strength capability with new grades, ensure production reliability with direct ship capability, and increase overall plate shipment capacity through debottlenecking and automation ⁵¹. The first phase, focusing on quality, is expected to be completed by May/June 2022, and includes installing a new primary slab de-scaler, an automated surface inspection system, an in-line hot leveler, and automation of the 166-inch plate mill ⁵². The second phase, focusing on productivity, is expected to be completed by November/December 2022, and includes onboard descaling systems, mill alignment, a 4Hi DC drive, new cooling beds, a dividing shear, plate piler, and automated marking machine ⁵³.

Operationally, management is focused on continuous margin stability enhancement and cost improvement, aiming to reduce costs through maintenance effectiveness, operations reliability, operational cost reductions, workforce effectiveness, power efficiency improvements, process yield improvements, product quality improvements, and optimization of gas usage ⁵⁴. The company also aims to increase the share of contracted revenue above 65% ⁵⁵ while maintaining flexible pricing mechanisms. The EAF transformation is expected to contribute to lower conversion costs and improve Adjusted EBITDA ⁵⁶.

Regarding capital allocation, the company anticipates making, on average, approximately C$50-C$60 million ⁵⁷ of capital expenditures annually to sustain existing production facilities. The EAF transformation is estimated to cost C$700 million ⁵⁸, and the PMM Project is estimated at C$120 million ³⁷. On March 3, 2022, Algoma announced a normal course issuer bid (NCIB) to acquire up to a maximum of 7,397,889 ⁵⁹ of its shares, or 5% of its 147,957,790 ⁶⁰ issued and outstanding shares as of February 18, 2022, subject to a daily maximum of 16,586 shares ⁶¹. No shares were repurchased under the NCIB during fiscal 2022 ⁶². On March 31, 2022, a dividend payment of C$9.3 million (US$7.4 million) ⁶³ was paid. Subsequent to the fiscal year end, on June 13, 2022, the Board of Directors approved the company's intention to pursue a Substantial Issuer Bid in Canada and a Tender Offer in the United States (Share Repurchase) with an aggregate value of US$400 million ⁶⁴.

Management explicitly flagged several structural headwinds and execution risks. The EAF transformation may never be completed or may only be completed after significant delays and/or cost overruns ⁶⁵. Failure to complete or delays in the EAF transformation could adversely affect the business and ability to compete ⁶⁶. The EAF transformation requires significant capital expenditures and diverts management attention ⁶⁷. It also requires environmental compliance approvals and indigenous consultations, which are not guaranteed ⁶⁸. There is a risk that the EAF and related technology may not reduce production costs sufficiently to justify the capital expenditure ⁶⁹, and may not achieve emissions targets ⁷⁰. Construction projects are subject to risks including unexpected long delivery times, shortages of skilled labor, unforeseen cost increases, design problems, work stoppages, and inability to obtain permits ⁷¹. The company's exposure to higher costs of internally generated power and market pricing for electricity in Northern Ontario may adversely impact production and financial performance if the EAF transformation is completed ⁷². Limited access to the current grid in Northern Ontario necessitates upgrading the internal natural gas power plant ⁷³, and regional power system upgrades may not be completed until 2029 or later ⁷⁴. Operating in "Hybrid Mode" (blast furnace and EAFs with internal power) presents operating and market risks due to suboptimal levels and potential outages ⁷⁵. The presence of ice and/or snow in steel scrap materials for EAF steelmaking could result in explosions and unplanned outages ⁷⁶. Failure to secure an adequate supply of various grades of steel scrap and higher-purity substitutes at competitive prices may disrupt operations and financial performance ⁷⁷. There is also a risk of reduced product qualities from EAF processing of scrap, potentially limiting the range of products or resulting in inferior products ⁷⁸.

Algoma faces material risks including market and industry volatility, particularly from protracted falls in steel prices or significant increases in raw material costs without corresponding steel price increases ⁷⁹. The steel market is cyclical, with significant price volatility influenced by demand, inventory levels, and imports ⁸⁰. Competition from numerous foreign and domestic steel producers, some with greater financial resources, poses a risk, especially with increased global steel capacity and low-priced imports ⁸¹. Macroeconomic pressures, including inflation and the effects of COVID-19, can adversely affect consumer spending and financial results ⁸². The recent Russia-Ukraine conflict is expected to reduce the supply of steelmaking raw materials and steel products in international markets, leading to volatile availability and pricing of inputs ⁸³. Operational risks include reliance on information technology systems, with any failure or breach potentially disrupting operations ⁸⁴, and the significant risk of injury or death inherent in industrial activities ⁸⁵. Environmental compliance and site remediation obligations could result in substantially increased costs, with the company subject to current and new measures, including a Canadian federal requirement by January 1, 2026, to implement plans to reduce sulphur dioxide emissions from coke oven gas by-product ⁸⁶. Increased regulation associated with climate change and greenhouse gas emissions, such as the federal Greenhouse Gas Pollution Pricing Act, could impose significant additional costs ⁸⁷. The company is also subject to litigation arising in the normal course of business, which could negatively affect profitability and cash flow ⁸⁸.

Management's overall tone to shareholders emphasizes a forward-looking, value-focused approach to growth, aiming for increased participation in sustainable markets, competitive returns on capital, and meeting stakeholder obligations. They are committed to improving quality, cost competitiveness, and customer service, while fostering a diverse organization and maintaining safety excellence and environmental stewardship. Management highlighted the ongoing continuous improvement program, which yielded C$24 million ⁸⁹ of net year-over-year benefit in fiscal year 2022. A key strategic priority is the Electric Arc Furnace (EAF) transformation, which is expected to reduce carbon emissions by approximately 70% ⁴⁰ and increase liquid steel capacity by 900,000 tons per year ⁵⁶. Another strategic priority is the Plate Mill Modernization (PMM) Project, a C$120 million ³⁷ investment aimed at enhancing capacity and quality of the plate product line, with completion expected by November 2022 ³⁹. Management also stressed maintaining a prudent financial policy, focusing on disciplined growth, a strong credit profile, eliminating net long-term debt, and enhancing liquidity. They announced a normal course issuer bid (NCIB) to acquire up to 7,397,889 ⁵⁹ shares, or 5% of outstanding shares, by March 2, 2023 ⁶², and a subsequent intention to pursue a Share Repurchase with an aggregate value of US$400 million ⁶⁴.