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, primarily serving the North American market ¹. The company's core business model revolves around the production and sale of these steel products to a diverse customer base across multiple sectors, including automotive, construction, energy, defense, and manufacturing ². Revenue is generated from the sale of steel products, freight services, and non-steel sales ³. The company emphasizes a diversified market and customer strategy to manage earnings volatility in the North American steel market, with a focus on providing products to customers in all sectors of the economy ⁴. Algoma also aims to increase its product portfolio to include more value-added products ⁵.

For the fiscal year ended March 31, 2022, Algoma reported total revenue of C$3,806.0 million ⁶, a significant increase from C$1,794.9 million in fiscal year 2021 ⁷. Gross profit, calculated as revenue less cost of sales, was C$3,202.8 million ⁸ for fiscal 2022, compared to C$1,318.9 million ⁹ in fiscal 2021. This translates to a gross margin of 84.1% ¹⁰ in fiscal 2022, up from 73.5% ¹¹ in fiscal 2021. Operating income for fiscal 2022 was C$1,411.0 million ¹², compared to C$84.8 million ¹³ in fiscal 2021, resulting in an operating margin of 37.1% ¹⁴ and 4.7% ¹⁵, respectively. Net income for fiscal 2022 was C$857.7 million ¹⁶, a substantial improvement from a net loss of C$76.1 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 in fiscal 2022, compared to C$8.1 million ²⁰ in fiscal 2021. As of March 31, 2022, the company had cash of C$915.3 million ²¹. Total long-term governmental loans were C$136.5 million ²² as of March 31, 2022. The company's Secured Term Loan Facility and Algoma Docks Term Loan Facility were repaid in full in November 2021 ²³.

In fiscal year 2022, steel revenue increased by 119.7% ²⁴ to C$3,548.8 million ²⁵, while steel shipment volumes increased by 9.3% ²⁶ to 2,297,159 tons ²⁷, compared to fiscal year 2021. The average net sales realization (NSR) on steel sales per ton shipped increased by 101.2% ²⁸ to C$1,545 ²⁹ in fiscal 2022 from C$768 ³⁰ in fiscal 2021. The cost of steel products sold increased by 45.0% ³¹ to C$1,968.5 million ³² in fiscal 2022. This increase was primarily driven by higher steel shipments and an increase in the purchase price of 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 ³³.

During the fiscal year, Algoma announced a normal course issuer bid (NCIB) to acquire up to a maximum of 7,397,889 of its shares, or 5% of its 147,957,790 issued and outstanding shares as of February 18, 2022 ³⁴. No shares were repurchased under the NCIB during fiscal 2022 ³⁵. A dividend payment of C$9.3 million (US$7.4 million) ³⁶ was paid on March 31, 2022 ³⁷. The company also initiated the Electric Arc Furnace (EAF) transformation project and continued with its Plate Mill Modernization (PMM) project.

Algoma's product portfolio includes Sheet & Strip steel and Plate steel. Sheet & Strip products, which represented approximately 88% ³⁸ of total steel shipment volumes in fiscal 2022, are available in various widths, gauges, and grades, both unprocessed and with value-added processing. Primary end-users include service centers, automotive, manufacturing, construction, and tubular industries ³⁹. Plate steel products, comprising approximately 12% ⁴⁰ of total steel shipment volumes in fiscal 2022, consist of carbon-manganese, high-strength, and low-alloy grades, sold in as-rolled and heat-treated conditions. The primary end-user is the fabrication industry, for applications such as railcars, buildings, bridges, and military applications ⁴¹. In fiscal 2022, Sheet & Strip sales were C$3,083.1 million ⁴² and Plate sales were C$465.7 million ⁴³. Freight revenue was C$172.9 million ⁴⁴ and non-steel sales were C$84.3 million ⁴⁵.

Algoma is committed to continuous margin stability enhancement and cost improvement, aiming to reduce costs and improve operating performance through initiatives such as maintenance effectiveness, operations reliability, workforce effectiveness, power efficiency improvements, process yield improvements, product quality enhancements, and optimization of gas usage ⁴⁶. The company also strives to increase the share of contracted revenue above 65% ⁴⁷ while maintaining flexibility to participate in increasing prices through flexible pricing mechanisms, with the majority of contracts tied to HRC and HRP CRU indexes on a one- and three-month lag basis ⁴⁸.

A major growth vector for Algoma is its transformation to Electric Arc Furnace (EAF) steelmaking, which is expected to reduce carbon emissions by approximately 70% ⁴⁹ and eliminate coal use in steelmaking operations over time ⁵⁰. The company plans to invest approximately C$700 million ⁵¹ in this transformation, funded by previously announced financing commitments and proceeds from the Merger ⁵². The EAF facility is anticipated to increase liquid steel capacity by 900,000 tons per year ⁵³, improve product mix, reduce fixed costs, and provide significant carbon tax savings ⁵⁴. The construction phase is expected to take 30 months, with completion between April 2024 and June 2024 ⁵⁵. Algoma has secured a loan of up to C$200.0 million ⁵⁶ from the Federal Strategic Innovation Fund (Federal SIF) and up to C$220.0 million ⁵⁷ in loan financing from the Canada Infrastructure Bank (CIB) for the EAF transformation ⁵⁸. Danieli & C. Officine Meccaniche S.p.A. has been selected as the sole technology provider ⁵⁹, and GE Gas Power will upgrade the natural gas combined cycle power plant to supply sufficient internal electricity for phase one of the EAF transition ⁶⁰. Walters Group Inc. has been awarded the structural building contract, with onsite assembly expected to commence in the fall of 2022 and completion targeted within a year ⁶¹.

Another key growth opportunity is the Plate Mill Modernization (PMM) project, with a total investment of approximately C$120 million ⁶², partly funded by government loan facilities totaling approximately C$50 million ⁶³. This two-phase project is expected to be completed by November 2022 ⁶⁴. The first phase, focusing on quality, is anticipated to be completed by May/June 2022 ⁶⁵ and includes the installation of a new primary slab de-scaler, automated surface inspection system, an in-line hot leveler, and automation of the 166-inch plate mill ⁶⁶. The second phase, focusing on productivity, is expected to be completed by November/December 2022 ⁶⁷ and involves upgrades to descaling systems, mill alignment, new cooling beds, a dividing shear, plate piler, and automated marking machine ⁶⁸. The PMM project aims to enhance the capacity and quality of the company's plate product line, satisfy higher product quality requirements, increase high strength capability, ensure production reliability, and increase overall plate shipment capacity through debottlenecking and automation ⁶⁹.

Operationally, Algoma is focused on maintaining a prudent financial policy, generating disciplined growth, and enhancing liquidity by eliminating net long-term debt ⁷⁰. The company utilizes hedging for both revenue and raw materials to further enhance earnings stability ⁷¹. The company anticipates making, on average, approximately C$50-C$60 million ⁷² of capital expenditures annually to sustain existing production facilities ⁷³. The EAF and PMM projects represent significant additional capital investments.

The company is committed to safety and environmental compliance, with a goal of carbon neutrality by 2050 ⁷⁴. The transition to EAF steelmaking is a key part of this, with an estimated reduction of 3.0 million tonnes of CO2 emissions per year ⁷⁵, representing a 70% reduction to current emissions levels ⁷⁶. This is expected to reduce the potential impact of the Canadian carbon tax regime on the business ⁷⁷. The company is also pursuing a local electricity transmission infrastructure upgrade and technical contingency solution to allow for earlier access to more grid power for EAF operations ⁷⁸.

Algoma faces material risks including market and industry volatility, particularly from fluctuations in steel prices and raw material costs, which can significantly impact cash flow and profitability ⁷⁹. The company is exposed to significant domestic and international competition, with some competitors possessing greater financial resources and new EAF steelmaking capacity in North America potentially increasing competition ⁸⁰. Macroeconomic pressures, including inflation and the lingering effects of COVID-19, can adversely affect consumer spending and demand for steel products ⁸¹. The ongoing Russia-Ukraine conflict is expected to reduce the supply of steelmaking raw materials and steel products in international markets, leading to volatile pricing and potential limitations on production levels and higher costs ⁸². Operational risks include the dependence on a single operating blast furnace (Blast Furnace No. 7) and critical steelmaking equipment, making the company vulnerable to unexpected equipment failures and business interruptions ⁸³. The EAF transformation itself carries risks of delays and cost overruns, and there is no guarantee that the anticipated benefits, such as reduced production costs or emissions targets, will be fully realized ⁸⁴. The company's exposure to higher costs of internally generated power and market pricing for electricity in Northern Ontario, coupled with limited grid access, may adversely affect production and financial performance post-EAF transformation ⁸⁵. Securing an adequate supply of various grades of steel scrap at competitive prices for EAF operations is also a significant risk ⁸⁶. Environmental compliance and site remediation obligations, including new laws and stricter enforcement policies related to greenhouse gas emissions and carbon pricing, could result in substantially increased costs and reduced competitiveness ⁸⁷. The recent oil-based lubricant release into the St. Mary's River on June 9, 2022, could lead to regulatory orders, penalties, fines, or other negative consequences, with the economic impact currently unknown ⁸⁸. Labor interruptions and difficulties, particularly given that approximately 95% of employees are unionized, could materially affect operations ⁸⁹. The company's substantial capital investment requirements for modernization and maintenance, including a future reline of Blast Furnace No. 7, pose a financial risk if sufficient cash flow or external financing is not available ⁹⁰. Reliance on a limited number of key customers (top ten customers accounted for approximately 49% of fiscal 2022 revenue) and dependence on third parties for transportation services and sophisticated machinery also present risks ⁹¹.

Management's message to shareholders emphasizes a forward-looking, value-focused approach to growth, aiming for increased participation in sustainable markets, competitive returns on capital, and meeting all stakeholder obligations ⁹². They are committed to improving quality, cost competitiveness, and customer service, while fostering a diverse organization and maintaining safety excellence and environmental stewardship ⁹³. A key strategic priority is the continuous enhancement of margin stability and cost improvement, with an expectation that the EAF steelmaking transformation will significantly contribute to this by improving Adjusted EBITDA through lower conversion costs ⁹⁴. Management anticipates the EAF facility will increase liquid steel capacity by 900,000 tons per year ⁹⁵, enabling a higher value-add product mix and a more flexible operating footprint ⁹⁶. Another strategic priority is capitalizing on low-cost growth opportunities through prudent capital investment projects, such as the ladle metallurgy furnace No. 2 (LMF2) debottlenecking and the plate mill modernization ⁹⁷. The company also plans to maintain a prudent financial policy, focusing on generating disciplined growth, achieving a strong credit profile, and eliminating net long-term debt while enhancing liquidity ⁹⁸. Management explicitly stated the company's intention to pursue a Substantial Issuer Bid in Canada and a Tender Offer in the United States, collectively a "Share Repurchase," with an aggregate value of US$400 million ⁹⁹, using a "Modified Dutch Auction" to repurchase common shares ¹⁰⁰. The company expects to fund this from cash on hand ¹⁰¹. Michael D. Garcia was appointed Chief Executive Officer effective June 1, 2022 ¹⁰², and will also join the Board ¹⁰³.