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Steel Dynamics Inc  (NASDAQ:STLD)
Q3 2018 Earnings Conference Call
Oct. 18, 2018, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, and welcome to Steel Dynamics Third Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. After management's remarks, we will conduct a question-and-answer session, instructions will follow at that time. Please be advised this call is being recorded today October 18th, 2018. Your participation implies consent to our recording this call. If you do not agree to these terms, please disconnect.

At this time, I would like to turn the conference over to Tricia Meyers, Investor Relations Manager. Please go ahead.

Tricia Meyers -- Investor Relations Manager

Thank you, Tara. Good morning, everyone, and welcome to Steel Dynamics third quarter 2018 earnings conference call. As a reminder, today's call is being recorded and will be available on the company's website for replay later today.

Leading today's call are Mark Millett, President and Chief Executive Officer of Steel Dynamics; and Theresa Wagler, Executive Vice President and Chief Financial Officer. We also have our leaders from the Company's operating platforms, including our Metals Recycling Operations and Russ Rinn, Executive Vice President; our Steel Fabrication Operations, Chris Graham, Senior Vice President, Downstream Manufacturing Group; and our Steel Operations, Glenn Pushis, Senior Vice President, Long Private Steel Group; and Barry Schneider, Senior Vice President, Flat Roll Steel Group.

Some of today's statements which speak only as of this date, may be forward-looking and predictive, typically preceded by believe, expect, anticipate or words of similar meaning. They are intended to be protected by the Private Securities Litigation Reform Act of 1995 should actual results turn out differently. Such statements involve risks and uncertainties relating to our steel, metals recycling and fabrication businesses, as well as the general business and economic conditions. Examples of these are described in our annually filed SEC Form 10-K under the heading Forward-Looking Statements and Risk Factors, found on the Internet at www.sec.gov and is applicable on any later SEC Form 10-Q. You will also find any reference to non-GAAP financial measures reconciled to the most directly comparable GAAP measures in the press release issued yesterday entitled Steel Dynamics reports record third quarter 2018 financial results.

And now I'm pleased to turn the call over to Mark.

Mark Millett -- President and Chief Executive Officer

Thank you, Tricia, and good morning, everyone. Welcome to our third quarter 2018 earnings call and we certainly value and appreciate your time and interest in our company. We're excited to share that the Steel Dynamics team delivered another tremendous record performance this quarter. Our underlying growth and market positioning during the last four to five years is showing its power in the strong demand environment.

I think that firms our perspective that SDI is a very different company today relative to the last market peak and I'd like to take a moment to specifically thank the leadership group here today. And along with the respective teams for an absolutely extraordinary job. Not just their execution in this past quarter, but over the last several years as we intentionally position the company for long-term prosperity and superior shareholder return.

Our growth expanded product diversification and market positioning will continue to achieve higher highs and just as importantly higher lows driving considerably higher through cycle cash flow generation capability. So team, hats off to you, you are the best team on the planet. But to begin this morning Theresa would you provide some clarity into our financial results.

Theresa Wagler -- Executive Vice President and Chief Financial Officer

I gladly do. Good morning, everyone. It's great to be with you here today. Our third quarter 2018 net income was a record $398 million or a $1.69 per diluted share, which includes fair value purchase accounting adjustments of approximately $13 million or $0.04 per diluted share associated with our recent Heartland acquisition and all of those additional charges are actually in our cost of goods sold line on the income statement, and we -- it also included a discrete tax benefit of $10 million or $0.04 per diluted share related to a change in tax accounting methodology, which is a one time pick up.

Excluding these two items, our adjusted results remain unchanged at $1.69 per share and we're above our guidance of between $1.64 and $1.68 as steel results came in above expectations. For the third consecutive quarter we've achieved record revenues hitting $3.2 billion in the third quarter higher sales reflected improved average realized product pricing across the steel platform. We achieved record quarterly operating income of $532 million and adjusted EBITDA of $626 million. A continued tremendous performance by everyone with our steel operations leaving the improvement.

As a reminder, we acquired Heartland, a flat roll steel processing company on June 29th of this year. Therefore, this quarter represents the first impact from an earnings perspective. Integrations going well and the teams are executing. The plan remains to maximize galvanized steel sales of approximately 360,000 tonnes, while building cold rolls and P&O sales during the next six to nine months. So, reaching average annualized total run rate of around 800,000 tons by midyear 2019.

On our last call, we noted that we believe that through cycle EBITDA estimate for Heartland is between $50 million and $60 million per year at run rate. Given the geographic location and optionality in production that Heartland brings to our Midwest flat roll group, we believe there are also additional benefits to be derived. Our early estimates for those group synergies are in the range of $10 million to $15 million per year at run rate.

Regarding our steel results for the third quarter 2018 steel shipments improved slightly to a record 2.8 million ton. For the third consecutive quarter steel metal spreads expanded meaningfully across the platform as our average quarterly realized sales price increased $56 per ton to $988 in the third quarter and our average scrap cost consumed only increased $4 for ton to $352.

The result was record operating income of $577 million, a 7% sequential improvement for steel. For our metals recycling platform third quarter operating income would be $3(ph)million and $8 million decline from last quarter. Non-ferrous shipments in metal spread were negatively impacted from declining non-ferrous commodity prices as well as the actions from China to ban certain recycle material import through our green storage(ph)policy. We continue to effectively lever the strength of our vertically connected operating model, which benefits both the steel mills and its scrap operations.

The metals recycling group shipped 65% of their ferrous tracks to our own steel mill increasing scrap quality, metal efficiency and reducing companywide working capital requirements.

Achieving record high shipments in the third quarter our fabrication operations continue to see strong demand in customer optimism moving into 2019. Order activity has been strong and our fabrication backlog was a near record high moving into October. However, our average steel input costs continue to rise and outpaced improves selling values, resulting in a slight decline in third-quarter earnings. Operating income from our steel fabrication platform was $13 million in the quarter.

During the third quarter 2018, we generated record cash flow from operations of $420 million. Operational networking capital grew $53 million in the third quarter due to the overall market improvement, which resulted in higher customer count balances and inventory value. So far this year, we generated cash flow from operations at $924 million, another record results.

Year-to-date capital investments were $176 million, we currently estimate fourth quarter capital expenditures to be in the range of $50 million to $75 million. An early estimate for 2019 capital investment is approximately $350 million we may update that -- we will update that on the fourth quarter conference call.

But right now we're looking at sustaining capital, which includes the environmental and safety initiatives of about $150 million for next year. We have some spending on the Columbus announcement for the galvanizing line that's about $100 million spend next year and then the remaining $100 million will be other expansion and efficiency growth projects.

Regarding shareholder distribution after our 20% increase in first quarter of this year, we maintained our cash dividend at 0.1875 per common share and we also repurchased $193 million of our common stock during the first nine months of 2018. Completing our $450 million program authorized in October 2016 and initiating a new $750 million program in August.

Our liquidity increased to $2.2 billion at September 30th representing $999 million in cash is short-term investments and $1.2 billion of available funding under our revolving credit facility. The strength of our through-cycle cash generation coupled with a strong credit and capital structure profile provides meaningful opportunity for continued growth and continued shareholder distributions to our positive dividend profile and our share repurchase program.

We're squarely positioned for the continuation of sustainable optimized value creation. And finally for those that request more detail concerning our flat roll shipments, we had hot rolled and (inaudible) [9:39] loyal shipment at 901,000 tons in the quarter. We had cold roll shipments at 138,000 tons and coated shipment at 819,000 tons. And then I would also note that in our supplemental financial data this quarter given the increase in the amount of what I will call process tons with the addition of Heartland, we actually broke up flat roll shipments so that you can see Heartland and The Techs combined, and then you can see Butler and Columbus combined. Mark?

Mark Millett -- President and Chief Executive Officer

Super. Thanks Theresa. Well safety is and all is will be number one priority. And fortunately, we have reversed the uptick in recordable incidence we experienced in the second quarter. But unfortunately, year-to-date our recordable incident rate is still lagging last year's results. But I think commendably, our lost time rate still continues its year-over-year downward trend and is significantly better than industry average. Nothing surpass the importance of creating and maintaining a safe work environment. And while our performance remains significantly better than the industry averages, it's certainly not enough. We must continually be aware of our environment and of those around us. I challenge all of us to be focus and to keep moving toward our ultimate goal of zero incidence.

The steel platform continues to perform exceedingly well. We achieved record quarterly steel earnings and continuing to reach numerous production milestones. With the addition of Heartland this quarter, we also have record high steel shipments as their volume offset lower shipments from our Butler Flat Roll Division. Underlying demand remained strong. The customers took a temporary purchasing hiatus in anticipation of lower transaction prices as scrap pricing dipped a little and imports moderated some. It's important to remember domestic steel inventory levels appear to be balanced and virtually every domestic steel consuming sector is already in good shape or continues to improve. We believe domestic steel consumption as reason for growth in 2019.

We continue to position Steel Dynamics for the future through new investment and our existing operations. In June, we announced a new $140 million galvanizing line at our Columbus Flat Roll Division. This investment is yet another step of further diversification into higher margin products. The 400,000 ton line is expected to begin operating mid-year 2020. In recent years, Columbus has transformed it's product offerings through the addition of painting and Galvalume coating capability, and through the introduction of more complex grades of Flat Roll steel, some of which serve the automotive sector.

The diversion of product to these value-added outlets has reduced the amount of volume available to our existing galvanized customer base. So the addition of a the third galvanizing facility will allow Columbus to serve these existing customers along with new customers in the region. This expansion will also reduce Columbus' exposure to a more cyclical hot roll market, which will results in higher and less volatile through cycle earnings.

Additionally, during the next two years, we plan to make additional investments at Columbus to upgrade certain processing lines in hot strip mill capability to further enhance and stabilize profitability with further product diversification and process efficiency gains. The investments will increase Columbus' range of complex grade capabilities and will improve the process control needed to produce advanced high-strength steel grades used in the automotive industry and also in the energy markets. These investments extend Columbus' strategy to diversify into downstream value-added capabilities.

We are also investing in our long product steel operations. These projects coupled with the improving construction and industrial markets have already resulted in increased capacity utilization. As an example, we have two primary organic initiatives to increase the utilization of our structural and rail division, which operated about 75% of its capacity in 2017, and in contrast has been operating in over 90% of its capacity this year.

First we've grown the production of SBQ quality blooms for internal supply to our engineered bar division. They need blooms to fully utilize their rolling capability. This improves through cycle utilization at both facilities. (inaudible) tons of blooms shipped in the third quarter, we are achieving our anticipated annual run rate of transferring over 200,000 tons from Columbus to Pittsburgh.

Second, we are investing over $80 million to utilize excess melting and casting capability at the Structural and Rail Division through expansion and product diversification for the addition of an annual production capability of 240,000 tons of rebar, including spooled, custom cut-to-length and smooth bar. Our unique rebar supply chain model is expected to substantially enhance customer optionality and flexibility, providing meaningful logistics yield and working capital benefits. In addition, we will be the largest independent rebar supplier in the Midwest region. We strongly believe that these innovative, cost-effective projects can provide a material improvement in future through cycle utilization and profitability at this facility.

The expansion also complements the recent growth at our Roanoke Bar Division. We invested approximately $38 million to also utilize their excess melting and casting capability. Planning for about 200,000 tons of rebar volume annually. We started operations a few months ago and commissioning is ongoing. I think the steel team should stand proud. And with the addition of the Heartland acquisition, we now have almost 12.5 million tons of annual shipping capability.

Historically, Heartland was operated at low utilization rates and they focused on galvanized steel. We plan to focus on a full breath of products, including very light gauge sheet, our operating expertise, product market familiarity and the geographic proximity of our existing Midwest flat roll operations allows for meaningful value creation. Consistent with our strategy to differentiate and grow through product diversification, Heartland provides wider and lighter gauge product capability.

We are familiar with their market and customer base. Due to the continued addition of value-added capabilities at our Butler Flat Roll Division, we have displaced some of our customers that can now be served by Heartland. Heartland will also provide pull-through volume. We plan to supply at least 300,000 tons of steel substrate from our Butler Flat Roll Division, thereby increasing through cycle profitability at both locations. Heartland should also improve Butler's cold mill productivity. We plan to produce lighter-gauge flat roll orders at Heartland, which should increased Butler's cold mill productivity. Lighter-gauge products require more time to run, so to speak, and Heartland is better equipped to make these gauges.

We believe the Heartland acquisition will result in numerous future earnings synergies both the Heartland's current operations and to our broader Midwest flat roll group. As Theresa explained, we believe annual synergies could be in the range of $10 million to $15 million. In whole, Heartland provides the unique margin enhancing opportunity for Steel Dynamics and we are excited to continue the integration and realize the value creation.

While metals recycling earnings decreased sequentially, the platform delivered a solid performance on a complicated freight environment. Non-ferrous shipments and metal spread decreased due to declining commodity prices and the changing export market environment, given China's recent ban on certain recycle material. Also the ferrous scrap exports picked up a little more than expected last month and the market recovered some of the price drop manifest in August and September. We expect seasonal tightness to keep the market firm in the rest of the year. Long-term, we are committed to the premise that scrap supply will outgrow anticipated demand, given expectations of higher steel mill utilization rates and associated scrap needs.

The steel fabrication team achieved record shipments in the quarter, and I'd like to congratulate them for an incredible job. Our order backlog remained strong. Similarly, our customer backlogs are extremely strong with some having to turn business away. The ongoing strengths of the business and customer optimism is a solid indicator that non-residential sector strength will continue well into next year.

Based on strong underlying domestic steel demand fundamentals and customer optimisms throughout all market sectors, we believe steel consumption will continue to be seasonally strong and grow into 2019. In combination with our expansion initiatives, we believe there are firm drivers for our continued growth. Furthermore, the actions the U.S. Federal Government has recently made to develop a healthy domestic steel industry should provide sustainable long-term support for the U.S. manufacturing base and continue to erode import running. We also believe that USMCA negotiations will result in a constructive outcome for our industry.

Specific to Steel Dynamics, our unique culture and execution of the long-term strategy continues to strengthen our competitive position through strong cash flow generation and long-term value creation, and it clearly demonstrates our sustainability and differentiates us from our competition. Customer focused coupled with market diversification and low cost operating platforms support our ability to maintain our best-in-class performance and differentiation. The company and the team are poised for continued organic and transactional growth.

Our team provides the foundation for our success, and I thank each and every one of them for their hard work and commitment to excellence in all we do, and I remind them safety is the first priority. We are committed to providing exemplary long-term values to our employees, to our communities, customers and shareholders alike, and look forward to creating new opportunities for all of us in the years ahead.

So once again, thank you for your time and interest in our company. And Terry, we would like to open the call up for questions now. Thank you.

Questions and Answers:

Operator

(Operator Instructions). Our first question is from Matthew Korn with Goldman Sachs. Please proceed with your question.

Matthew Korn -- Goldman Sachs & Co. LLC -- Analyst

Hi good morning everyone, thanks for taking my questions. So I had a couple of questions. One is short-term, the other one is long-term. First, you have highlighted this temporary backing off of orders that you saw on your buyers as the imports of hot rolled coil rose. I want to ask was this hesitancy in orders was that really centric to hot rolled coil? Or did you see any similar behavior across the longs? And then second as it's normalized since then, are you seeing a tick backup or would you expect with the season and as you are seeing prices somewhat stabilize here in the mid-800 or so? Thanks.

Mark Millett -- President and Chief Executive Officer

I think certainly the hiatus was reversed itself in the last couple of weeks and we have seen on the flat rolled side very, very strong order intake. And I think on the long product side, it wasn't quite as pronounced. I think the order rate just continued at a reasonably strong pace through that period.

Matthew Korn -- Goldman Sachs & Co. LLC -- Analyst

Okay. So really focused in that particular product. Let me ask my longer-term one, a little bit -- and more of a thematic. There has been a lot of announced steel expansion projects year-to-date, your own, your established competitors, from new entrants. So even if you handicapped for the normal discount or what's been announced versus what gets executed, it seems like a lot of metal coming in, especially if we are going to keep aiming for this 80% capacity utilization. Does this concern you? Or do you feel comfortable that all this new supply could be absorbed out much disruption, and if so why?

Mark Millett -- President and Chief Executive Officer

Well, I think the -- firstly, the market remains incredibly strong as I said in every market sector and we continue to see and believe strongly that that's going to go into 2019. And so demand will be strong and increase -- maybe incrementally, but it will continue to increase. At the same time, imports are going to dissipate. I think the actions the government that made are starting to take place. With the slight refraction in market pricing of the highest we saw a couple of months ago, the arbitrage, the import pricing has dissipated to some degree. I think imports are going to erode further. And if you look at the imports returned to just a regular normal historical rate, I think the supply and demand to absorb the increased supply.

Theresa Wagler -- Executive Vice President and Chief Financial Officer

And the only other things I would add Matthew is that if you look at the Greenfield capacity expansions that have potentially been announced, those wouldn't come into market for probably two to three years at the earliest. So, there is that part of the equation as well.

Matthew Korn -- Goldman Sachs & Co. LLC -- Analyst

Got it. So between timing, import reduction and continued strength in demand you feel pretty confident?

Mark Millett -- President and Chief Executive Officer

Yes.

Matthew Korn -- Goldman Sachs & Co. LLC -- Analyst

Thanks very much, folks. Good luck.

Operator

Our next question is from Chris Terry with Deutsche Bank. Please proceed with your question.

Chris Terry -- Deutsche Bank -- Analyst

Hi, Mark and team. I just had a question on the fabrication margins. Based on the order backlogs, do you think that margins have broadened and should we see recovery going forward or is it still a couple of quarters out given the seasonality?

Chris Graham -- SVP, Downstream Manufacturing Group

I think you make a good point. This is Chris. We think that seasonality will idle -- mask it a little bit, but we do think that we will continue to -- we will begin to start seeing spreads improve.

Chris Terry -- Deutsche Bank -- Analyst

Okay. Okay. Thanks. And just maybe one for Mark on the M&A top line. Has it changed at all over the last few months? Are you still looking for sort of smaller scale? How you're think about the size and the opportunities that it seems since we had the call last time?

Mark Millett -- President and Chief Executive Officer

While preference is fairly not small scale, as you appreciate and we certainly appreciate, it seems to take just as much time and effort and distraction on a small deal than the big deal. But we certainly have a pipeline that is still very active and active across the breadth of scales and honestly I think perhaps on the downstream pull through volume type opportunities, they are smaller scale, just the Vulcan purchase we made some time ago. But there are other larger opportunities as well. We remain, I would say, disciplined, obviously, given the market euphoria out there, valuations are pretty strong and we're working through those issues in our sort of negotiations and discussions.

Chris Terry -- Deutsche Bank -- Analyst

Okay. Thanks, Mark.

Operator

Our next question is from David Gagliano with BMO Capital Markets. Please proceed with your question.

David Gagliano -- BMO Capital Markets -- Analyst

Thanks for taking my questions. I think you may have just covered off one of them. I'm just going to ask just one near-term. Based on your visibility of the order books, what's a reasonable range of assumptions for changes in your steel operations volumes quarter-over-quarter and in the fourth quarter is my first question.

Theresa Wagler -- Executive Vice President and Chief Financial Officer

I mean, as you know Dave, based on seasonality, the holiday and the customers base looking to realign inventories at the end of the year, the steel shipments are always lower in the fourth quarter and that goes back to as long as I have been doing this for the last 20 years. So that would be our expectations as well, but I don't think it's (inaudible) anything that is unique to this market environment, it's just normal seasonality.

David Gagliano -- BMO Capital Markets -- Analyst

Okay that's helpful. And then just on -- strategic question. Just kind of in generic terms. When you prove the landscape of acquisition opportunities that you are seeing out there right now. How do the valuations that you see compared to the other options in terms of, for example, getting even more aggressive on buying back more of your own stock that kind of thing?

Mark Millett -- President and Chief Executive Officer

I think -- I guess just on a broader prospective, this is a cash allocations strategy in general. Obviously we evaluate I wouldn't say daily, but frequently the best use for our cash. And we have always, I think, at least in the past used you have seen us use all the tools in our tool box there. We have the financial strength and basis to be able to not have to directed to one or another. So I believe the positive dividend stream profile will continue as our through cycling cash generation profile continues to increase as well. You are seeing the completion of the initial share repurchase program and we have got another in place the $750 million. And I think we believe prudently even more strongly today that our shares are -- our market cap is undervalued and there is great value there. So I think you will us aggressively peruse that program as we continue to evaluate further organic growth and transactional opportunities. So I think we look at all those mechanisms there we believe the opportunities for good value on transactional side yet and certainly obviously our organic and internal projects are absolutely the best place to spend on them.

David Gagliano -- BMO Capital Markets -- Analyst

Okay. That's helpful, that sounds somewhat of our previous comments. But what I'm kind of trying to get to is right now in the current market place, you are stock where it is, opportunities out there right now, what do you think is a better opportunity for you? Is it buying back the stock? Or is it -- are there good sizable acquisition opportunities available?

Mark Millett -- President and Chief Executive Officer

I think there is the opportunity to do both.

Theresa Wagler -- Executive Vice President and Chief Financial Officer

If you look Dave at the profile that we have I mean in any deal. So if you look at the cash on the balance sheet and the generation pace that we are adding in, we have -- definitely have the capability to both maximize the repurchase program as well as look at the deals that we are looking at and it wouldn't jeopardize our credit profile nor our ability to grow both in the next downturn as well which is always something that we like to do, we find great value in doing that.

Analyst -- -- Analyst

Okay, thanks very much.

Theresa Wagler -- Executive Vice President and Chief Financial Officer

Thank you.

Operator

Our next question is with Curt Woodworth with Credit Suisse. Please proceed with your question.

Curt Woodworth -- Credit Suisse -- Analyst

Thanks. Good morning, Mark and Theresa.

Mark Millett -- President and Chief Executive Officer

Good morning.

Curt Woodworth -- Credit Suisse -- Analyst

Two questions, the first is just looking at your cost structure in the third quarter, it seemed like conversion costs increased pretty significantly year-on-year. I know, there's a lot of sort of moving pieces within that between variable labor, power, maintenance maybe some Heartland inventory impact, but can you just comment on that because it looked like it was up close to $500 million annualized this quarter versus last quarter in the mill segment.

Theresa Wagler -- Executive Vice President and Chief Financial Officer

Curt, I'll take that, I saw your note last night, so I want to be able to comment. Thanks for asking the question. Actually, if you look, I'm going to address quarter-over-quarter, before year-over-year. But if you look quarter-over-quarter, our conversion costs are actually lower if you back out, remember I previously mentioned that $13 million is going to the cost of goods sold line for Heartland, but more impactfuly is the fact that now if you look at Heartland in the tax and it's the reason we are breaking out their volume. They make up about 11% of our total steel shipments and you have to look at conversion on total steel shipments or you missed the cost impression, you can't look at it based on external.

So because it's now at about 11% of our volume versus when it was just the tax, it was somewhere between call it 5% to 7%. There is a bigger impact because we can't get as much. There's a higher conversion cost that it looks like it's having because we're buying our substrate outside the company and so that steel cost input is getting mixed up. If you just look at straight conversion cost to steel operations, in the sequential quarters, they actually decreased. If you look at it year-over-year, there has been an increase, but not as sizable as you mentioned, the increase is closer to $10 to $15 and that's related to electrodes, refractories, our operations, they are still performance-based from an incentive perspective.

There's higher bonuses as well because the profitability is higher. So there's nothing that is significant for us to point out and I'm happy to walk you through it later as well.

Curt Woodworth -- Credit Suisse -- Analyst

Okay. So that reported figure this quarter then is a reasonable baseline these going forward then?

Theresa Wagler -- Executive Vice President and Chief Financial Officer

As you look at your model, I would encourage you to try to separate the tax in the Heartland volume from the other steel mill volume and there's going to be an impact. So as you look at it, the only thing I would tell you, you do need to change is your denominator is going to be actual shipments -- there really needs to be total shipments.

Curt Woodworth -- Credit Suisse -- Analyst

Yes, we are running it off total shipments.

Theresa Wagler -- Executive Vice President and Chief Financial Officer

Okay.

Curt Woodworth -- Credit Suisse -- Analyst

So, we can catch up online. I don't know if the arithmetic would necessarily change. But that's fine. Okay. Second question is just around maybe for you, Mark, just kind of communication with Commerce or sort of trade -- people you speak to in Washington, do you feel that there is that article in AMM about, I think the AISI President have potential resolution with Canada in November on tariffs. Do you have a sense of sort of what that negotiation looks like, has the steel managements kind of communicated what they would like to see happen with respect to Canada.

Mark Millett -- President and Chief Executive Officer

Well, I think the negotiations are playing out reasonably well for us, generally in the steel industry. And again, I'm very glad that the administration has been able to find common ground with Canada, Mexico (inaudible) as a block. We need to be working together and another game goes out. But trade in general, the 232 program, I think is looking incredibly well, its created a much level of playing field and has given relief to the industry and it's going to support, I think pricing in the market into next year, and I think as I said earlier, imports generally are going to continue to roll, I believe. Relative to Mexico and to Canada to the so-called USMCA, I guess we're going to be going in the future. (inaudible) is the same assets, but nonetheless. It's going to be a benefit to us, primarily it's -- the sales of autos and auto parts, which now will have a minimum content requirement and minimum wage component favoring more US loss production and more North American steel inputs.

And we've seen actually, just recently, since the announcement of a resurgence in orders and order inquiries from Mexico that there was a lot of uncertainty there for a while when no one knew exactly what was going to pan out, but as clarity has come to the forefront. Again, our customer base in Mexico has been pretty strong. Generally, I think no one knows, and one can only speculate is the sort of final details, but I think prudence will rule the day and it's going to be a benefit for us.

Curt Woodworth -- Credit Suisse -- Analyst

Great. Really, appreciate it.

Operator

Our next question is from Timna Tanners with Bank of America Merrill Lynch, please proceed with your question.

Timna Tanners -- Bank of America Merrill Lynch -- Analyst

Hey, good morning, guys.

Mark Millett -- President and Chief Executive Officer

Good morning.

Theresa Wagler -- Executive Vice President and Chief Financial Officer

Good morning.

Timna Tanners -- Bank of America Merrill Lynch -- Analyst

I was wondering, if you could talk us through Q4 pricing -- your current market conditions, just because it's always helpful to get a reminder about how much of your business operates on a CRU kind of lag and how much would be exposed to the spot price and granted, I know you're not just flat rolled. But if you could just remind us like what percentages would be exposed to spot and what percentages might see a lag and help us think about that again considering current conditions?

Theresa Wagler -- Executive Vice President and Chief Financial Officer

The only real significant contract business that we have to date filling within the flat roll and generally about 50% of it is contractual where you're going to get a lag is going to be based on CRU index and that lag generally is probably about two months. And so, you're going to have 50% that will be subject to spot and the other 50% subject to that contract. On the long product side, generally there is no contractual business, there is a very small amount in the SBQ side of the business, but not enough for you to try the model.

Timna Tanners -- Bank of America Merrill Lynch -- Analyst

Okay, I appreciate that. And then I was wondering, separately if you could talk about the rebar expansion and the Columbus plans in a little bit more detail. So Columbus is already a really strong asset, really strong profitability and so I'm curious like what further, if you could detail a little further what you can do to enhance that. Is it more product, is it cost or both. And on the rebar side, your new entrants into that market, somewhat right, I know you dabbled in the past, I believe, but how are the customers receiving your product. How are you finding that market acceptance so far? Thanks.

Mark Millett -- President and Chief Executive Officer

Timna, on the -- in the Columbus plant, bringing the new galvanized line allows us to make galvanized products for general consumption. So as we've grown our automotive business from that plant as well as our painted business, it really put pressure on regular galvanized customers. So the additional galvanized allows us to put more of our product mix into to get value-added products. It also allows us to fully kind of exploit the day (ph) lines down there as well as some of the more demanding products in the automotive side that we've taken, so some of those out, and much more difficult process parameters to control. So this allows us to grow our business and keep the quality in line for our customer base. So we're really looking forward to get this line online and continue to take care of the customers we have as well as grow the business.

Theresa Wagler -- Executive Vice President and Chief Financial Officer

That line is a 400,000 ton line and is expected to be sometime in the first half of 2020 and so if you think about it also substantially reduces the amount of exposure that Columbus has in just straight hot roll, which should be through cycle much higher margin.

Glenn Pushis -- SVP, Long Steel Group

Yeah, Timna, good morning. Glenn Pushis here, on the rebar project at Columbia City, we plan on starting that project up here, commission at the -- in the end of the fourth quarter this year and you asked about reception in the marketplace, obviously, we've not made anything yet but the reception that we're hearing from our potential customers and independent fabricators has been very strong. Lot of interest in that facility with the spooled coils and the custom cut-to-length that Mark said earlier.

Analyst -- -- Analyst

Okay. So I was referring to the operation that you said you had just started up in Roanoke and also on the Columbus I was referring to Mark's comments about over the next several years, even further expansion, so I wasn't clear on that.

Mark Millett -- President and Chief Executive Officer

No problem. In Roanoke, we have started up the rebar bundling area and that's running much better than it did six months ago as we first started the commissioning process. We had some equivalent problems from our supplier there. We are through those and that facility is up in running in a much better pace now. We anticipate that being in full operation at full time at the 200,000 ton per year level by the end of this year.

Chris Graham -- SVP, Downstream Manufacturing Group

Timna, Columbus, a couple of things of it. Obviously as Barry mentioned the $140 million galvanizing line is going to be growth when that comes online in 2020. We are spending about $90 million to $100 million on I would say a variety of enhancements at Columbus. It's going to give us further product diversification. It allows us to get to higher-strength auto grades. It allows us to get the higher-strength heavier-gauge energy pipe and tube grades. And then thirdly, you have the paint line and although that's been running for some time and it's well utilized, obviously they are going through product evaluation and the product although the margin will be enhanced as we get into more HVAC and appliance type applications.

Timna Tanners -- Bank of America Merrill Lynch -- Analyst

Thank you very much.

Operator

Our next question is from Seth Rosenfeld with Jefferies & Company. Please proceed with your question.

Seth Rosenfeld -- Jefferies & Company -- Analyst

Good morning, thanks for taking my question. Just to begin little bit more for Kentucky Electric Steel. Can you just give us a bit more color on the planned ramp up trajectory that facility. Which are the mills we should expect to be leading the substrate? And when you think about this asset and the product mix, how to consider the margin contribution compared to the base load across division? Thank you.

Mark Millett -- President and Chief Executive Officer

Glenn?

Glenn Pushis -- SVP, Long Steel Group

Yes. Hi Seth, Glenn Pushis here. The Kentucky Electric Steel asset that we just purchased, we will be starting that facility up in two to three weeks. We have got employees hired and we have got our first order of billets showing up for the materials to run. We have got about 4,000 or 5,000 ton backlog right now, it's about 12,000 tons total, we've got earmarked to start the facility up on. Really, the play there is for us because we'll be able to supply our own billets. The three of our facilities will supply those, Steel of West Virginia will be supplying Kentucky Electric some of the sizes; Roanoke Electric Steel and Roanoke Virginia will be supplying some; and then some of the alloy SBQ grade will come straight out of Pittsboro facility. So really those three facilities. We will be feeding that new rolling mill assets, and that will supplement Steel of West Virginia.

Mark Millett -- President and Chief Executive Officer

So is that -- from a high level, there will be some margin contribution from the asset itself, but the strong advantage is that pull through volume through cycle from those other divisions to allow a high utilization rate there.

Seth Rosenfeld -- Jefferies & Company -- Analyst

Great. Thank you very much.

Operator

Our next question is from Phil Gibbs with KeyBanc Capital Markets. Please proceed with your question.

Phil Gibbs -- KeyBanc Capital Markets -- Analyst

Hi team, good morning. Hello.

Mark Millett -- President and Chief Executive Officer

Hello.

Phil Gibbs -- KeyBanc Capital Markets -- Analyst

Okay. I just didn't hear myself. I had a question Mark just on the automotive strategy and if you could update us on that in terms of where we are this year, perhaps in terms of volume and where you expect to be in the next couple of years as some of your platforms take off?

Mark Millett -- President and Chief Executive Officer

In Butler, we remain steady at around by 30% or so of the 32% of its output is going to automotive principally through processes. Columbus where we focus more on direct sales to three automotive clients, particularly in Mexico. They are continuing to gain market share. We are on platforms to take that up to 450,000 tons or so by the end of 2019. So I think it's going very, very well.

Phil Gibbs -- KeyBanc Capital Markets -- Analyst

And just to frame, where do you see Columbus now and how much of your Engineered Bar business should we think about being automotive as well?

Mark Millett -- President and Chief Executive Officer

Columbus is (inaudible) and SBQ is around about 15%?

Chris Graham -- SVP, Downstream Manufacturing Group

Yes, 20% right now Mark, and that's growing because we're starting up our new inspection in the bar turning line. A lot of that automotive SBQ still needs to be inspected so we had -- we're kind of bottleneck right in that finishing area. So with this expansion project that we are putting in right now and starting up, that helps us to delve more into automotive. So we need to grow that from 15%, 20% now let's say to 25% to 30% in the future.

Phil Gibbs -- KeyBanc Capital Markets -- Analyst

Okay. That's helpful. And I just have one more, Glenn, on the Engineered Bar business if I could. What are you seeing on the energy side? It certainly looks like there has been a mix shift in the market to more seamless product away from welded, given some of the demands of the EMPs. And has there been any positive stress or strain on your business to supply that more so for today and greater needs in the future as some of these import restrictions play out?

Glenn Pushis -- SVP, Long Steel Group

I'd say from that market right now, we are seeing order in three-year historical highs both in the third quarter and fourth quarter. And we anticipate that that's going to be continue into 2019.

Phil Gibbs -- KeyBanc Capital Markets -- Analyst

You are saying broadly or for the energy piece?

Glenn Pushis -- SVP, Long Steel Group

Well broadly I would say the energy piece for certain.

Mark Millett -- President and Chief Executive Officer

As we said in the past, our Engineered Bar is kind of our bellwether to the general steel consuming industry or market. And it is literally across the board incredibly strong. Pittsboro has the highest backlog it's ever had for the fourth quarter. And literally, well as Theresa pointed out, we will see a little seasonal impact on shipments in the fourth quarter. We expect things to really, really open up in the first quarter next year.

Phil Gibbs -- KeyBanc Capital Markets -- Analyst

Perfect. And Theresa I do appreciate the color you provided on the mix straight away. And is Heartland about 50/50 as well in terms of contract in spot?

Mark Millett -- President and Chief Executive Officer

Yes.

Theresa Wagler -- Executive Vice President and Chief Financial Officer

Yes.

Phil Gibbs -- KeyBanc Capital Markets -- Analyst

Thanks everyone.

Operator

Our next question is from Andreas Bokkenheuser with UBS Securities. Please proceed with your question.

Andreas Bokkenheuser -- UBS Securities -- Analyst

Yes, thank you very much. And good morning. Just a quick question on the tariffs, you always have mentioned that you think the tariffs are working quite well and we are seeing that in the prices as well. Do you have a preference for tariffs over quota or the other way around? Obviously there has been a little bit of talk about replacing some of the tariffs with quotas on Mexico and so and so forth. What in your view is maybe thinking about a framework of the quotas that are in place right now for South Korea. Do you have a preference of what do you think is healthier for the industry, what gives you the most pricing power, a tariff versus a quota going forward?

Mark Millett -- President and Chief Executive Officer

Well, I think long-term quota is probably a preference from our perspective because it allows the support of the manufacturing base. And it's -- long-term -- section 232 tariffs I do believe is a good stop back but one has to recognize this, we are going to continue to have a little bit of capacity for some of time to come. Of that, virtually every economy that's matured and/or emerged since World War II are all based on exports, their export economies. So there have to be some long-term sort of moderator or moderation of the flow of imports on to our shores. As a country, we are still short, and one of the few countries that is, so we needed imports. Our manufacturing base needs that product. And I think quotas tends to be the better way of controlling that.

Andreas Bokkenheuser -- UBS Securities -- Analyst

That is very clear. Thank you very much.

Operator

Our next question is from Derek Hernandez with Seaport Global. Please proceed with your question.

Derek Hernandez -- Seaport Global -- Analyst

Hello. Good morning and thanks for taking my question. I just want to touch on additional growth opportunities that you had mentioned beyond ongoing growth projects which sort of product lines do you see opportunities, and at this time.

Unidentified Speaker --

Our focus is, well, we have three sort of growth areas of focus. One is just continuing to look at steel assets, under-performing steel assets that we can infuse our culture and our business model to turnaround. Secondly, our teams have developed an expertise in processing -- downstream processing lines, whether they would be coated, whether they would be painted. So, there is opportunity I think for that.

On the fabrication side, continued growth in debt offerings. And then lastly WholeStream opportunities that we feel they would add and improve our margin profile. But more importantly or as importantly would allow a higher through cycle utilization rate and not to be redundant, but we really are focused long term, but focused on making sure that our future highs are much, much higher than they are today. But as importantly, our future levels (ph) are higher and we think pull through volume allows us to achieve that.

Unidentified Participant -- -- Analyst

That's very good. Thank you for the color. And my second question being, where do you see potential for cost savings given the current environment is bit leaning toward a bit of inflation there? Where do you -- might you target opportunities to keep margins strong despite this?

Mark Millett -- President and Chief Executive Officer

Well, I guess, I will kick off first. But I think if you actually look at most of our operating lines or processes, over time conversion costs remarkably stays somewhat stable and it's because the -- the teams out there are continually innovative and creative to become more efficient but more importantly, they seem to have an incredible aptitude to push more tons through. And so the increased effectiveness of our operations seems to offset any sort of inflationary cost of materials or commodities.

Unidentified Participant -- -- Analyst

Thank you very much. Appreciate the time.

Operator

Our next question is from Sean Wondrack with Deutsche Bank. Please proceed with your question.

Sean Wondrack -- Deutsche Bank -- Analyst

Hi, apologies if you've touched on this, but can you talk about what you are seeing in the scrap market and kind of what your expectations are moving into year end?

Russ Rinn -- Chief Operating Officer

Sean, this is Russ. As we look at scrap market, I think, we are seeing a relatively firm market through the year and probably into the first month or two of next year. Again, seasonal factors as weather comes in but again in my opinion just to reaffirm this is going to depend on what happens on the coast and exports. If exports pick up to a higher level, it will become firmer. If they remain at the level they are at right now, it will be a steady increase, but not a dramatic one.

Sean Wondrack -- Deutsche Bank -- Analyst

That's helpful. Thank you. And then just more kind of big picture. Can you talk about a little what the impact of tax reform has been on your customers? Do you find some of this optimism is related to that or do you think most of that's worked its way to the system? If you could touch on that, I appreciate it.

Theresa Wagler -- Executive Vice President and Chief Financial Officer

I would not say that its worked its way through the system because the impact on tax reform, obviously the biggest impact was noted in the first quarter of this year. However, to say that that's gone through the systems to have additional projects, additional fixed asset investments which currently in the higher steel consumption, and in fact it would be always incorrect or indicates (ph) hasn't been sufficient time. In addition to that with the repatriation of funds coming into US from global company, that as well, just wouldn't have had time to translate from bringing the money in to building the factories to having additional investments in the US in totality. So my expectation is that tax reform actually gives leg, to what some think is an economy that's already been on the up slope for too long way, we try to measure it in years, and I don't think that's probably appropriate for this time, because I think with tax reform, it allows it to have more legs into last even further. So my personal view, our view is that no, there still more to come.

Chris Graham -- SVP, Downstream Manufacturing Group

Theresa, in support of that the fabrication group would note that quote activity in retail and hotels is now just starting to increase and to your point, that will take some time to get through the system. But we do assume that some of that might be from the effect of lower taxes on consumer spending.

Theresa Wagler -- Executive Vice President and Chief Financial Officer

Excellent. Thanks, Chris.

Sean Wondrack -- Deutsche Bank -- Analyst

Thank you. And then just one last one. You obviously have a large revolver outstanding. I apologize, could you remind me, if you were to get upgraded, would that go unsecured or have you had any thought about potentially moving to an unsecured revolver there?

Theresa Wagler -- Executive Vice President and Chief Financial Officer

So the Treasury team did an excellent job in that the revolver has a provision that -- it's our choice to execute. Now if we were to get an upgrade in any one of the agencies, we would have the ability to actually spring into an automatic unsecured revolver, which then could allow the other agencies to upgrade us as well. So it's at our election but yes, it's already there so we don't have to make a change in the revolver structure today.

Sean Wondrack -- Deutsche Bank -- Analyst

Okay, great. Well, congratulations on a great quarter and good luck 4Q.

Theresa Wagler -- Executive Vice President and Chief Financial Officer

Thanks, Sean.

Operator

Our next question is from Bryan Lally with Barclays. Please proceed with your question.

Bryan Lally -- Barclays -- Analyst

Hi, good morning. Thanks for fitting me in. If I -- maybe could follow-up on actually a couple of Sean's question, maybe first on just the investment grade side, Theresa, do you have any additional thoughts or are we kind of in that same place of positive outlook at both and if you get there great, but you're obviously clear on your goals in terms of shareholder returns and M&A?

Theresa Wagler -- Executive Vice President and Chief Financial Officer

I would say that our goals are still the same on the shareholder distributions on wanting to grow transactionally and organically. That being said, just to strengthen what we believe the steel markets are going and the strength that we think we have internally for levers to be pulled to Mark's point both in the kind of the high market and in the low market. I think, we're probably heading toward that IG rating more quickly than what we may have anticipated and we may start talking a little bit more about it kind of in the coming months.

Bryan Lally -- Barclays -- Analyst

Got it, OK. That seems like a little bit of a change, that's good to hear. And then, I guess, the second question I have it relates to the -- relates to the scrap side of things, but we're starting to hear more obviously, Cliffs for instance talking about building a HPI facility. I guess, where do you see kind of your iron content. I know this is a longer-term question. But is this something where that you want to compete more with the blast furnace producers, you see that there is a greater need for higher iron content, and I guess where do you see that in your mix right now? That would be helpful. Thank you.

Mark Millett -- President and Chief Executive Officer

I don't believe we see a near-term need to increase iron content from a quality standpoint necessarily. We certainly, obviously are very aware of the cost -- the best mix to get the most economic cost of raw materials into the furnace and at the same time, maintain high level of volatility. So you will see that in Columbus, we're probably 25% barrier thereabouts pig iron and in Butler, we are around about 15%, and that's purely an economic decision, that we can get pig iron into the Columbus mill at a lower rate out of Nova (ph). Obviously the (inaudible) projects and any other project and those project down south, but the more iron units coming into the marketplace, the better off we and everyone in the electric-arc furnace communities is going to be.

Bryan Lally -- Barclays -- Analyst

Got it. Really helpful, Mark. Thanks so much.

Operator

Our next question is from Matthew Fields with Bank of America Merrill Lynch. Please proceed with your question.

Matthew Fields -- Bank of America Merrill Lynch -- Analyst

Hey, everyone. Thanks for all the color and appreciate the updated thoughts on the IGE outlook. Sort of a bigger picture question. We've kind of seen some small M&A transactions with Heartland and some other ones. Just wondering, maybe why we haven't see bigger large scale . Just wondering maybe why we haven't seen bigger large scale M&A transactions and more consolidation in the steel sector? Is there evaluation gap between buyers and sellers, is there kind of an expectation that 800, 900 hot rolled is kind of the future forever from a sellers point of view, but the buyers are kind of hold it seller -- sorry buyers are kind of hold in the line?

Mark Millett -- President and Chief Executive Officer

Well, I would say that folks have a pretty proud of their assets right now. So, yes valuation is generally or as you would expect toward the high end. If you actually reflects -- as we reflect on the deals that we have done even going back to the Columbus deal, there has always been other factors in our successful transaction, whether it'd be folks wanting their employees to be in the SDI family, whether they want sort of clarity and speed of transaction, there are other things that can perhaps play a role and get you an asset perhaps as not top valuation. But it certainly is a hinderance, that's all.

Analyst -- -- Analyst

Do you see anything changing with that, do you see that pace of consolidation picking up or kind of is this what is it from your outlook? And I obviously appreciate you can't predict the future.

Mark Millett -- President and Chief Executive Officer

Well certainly I can't predict it. I can only say and I can't speculate as to the outcome. All I can say is that the pipeline is very reactive. There are a lot of assets out there. At some point in time, they are likely to, I guess being transacted, but it's a slow process I'd say.

Unidentified Participant -- -- Analyst

Okay, that's it for me. Thanks very much.

Theresa Wagler -- Executive Vice President and Chief Financial Officer

Thank you.

Operator

That concludes our question-and-answer session. I'd like to turn the call back over to Mr. Millett for any closing remarks.

Mark Millett -- President and Chief Executive Officer

(inaudible) and again thank you for taking time to listen to us today, listen to our story. We are pretty happy with the performance. Like I said at the very beginning, I can't be proud of the team in this room and the other 7,700 employees that we have across the nation and in Mexico. So from us we want to keep doing what we do, best. Provide the greatest shareholders value in our space. So have a great day and be safe. Bye, bye.

Operator

Once again ladies and gentleman that concludes today's call. Thank you for your participation. Have a great and safe day.

Duration: 63 minutes

Call participants:

Tricia Meyers -- Investor Relations Manager

Mark Millett -- President and Chief Executive Officer

Theresa Wagler -- Executive Vice President and Chief Financial Officer

Matthew Korn -- Goldman Sachs & Co. LLC -- Analyst

Chris Terry -- Deutsche Bank -- Analyst

Chris Graham -- SVP, Downstream Manufacturing Group

David Gagliano -- BMO Capital Markets -- Analyst

Analyst -- -- Analyst

Curt Woodworth -- Credit Suisse -- Analyst

Timna Tanners -- Bank of America Merrill Lynch -- Analyst

Glenn Pushis -- SVP, Long Steel Group

Seth Rosenfeld -- Jefferies & Company -- Analyst

Phil Gibbs -- KeyBanc Capital Markets -- Analyst

Andreas Bokkenheuser -- UBS Securities -- Analyst

Derek Hernandez -- Seaport Global -- Analyst

Unidentified Speaker --

Unidentified Participant -- -- Analyst

Sean Wondrack -- Deutsche Bank -- Analyst

Russ Rinn -- Chief Operating Officer

Bryan Lally -- Barclays -- Analyst

Matthew Fields -- Bank of America Merrill Lynch -- Analyst

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