Commercial Metals (CMC) Q1 2024 Earnings Call Transcript

Commercial Metals (CMC -0.43%)
Q1 2024 Earnings Call
Jan 08, 2024, 11:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Hello, and welcome, everyone, to the first quarter fiscal 2024 earnings call for CMC. Joining me on today's call are Peter Matt, CMC's president and chief executive officer; and Paul Lawrence, senior vice president and chief financial officer. Today's materials, including the press release and supplemental slides that accompany this call, can be found on CMC's investor relations website. Today's call is being recorded.

[Operator instructions] I would like to remind all participants that during the course of this conference call, the company will make statements that provide information other than historical information and will include expectations regarding economic conditions, effects of legislation, U.S. steel import levels, construction activity, demand for finished steel products, the expected capabilities, benefits and timeline for the construction of new facilities, the company's future operations, the timeline for execution of the company's growth plan; the company's future results of operations, financial measures, and capital spending. These and other similar statements are considered forward-looking and may involve certain assumptions and speculation and are subject to risks and uncertainties that could cause actual results to differ materially from these expectations. These statements reflect the company's beliefs based on the current conditions but are subject to certain risks and uncertainties, including those that are described in the risk factors and forward-looking statements section of the company's latest filings with the Securities and Exchange Commission, including the company's latest annual report on Form 10-K.

Although these statements are based on management's current expectations and beliefs, CMC offers no assurance that these expectations or beliefs will prove to be correct, and actual results may vary materially. All statements are made only as of this date. Except as required by law, CMC does not assume any obligation to update, amend or clarify these statements in connection with future events, changes in assumptions, the occurrence of anticipated or unanticipated events, new information or circumstances, or otherwise. Some numbers presented will be non-GAAP financial measures, and reconciliations for such numbers can be found in the company's earnings release under supplemental slide presentation or on the company's website.

Unless stated otherwise, all references made to year- or quarter-end are references to the company's fiscal year or fiscal quarter. And now for opening remarks and introductions, I would like to turn the call over to Peter.

Peter Matt -- President and Chief Executive Officer

Good morning, everyone, and thank you for joining CMC's first quarter earnings conference call. I hope each of you had a wonderful holiday season. As we reported in our press release issued this morning, the first quarter of fiscal 2024 marked another period of strong financial performance with core EBITDA, core EBITDA margin, and free cash flow continuing at historically high levels. I would like to thank CMC's 13,000 employees who make these result, make results like these possible.

Your hard work and focused efforts for customers are the driving force behind CMC's success. I will start today's call with a few comments on CMC's first quarter performance, and then discuss the rationale behind the realignment of our reportable segments, and then provide an update on the current market environment and our strategic growth investments. Paul will cover the quarter's financial information in more detail, and I will conclude with our outlook for the second fiscal quarter and beyond. We will then open the call to questions.

Additional information regarding the quarter is provided in the supplemental slides that accompany this call, which can be found on CMC's investor relations website. Before commenting on CMC's financial performance during the quarter, I would like to highlight our exceptional safety performance. Our incident rate was the best on record, meaning we work safer than ever before. Keeping our employees safe is a core tenant of our culture and priority No.1 for every team member from the shop floor to executive leadership.

Performance in the first quarter demonstrates how seriously we take this responsibility. Despite records being set, there is more work to be done to push forward our ultimate goal of zero incidents. As I mentioned, CMC's first quarter financial results were among the strongest in our company's history, though down from recent record levels. CMC generated net earnings of 176.3 million, or $1.49 per diluted share, on net sales of 2 billion.

Excluding the impact of nonoperational items, which Paul will cover in detail, adjusted earnings were 192.7 million, or 1.63 per diluted share. CMC generated consolidated core EBITDA for the quarter of 325.3 million, producing a core margin of 16.2%, and an annualized return on invested capital of 14.9%. Results in our North America steel group were supported by healthy construction activity and near record margins on downstream products. Our Europe steel group performed well against a difficult market backdrop, benefiting substantially from the recognition of 66.3 million related to energy cost rebate programs.

The emerging businesses group was a solid contributor to profits during the quarter, driven by supportive conditions in our North American markets, customers continued adoption of our high-margin proprietary solutions, and the recent acquisition of EDSCO Fasteners' industry-leading portfolio of anchoring systems. I would like to next cover the recent realignment of CMC's reportable segments. This decision follows important changes we have made to our organizational structure to better facilitate the execution of our strategy. From a financial point of view, our objectives are to drive higher through-the-cycle margins and accelerate value-accretive growth.

The new structure also better reflects the varying characteristics and needs of our business groups. Internally, we believe these changes will greatly enhanced visibility into our key value drivers, helping unlock commercial and operational synergies across the business, optimize capital resource planning, and better focus our decision-making on value creation. Externally, CMC's realigned segment reporting should provide enhanced insights into the factors that drive value creation across the company and enhance the investment community's understanding of our strategy, future growth plans and capital allocation. Slide 5 of the supplemental presentation offers a brief outline of the strategic focus for each business group.

Our North America and Europe steel groups operate in large, more mature markets where they have a high degree of penetration and strong positions. Their primary focus areas will be operational and commercial optimization to produce higher through-the-cycle margins with less volatility and value-accretive growth that strengthens our core operations and enhances CMC's customer value proposition. The businesses in our emerging businesses group, or EBG, while often serving mature markets ,can bring innovative solutions with relatively low levels of penetration that typically have higher, more stable margins. As an example, we estimate current penetration of CMC's Tensar Geogrid solutions is around 10% to 15% of the addressable market with margins that are higher than our overall Group margins.

Our new structure will provide the attention and stewardship to these businesses to enable them to realize their full potential in the CMC portfolio. Accordingly, we expect that overtime, EBG will grow faster and maintain higher through-the-cycle margins compared with the more mature steel groups, driven by an increasing levels of market penetration, commercial synergies across our portfolio, organic investments, and acquisitions. A key role of EBG will be to strengthen our core steel business through the creation of commercial solutions that enhance the value of our steel offerings to customers. In summary, we are excited about what these organizational and reporting changes will mean for the future of CMC.

We believe tremendous value can be realized overtime by optimizing how we manage each group and by working as a group to strengthen CMC's commercial proposition. We are committed to providing updates on the evolution of this strategy over time. Turning now to CMC's markets in North America, construction activity remained healthy during the first quarter, providing a good demand environment for our reinforcing products. Total finished steel volumes increased on a year-over-year basis, as did combined rebar shipments from our mill and downstream operations.

Activity levels across our geographies and into our various customer groups were consistent with recent quarters. Overall, the seasonal volume pattern was normal. Last quarter, we discussed the pressure that increased import competition exerted on CMC's steel product margins. This trend continued during much of the first quarter, but has since abated.

We expect that recent developments, including domestic price announcements and higher global rebar pricing, will support an inflection in steel product margins over the next few months. Turning to key external forward-looking indicators, the indices we track point to stability in nonresidential construction overall and the likelihood of increasing levels of infrastructure activity in the quarters ahead. The Dodge Momentum Index, which measures the value of nonresidential projects entering the planning phase, generally leads on-the-ground activity by approximately 12 months. While off highs above 200, it has registered four consecutive months of stability around 180, which is still within the top decile of all historical readings.

On the infrastructure side, the value of projects in pre-design and design phases reflects by strong multiyear pipeline of future work. Data provided by Dodge Analytics indicate, that projects in these stages of development increased more than tenfold during the three months ended in November compared to the same period of the prior year. This indicator has a long-lead time, because once the project has been designed, it generally moves to budgeting, funding, and letting phases. It is in the letting phases that contracts are awarded, resources are scheduled, and on-the-ground activity can begin.

The Dodge Analytics data has now been running at an elevated level for the past nine quarters. We are seeing average increases in State Department of Transportation budgets of around 15% and continued strong growth in highway contract awards. We expect this to drive increasing infrastructure activity during the upcoming construction season. Although the construction pipeline is robust, we have continued to experience a slower rate of contract awards.

This, in turn, has caused some reduction to the volume and the value of CMC's quarter ended downstream backlog, which declined 13% by volume compared to the prior year. We believe this weakness is temporary and would note that we saw a pickup in award activity during December. Looking beyond these near-term dynamics, we remain very confident in the long-term outlook for our business, which is driven by powerful structural trends that are remaking much of our economy, and will bolster construction activity for years to come. Enormous investments have been announced with some already underway to improve our nation's transportation infrastructure, reassure vital manufacturing, electrify vehicle fleets, and upgrade the electrical transmission grid to facilitate the transition to renewable energy.

As seen on Slide 8, we estimate that these structural trends could lead to incremental rebar consumption equal to 20% or more of the current domestic market. So, even with the challenges in some areas of construction, such as office, retail, and hospitality, we anticipate higher overall rebar demand over a multiyear period. Additionally, the benefit won't be limited to rebar. We also expect a meaningful tailwind for many of the value-added solutions within our emerging businesses group.

I'll now turn to Europe, where market conditions remain challenging. Sluggish demand put pressure on pricing and margins during the quarter. General economic uncertainty continues to negatively impact sentiment and activity levels across our construction and industrial end markets. The Polish long steel industry has responded to market imbalances by meaningfully reducing production and right-sizing inventory levels.

These supply side adjustments appear to be having an impact as long steel pricing has begun to rebound from the lows reached in our fiscal first quarter. Since our last earnings call, two potentially meaningful green shoots have appeared. The first is a rapid increase in new mortgage originations driven by a government program to assist first-time homebuyers. The value of new mortgages taken out in October improved fourfold from the calendar 2023 low and approached all-time highs.

Higher new loan activity since late summer should support Polish residential construction over the next several quarters. The second development is the likely release of approximately $60 billion of European Union COVID relief funds that were held due to disputes with the prior government. Following the Polish elections held in mid-October, the roadblocks have been cleared for receipt of the funding. In fact, 5 billion has been already released to projects in Poland.

Much of this package is earmarked for renewable energy and the modernization of infrastructure, and it should begin impacting construction activity within the next 12 months. The environment in Europe is currently difficult, but we expect that it will normalize. Given our view of market conditions and the steps we have taken to optimize costs, we expect that beginning with the spring construction season, operational EBITDA for our Europe steel group should improve sequentially for the remainder of fiscal 2024. Market conditions for the emerging businesses group were supportive during the quarter, benefiting from good levels of construction in North America, where we derived nearly 90% of our net sales.

Activity remains slow within our European markets, primarily due to the impact of economic uncertainty on construction activity in the region. Encouragingly, across our global footprint, we continue to see increasing adoption rates for CMC's newest and highest margin Tensar Geogrid solution, driven by a superior customer value proposition that reduces project costs and extends asset life. Growing investment in infrastructure, renewable energy, and electricity transmission capacity have supported demand for EBG's soil stabilization, performance-reinforcing steel, and anchoring system solutions. Before turning the call over to Paul, I would like to provide a brief update on CMC's key strategic projects, where we made significant progress over the quarter.

First, after a successful summer start-up, production levels at our new state-of-the-art Arizona 2 micro mill have increased each month and are now routinely setting new daily output records. The team has done an exceptional job commissioning a very technologically advanced operation. However, the learning curve has been more extended than we originally anticipated. We now expect to produce approximately 250,000 tons in fiscal 2024 compared to our previous guidance of 400,000 tons.

As a reminder, we are targeting 500,000 tons of output at a full run rate, consisting of 350,000 tons of rebar and 150,000 tons of merchant product. Currently, the mill is focused on increasing rebar production and will begin commissioning merchant products early in calendar 2024. We anticipate monthly EBITDA break-even for AZ2 by the end of the third quarter. Work at CMC's future steel West Virginia site is progressing well.

Civil work is nearly complete after which we will begin setting foundations. We expect to begin commissioning this exciting project in late calendar 2025. Finally, we have successfully integrated a number of recent acquisitions, which extend our operational and commercial capabilities and further our strategic position. CMC's mill projects along with our recent strategic bolt-ons, broaden our exposure to favorable structural trends powering domestic construction, and are expected to drive strong future growth in earnings, cash flow, and shareholder value.

With that, I will now turn the call over to Paul for more detail on our financial results.

Paul Lawrence -- Senior Vice President, Chief Financial Officer

Thank you, Peter, and good morning to everyone on the call. As noted earlier, we reported fiscal first quarter 2024 net earnings of 176.3 million or $1.49 per diluted share, compared to the prior year levels of 261.8 million and $2.20 respectively. Results, this quarter include net after-tax charges of 16.4 million related to the ongoing commissioning efforts at Arizona 2. Excluding these items adjusted earnings were 192.7 million or $1.63 per diluted share in comparison to adjusted earnings of 266.2 million or $2.24 per diluted share during the prior-year period.

Core EBITDA was 325.3 million for the first quarter of 2024, representing a decline from recent levels, but still among the most profitable quarters in CMC history. Slide 11 of the supplemental presentation illustrates the year-to-year changes in CMC's quarterly results. Financial performance at our North American Steel and Europe Steel groups declined from the prior year, while results of the emerging business group were largely unchanged. Consolidated core EBITDA margin of 16.2% remained well above average historical levels.

Before reviewing our segment results, I would like to make a few comments on how CMC will report and discuss each group. For both the North America steel group and the Europe steel group, we will continue providing the same operating statistics as we did under the previous segmentation. You can find the recast figures on our investor relations website. We view these metrics as offering valuable insight into the factors that drive these businesses, including selling prices, margins over scrap and product volumes.

We will also begin highlighting adjusted EBITDA margins as a percentage of net sales to support our focus on higher through-the-cycle margins across our businesses. The two key metrics for the emerging business group are net sales and EBITDA margins. As Peter mentioned, we expect faster growth from this segment over time and a fundamental measure of our success will be the ability to increase top-line performance in an EBITDA and value-accretive manner. Given the high-value-add proprietary nature of the solutions offered by EBG, we anticipate EBITDA margins will be higher and more stable relative to traditional steel industry levels.

With that, I will now review our segments for the first quarter of fiscal 2024. CMC Steel Group generated adjusted EBITDA of $266.8 million for the quarter, equal to $243 per ton of finished steel shipped. Segment-adjusted EBITDA decreased on a year-over-year basis, driven primarily by a lower steel product margin over scrap costs, as well as higher costs related to the operational start-up of Arizona 2. The adjusted EBITDA margin for the North American steel group of 16.8% compares to 21% in the prior-year period.

Turning to slide 13, of the supplemental deck, our Europe steel group reported adjusted EBITDA of 38.9 million for the first quarter of 2024 compared to 61.2 million in the prior-year period. The decline was primarily driven by a lower margin over scrap costs and a 27% reduction in shipment volumes. Partially offsetting these headwinds was the recognition of energy rebates totaling $66.3 million during the quarter. Of these, 27.7 million is related to an annual CO2 credit under a government program that extends to 2030.

And the remaining $38.6 million is structured as a reimbursement by the Polish government for elevated energy costs incurred during the European energy crisis. The prior-year period includes 9.5 million related to the annual CO2 program. The first quarter adjusted EBITDA margin for the Europe steel group of 17.3% compares to 15.8% in the prior-year period. Despite lowering production levels to meet demand, controllable costs benefited from lower energy costs during the quarter.

The emerging business group first quarter net sales of 177.2 million decreased 3.9% from the prior-year period, driven largely by the addition of anchoring systems, previously called EDSCO Fasteners. Demand conditions were generally positive during the quarter, with relative strength in North America and a weaker environment elsewhere. Construction activity in the United States drove solid demand for Tensar Geogrid solutions, construction services, anchoring systems, and performance reinforcing steels. Adjusted EBITDA for the emerging business group of 30.9 million during the first quarter was flat compared to the prior-year period.

The adjusted EBITDA margin of 17.4% represented a decline of 100 basis points as a positive impact from the addition of CMC anchoring systems and the benefit of improved adoption rates for the proprietary geogrid solutions in North America were offset by lower construction activity in Europe and the Middle East impacting our geogrid business outside of North America. Turning to the balance sheet, moving as of November 30th, cash and cash equivalents totaled 704.6 million. In addition, we had approximately 820 million of availability under our credit and accounts receivable facilities, bringing total liquidity to just over 1.5 billion. During the quarter, we generated 261 million of cash from operating activities.

Our free cash flow amounted to 194.1 million, defined as our cash from operations, less 67 million of capital expenditures. Our leverage ratios remain attractive and have improved significantly over the past several fiscal years. As can be seen on Slide 18, our net debt-to-EBITDA ratio now sits at just 0.3 times with no maturities until 2030. We believe our robust balance sheet and overall financial strength provide us flexibility to finance our strategic organic growth projects and pursue opportunistic M&A while continuing to return cash to shareholders.

CMC's effective tax rate for the quarter was 21.6% due to the release of evaluation allowance. Looking ahead for the remainder of fiscal 2024, we currently expect an effective tax rate of approximately 24% with a rate slightly higher in the second quarter. Turning to CMC's fiscal 2024 capital spending outlook, we reiterate our previous guidance of between 550 million and 600 million in total. Outside of normal sustaining investments, anticipated expenditures in fiscal 2024 include substantial capital dollars for the construction of steel West Virginia of approximately 250 million.

Lastly, CMC repurchased nearly 622,000 shares during the fiscal first quarter at an average price of $45.70 per share. Transactions since the initiation of the buyback program through the first quarter have amounted to approximately 292 million, leaving 58 million remaining under our current authorization as at November 30th, 2023. This concludes my remarks, and I'll turn the call back to Peter for additional comments on CMC's financial outlook.

Peter Matt -- President and Chief Executive Officer

Thank you, Paul. We expect shipment volumes within our North America steel group to decline sequentially due to normal seasonality during the winter months. Margins on steel products are likely to experience some further compression during the second quarter. However, recent price announcements on rebar, merchant bar, and wire rod should support an inflection point in the coming months.

Downstream product margins should exhibit good stability sequentially. Conditions in Europe are expected to remain challenging, but adjusted EBITDA excluding energy rebates should improve from the levels of the past two quarters. Financial results for our emerging businesses group are anticipated to follow a typical seasonal pattern with some slowing of activity in Q2. Looking beyond the second quarter, which is CMC's seasonally slowest period, we expect robust spring and summer construction activity, driven by the increased impact of rising infrastructure investment, which should support an already healthy demand backdrop.

Both the North America steel group and the emerging businesses group should benefit from anticipated strong activity levels. Regarding the Europe steel group, supply side adjustments and the impact of increasing levels of residential and infrastructure construction should drive sequential improvement in financial results beginning with the spring construction season. It's an exciting time for CMC. We believe the realignment of our organizational and reporting structure will allow us to better execute our key strategic priorities and harvest significant value for shareholders.

Powerful structural trends in North America should drive construction activity for years to come, and CMC has positioned itself as a key beneficiary. Additionally, the green shoots emerging in Poland and our strong cost position should provide an opportunity for results to rebound going forward. Once again, I would like to thank our customers for their trust and confidence in CMC and all of our employees for delivering yet another quarter of very solid performance.

Questions & Answers:

Operator

[Operator instructions] Today's first question comes from Phil Gibbs with KeyBanc Capital Markets. Please go ahead.

Phil Gibbs -- KeyBanc Capital Markets -- Analyst

Hi, good morning.

Peter Matt -- President and Chief Executive Officer

Hi, Phil.

Paul Lawrence -- Senior Vice President, Chief Financial Officer

Hi, Phil.

Phil Gibbs -- KeyBanc Capital Markets -- Analyst

In terms of the scrap market for January, there's been a lot of mixed news on the market over the last couple of weeks. Just curious in terms of what you all are seeing for your key consuming grades.

Peter Matt -- President and Chief Executive Officer

Yeah, so thank you, Phil, for the question. We have kind of heard and anecdotally seen some of this weakness and, honestly, not a huge surprise for us given the rapid run-up that we've seen, you know, kind of over the last several months in scrap. I think it's important to say that, you know, as it relates to the price increase that we announced, which I think may be part of what you're getting at, the move-in scrap -- the price increase that we announced did not fully cover the move that we've seen in scrap. And the move-in scrap was kind of part of what motivated our move on price, but only part.

And the other part was the strong demand that we're seeing in the market. So, in spite of the kind of potentially sideways movement in scrap, we remain very confident in the kind of pricing position that we've taken and our ability to kind of hold onto it and build on it

Phil Gibbs -- KeyBanc Capital Markets -- Analyst

Thank you. And then as it relates to capex, you said your outlook there was intact. You had 250 million related to West Virginia. How much is left over to spend for West Virginia in 2025 and beyond -- fiscal '25 and beyond? And what's your sustaining capex with all the investments you've made?

Paul Lawrence -- Senior Vice President, Chief Financial Officer

Yes, Phil, as far as our capex, our guidance typically is that our capex, our maintenance capex, which is a pretty liberal definition of anything not significant enough to call out, is around 250 million per year. This year, you know on top of that, we've got the finishing off of the investments in Arizona, too, as well as the West Virginia spend. So, we anticipate, given that we anticipate starting up West Virginia late 2025, that next year's spend will be somewhat similar to this year in West Virginia, and then possibly finishing up a little bit into 2026.

Phil Gibbs -- KeyBanc Capital Markets -- Analyst

Thank you.

Peter Matt -- President and Chief Executive Officer

Thanks, Phil.

Operator

Thank you. The next question is from Timna Tanners with Wolfe Research. Please go ahead.

Timna Tanners -- Wolfe Research -- Analyst

Hi, guys. Good morning, and Happy New Year. I wanted to just kind of ask a little bit more about capital allocation. Just because of the stark reduction in your debt, you point out really nicely on Slide 18, you kept the dividends flat.

I think some of us were expecting that you might have raised that. And your cash is running above 10, at least for the last six quarters. So, can you talk to us a little bit more about how you're seeing opportunities in M&A versus organic? You said you're not going to build any more steel mills after these next ones, which sounds good. What else are the types of opportunities that you might be looking at for uses of cash?

Peter Matt -- President and Chief Executive Officer

Yeah, so thank you for the question, Timna. I mean, we continue to plan a balanced capital allocation strategy, and that's going to include, given our balance sheet condition is very good, it's going to focus on really growth and then returns to shareholders. We have -- on the growth side, obviously, we've got the -- you know, West Virginia project that we're in full course on at this point in terms of getting that spending ramped up. And there are, you know, kind of other smaller organic projects around the company that we're also investing in at this time.

On the M&A side, we see a lot of different opportunities, and we're doing a lot of work around strategy to figure out, you know, precisely where our priorities are, because we want to make sure that the M&A growth that we do pursue is M&A growth that is, number one, complementary to the core; and, number two, growth where we can generate returns in excess of our cost of capital. But we do see a decent amount of M&A opportunity out there, and we're just going to be kind of disciplined about doing that. As it relates to returns to shareholders, we did increase our share buyback in the most recent quarter. You'll note, as others have noted, that we are coming to the end of our authorization on share buybacks.

And I would say this is a topic that we discuss on a regular basis with our board, so I would stay tuned on share buybacks as an overall piece of the pie. And on dividends, again, we periodically review the dividend, and we'll continue to do that. But overall, the strategy is balanced capital allocation between kind of growth and return of capital to shareholders.

Timna Tanners -- Wolfe Research -- Analyst

OK, great. Thanks for that comprehensive answer. I know I threw a lot in that last question. Just the next one is a little, hopefully, smaller one.

We have seen the pace of government awards and highways slow down a bit, and I know you alluded to that in your commentary. Can you give us a little more color on what's driving that? Is that just tough comps? Is that resources availability? Is it anything to be cautious about, or is it just kind of the normal cadence after a big -- big spending program coming through?

Peter Matt -- President and Chief Executive Officer

Yeah, we actually feel very confident about where we are on government awards, and actually we've seen government awards continue at a healthy pace here. What I'd say is just kind of taking a couple steps back, if you look at infrastructure spending, infrastructure spending grew in 2023. We expect, and all the other prognosticators expect, that it's going to grow in 2024. And we can see, both in the form of kind of the pipeline of projects and the design and pre-design phase, significant increases that have been significantly increased over, you know, the last literally nine quarters.

So, that, we think, is kind of evidence that there's more coming through the pipeline. And lastly, what we're seeing is state budgets are growing at a healthy rate. And we commented in the prepared remarks that they're up about 13% on average. And we believe we are seeing some of the IIJA money coming through now.

Remember, it's a little difficult to see precisely when it comes because the funds are commingled with state monies, but we do believe we're starting to see that, and we believe that's going to grow over the course of 2024. And one thing that I'd also kind of point out on IIJA is, remember, the way the program is structured, every year there's a grant, but it doesn't necessarily mean that the spend in that year is the same. So, over the course of the program, we believe you're going to see kind of an escalating level of spending. So, we continue to be very bullish on what infrastructure means for our business and the demand for rebar.

Operator

[Operator instructions] The next question comes from Alex Hacking with Citi. Please go ahead.

Alex Hacking -- Citi -- Analyst

Yeah, hi. Good morning. On the emerging business group, which you've highlighted that you see that growing faster than everything else, are there any long-term targets there for how big you want that business to ultimately get, either in absolute terms or as a percentage of the total company? Thanks.

Peter Matt -- President and Chief Executive Officer

Yes, thanks, Alex. Good question. We're very excited about the potential of the emerging businesses group. I think it's premature at this point to kind of articulate a specific target for where we think it will be.

What we like about that business, as we said, is it tends to have -- the businesses in there tend to have solid organic growth rates, they tend to have higher margins, and they tend to have less volatility, all of which will be, you know, kind of helpful in the overall financial profile for our company. So, it's an area that we intend to grow, we want to grow. But coming back to my comment on M&A, we've got to be disciplined about how we grow, and that means that we've got to be comfortable that we can generate returns in excess of our cost of capital in the moves that we're making in that space. We are very optimistic that we can do that, so we're confident that you're going to see some nice growth in that segment.

But it's a little bit premature to call it specifically. What I would say is that our expectation is that it will be a significant contributor to our earnings and cash flow if you look out, you know, kind of three, five years.

Alex Hacking -- Citi -- Analyst

OK, thanks. And then, something a bit more discreet. The European cost rebates, energy rebates, given where energy prices are today, do you have any estimate of what kind of rebate you would expect at the end of this year? Thanks.

Paul Lawrence -- Senior Vice President, Chief Financial Officer

Yeah, Alex, it's a good question. So, there's two separate programs, as I outlined, that we received. The first relates to the cost of CO2 credits that's embedded in the underlying energy costs that the operation pays, and that is most closely tied to the CO2 credit costs themselves. And given that the demand over time is expected to continue to increase for those credits, we expect that that credit is likely to remain at the level it is today or increase.

The other credit was in relation specifically to higher cost energy, and you're correct as you state that energy costs have come down from their peak. They're still elevated, and so while the program itself was simply for 2023, and we have received the full amount of that. It could be that the new government that comes in place puts a further program in place should the energy costs continue to remain elevated and uncompetitive with other geographic jurisdictions.

Alex Hacking -- Citi -- Analyst

OK, thanks. So, just to clarify, the CO2 program is still in place and is sort of linked to the market price of CO2 credits, and the energy rebate program is now gone, but potentially could be replaced?

Paul Lawrence -- Senior Vice President, Chief Financial Officer

That's correct. The CO2 is in place through 2030.

Alex Hacking -- Citi -- Analyst

OK, perfect. Thank you.

Operator

Thank you. The next question is a follow-up from Phil Gibbs with KeyBanc Capital Markets. Please go ahead.

Phil Gibbs -- KeyBanc Capital Markets -- Analyst

Thank you. What's the length of your fabrication backlog right now if you think about it in terms of months or quarters?

Peter Matt -- President and Chief Executive Officer

Yeah, I mean the fabrication backlog tends to run with a duration of about 12 months, and that's kind of, you know, a weighted average duration. That's, I think, a good level for where it is today.

Phil Gibbs -- KeyBanc Capital Markets -- Analyst

And then, as you talk about the typical force or normal seasonality associated with the second quarter versus the first quarter, what is that in your mind? Is that 5%? Is that more or less?

Paul Lawrence -- Senior Vice President, Chief Financial Officer

Yeah, Phil, typically because of the weather and the slowdown in construction activity that occurs, usually it's between 5% and 10% of a reduction in volume. The volumes in the first quarter were relatively strong in relation to other seasonal impacts, so we would expect somewhere in the middle there, around a 7% reduction in volume. Now, that all depends on what weather occurs. So far, December was a very strong month from a construction activity despite the holidays.

However, I think there's an arctic blast coming through affecting much of the U.S. this week, and so we'll see what happens over the remainder part of the quarter.

Phil Gibbs -- KeyBanc Capital Markets -- Analyst

And when you talk about this 5% to 10%, is that for U.S. mills and U.S. fabrication?

Paul Lawrence -- Senior Vice President, Chief Financial Officer

Correct. Yes, as well as the EBG businesses which are construction-oriented.

Phil Gibbs -- KeyBanc Capital Markets -- Analyst

And then lastly, depreciation, as you guys noted and carved out, stepped up pretty solidly, I would think, based on your disclosure, that it was largely for AZ2. But is that a good level to be using moving forward, that stepped-up rate that we saw in Q1?

Peter Matt -- President and Chief Executive Officer

Yes, that reflects both the AZ2 depreciation, as well as the acquisitions that we did throughout 2023.

Phil Gibbs -- KeyBanc Capital Markets -- Analyst

Thank you.

Paul Lawrence -- Senior Vice President, Chief Financial Officer

Thank you.

Operator

At this time, there appears to be no further questions. Mr. Matt, I'll now turn the call back over to you.

Peter Matt -- President and Chief Executive Officer

OK, well thank you for joining us on today's conference call. I just want to say in conclusion, CMC has positioned itself to take advantage of the wave of construction spending underway. And in this environment, we're confident in our ability to drive higher through the cycle margins and generate excess returns from our growth initiatives. We look forward to speaking with many of you during our investor calls in the coming days and weeks.

Thank you very much.

Operator

[Operator signoff]

Duration: 0 minutes

Call participants:

Peter Matt -- President and Chief Executive Officer

Paul Lawrence -- Senior Vice President, Chief Financial Officer

Phil Gibbs -- KeyBanc Capital Markets -- Analyst

Timna Tanners -- Wolfe Research -- Analyst

Alex Hacking -- Citi -- Analyst

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