Gerdau S.A. Q3 FY2020 Earnings Call

Good afternoon, and welcome to Gerdau’s conference call to discuss the results of the third quarter of 2020. At this time all participants will be in listen-only mode and later on we will initiate the Q&A session. We would like to emphasize that any forward-looking statements that might be made during this conference call relate to Gerdau’s business outlook. Projections and financial and operating goals are mere assumptions based on management’s expectations related to the future of the company. Even though Gerdau believes that its comments are based on reasonable assumptions, there is no guarantee that future events will not affect this evaluation. Here today are Mr. Gustavo Werneck, Director, President and CEO; and Harley Scardoelli, Vice President and CFO. Now I would like to turn the floor over to Mr. Gustavo Werneck. You may proceed, sir.

Well good afternoon, everyone. I would like to begin by welcoming each one of you to Gerdau’s conference call on the results of the third quarter of 2020. I really hope that you are all well, in good health, and safe, making it through this period as best as possible. Also present here today is our CFO, Harley Scardoelli. For both of us, it is always a pleasure to talk to you about our performance, clarify possible issues, and answer questions that may come up during this presentation. Scardoelli will then start by talking about the highlights and the general results of the quarter and also about the performance of our operations. Next, I will refer to the markets where we operate and talk about the landscape looking forward. At the end, we will both be available to answer your questions. So now, Scardoelli, the floor is yours.

Thank you, Gustavo, and good afternoon, everyone. It is a great pleasure to be with you once again for another earnings release, and I hope you are all well. I will start with the financial results for the third quarter of 2020. As you can see on this slide, free cash flow in Q3 of this year was positive by BRL2.3 billion. This increase versus the second quarter of 2020 reflects a combination of an EBITDA 62% higher than in Q2 and lower working capital attributed to the return to less than 70 days of cash conversion cycle. It is also important to mention that in the last 12 months, the company posted positive free cash flow, around BRL4.4 billion, reinforcing its liquidity position. The cash conversion cycle went from 95 days in June 2020 to 63 days in September of this year, thus optimizing working capital after the effects of the COVID-19 pandemic, promoting a reduction in inventories during the period, combined with days payable increasing more than days receivable, reflecting the recovery in economic activity and good conditions for payment terms. Now, moving to Slide 3. I would like to emphasize that at the end of the third quarter of this year, our net debt came down to BRL12.3 billion. I also take this opportunity to mention that 89% of this debt is long-term, with an average tenor of 7.7 years at an average nominal cost of approximately 5% with a well-balanced amortization schedule distributed along the coming years. Currently, 85% or BRL16.5 billion of the debt is denominated in U.S. dollars. We understand that with a significant portion of our EBITDA being generated in U.S. dollars and with a large part of our assets and operations located in North America, due to our geographic diversification, we have a natural hedge to support this debt position. In addition, this is long-term debt with maturities staggered over this period with no overlapping of commitments in any given year. Even so, we have been monitoring the Brazilian debt market to detect possible windows of opportunity to rebalance our exposure. The net debt over EBITDA ratio went from 2.78 times in Q2 of 2020 to 2.07 times in the third quarter of the year due to higher EBITDA in the last 12 months. The company remains focused on reducing leverage and reaching the indicators defined by the Board, which is between 1.0 to 1.5 times the net debt over EBITDA in the long range. Moving to Slide 4, we will now highlight the main factors that impacted the consolidated EBITDA, which went from BRL1.3 billion in Q2 of 2020 to BRL2.1 billion in the third quarter. This increase was partially attributed to higher shipments to the domestic market in Brazil, good levels of demand in North America, and improved results in South America. EBITDA margin was also positively impacted, reaching 17.5%, with a margin of 25.1% in Brazil. It is also important to stress that the Company’s discipline regarding SG&A reached 3% this quarter, the lowest historically ever posted by Gerdau, with a direct positive impact on the EBITDA margin. In Brazil, EBITDA was higher due to an improved market mix. Shipments to the domestic market when compared to total shipments went from 73% in Q3 2019 to 86% in Q3 2020. I also take this opportunity to mention the increase of total shipments in Q3 versus the previous quarter due to the vigorous rebound in construction, both retail and direct sales to construction companies, in addition to the recovery of the industry and the domestic market. In North America, EBITDA in Q3 2020 was higher quarter-on-quarter due to resilient shipments and efforts to optimize costs despite the metallic spread reduction that went from US$415 per short ton in the second quarter of this year to US$402 per short ton in Q3 of this year. Additionally, margins of this operation were above 10%. In South America, good results stem from the strong demand from the civil construction industry, mainly in Peru and Argentina, also considering the unsatisfied demand from the second quarter of this year when some projects were shut down during the pandemic period. To conclude, in the special steel division, the rebound came from the automotive sector with a positive impact on EBITDA. For almost four months, this industry was heavily affected by the negative impact of the pandemic. In Q3 of 2020, things started to recover volumes, and as a consequence, the capacity utilization rate was 30% in Q2 of this year, and it is now at 50%. Thank you all for your attention, and now I will give the floor back to Gustavo, who will comment on the market outlook.

Thank you, Scardoelli. So please, let’s go to the next slide, where we will talk about how Gerdau has operated throughout this year of 2020. Scardoelli talked about Gerdau’s performance in the third quarter, and we continue to post solid results. I would even tell you that acting quickly to resume our industrial operations and the fact that we were very close to our customers allowed us to serve all the different markets where we operate globally, amid a robust rebound in steel demand, after a period of great uncertainties and volatility brought about by the COVID-19 pandemic, as you have also been experiencing. I would also like to say that in the last few months, we were also able to accelerate the pace of our digital transformation strategy, which resulted in an increased number of quotes on our website from 14,000 back in January to 50,000 in September, thus reinforcing our commitment to generate greater value for our commercial partners. Moving to the next slide, I will talk about the markets operated by Gerdau and also share the outlook moving forward. In Brazil, we are now reaping the benefits of having an anticipated and constructive view about the rebound in different markets we serve, especially in the construction industry, which is showing clear signs of a V-shaped recovery, driven by increased sales of properties and retail. With the speedy and gradual restart of all of our industrial units in the country in the second half of April, meaning less than a month after the onset of the pandemic, including the resumption in July of the blast furnace two in Ouro Branco in Minas Gerais, our team was able to diligently serve all of our markets and sectors where we operate. This agility to resume operations after a strong effort to adjust our production capacity, as I said at the end of March, combined with a rebound effect of repressed demand seen in the second quarter led us to increase production volumes and long steel shipments in the third quarter, compared to the pre-crisis period and even similar periods of the last few years. There is vigorous recovery of the construction industry in Brazil, especially between July and September, benefiting not only from its growth trajectory but also from the resumption of several projects that had been interrupted or slowed down in the second quarter. These led companies in the industry to accelerate their project pace to compensate for this delay, which in turn boosted steel consumption. We monitor an indicator from C&I called the construction activity index. This index evolved quite a bit, showing the construction activity at 51.4 points in September, meaning that it was 3.3 points higher compared to July. This 51.4 index is the highest rating since June of 2009, indicating a significant improvement when compared to the previous month. The third quarter was also impacted by a strong movement to replenish inventories in the construction chain as a whole, as the sector suffered a significant reduction in inventory levels in the second quarter due to all of the market uncertainties. I think it is worth mentioning the continued progress in the retail segment, which has shown impressive growth, mainly boosted by sales of construction materials to self-builders who received emergency aid from the federal government. According to the last monthly trade survey conducted by IBGE, the retail market for construction supplies experienced its third consecutive sales volume growth. It was 3.6% above July and 24.1% higher than what was posted in August 2019. Year to August, it shows a 4.9% sales increase compared to the same period of 2019. Also, I think it is worth noting that different industrial segments in Brazil resumed their growth trajectory after a sudden interruption in March and April when most of them restarted their production at levels equal to or higher than those posted early in the year. I would like to highlight, in particular, the sectors related to agribusiness, energy, and durable goods. Similar to what we saw in the construction industry; we also experienced an important movement towards replenishing inventories in the industrial market. The industry confidence index from Fundação Getulio Vargas is something that we monitor very closely and advanced eight points in September, reaching 106.7 points, the highest level since January 2013, which again reinforces the recovery outlook. Now looking forward, we are very confident that the demand for long steels in Brazil will be maintained, reflecting the increase in sales of new properties, retail purchases, and also infrastructure projects. For instance, in terms of infrastructure, we already saw the restart of important projects like the subway in São Paulo and Fortaleza as well as bridges and overpasses around the country. We are also very optimistic regarding the new legal framework for basic sanitation. Now as for the industrial sector, our outlook is also very positive for 2021. A recent survey conducted by C&I indicates that the confidence rate of industrial entrepreneurs increased in all 30 sectors of the industry considered in the survey. This indicator for the downstream industry rates 62.6 points, a leap of 51 points in the monthly comparison. I would also like to stress that the continuous growth of steel demand in Brazil relies on solving the structural problems of the country in the long run. This also includes the evolution of the reforms proposed by the government, like the tax and administrative reforms, plus other measures to boost the economy and increase competitiveness and productivity in the industrial sector. Now, I will talk about our special steels operation, focusing on Brazil, especially during the Q&A session. Starting with Brazil, I think the demand recovery in the automotive industry was intensified during the third quarter after four months of a significant drop in consumption, resulting in relevant growth in the orders portfolio. Because right now, we are seeing a growth in the number of orders. Despite the positive outlook, automakers are still operating at lower levels compared to early projections for the year. According to the National Association of Automotive Manufacturers, ANFAVEA, the daily average production for new vehicles was 9,900 vehicles year-to-date September against 11.2 in 2019. Just to illustrate this point, in the worst moment of the crisis in April, only 1,847 vehicles were produced that entire month. In the following months, the performance of the automotive industry will be supported by positive performance in the wind farming and agricultural sectors. We will remain very diligent to capture opportunities to increment domestic production of auto parts due to this new market dynamics following the crisis. In terms of the U.S., the demand for special steels, especially in the automotive industries, is also growing in the second half of the year, thus contributing to an increase in vehicle sales and by the end of 2020, the industry should produce over 14 million units. The country continues to post a lower level of activity in the oil and gas industry. However, in terms of other sectors like agriculture, they have been quite resilient despite the crisis. Moreover, we remain focused on our initiatives to increase productivity in the special steel units in the United States, with the shutdown of the Jackson unit in Michigan and the transformation of the Monro unit in that same state into a world-class mill that will be a global reference in technology and productivity. This mill is being prepared to fulfill the future demand for steel. Now we will talk about long steels in North America. I would like to start by highlighting that the volumes for this operation remained very high during the third quarter since manufacturing and construction industries performed well. Another important index is the architectural building index, which anticipates the performance of the non-residential construction sector in the U.S., which went from 40 points in August to 47 points in September, even above pre-pandemic levels. On the other hand, the metallic spread had a slight decline in the quarter, reaching close to US$400 per short ton, but we believe that there should be a recovery in the coming months, returning to previous levels of approximately US$415. Also, I would like to highlight our relentless initiatives to reduce costs and improve performance, including the shutdown of the St. Paul unit in Minnesota. Now looking forward, we see a positive outlook not only for the construction industry but also for the industrial sector. We are also closely monitoring the unfolding of the presidential election in the U.S., which will take place in early November, and we hope that the significant investments in infrastructure are finally released in 2021. Moving to South America, I would like to highlight the rebound of the industrial and civil construction sectors, especially in Argentina and Uruguay, and significantly in Peru, with sales performance in their respective domestic markets being quite strong, particularly during this third quarter. Finally, to conclude this slide, I would like to say that we invested BRL360 million in plant property and equipment in this third quarter, as part of our BRL1.1 billion of investment during the first nine months of the year, with a total investment estimate of BRL1.6 billion for 2020. Now let’s jump to the next slide. Here I would like to mention the establishment of Ventures Gerdau, the recently created startup for Gerdau Next, our new business arm, which I mentioned to you before. In October, we ran the first batch of the accelerator focusing on entrepreneurship in the civil construction industry. By doing so, we connected with the main global innovation ecosystem and with Consta, seeking to generate value and propose solutions to our own sector. Furthermore, I would like to say that our teams have worked non-stop to serve our customers during this moment of strong rebound. From the onset of the pandemic, we were very close to our customers, trying to understand their needs and putting our teams at their disposal to help them capture all of the opportunities that we were able to identify. Very quickly, we managed to increase our overhead, and we are trying to operate as productively as possible, especially in Brazil, to serve all of the different markets. I have a special thanks to our customers for their partnerships during these challenging months, reinforcing Gerdau’s commitment to generate even more value in the things where we are involved. I would also like to highlight another important move during this quarter, which was the approval of the acquisition of the steel producers, Steel Latin Seara. This acquisition will contribute to helping Gerdau serve the future demand for steel in the Brazilian market, more specifically in the northeast of the country. Additionally, I would like to mention that at Gerdau, we have deepened our discussions around sustainability and how we evolved with our business. We constantly seek to generate more value for all the stakeholders involved. As part of our commitment to sustainable development and a consequence of our purpose, as of September, we became part of the Be Movement Builders, a coalition launched by B Lab and Sistema de Brasil with large listed multinational companies aiming to transform the global economy into a more sustainable model that contemplates long-term value generation for all stakeholders. Finally, to conclude this part, I would really like to thank our employees for their enormous effort and dedication during this third quarter, because due to their hard work, we were able to ensure the quick rebound of our production units and serve all of our customers. I extend our thanks to the teams for putting the health and safety of our employees first, because for Gerdau, nothing matters more than the lives of each one of us. Now I conclude this part, and Scardoelli and I will be at your disposal to answer your questions and provide more details about our performance in this third quarter and what we see looking forward. So now let’s go to our Q&A session.

Our first question comes from Mr. Leonardo Correa from BTG Pactual.

Hello, good afternoon. Can you hear me well? I think my line is not very good. Congratulations on your results. My first question is about, and I know that you have been monitoring the pace of the market. I think that investors are debating the sustainability of this level of demand. What is happening in this third quarter is something that I have never experienced before. I don’t know whether you have seen something like that before, but it is unprecedented. Demand is spiking in the domestic market, increasing by 30% year-on-year. I know that the chain was not well supplied, and I know that there was a drop in demand during the pandemic. There is a lot of competition from the small market or self-builders. It is hard to monitor all the data, but we know that demand is increasing by 30% year-on-year. So it is a bit asymmetric. I think people are questioning how much longer this level of demand can be sustained because maybe in the next few months this will be exhausted, as I don’t think the government will be able to sustain this level of emergency aid for much longer. So what do you see looking forward? Once you look at your orders portfolio, how do you see this evolving towards the fourth quarter? If you could tell us a bit about 2021, even though it is very soon, maybe this will help us understand whether this will be sustainable. The second point is about the fact that this is unprecedented. We are living in an unprecedented time. I think pricing is a one-off thing, but I think what happened was the variable of FX increased by almost 40%, which led you to announce these four or five readjustment moves, but we still see zero-sum premium after the increase in November, depending on how you look at it. How do you see this scenario? We are already looking at things from some associations. There is some political noise here and there. I just want to hear from you. How do you see the pricing behavior and whether you still think that you can revisit the premium prices in the future?

Great question. Let’s focus on demand and market and prices. I would just like to say one important thing. People are constantly talking about digital transformation in other segments like services, etc., but I have always insisted, and I have always talked to you about the fact that Gerdau, being a centenary company, a 100-year-old company, it is important that we introduce digital transformation that can bring good results for the company. So if you recall, back in May, in one of our earnings release calls, I said that according to Gerdau, I think the worst is already behind us. Back then, I was very certain about what the landscape would be and things beginning to recover. My reading could be based on intuition or feeling, but rather than that, my reading comes from concrete data and elements that we were able to collect in the market. I would say that, today, our company has the capacity to utilize a lot of data and algorithms. In a way, we also resort to artificial intelligence to anticipate future demand. Our projections looking forward contemplate science and digital transformation. Not only that, I would say that it is higher than what we have seen because we are about to celebrate our 120th anniversary, and with long-term relationships with our customers, we have an idea of what happens at the other end. This is just an introduction to say that our reading right now is very constructive. I know that demand will remain sustainable for longer throughout 2021. Our projection when you compare 2020 to 2021 should grow between 6% to 8%. At the end of this year, our portfolios are already built up. Therefore, this move now should continue to last over the next few months. Throughout the year, we will have the accommodation of the main markets, and I’m talking about civil construction and retail that was posting growth. This also includes agriculture, even though it is far from what it was months ago. I mean, we already have a backlog of orders. I’m talking now about infrastructure, and the industry housing market is also recovering well, and we believe that this recovery will last longer. This is a positive moment when you think of what is ahead of us. Now in terms of prices, I want to be very direct. Maybe my pricing answer could be a bit academic. I have been hearing opinions and rumors that are not really true in terms of that topic. I don’t want to stir any more plemich about this topic. What I’m saying is that that statement that some are saying that the price of steel has been sequentially increasing, especially in the domestic market, is unfounded. It is not true. We have been facing a strong increase in the price of input, so the levels of steel in 2020 have not recovered when compared to 2019. Our financial results in the third quarter of 2020 reflect a combination of a very strong volume increase due to stronger steel demand that nobody anticipated, but also a very strong move to reduce costs and expenses. This is a movement that has been happening for a few years back, as we are trying to focus there - to support our cause. So the company is absolutely ready to face high demand. We are able to post a sustainable performance. The record we posted in terms of SG&A versus revenue proves my statement. Also, you have to think about our cost reductions being an important part of our bottom line. We are working hard to supply the market. In our view, we were one of the first companies to resume production. This happened back in April; therefore, we could fully serve our customers. The rebound of the blast furnaces in Brazil until they resume pre-crisis levels for supply and demand. Despite that, we were able to fully serve our customers. We are supplying products to all of our customers. We do not anticipate any scarcity of products. Therefore, to conclude, we will increase our profitability levels. Scrap and input prices are going up, and in order to be profitable, and to remunerate our shareholders, we have to work really hard and diligently.

Alright. Thank you, Werneck, very much.

Thank you, Leo, for your questions.

Our next question is from Daniel Sasson from Itaú BBA.

Congratulations for your results. My question is a follow-up to Leo’s question. Could you elaborate a bit on your market share? I mean, comparing your volumes to that of the industry? How do you see this competition in the third and fourth quarter with the resumption of the blast furnaces? Do you think there should be a difference in your market share once the other industries also resume their operations? Now as regards to pricing, you talked about margin recovery and cost pressure. I know you don’t talk about potential future announcements, but maybe you could shed some light on the pricing carryover to the fourth quarter of what has been already announced in the third quarter. I think this could be helpful. My second question is about the South America margin. I think that the margins were repressed because of all of the shutdowns, and there are some countries where things were more restricted like in Peru, but a 30% margin was the highest in your history. Could you tell us what was behind that and how sustainable the South America margin could be?

Thank you, Daniel. It is always a pleasure to talk to you. Well, the numbers that are public, we compare sales to the domestic market and the numbers published by IRBR and the numbers published this morning, they all prove that, that information about share sales grew by 1.4%, whereas ours, 6.4%. There was a reduction of 8% in the market, whereas we grew 10%. Therefore, Daniel, this is what I said before. We were very quick to read the rebounding signs. I think we were the first company to resume operations. We had the right products to deliver to our customers when they needed it. This is due to an enormous effort on the part of our teams. We were quick to market, and we were quick to act to serve the demand. So now what we have to do is sustain the current levels that we reached now. This is the work we have ahead of us. But I don’t want to give you too many details about pricing because certainly, there will be some carryover into the next months or the next quarter. This is natural. We have to constantly seek profitability. We are trying to revisit our historical spread volumes. The pressure is here to stay. Scrap prices have had an important impact, but certainly, for the next few months, I think we should expect some carryover. Now I will give the floor to Scardoelli to elaborate on the margins in South America. So I will just share the answer with him, and he will be able to give you more details about that topic. Thank you. Scardoelli, I think you are muted. Could you please start over?

I’m sorry, I touched the mute button inadvertently. In South America, we are seeing a demand improvement, which has been very strong in the third quarter. What we can tell about these operations is that our EBITDA forms part of the consolidation of South America. Sometimes there is also that aspect that we had a very good performance in Colombia and others because they had very good market recovery in the quarter. This had a positive effect on the margin. If you look historically, in the South America operation, margins have been much higher compared to a few years back. So in fact, I would say, yes, these margins are sustainable in the long range. But if we look at the second quarter and look forward to this third quarter, we experienced strong leverage, especially because of our EBITDA numbers as well.

Excellent, Harley, thank you very much and thanks, Gustavo, as well.

Thank you, Daniel.

Our next question comes from Rodolfo Angele from JPMorgan.

Good afternoon. I have two questions. First, working capital. We have seen a major reversion of working capital, even though this was a quarter of strong growth. So I would like to know whether Harley could comment on what we should expect looking forward, like the fourth quarter and also 2021. And my second question is addressed to Gustavo. We clearly see that we are entering a very interesting phase for the company, strong growth. So my question to you is within the company, your agenda for next year and the following year, with this cash surplus, whether next year is just as good. Are we going to use that to pay out dividends? Or are you thinking in terms of organic growth?

Hi Rodolfo, it is always a pleasure to talk to you. So Scardoelli will start with working capital.

Rodolfo, good afternoon, I hope you are well. In terms of working capital, we were able to post an important reduction this quarter. If you look at the trends, you will see that according to the activity level, we grew a lot this quarter. There was an increase both in terms of accounts receivable and payable. There was an increase in the activity of the company, but we were able to manage that accounts payable exceeded accounts receivable and was not higher than accounts payable. There was also a restriction in terms of inventory mix. In special steels in South America, it was quite robust considering also that we had some shutdowns due to the pandemic and had an important reduction in inventory. There was a reduction in terms of BRL of around BRL700 million, which is quite strong. But we have to look at the foreign exchange. If we look at that, this reduction could be even higher. The cash effect is high. At the same time, when you look at the balance sheet in BRLs, it was down; the net sales were up, and this helped us to reach that 73 days. For the next quarter, and especially the last quarter, we will still see an optimized working capital position. I think that we will be able to end the year at a good level of working capital. Even for next year, if we look at every year, we start the first quarter with lower levels, and then it goes up in the second and third quarters. But we do not see our working capital in terms of days of the cycle going beyond 70 or 75 days. This crisis gave us the opportunity to maintain this level of results.

Okay. Thank you very much, Rodolfo. Now as for your second question about cash generation and our agenda. I would say we already know that the market can be very volatile, and how this debt position is important to us. So nobody here will rest. Nobody will sleep until we can take the debt of the company to the level of 1.5 times which we said before. Therefore, we are still very obsessed with that. We are obsessed with reducing our indebtedness position, and this is the main topic on our agenda. In terms of the operation, we are constantly seeking to increase our performance in terms of cost and expenses, increasing profitability, trying to build Gerdau of the future. As I said in January, we will celebrate 120 years of history and try to still generate value for our stakeholders and shareholders for many years to come. We are constantly looking for ways to generate further profitability with our current units, looking for some niche operations. With Gerdau Next, we see other opportunities to generate further value for our customers. So basically, this is the Company's agenda. I think you are familiar with it, and we don’t anticipate any major change in the coming quarters.

Okay, thank you. Just another follow-up. What is the capacity utilization in Brazil today? Just so I can have an idea.

Rodolfo, in Brazil, it is currently 80%.

With ASO Minas or with everything?

With everything, Rodolfo, everything included.

Thank you. Thank you so much.

Thank you. All the best.

Our next question is from Thiago Lofiego from Bradesco BBI.

Thank you, good afternoon. Werneck, could you please talk about the inventories in the chain? You also said that this was a factor that boosted demand in the third quarter. How do you see this looking forward? Are inventories back to normal levels, or do you see a replenishment in the fourth quarter and going towards next year? And the second question refers to demand for longs in Brazil. How much does retail represent in terms of the demand for longs? I just want to understand the size of that part of the pie and how much it grew?

Well, two very good questions, Thiago. Let me talk about the inventory in that chain. It is still below normal levels. A normal level would be 25 to 30 days of inventory. Currently, this level is at 10 to 15 days. So the trend is that there will be a recovery over the next six months. It is not a very quick recovery in the short-term, but the trend is that there will be a full recovery in the next six months. Retail accounted for 30% of our long shipments. With the investments through commercial Gerdau, the program, Juntos Mis, retail represents 30% of our shipments.

Now in terms of retail again. How do you see 2021, including that part related to income risk, and loss by the government? How do you see the segment looking forward? And what kind of work do you have to do? I know you have been doing a few things. Do you think that it could offset a negative move in terms of the income level?

Well, our grassroots work in terms of going directly to retail has been very positive over the past two years. Retail grows 60% every year. Currently, the demand is higher when you compare to pre-crisis months, but our position will remain very strong even after the removal of the emergency aid. I do believe that even with this decline that will occur after the termination of the aid, we will still be able to make strong shipments because we are very excited about this segment.

Our next question comes from Caio Ribeiro from Crédit Suisse.

Good afternoon, everyone, and thank you for taking my question. My first question is about special steels because regarding other underperforming segments. Do you see any room for a potential price adjustment next year in Brazil? And what will be the magnitude of this increase? And how could that help improve your margins to reach more normalized levels? My second question is about the margin of the Brazil segment. Now it is above 20%. But with the price of scrap going up in Brazil, also considering that in the fourth quarter, there is traditionally weaker seasonality. How do you see the evolving margin in the fourth quarter, and will the price increases also have an impact?

Caio, it is a pleasure to talk to you. Well, I will jump straight to your second question. We believe that we will sustain the margins toward the fourth quarter. We are working with that assumption. Now in terms of special steels, pricing for special steels, we are just going along the global prices in the market. In terms of performance improvement, this will come from increased demand. We had to face difficult months and benefited from the automotive industry in our results afterwards, and we are very optimistic that with all of the incoming orders and our operations in Brazil and the U.S., we will experience a new phase of margin recovery from now on.

Perfect. Very clear. Thank you, Gustavo.

Our next question in English is from Carlos de Alba from Morgan Stanley.

So just following on the inventory question before. I think you mentioned just to reiterate to make sure I understood that the supply chain typically has around 30 days, and you are now seeing the inventories between 10 and 15 days. Can you make comments similar to this in terms of your own inventories? There was an important generation of cash from lower inventories in the quarter. How do you see that going forward in the fourth quarter, maybe into next year? If you can make comments both in terms of cash flow generation as well as the days of inventories that you currently have in your different plans, particularly in Brazil, I guess will be more interesting to me. Given your target of reducing net debt to EBITDA to between one and 1.5 times, we see a very comfortable amortization schedule. You don’t have too much coming due in 2021 and 2022, and really, until 2026, where you have a significant amount. What are you really planning on doing? Is it the accumulation of cash in your balance sheet, or retiring whatever is due in the coming years and not really raising more debt? How should we think about your strategy in getting to the one to 1.5 times? Obviously, EBITDA is going to increase, but I’m more talking about the debt management.

Thank you, Carlos. Now I will let Scardoelli answer your question. So Scardoelli, go ahead.

Carlos’s question was, firstly, related to inventories. You also mentioned how we talked about the chain and our own inventories. The second part of the question was about cash flow, which is very strong and our debt cycle is well balanced. What is our view of this cash position moving forward? Regarding your first point, especially in Brazil, our inventory levels are slightly below normal, but we still have some room to recover our inventory levels in the next few months. This allows us to predict that this market dynamic has certain momentum or trend looking forward. Now at Gerdau itself, this strong inventory reduction that we mentioned, about BRL600 million from June to September. If we look at that per operation, this would relate more to special steels. North America and Brazil had a very stable inventory level. We know that when it comes to rebuilding inventory in the system, there is a relationship with working capital. Maybe working capital will consume a bit more cash, yes. However, in terms of cycle days, it should be more stable at regular levels. We may use a little bit of working capital to replenish our inventory level. There is also the issue of scrap and some other components that will probably need some additional cash to replenish the inventory. In terms of strong cash generation, first of all, I would say that we try to minimize the maintenance of a negative carry or investments that were below the cost of the debt. It is easier to do this in Brazil rather than abroad. We try to carry the lowest possible negative carryover. This year, in addition, our debt position is very well balanced. We have a majority coming in three months due to a bonus that was issued that matures in 2021, which is about close to BRL1 billion, about BRL600 million. Therefore, this cash will be used for that. Our trend is to use the proceeds to pay short-term debt. We haven’t yet conducted any further evaluation in terms of paying out dividends. In this second and third quarter, this will certainly need more cash to pay more dividends. If we get more cash, we will be able to pay out more dividends. I think this is what I had to say about liquidity.

Thank you, Scardoelli.

Next question from Timna Tanners from Bank of America.

Hello, good afternoon. I wanted to ask two questions. One was regarding the guidance you gave for volume, but I didn’t know if the 6% to 8% improvement for 2021 applied to all of Brazil or for the entire company. If it is just Brazil, any color on the other segments would be great. My second question is really more on the U.S. market. The non-residential construction leading indicators are pointing to a decline. Scrap demand is up, so just wondering if you have a little more color on the margin outlook in the seasonally weak fourth quarter and then into 2021. Thanks very much.

Thank you, Timna. Timna’s first question related to demand growth and what is expected for next year. I said that we are expecting a demand growth between 6% to 8%, and this refers to our operations in Brazil for flat and long steels. We have different numbers depending on the operation. We anticipate a 1% growth in demand for the long steel operations in North America. I think that was Timna’s question. And also in special steels, we predict a higher growth due to lower demand in Brazil. We anticipate 18% growth, and for our special steel operation in the United States, we predict some growth of around 9%. I mean she asked for a bit more color per operation. Therefore, I believe with that, I answered Timna’s first question. Her second question was related to the fourth quarter outlook. Right now, our backlog is quite strong. It remains at the levels that we have been experiencing in the past few months; we see a good number of orders and good shipments coming. Our main issue in the U.S. is the spread. As I said before, there was a reduction in metallic spread between the third and the second quarter. It was down by US$410 - from US$410 to US$400 to $395. We continue to buy in the U.S. at prices similar to what we had in the past, but we are now working hard internally to reduce costs and improve performance. In the fourth quarter, we will be able to sustain these margins. Basically, these were the two questions posed by Timna. Thank you for her questions, and please feel free to come with more if you have, and you can talk to our IR people.

Thank you.

Our next question from Andreas Bokkenheuser from UBS.

Thank you very much for taking my question, and I hope you are all well and your families are well as well, given the difficult circumstances at the moment. I just wanted to follow up on Timna’s question. If we look at the construction industry, it tends to lag the overall economy by about one year. Typically, when it goes into a bear market, it typically declines for about two to three years. We are seeing in North America a lot of U.S. construction steel producers doing quite well. To your point, you have a very strong backlog, but we also understand that a lot of that backlog is due to projects that were started in 2018 and 2019 before COVID. These projects need to be completed. If we look at new orders again to Timna’s point, non-residential construction starts are down 30%, 40%. I think you mentioned the ABI. The ABI is still in contraction level; we are seeing a decline in construction jobs. There are a lot of leading indicators suggesting that with damage to the economy this year, there is just not going to be a lot of money for projects into next year. So I guess the question is, given that the construction sector lags the overall economy by one year and how bad the global economy did this year, what gives you the confidence that demand is going to do particularly well next year? Because it would suggest that we are going to get a material contraction in demand next year. That’s just my one question. Thank you very much.

Andreas, thank you for your question. Andreas is asking for more details about the outlook, not only for one year but three years ahead in the sectors where we operate in the U.S., especially non-residential. He wants us to elaborate on growth in about a few years, the conclusion of projects, and the expectation looking forward, especially considering the results for the upcoming elections that will take place next Tuesday. Well, Andreas, this is a topic that has been extensively debated in the past few months. We analyzed all possible scenarios, and we focused on the main indicators. When we look at the indicators, we continue to see a positive outlook in the segments we operate in. Our structural profiles and our lighter commercial profiles even lead us to see slight growth in the next three years in the segments we service. We look at all the infrastructure gaps in the U.S., but at the moment, we do not see any major infrastructure project coming that would lead to a very strong demand pick up in the coming years. We only see slight growth, but in parallel, for the past few years, we have been working very diligently to increase the performance of our operations. We made a decision to invest in our larger mills, and all of these investment decisions and decisions to reduce cost and increase performance will certainly lead us to improve our financial results in the next three years, even in a market that may not grow significantly. However, there should be some growth, allowing us to sustain our margins.

Thank you very much.

Our next question comes from Mr. Jon Brandt from HSBC.

Hi, good afternoon, gentlemen. Just to follow up on Andreas’ question. I just want to make sure that you are not expecting any major infrastructure spending despite the pledge from both U.S. presidential candidates to actually do just that. I know we have seen this historically many times, but potentially, depending on the outcome of the election, it could be a better scenario than before. In relation to that, if we were to see U.S. infrastructure spending, and it is of the green nature, is there a big difference in steel intensity versus traditional infrastructure spending? I guess my second question is somewhat related to that on the ESG side of things; this has been a major theme, not only in Brazil but also globally. We have seen other companies in the sector make improvements, so I hope you could comment a little bit on what your main initiatives are for improvement in the ESG world.

Jon, thank you for your questions. His questions refer to our outlook for the U.S. after the election in terms of the stimuli, also 232. He asks about ESG, where we are placing our efforts and where our priorities are. I will start with your first question, and then I will give the floor to Scardoelli. From all the analysis we conducted in terms of the possible outcome of the U.S. election shows that in 2021, regardless of the outcome, there shouldn’t be any major operation in terms of stimuli or economic aspects that could directly impact our business. Therefore, in 2021, we are expecting certain stability. This is slight growth. Now I will give the floor to Scardoelli to see whether he has anything else to add to the comment, and then we can also talk about ESG too.

Good afternoon, Jon. Regarding infrastructure, I think an important aspect is that when you look at our outlook for North America next year, we are not including any possible increase in infrastructure. There is a possibility that this might happen, but the debate today on both sides of the political spectrum, Republicans and Democrats focus on this point. We see a potential demand increase in the U.S., but we are not including that in our planning right now. There is certainly a possibility that we will see a significant demand for steel. It is difficult to compare because the U.S. needs to invest in infrastructure. When these investments are finally materialized, the amounts at stake will be quite significant. Infrastructure investments in the U.S. that use any kind of funding from the government at any level, Federal, State, or municipal, carry the famous so-called buy American behind it. That means this demand, once it comes, will be geared towards local producers like us. By locking the rebar business some two years ago, we will not be so subject to market effects. At the same time, we maintained our capability to enter more strongly into the rebar market in case of stronger demand. The effect would certainly be very positive for the steel producers in this market.

Thank you, Scardoelli. I will move on. First of all, I would like to thank Jon for his question on ESG. This is a very important question, as it relates to the future of the company. We believe that any company, and I’m right now speaking about the steel industry, it is important that if we want to continue writing a successful story in the future, we have to incorporate topics of sustainability like ESG. ESG is a very important topic that gained relevance this past year. Our Board is totally committed to ESG, and we want ESG to reach every single employee of the company in everything they do in any area of the company. We evolved quite well in all three letters of ESG. In terms of G, governance, we made significant advances. We approved our sustainability policies. We also approved a human rights policy. We created a very important committee called the Strategy Committee for Sustainability just to ensure that all long-term strategic decisions like CapEx, investments, and capital allocation are well adjusted to ESG. In terms of the S letter of the acronym, social, we made important advances this year, and the major move was that we are now certified as a B company. We will be one of the largest B certified companies. This journey starts with the certification of our Brazilian operation. We also reviewed our strategy in terms of social responsibility at the Gerdau Institute. We were able to escalate our activities like housing systems and recycling systems. We also included other initiatives of inclusion, demonstrating respect for people and society. This is also reflected in our overhead and our employees. We include all brackets of society and ethnicity. In terms of the environment, the letter E, this is a challenge for all steel producers. In our case, we have an advantage because 70% of our production base uses electric furnaces and scrap. In the next few months, we will publicize our goals to reduce gas emissions and the greenhouse effect. Therefore, I believe that in all three areas of ESG, we have well-structured plans, and they will be executed in the best possible way. In the future, we want to be a reference in sustainability among steel producers.

Thank you very much, gentlemen.

We now conclude the Q&A session. I would like to turn the floor back to Mr. Gustavo for his final remarks.

I would like to thank you very much for joining us today. It is always a pleasure for both of us to talk to you. I also would like to invite you to join us again for our next earnings release related to the fourth quarter of 2020, which will take place on February 24 of next year. Time flies; it is almost early November. So in case we do not talk again this year, I would like to take this opportunity to wish you a very good 2021, with plentiful health and the possibility of revisiting your personal plans or projects that have been put to sleep for now, and I wish you all brighter days in the future. Thank you very much, and be well.

Gerdau’s call is now concluded. Thank you very much for participating, and have a very good afternoon.