Gerdau S.A. Q2 FY2022 Earnings Call

Gerdau's conference call is to discuss the results of the second quarter of 2022. This video conference is being recorded and will be available on the company's investor relations website, where the complete earnings release can be found. The presentation can also be downloaded via the Chat icon. I want to emphasize that any forward-looking statements made during this call regarding Gerdau's business outlook, projections, and financial and operating costs are based on management's expectations and current information. These forward-looking statements are not guarantees of performance, as they involve risks, uncertainties, and assumptions related to future events that depend on various circumstances. Investors should be aware that general economic conditions, market dynamics, and other operational factors could influence Gerdau's future performance and result in outcomes significantly different from those expressed in the forward-looking statements. Joining us today are Gerdau's CEO, Gustavo Werneck, and Gerdau's CFO and IRO, Rafael Japur. I will now hand it over to Gustavo Werneck to begin the presentation.

Good day, everyone. I want to begin by welcoming you to the video conference call to discuss Gerdau's results for the second quarter of 2022. I hope you are all doing well. I also want to welcome Renata, our new IR manager who recently joined Gerdau. I wish her great success in her role here. Joining us for this presentation is our CFO, Rafael Japur. It's always a pleasure for us to update you on our performance and clarify any questions during our presentation. I will start by discussing the international scenario and the key highlights of the company's overall results before detailing our business operations in Q2. Rafael will then share insights on our financial performance. I will return to discuss key points regarding our ESG agenda. We will be available to address any further points you would like us to elaborate on. First, I want to extend a special thank you to our thousands of employees across our operating countries for helping to achieve the best first half-year in Gerdau's 121-year history. We are confident that with our team's dedication and focus on delivering value to our customers, we can make 2022 an even better year than 2021. To begin, I will discuss the macro environment affecting Gerdau. We view the measures announced by the Chinese government to stimulate the economy and control steel supply positively, which should help sustain profitability and prices in the short to medium term. We are closely monitoring the effects of the slowdown in China’s economic growth, as the GDP rose only 0.4% in Q2 year-on-year, and how this may affect the international landscape. We continue to assess the impacts of the ongoing conflict between Russia and Ukraine on the global market, particularly the pressure on production costs from fluctuations in raw material and energy prices. I want to emphasize that our operations have not been impacted by raw material supply restrictions as we maintain safety inventories and a diversified supply base. We are also keeping a close eye on global economic growth uncertainties and the potential effects that inflationary pressures in Brazil and worldwide may have on steel demand. In the next slides, I will provide highlights showcasing Gerdau's strong performance in the second quarter. We ended Q2 2022 with an adjusted EBITDA of BRL 6.7 billion and an adjusted EBITDA margin of 29.1%, both record figures for this period. These results were driven by strong demand for steel from the construction and industrial sectors and record performance in North America. Gerdau's net income reached BRL 4.3 billion in the second quarter of 2022, a record amount for this period that represents a 27% year-on-year increase. Additionally, net sales amounted to BRL 23 billion between April and June, up 28% compared to the same period last year, with steel shipments totaling 3.2 million tonnes. These impressive results highlight Gerdau's solid standing in the Americas and reflect the transformations the company has undergone in recent years. Gerdau has shown resilience in navigating macroeconomic uncertainties, delivering improved outcomes and greater value for our stakeholders, including customers and shareholders. In the following slides, I will detail the highlights from each of our business operations and offer insights into the market outlooks. To begin, the adjusted EBITDA of our North America business operation doubled between April and June year-on-year, reaching a record BRL 2.8 billion, with a record adjusted EBITDA margin of 33.1%. I’d like to note that the metal spread remains at a historically elevated level. Shipments in the second quarter stayed high, driven by robust demand from the non-residential construction and manufacturing sectors. The outlook for Q3 appears positive, with our order backlog in the U.S. remaining above 70 days of purchases. As such, we are operating our North American plants at over 90% capacity utilization. We are optimistic about steel demand in North America, especially from the construction sector. For example, the Architectural Building Index, which measures non-residential construction activity, and the Institute for Supply Management Index for the manufacturing sector both remained above 50 points in June, indicating a strong trajectory since February 2021. Furthermore, the infrastructure investment package of $1.2 trillion is set to generate significant additional steel demand, estimated at up to 5 million tonnes annually in the domestic market over eight years, starting in Q4 2022 through early 2023. In this favorable context, we are committed to enhancing productivity and profitability in North America to deliver even greater value to our customers. Notably, we are investing approximately BRL 300 million to increase the capacity of the Midlothian Steel Mill in Texas, our largest operation in the U.S., to 2 million tonnes. However, we must also address challenges such as labor shortages, inflation, and logistics issues that have impacted numerous companies in the region. Moving on, I will share details about our special steel operation. For the second quarter, we reported an EBITDA that is 87% higher than the same period last year, driven by strong profitability levels achieved this quarter. The light vehicle market in the U.S. remains affected by chip shortages, with regular component supply not expected until 2023. Nonetheless, U.S. production of light vehicles in 2022 is projected to reach around 14.5 million units, which, although below expectations, is still significantly higher than numbers recorded in the past two years. The heavy vehicle market outlook is more positive, with an anticipated production of 300,000 trucks in 2022, representing a year-on-year increase of 15.8%. Meanwhile, the oil and gas sector is expected to grow in the coming months, driven by international fuel prices. I also want to highlight that the modernization of our mill in Monroe, Michigan, has now positioned us to deliver increasing volumes of high-value special steel to our North American customers, enhancing profitability and productivity. Moving forward, we will embark on a new investment cycle to upgrade the rolling operation of this mill to establish Monroe as one of the most modern mills globally, continuing to meet our customers' demands. The special steel market in Brazil has similarly faced chip shortages, with the National Association of Vehicle Manufacturers forecasting a 4.1% increase in light vehicle production in 2022, a decline from the previous estimate of 9%, influenced by semiconductor supply issues alongside rising inflation and interest rates. The heavy vehicle segment remains strong, supported by the government's signals to implement a fleet renewal program encouraging the replacement of trucks over 30 years old. The agricultural machinery segment is expected to grow by 4% this year to around 100,000 units, attributed to anticipated record harvests. As we move to the next slide, I will address the performance of long and flat steel in Brazil. In Q2, we witnessed sustained steel demand across various sectors, with shipments from our Brazilian operations increasing 4% year-on-year from April to June. Demand from the construction sector remains vibrant, and I have examples reinforcing confidence that this scenario will persist throughout 2022. The sales value of real estate launches in Q2 was nearly BRL 10 billion, marking a 2.4% increase compared to the previous year, while the number of active construction sites in Brazil has reached its highest level in 15 years as of July. Additionally, the forecast for civil construction GDP growth in 2022 has been updated from 1.6% to 3.8% by the Brazilian Chamber of Construction Industry. Despite inflation and declining average incomes, retail sales have remained stable, and it is encouraging to see the consumer confidence index rise again in June, gaining 3.5 points from May and now standing at 79 points. Furthermore, investment in infrastructure, particularly in industrial construction for new warehouses and operational units, is expected to exceed BRL 150 billion in 2022 according to FGV studies. Continued high demand for steel is also observed in the industrial sector, reflecting high activity levels in agribusiness, capital goods, machinery, equipment, road equipment, and energy segments. Additionally, ABIMAQ has revised its projections for the machinery and equipment sector, anticipating a 5.8% domestic market increase for 2022 from a prior estimate of 3%. In the energy segment, Abeeolica expects BRL 100 billion in investments over the next five years for wind farms, and roughly BRL 50 billion in solar energy investments is projected just for this year according to ABSOLAR. I also want to reiterate that we are proceeding with our previously announced investment of around BRL 200 million in the Riograndense mini-mill in Rio Grande do Sul, focused on modernizing melt shop facilities, enhancing digital transformation, and improving environmental and safety conditions. We will now proceed to the next slide to discuss South America. In Argentina, steel demand from construction and agribusiness sectors remains robust, driving local market sales. The Argentine construction sector grew 13.6% year-on-year in May. The latest data from the Statistics Institute (INDEC) suggests that construction activity will remain elevated throughout 2022. The same strong demand pattern is evident in Uruguay’s steel market. In Peru, steel demand continues to be healthy, bolstered by the construction industry. We maintain a positive outlook for this operation, aligned with the Peruvian Central Bank's forecast for a 2% GDP growth in 2022. This concludes my general overview. I will now hand over to Rafael Japur, and after his presentation, I will return to discuss our ESG journey. Following that, Rafael and I will be available for your questions.

Thank you, Gustavo. Good day everyone. It’s a pleasure to be here with you again in our video conference to discuss our results. I’d like to welcome Renata and wish her success in her new role. In terms of our financial performance in the quarter, we begin with our operating cash flow. This quarter, we reported an EBITDA of BRL 6.7 billion. Additionally, we invested BRL 1 billion in CapEx, consistent with our earlier forecast, and another BRL 800 million in working capital due to increased sales and revenues during this period. After deducting taxes and our net financial expenses, we generated a free cash flow of BRL 3.250 billion, which represents about 48% of EBITDA and 14% of net sales for the quarter. Moving to the next slide, I will elaborate on our cash flow and working capital. Over the last four quarters, our free cash generation amounted to BRL 13.485 billion, demonstrating the resilience of our business model and our capability to generate cash in various scenarios as well as our ongoing efforts to reduce debt. Analyzing the investment of our free cash over the past 12 months, we returned 43% of our free cash flow to shareholders through dividends and share buybacks, and we allocated another 41% to reducing our net debt. Regarding working capital, this quarter it totaled BRL 16.3 billion, increasing by 9%, which was proportionally less than our net sales growth of 13%. Our cash conversion cycle improved to 64 days, marking the second-lowest cycle for a second quarter over the past decade, reflecting the effectiveness of our culture. We continue to enhance our discipline in capital allocation while also becoming more agile in our decision-making processes. Now, let’s discuss our liquidity and debt situation. We reduced our gross debt by more than BRL 300 million this quarter despite a significant appreciation of the dollar against the Brazilian real, which affects our dollar-denominated debt. We concluded the period with a gross debt of BRL 12.445 billion and a strong cash position of BRL 7.755 billion, resulting in a net debt of BRL 4.7 billion. Our financial leverage, indicated by the net debt to EBITDA ratio over the last 12 months, stands at 0.18x. Our debt profile averages an 8-year term with a well-structured amortization schedule for the coming years. We aim to reduce our gross debt below BRL 12 billion and decrease the share of our debt issued in foreign currency. In line with this goal, we reduced our dollar-denominated debt by $220 million this quarter. Next, let’s focus on shareholder returns. Over the last 12 months, we distributed nearly 40% of our adjusted net income, as shown in the evolution of net income and dividend payout on Slide 14. The accompanying chart illustrates how improved results combined with significant debt reduction have positively impacted our dividend yield, increasing from 3.6% in 2018 to almost 12% in the last year. Regarding our share buyback program launched in May, by July 18, just before the quiet period, we executed 32% of the program, purchasing 17.8 million GGBR4 shares at an average price of BRL 23.88. In Metalurgica Gerdau's buyback program, we executed 24%, acquiring 16.9 million GOAU4 shares at an average price of BRL 10.06. Lastly, concerning the dividend distribution for the second quarter, Gerdau S.A. and Metalurgica Gerdau S.A. will pay dividends on August 25 and 26 respectively. Gerdau S.A. will pay BRL 1.200 billion, or BRL 0.71 per share, while Metalurgica Gerdau will distribute BRL 383 million, or BRL 0.36 per share. Both distributions will consider the position of shares held on August 15, 2022. Thank you for your attention, and I will now hand it back to Gustavo to discuss some of our ESG initiatives.

Thank you, Japur. I want to provide an update on some key aspects of Gerdau's ESG agenda, highlighting our progress. We have been addressing ESG matters for many years, and I want to emphasize that as part of our diversity and inclusion efforts, the percentage of women in leadership roles increased from 17% in 2019 to 23.6% in 2021, aligning with our goal of reaching 30% by 2025. Additionally, at the end of last year, we achieved 5% women working as operators at Gerdau for the first time in 121 years, with over a thousand women now involved in production. This information is part of the many indicators included in our annual report, which outlines our social, environmental, and financial highlights for 2021. This year, for the first time, the report underwent an external audit, demonstrating our progress in transparency and communication with society. Our commitment to tackling climate change is also reflected in this report, as Gerdau's audited average greenhouse gas emissions fell to 0.9 tonnes of CO2 equivalent per tonne of steel in 2021, down from 0.93 tonnes the previous year. This new figure reaffirms our commitment made earlier this year to lower our emissions to 0.83 tonnes of CO2 equivalent per ton of steel by 2031, helping to foster a more sustainable steel industry. Moving to the next point, I want to mention the 15% growth of Gerdau Next, our new business, which marked two years of operations last month. We have a U.S. startup focused on prefabricated and smart homes, enhancing our sustainable performance and offering solutions for improved productivity in the industry and construction. Lastly, in June, Gerdau was recognized by Merco as the best B2B company and the top company in the mining and steelmaking sector. We are the sole steelmaking entity among the 100 Brazilian companies noted for their reputation, reflecting the hard work of our more than 30,000 employees. Additionally, as a testament to our ESG journey, Gerdau was acknowledged in the mining, metallurgy, and steelmaking category of the 2022 best ESG awards by Exame magazine. Thank you all for your attention, and now Japur and I are ready to answer any questions you may have. Back to you, Renata, and we appreciate your support for this session.

Now we will begin the Q&A session. We already have questions coming in via chatbox. Rodolfo from JPMorgan asks Werneck about the outlook for the third quarter by business, particularly in the U.S. and Brazil, and is seeking more information as this is crucial for the market given concerns about a potential global recession. He also requests an update on spreads in the U.S.

I appreciate your question as it gives us an opportunity to provide an overview of our U.S. business and our operations in Brazil. Last year marked the best year in Gerdau's history, and the first half of this year was even stronger than the same period last year. Our EBITDA in the first half increased by 22% in BRL compared to the previous year. Looking ahead to the next two quarters, we are confident that our overall results for 2022 will closely match the earnings of 2021. While we do not expect Q3 to be as strong as last year's third quarter, our results for Q3 and Q4, combined with our record first quarter, suggest we will finish the year with similar outcomes. Our U.S. operations continue to demonstrate significant strength and resilience, despite concerns about recession and high inflation impacting markets globally. Based on the current trends we observe, including the unmet infrastructure package demand, we anticipate robust performance in the upcoming quarters. The reduction in our order backlog has been minor; it remains at sustainable levels above 70 days. We've also noticed an increase in labor supply within the industrial sector after previously struggling to fill positions. This is a positive indicator of labor recovery in our industry. Additionally, we have seen a substantial decrease in scrap prices, which required us to adjust our product pricing accordingly to maintain sustainable margins. We are optimistic about our North American results continuing to be strong, with a positive outlook for 2023. In Brazil, while we see a year-on-year decline in delivery figures for the first half of this year, this is attributed to inventory levels from 2021 rather than a decline in demand, which remains resilient across several segments. Some areas, like retail construction, have shown more accommodation due to interest rates and purchasing power issues, but this segment represents a small share of our steel deliveries. Overall, the construction sector remains robust. Despite rising interest rates, we do not expect a short-term decline in demand, as our understanding of construction activity through digital transformation provides us with deep insights into ongoing projects. This July marked the highest number of open construction sites in Brazil in 15 years, indicating strong demand in the construction industry. Additionally, we continue to see growth in steel demand for infrastructure projects and partnerships. While we face some challenges with rebar distribution, demand remains stable across other sectors. For the third quarter, we anticipate that rising coal costs will be a primary factor impacting our expenses, but these costs will stabilize for fourth quarter orders. Overall, we are confident in our solid performance for Q3 and Q4, positioning us to match our 2021 results by year’s end.

Concluding the questions by Rodolfo, JPMorgan, addressed to Japur, he also would like to have an update on investment projects and expected returns.

About our projects, I would like to say that we are very diligent when it comes to the approval process of our projects in line with our robust capital allocation. So we have the management involved, the team, Gustavo, myself, and all the team. And before we actually start any of the projects, we have everything in line. We take into account interest rates and increases in the cost of capital. Sometimes, it is more challenging to approve projects. But what we have in the portfolio, all the projects were carefully studied, thoroughly studied, and we believe they are resilient under different scenarios, both generating more revenue, improving our product portfolio, but also supporting and leveraging our competitiveness in different scenarios of the economic cycle, cash conversion cycle, be in moments where we are right now or even in more challenging times.

Can you hear me? I don't think you can see me. For any reason, I cannot open my camera. Anyway...

Rafael, I'm sorry to interrupt you. Would you mind starting again? We can hear you well right now.

Sure, I apologize. For some reason, I cannot open my camera. My first question is about the allocation of capital and dividends. I understand the company had a payout slightly above the minimum rate this quarter. However, considering the gross debt is close to the limit of BRL 12 billion and the outlook for solid results, how do you view the possibility of having larger extraordinary dividend payouts in the short term? Additionally, could you provide more details about CapEx for this year? May I ask my second question now?

Yes, please go ahead.

The second question is about the market, the Brazilian market. Just to have more color on the domestic market dynamics. You talked about civil construction. So what about retail? What is the share of Gerdau's portfolio? And is this the most important point of concern in the short term, just to have a better understanding of this dynamics as well?

Well, maybe he can talk about the allocation of capital, CapEx. And then I'll come back to talk about the domestic market and retail.

We have a number of individuals with the same name, Rafael. Regarding capital allocation, your question is timely and allows us to emphasize various points. When considering our investments, not just in dividend payouts but also in our share buyback program, we are preparing to disburse BRL 1.2 billion by the 18th. We have already spent BRL 424 million, which includes over BRL 400 million on share buybacks, representing an efficient way to return value to shareholders. Overall, when we look at the total payouts—not just dividends—the returns to shareholders exceed the minimum established by our bylaws. It's also worth mentioning that we have executed about one-third of our share buyback program. This program remains open for Gerdau S.A. and Metalurgica Gerdau, and we will be keeping an eye out for additional opportunities in the market in the coming days and weeks. Regarding capital expenditures, I noted on the slide that we covered our operating cash flow. For free cash flow, we reported a disbursement of BRL 1 billion this quarter, aligning with our earlier forecast of BRL 4.5 billion for the year 2022. Our provision remains unchanged. Additionally, it's important to emphasize that we currently do not have any greenfield projects. All our initiatives are based on existing plans, and typically, it is more practical to manage interventions and investments with respect to downtimes. This occurs in both the Northern Hemisphere and Brazil, primarily during Q3 and Q4. Thus, our guidance for capital expenditure disbursement for 2022 remains unchanged. Now, regarding the question on North America, I'll pass it to Gustavo.

I think Rafael was curious about the retail situation in Brazil. Currently, our product mix shows that retail accounts for less than 20% of our sales. Retail experienced significant growth after the pandemic, as households focused on home improvements. However, there was a slowdown towards the end of last year, and it has stabilized at that lower level in recent months. We anticipate some volatility ahead, with growth possibly lagging behind Brazil and broader economic trends. The decline in retail has been somewhat balanced by the rising demand for steel in infrastructure projects. Generally, retail uses smaller steel gauges, whereas infrastructure projects require larger steel, which is promising for future growth. We have already received numerous orders related to parks and solar energy farms. For the upcoming months, while we expect demand to remain flat and stable, the retail sector will likely stay at a lower, stable level.

He asks two questions. He would like to understand the rationale of a very conservative dividend payout policy considering the strong cash generation and leverage close to 0. What are the next milestones for the change in the formula? Second question regarding North America. He would like to know about the order book and the expectation of metal spreads for Q3. Do you think you can sustain an EBITDA margin close to 30% in the next quarters?

Japur, you start about the dividends, and then I'll answer the second question.

Sure. Regarding our dividend payout policy, we currently have no immediate plans to review it. We recognize that our balance sheet is becoming increasingly strong, and a significant portion of our cash generation is closely aligned with our net income, leading to a tighter relationship between the two. Today, a substantial amount of the free cash flow we generate is returned to shareholders through dividends and buybacks. In this quarter, when considering the adjusted net income after setting aside reserves, we're looking at a payout and return to shareholders that exceeds 40%. Concerning our debt, there was a decrease in the company's indebtedness this quarter. However, as noted during the presentation, fluctuations in foreign exchange rates on our dollar-denominated debt have increased our overall debt despite making payments on our gross debt in both BRLs and foreign currency. We believe our balance sheet is in a good position. At this moment, we do not plan to make significant or aggressive changes to our dividend payout policy. We see the consistency of payouts in relation to our net income, along with the share buyback program, as an effective way to deliver value to our shareholders.

As Japur mentioned, we have been discussing how to allocate our capital more efficiently at the company, and your questions will certainly be part of that discussion. I want to emphasize that we are not currently considering large acquisitions or M&A deals, nor significant new capital expenditures as we have in the past. Our focus will continue to be on cautious and smart capital allocation in our operations with a strong emphasis on calculating returns. I’d like to clarify that these types of acquisitions are not part of our agenda or plans. Recent activities in Brazil and the U.S., including the way those deals were executed, have shown us that we were not involved in those discussions. It’s important to note that our future approach to capital allocation in cash-generating assets will differ from our past practices. Regarding North America, our portfolio and order book are in very good shape, remaining at a high level over the last year. We did not expect this level of activity to sustain, and I'm not referencing any economic slowdowns. However, this level has made it challenging for us to meet customer demands. That said, we are now seeing a more balanced order book that has shifted away from warehouse construction to include more orders related to semiconductor production and the internationalization of components, creating additional loan demand. Although there's been a slight reduction, the portfolio is now at a healthy level and is evolving positively, providing reassurance as we anticipate significant investments in the U.S. in the coming years, particularly with the infrastructure package. Notably, none of our U.S. competitors have received orders from this approved package, which will lead to future orders. The metal spread is currently at unprecedented levels. The best results we've achieved prior to this quarter were back in Q3 of 2008, with a different asset portfolio. Although we are dealing with lower volumes due to the sale of wire rod and rebar assets, our strategy has been to focus on sales with higher margins in structural products. The spreads we see are sustainable, and while pricing may fluctuate, it aligns with market scrap prices. We expect that these margins will remain stable and will only vary slightly in the upcoming months.

Next question by Mr. Ricardo with Morgan Stanley. He asks, Japur, what is the rationale to determine a payout of approximately 30% on the profit and net income of the second quarter? And one more. Could you describe the operating or financial scenario that would make sense to have a payout in 2022 greater than 37% in 2021? And the other question addressed to Werneck thinking about margins, Brazil and North America. How can we think about the sequential evolution of margins in Q3 considering drop in prices, cost of raw materials and inventory of products? Is there any different factor, perhaps greater dilution of fixed costs, that could help improve the margins in the quarter?

Japur, let's start with you.

I think that we have kind of answered that. We understand that in this quarter, our payout is not 30%. It's closer to 40%, because we also take into account as return to shareholders the buybacks that we executed along Q2. If we add both things: a dividend of BRL 1.2 billion, the distribution of BRL 1.6 billion over a base of BRL 4 billion of net income before taxes, which is close to 41% of distribution in this quarter alone. So we understand that and our possibilities. And considering that our shares are extremely depreciated in their intrinsic value and their ability to generate value in the long term, we understand that this is an adequate capital allocation. So we are paying more dividends, as was the case in 2021, but also leveraging our shares and maintaining a disciplined and austere execution of our share buyback program.

Well, Ricardo, let me provide more details on Q3. As previously mentioned, we anticipate a flat, stable scenario for our business. The two primary factors likely to differentiate Q3 from Q2 are both related to costs. First is coal, which will have a more significant impact in Q3 due to high purchase levels at the beginning of the year. The second is the metal scrap from our special metal operations in the United States, taking into account the current pricing mechanism. These factors are expected to change how our business operates in the second half. Of course, we are constantly seeking alternatives to mitigate these costs, particularly in Brazil and North America concerning raw materials, scrap, and so on. We are exploring options to see how much we can lessen these impacts. What you're asking, Ricardo, and what other questions have pointed to recently, is largely about a reduction in the international market price of steel. This brings to mind the strategic moves we have made in recent years at Gerdau, aimed at making us less vulnerable to price impacts and fluctuations in the international market. We have implemented mechanisms in our businesses to reduce exposure to such variability, which translates into more stable and practical outcomes. Regarding Turkish rebar and the potential for reduced pricing and competition in Brazil, this relates to the distribution of straight rebar, which represents a small portion of our business, about 8%. Given how rebar is delivered to construction companies in Brazil, it is nearly impossible for imported rebar to compete with the necessary level of service. Construction companies are eager to enhance their efficiency and productivity, prompting us to establish plants close to major cities like Sao Paulo. Each night, we prepare a steel kit delivered at the scheduled time so construction companies can work floor by floor. This involves a significant logistics component and level of service that no competitor can match. Therefore, considering the way we run our business, we are not significantly exposed to the volatility of international prices. When discussing volatility from Turkish, Chinese, or possibly Russian steel, we believe we have the right conditions to sustain the profitability of our products. We anticipate demand remaining stable, profitability under control, and an ongoing effort to lessen the impacts of raw materials like coal.

And I'd just like to add something, Gustavo. I believe that this applies to the Brazilian case and to the U.S. case. In the United States and Canada, about 10% of our portfolio of products includes rebar and wire rod. We have a much more premium portfolio, focused on structured steel, SBQ, that gives us more resilience and greater protection from imports of Turkish material and other materials than in the past when we had a different industrial setup, configuration, and different markets in which to compete. Well, Renata, back to you.

Next question by Daniel Sasson, Itau BBA.

Werneck, you talked about margins in the U.S. In the short term, you believe them to be sustainable at 30% with healthy spreads in the coming months. My question is more related to mid- to long run. In recent years, you've been very much focused on improved efficiency projects, IT. You managed to fill the gap cost vis-à-vis U.S. And maybe 10% margin, which was your target left behind. So what should we expect to see margins in the U.S. getting stable in the mid to long run? I know that every industry has cycles, ups and downs, worst and best moments. So could you please give us an average number? And Japur, if I may? I'm sorry to go back to allocation of capital. Most of the discussions we've been having with investors are around this. If we think about one of the parts of the maximum, gross debt. There is another part, which is leverage between 1.5 and 1x net debt over EBITDA ratio. So when do you believe it is appropriate? What do you think about the structure of capital in order to get to this level that you consider to be efficient between 1 and 1.5x since you're at 0.2x net debt over EBITDA ratio?

Japur will provide more insights on capital allocation. Your question about North America is excellent. Time passes quickly. It brings to mind one of my earliest discussions after joining the company five years ago regarding the gap we identified in our U.S. operations. We've put in a lot of effort to close that gap over time. However, there remains one area we need to address, which is our Midlothian facility in Texas. This is the only location where we still need to fill the gap. There are still opportunities at the plant to enhance our performance and expand production at our major mill in the U.S. This investment is ongoing, and part has already received approval. This initiative will enhance our competitiveness alongside other mills in North America. As you mentioned, Daniel, it's challenging to predict if this will materialize in five or ten years, as that's a significant timeframe. However, we see positive indicators suggesting that, in the medium to long term, we will achieve higher margins. For example, in the rebar sector, we have the highest share of imported products, and this gives us a level of protection from global supply chain issues. Many of our clients are making substantial investments in new plants in North America, particularly in semiconductor production, which will unfold over the next three to five years. There is strong demand for steel in these areas, along with ongoing infrastructure projects that will strongly require the products we manufacture. Additionally, we do not see a lot of investment activity from competitors in our market. While there are announcements regarding new greenfield plants and developments in other product segments, we currently do not see significant capacity coming online in North America in the years ahead. We continuously evaluate scenarios, analyze data, and remain confident in our ability to sustain current margins. Of course, there will be fluctuations over time, but these factors are reassuring. We believe we are making the right choices, and addressing the performance gap has prepared us well to compete with our rivals in future market conditions. Japur, could you discuss capital allocation further?

Yes, there is discussion around your question. Time certainly passes quickly. When we reflect on our long journey, our net debt over EBITDA in 2015 was around 4 times. Since then, we have been gradually reducing this ratio, starting more significantly in 2018 and 2019. We approached a level where our cash conversion cycle stood between 1 and 1.5 times net debt over EBITDA. Then came 2020, which was marked by the pandemic. It may seem distant, but it was just recently. In the latter half of that year, our net debt over EBITDA was 2.8 times. So, it wasn't that long ago; it was just yesterday. Fortunately, we have seen substantial improvements in our margins and overall returns. Additionally, we capitalized on the market boom, enhancing our results and expanding our ratios. We recognize that in such a cyclical industry, it’s essential to maintain focus not only on relative targets, since EBITDA can increase or decrease, but also on the absolute levels of net debt and cash on hand. This is why we emphasize the importance of maintaining our net debt at the current level of BRL 1 billion.

A question by Thiago Lofiego from Bradesco BBI, a live question.

Hello? Can you hear me?

Yes, we can hear you. Go ahead.

I believe most of my questions have already been addressed. I want to emphasize again the topic of leverage. Japur, you mentioned BRL 12 billion, which has been your consistent figure since you became CFO. Considering recent cash generation, you are likely slightly below that. I would like to know your cash target. You mentioned $1 billion; is that still accurate? Additionally, at an exchange rate of 5.50, that implies a structural debt of 6.5 billion after accounting for 5.5 billion. I think that you are below that amount and should continue to reduce the company's debt in the upcoming quarters. Is that still the case? Specifically, I'm interested in understanding your cash flow and whether you can achieve a position as a net cash company. I have another question regarding whether Gerdau envisions becoming a net cash company for conservative reasons or if there are other plans. My second question, for Werneck, pertains to exposure in South America. The political landscape has changed significantly in many countries where Gerdau operates. Is there a chance that Gerdau will reconsider its assets and potentially sell some of its interests in South America?

Okay. You asked about South America, which is a common question. We really enjoy operating in South America. We have gained insights into the region and its current challenges. There was a time when South America seemed uniform, but now the countries differ greatly, and we understand each of them well. We do not plan to divest regardless of the political climate. This region provides us with considerable economic and financial benefits. For example, take Peru. The country has been facing significant political challenges with the current administration, yet it remains remarkable. The economy does not reflect its political issues. The macroeconomic fundamentals are strong, boosted by substantial mining revenues. There are promising government projects and a robust economy with high steel demand. We have competition in Peru, but the financial results there have been quite favorable for us. Now, looking at Argentina, we see a country with its unique challenges and characteristics. When the people of Argentina seek stability, they often turn to the real estate market, which strengthens demand for construction. Despite the political issues, we see solid economic fundamentals throughout the region. We are keen on continuing our investments where it makes sense and have no plans to divest. Our quarterly performance supports this, as we leverage our expertise and proximity to customers to pursue emerging opportunities.

In general terms, when you discussed gross debt, cash, and our balance sheet, the references you mentioned regarding our cash, gross debt, and net debt align with what we have communicated to the market and rating agencies. Sometimes, at specific points in time, such as a month, we may generate more cash that doesn’t necessarily match where we need it. For example, there are quarters when we must be prepared to pay a bond, requiring us to have sufficient cash. In Brazil, if we generate excess cash, I might prioritize other uses like dividends or share buybacks. Occasionally, we might generate more cash in North America while obligations remain in Brazil, leading to mismatches on a quarterly or monthly basis. These are resolved over time. Regarding our net debt, you are correct that it is currently slightly below the expected level. Taking into account the upcoming BRL 1.2 billion dividend payout and share buybacks that took place between the end of Q2 and early July, a significant portion of the net debt will be allocated to specific areas. Over the quarters, these figures tend to balance out. Additionally, fluctuations in foreign exchange impact our gross and net debt. During this quarter, the dollar depreciated by 11% from Q1 to Q2 2022, and about three-quarters of our debt is dollar denominated. This inevitably alters our balance sheet position regarding cash and debt in dollar terms. However, our business model remains balanced and solid, with our net position moving in a positive direction. We have operations in the U.S. that generate strong currency and operations in Brazil where we need to meet tax and dividend obligations. Eventually, these figures will align over time, and I hope this clarifies the situation.

Yes, it is very clear, Japur. So I understand that Gerdau going or becoming a net cash company is not an option. I think that over time, you will aim at BRL 6.5 billion or something close to that ballpark figure.

It is not our goal to become a net cash company. If we happen to generate a significant amount of cash from a particular operation in a given quarter, it would be an unusual occurrence. However, we do not aim to be cash-restrained since, regarding capital allocation in Texas, it is inefficient to retain excess cash.

Next question by Kai Rivero with Bank of America. He asks, how do you see the demand for longs in North America in 2023 given that we are seeing signs of a recession coming? On the other hand, the $1.2 trillion infrastructure package has been approved. What in your opinion will prevail?

I believe this aligns with my previous statements, Kai. I partially addressed that in Daniel's question. We view this as a very positive aspect. While there has been talk of a recession, we need to consider the overall business landscape. It's important to analyze the various types of businesses and companies involved, particularly regarding our infrastructure segment. With the ongoing onshoring in the United States and the lack of new capacities in that area, I think this is an ideal time for us to experience steady and strong demand not just in 2023 but also in the following years. I want to emphasize that we have prepared for this situation. We made past decisions that have now positioned us well, such as divesting certain assets and halting less profitable product lines, along with investments in our core operations over recent years. We are ready for this moment and I believe we have every chance to benefit from the efforts we've put in over the years, not only in 2022 and 2023 but also in the future.

Next question, Marcio Farid with Goldman Sachs. What should we expect to see of shipment in the Brazilian market? How do you see margins in exports and freight competitiveness?

Shipment, right?

Correct.

Like I said before, in the domestic market, we will see very flat delivery rates for the next months. We don't expect to see any structural issue or any scenario issue that might bring a dramatic drop on demand. Quite the opposite. We came back to historical export levels around 22%. We've been maintaining our operations going on. There were no reductions. We have customers that are very loyal in the Americas. We have our subsidiaries, where we export semifinished goods. So the domestic market is very stable, and we are pursuing any export opportunities in our subsidiaries and sister companies in the Americas with a very healthy level. For the coming months, well, I believe our main concern is how to find alternatives to keep on evolving in terms of being more competitive or using digital transformation more and more to fill any gaps that we see in-house and pursuing more efficient processes. So I think that's the focus right now. When it comes to demand, like I said over this call, we don't have major concerns for the next months of 2022.

And I still have a number of questions. We have at least another fifteen questions to be read. But because of the time allotted, we are going to end the Q2 earnings video conference call. And the IR department commits to answer all of the questions that were not able to be answered. So I turn the floor back to Gustavo for the closing remarks. And thank you for joining us.

Thank you again, Renata, for moderating the session. I'm confident you will have a successful career here. I appreciate everyone's participation. We want to stay close to you and improve our visibility regarding our business operations and insights. Please feel free to reach out to Renata, myself, Japur, or anyone on our team if you have any questions. Thank you for allowing us to share more about our results. I also invite you to join our next earnings video conference call for Q3 2022 on November 9, where we aim to present consistent earnings. We have a significant opportunity ahead of us to capture. Thank you all once again. Japur and I have truly enjoyed this time with you. Best wishes and take care.