Earnings Call Transcript - SID Q2 2022

Operator, Operator

Good morning, ladies and gentlemen, and thank you for holding. At this time, we would like to welcome everyone to CSN's conference call to present results for the second quarter '22. Today, we have with us the Company's executive officers. We would like to inform you that this event is being recorded, and all participants will be in listen-only mode during the Company presentation. Ensuing this, there will be a question-and-answer section at which time further instructions will be provided. We have a simultaneous webcast that may be accessed through CSN's Investor Relations website ri.csn.com.br/english, where the presentation is also available. The replay of this event will be available soon after the closing for a period of one week. Please feel free to flip through the slides at your own convenience. As a reminder, some of the forward-looking statements made herein are mere expectations or trends and are based on current assumptions and opinions of the company management and they may differ materially from the results, performance and events as they do not constitute forecast. In fact, actual results, performance and events may differ materially from those expressed or implied by forward-looking statements as a result of several factors, such as general and economic conditions in Brazil and other countries, interest rate and exchange rate levels, future rescheduling or prepayment of debt denominated in foreign currencies, protectionist measures in the U.S., Brazil and other countries, changes in laws and regulations and general competitive factors globally, regionally or nationally. I would now turn the conference over to Mr. Marcelo Cunha Ribeiro, CFO and Investor Relations Executive Officer. He will present the operating and financial highlights for the period. Mr. Cunha Ribeiro, you may proceed, sir.

Marcelo Cunha Ribeiro, CFO and Investor Relations Executive Officer

Good day everyone, and thank you for joining our conference call. We have our executive directors and Chairman, Benjamin Steinbruch, here to participate in the Q&A session. We will start with the presentation on page two. This period was characterized by significant uncertainty and volatility in the steel and mining markets. The diversification of our businesses resulted in strong outcomes, despite mining experiencing a price drop this quarter. Notably, our cement segment achieved record results due to a recovery in prices. We also announced investments in energy, including a solar plant and Quebra-Queixo, in partnership with CEEE-G, which will enhance our self-sufficiency and competitiveness. Moving to page three, the EBITDA evolution clearly shows that the company has encountered fluctuations in a highly volatile price environment, particularly in mining. In 2021, we saw high iron ore prices that continued through the second quarter, bringing our EBITDA closer to current levels. In the first quarter, rising iron ore prices benefited our results due to a reversal of provisions. However, in the second quarter, we faced a decline in iron ore prices, which led to a negative result for the period. EBITDA reached BRL 3 billion, experiencing a 1.5% decrease in mining, balanced by stable results in steel with good volumes and a rise in prices and margins approaching record levels. In cement, we achieved a 64% increase in operational results, benefiting from favorable margin growth and volume, resulting in a 31% EBITDA margin. Next, we discuss our operating and financial indicators. Our CapEx grew to BRL 838 million, with mining showing stronger growth as anticipated due to projects P-15 and C+3. In steel, important projects and port renovations are also underway. These figures are aligned with our initial expectation of a BRL 4 billion CapEx for 2022. However, we are currently reassessing our projects, prioritizing them, and adjusting our investment levels to save costs throughout 2022, expecting lower numbers than BRL 4 billion in the second half of the year. Regarding net working capital, it remained stable this quarter compared to the first, albeit with high inventory levels. We anticipate good news, as inventory normalization for finished products is underway. We have prioritized price over volume and made adjustments after experiencing high inventory levels for two or three quarters. In raw materials, we faced record prices for coal and coke but are now seeing normalization, which should enhance production. In the second half of the year, we expect to reduce inventory significantly, positively impacting cash generation. Moving to our cash flow on the next slide, we have seen fluctuations each quarter, with strong cash generation in the second quarter of last year followed by a correction due to increased working capital. In the first quarter of this year, high working capital demands and seasonality of payments, plus tax liabilities from a strong 2021, led to normalization. We now report BRL 830 million in adjusted free cash flow, with a clear positive outlook. We are also optimistic about consistent or growing EBITDA and reduced working capital, which should improve cash flow quarter-by-quarter. It's crucial to highlight our leverage maintenance. This quarter, net debt increased despite operating cash flow generation, impacted partially by exchange rate fluctuations as the dollar rose from 4.7 to 5.2, affecting net debt by 1.6%. We also distributed dividends from our equity, resulting in total debt of BRL 21 million. The net debt to equity ratio rose to 1.2, our target being 1.3. This rise is a one-time effect, as we transitioned from an extraordinary BRL 8 billion EBITDA semester to more typical quarters, leading to a decrease in EBITDA. Due to recent developments, including the anticipated acquisition of Holcim, we expect to experience increased leverage temporarily, with projections possibly adjusting to 1.4 or 1.5 times by year-end. We have not yet consolidated EBITDA from Holcim operations, so this effect is also a one-time occurrence and does not alter our long-term target of maintaining leverage around one time. Now, turning to liquidity on page seven, our cash position reflects our strategy of sustaining BRL 15 billion in liquidity, or slightly less, while ensuring efficient management of our liabilities. We issued $375 million with the Italian agency SACE at competitive rates and secured funding for mining projects. We're committed to maintaining our debt close to BRL 4 million, utilizing highly differentiated funding rather than conventional debt, which allows us to keep low leverage and manageable debt. Focusing on the details of our operations, in steel, we observe stability in domestic volumes, which is positive. We are prioritizing price over volume amid market uncertainties, where some sectors are being cautious. However, we achieved excellent performance in the construction industry, remaining resilient, though distribution has been more cautious, keeping our levels close to those in the first quarter. We experienced excellent margins and record prices in the domestic market, but faced delays in shipments due to logistic disruptions stemming from the situation in Eastern Europe, leading to a backlog of tons remaining undelivered. Still, our margins remained strong as prices rose, reflecting international trends. We adjusted our prices to cover rising costs, which increased by 5%. We maintained EBITDA margins of about 25%, with EBITDA at BRL 2 billion, similar to the first quarter. In terms of production costs, we maintained slab production and adjusted for high finished product inventories, resulting in planned maintenance that kept production below last year's levels. Despite this, we controlled price increases, with a modest 4.5% rise below true price growth, due to pressures from coal and coke prices. We now see a gradual decline in these raw material costs, which should benefit us in the second half of the year. In mining, on page twelve, we had a recovery in sales and production during the second quarter, with sales increasing by 9.3% and production rising by 29%. However, when compared to 2021 periods, our performance remained below potential due to operational impacts from early-year rainfall and lower productivity levels caused by port disruptions in April. We needed to manage dam conditions and faced bottlenecks due to rainfall damage repair. Fortunately, we are moving past that phase, with new projects commencing operations that should align mines, shipments, and ports in the second half of the year for enhanced sales and production. Regarding price realization, we were affected by declining iron ore prices, with quarter prices dropping from 140 to 120, compounded by increased shipping costs rising from $23 to $29, impacting our EBITDA realization near BRL 900 million with a 5% margin. In comparing quarterly results, the positive adjustment in the first quarter due to rising indexes created a BRL 650 million benefit, which contrasted with a negative impact of BRL 360 million in this quarter. Volume helped us, but factors like iron ore price drops affected overall results. Lastly, in cement, we see a notable increase not only in volume but also in improved seasonality compared to the first quarter, known for fewer working days. The second quarter showed stronger results, particularly in the Southeast. The Northeast region still faced challenges from rainfall, but we adaptively managed prices amid rising costs in energy and logistics. We are witnessing margin recovery, now at 34%. We are also accelerating our integration with Holcim and are optimistic about forthcoming decisions from the antitrust agency this week. As for energy, we underwent rapid movement through three acquisitions aimed at self-sufficiency, including solar plants and the privatization of CEEE. These initiatives are designed to enhance our energy management with promising returns and reduced costs. They will support our decarbonization strategy, where the entire group will operate on renewable energy. Ultimately, these capital allocation decisions enhance diversification and lower our reliance on external sources. Finally, I’ll now pass the floor to Helena Guerra, our Sustainability Director, to share updates on our ESG initiatives.

Helena Guerra, Sustainability Director

A good day to all of you. We're going to speak about ESG, and I would like to highlight the publication of our 2021 integrated report. And we will include indicators, KPIs that are relevant and of importance to the Company, and you will be able to follow up on these quarter-on-quarter. This enables us to be very transparent with our audience. We have reports that were published in the second quarter for mining, cement and steel. And as we had mentioned, we're presenting all of this according to the TCFD reporting format. We have had a continuous evolution in our ESG ratings. And once we analyze the new cycle, we will have further enhancements. We have also launched the Company's new ESG website, where you can find more updated information. In this last quarter, we signed with Shell and Itochu a memorandum of understanding to work jointly on decarbonization and operational efficiency initiatives for coal projects, fleet projects that are presently already being tested in the company. Now, when we speak about decarbonizing, we have had some highlights in the cement operation with the co-processing operation kickoff at Cimentos Arcos with a quarterly reduction of 8% in CO2 emissions. And Arcos will have electric trucks, and these are the first trucks in Brazil. And they are being tested at CSN Mining. We have also made great strides in terms of our dam management. The Auxiliary Vigia dam was definitively unregistered as a dam, and we're following the schedule for the decharacterization of dams, with the completion scheduled for the next quarter. In safety, we had the best performance in the historical record of the Company. And we feel that this is our best year. When we compare this quarter with the same period last year, we had a reduction of 27% in the accident frequency rate and 26% in the number of total accidents. Once again, the very best figures we have ever had in terms of our safety background, and we continue to make strides in terms of making the company more social and diverse. We had an increase of 70% in the participation of women in the Company. We have a higher representation when compared to the same period last year. Well, with this, we can now go on to our question-and-answer session.

Operator, Operator

Our first question comes from Isabella Vasconcelos from Bradesco BBI.

Isabella Vasconcelos, Analyst

I have two. The first referring to your price dynamic. How do you look upon this and if there are pressures to offer greater discounts? The second question refers to capital allocation. Recently, you have carried out three acquisitions in energy. I would like to better understand the mindset of the Company at present. The amounts that you had mentioned of BRL 3.29 billion, are those now out? And what has changed in your scenario? Is it more challenging? And if you're going to make investments outside of Brazil? Thank you very much.

Marco, Company Representative

Good morning, Isabella. This is Marco speaking to you. An important point that I read in your report to Dave and the Goldman report as well is that in your report, you speak about a rebound in the second half of the year led by China. And in the report of Goldman, they say that we were better than China in August. What do we believe will happen in the international scenery and what will happen in Brazil as well? We have a positive overbooking in several sectors, air conditioning, automotive. What is interesting is that our steel, coal, cement and iron ore inventories are low. This market dynamic and the possible rebound in China in the second half of the year will leverage the situation worldwide. I would like to remind you that if you think of premiums, we have a BK in China that reached a level that is impossible to continue with. We're referring to $596 per ton FOB. And 3, 4 months ago, it reached $845 in the USA. The lever of BQ is 280, 920, in Europe, 780, and they have both reached $1,600. So, when it comes to premiums in BQ, the premium still is very relevant, representing 20% to 24%. Perhaps what is more uncomfortable is the premium of 34% in rolled products, laminates. What will be the dynamic in the third quarter? We should have a more stable price situation. We're going to fight more in the markets of interest where we have zinc products and domestic products vis-a-vis imported products, and we have 8% to 10% sales more in the third quarter than in the first quarter. Therefore, the scenario is positive. We're observing what is happening in the economy, the reality. The signs are very interesting. There is more money inflowing into the market. And we think that part of this money will go for consumption, and part will go to construction, and this should increase our dynamic in the second half of the year in terms of price and demand. Another important point is that we have a cost position that is more aggressive. We want to get 3,700 per ton in slab, which is positive. The real dollar position is not that important, and imports continue at a somewhat lower pace. Last year, the imports were 2,700,000 tons. This year, this has been cut in half, a penetration of 10% or 11%, which is very healthy for the domestic market as well. On our side, as part of our strategy, we're going to work at full steam. We're acquiring slab to work at a fuller production. We have an acquisition of 200,000 to 250,000 tons of slab. In the domestic market, as Benjamin says, focused on quality. We have a few sales based on contract, and 85% are based on spot from the viewpoint of other businesses. Although the margin in Germany is very poor, we expect to have a recovery of volume, once the freights are normalized. And in Portugal and U.S., we are also active there as local players. This is a very general view of what we have backed up by a resumption of the world economy led by China.

Isabella Vasconcelos, Analyst

Well, thank you. Thank you very much. That is very clear.

Marco, Company Representative

The second question, I will begin answering it, but Benjamin is here with us. Without a doubt, he will also complement it. From the financial viewpoint, we do have to be more cautious. There's greater volatility in the price of commodities, the scenario of China, inflation, the potential of recession, all of this, given our strategy of maintaining our leverage low, makes us become more cautious when it comes to new investments. We do want to grow during the period undoubtedly, but we still haven't announced projects because we're not fully convinced about each of them. We're carefully serving each product and we will only put them in place when we're truly convinced that they will maintain our conservative capital structure as it was planned.

Operator, Operator

Our next question comes from Daniel Sasson from Itau BBA.

Daniel Sasson, Analyst

My first question still refers to capital allocation. Marcelo remarked on the leverage ending the year at 1.4% vis-a-vis EBITDA already considering the disbursements with Holcim Lafarge. My question refers to how this impacts your short-term capital allocation plans if you have slowed down the pace in the last two months in June and July? Are you awaiting to see if there is more visibility in the second half of the year to resume your program, or will you be more aggressive in your capital allocation program? Perhaps you think your assets have been under-evaluated, and there's still a good source of cash for you. My second question refers to steel volumes in Brazil. A question for Martinez. In the first half of the year, your total volumes had a drop of 14% vis-a-vis the first semester and the guidance is an increase of 11%. What do you expect for the third quarter? Martinez had a more positive viewpoint. But, is there room for a review of that growth guidance in terms of steel if it will have a drop? These are my questions. And thank you very much.

Marco, Company Representative

Let’s start with capital allocation, which relates back to my previous answer to Isabella. We see share buybacks as part of this strategy. We believe the shares are currently undervalued in relation to the company's fundamentals, and we maintain a strong capital structure due to ongoing uncertainties. However, we will continue to uphold our dividend policy. Our profitability levels suggest that dividends for CSN and mining will remain high, and we'll consider acquisitions when we have better insights on capital allocation. This could involve mergers and acquisitions or new projects in the USA. Priorities might shift as we make decisions regarding buybacks. In mining, we exercise caution with liquidity and are focused on maintaining low leverage and our established dividend policy. To provide further context on capital allocation, it reflects our current business strategy. The second quarter was notably chaotic, influenced by fluctuating prices, logistics challenges, and inconsistent availability of raw materials and finished products. We operated under high raw material prices but have since seen a notable decrease in prices in Asia, which has not yet impacted the USA and Europe. The logistics sector is experiencing disorganization, with delivery delays and varying factors that we typically rely on. We essentially spent the second quarter organizing our inventories of raw materials and products, as well as our infrastructure and logistics. In mining, dropping prices created a significant dual impact on current and future prices we had already sold. This volatility created substantial challenges. For steel and cement, rising prices for raw materials, fuel, and transportation had an effect. Despite this, we achieved full production but chose to reduce output to manage costs more effectively. We're now gearing up for increased sales, evidenced by solid performance in both steel and cement. We anticipate a stronger third quarter ahead. Our mining operations have stabilized after absorbing the impact of price fluctuations. While current prices are lower, any increase could yield better results. In cement and steel, we are optimizing production and reducing costs. Although we haven't seen the expected drop in prices, we are committed to showcasing our capabilities. We are positioned for a robust third quarter with substantial inventories and the right product offerings, and we hold a significant domestic market share while also performing well internationally. Despite reliance on international prices for iron ore, our focus remains on the domestic market. We foresee a positive third quarter, bolstered by conditions we've established, including inventory levels of BRL 3 to 4 billion, which we are eager to sell. Our exposure to Lafarge Holcim will be crucial, and we expect to make decisions regarding this partnership shortly. Cement has contributed positively, especially as we integrate Lafarge Holcim into our operations. In steel, we are pursuing a more direct approach in the market while maintaining price levels and offering differentiated solutions. With expectations of a market improvement by year-end, we anticipate a significant enhancement in cash flow, supporting our efforts to reduce leverage. There is potential for restructuring our energy and cement businesses to invite third-party participation, including an IPO in cement, which could inject capital and help with deleveraging. We aim to strategically expand our international presence, considering the competitive advantages of having assets abroad. As it pertains to share buybacks, you are correct; we did not engage in this during the last quarter. The financial market exhibited caution, and while share prices are regaining realism, they remain attractive. Our decision not to buy back shares was rooted in our commitment to disciplined capital allocation and the operational disarray in the second quarter. Starting in the third quarter, we plan to initiate some buyback activity. We understand our business well, and it would be illogical to refrain from this strategy due to isolated challenges. We view the second quarter as a transitional period, and expect the market to stabilize regarding raw materials, logistics, and financial aspects, thereby opening additional avenues for capital allocation. I would like to underscore nevertheless. And our priority is to keep leverage in mind. We can reaffirm this. We want to work with low leverage. It's easier, safer, more easy to forecast to work this way, and we fully respect low leverages. Everything that we do will have, as a basic assumption and priority, respect towards a low leverage. Of course, every once in a while, we do have some slips here and there. Neither Lafarge Holcim nor CEEE were part of our plans. Quite the contrary, I thought that we would lose CEEE. Why? If it was good for us, it would have been much better for our competitors. But we did win the bid, and we were extremely satisfied with that. And from the viewpoint of Lafarge Holcim, our priority was to look abroad. It appeared there was no Brazilian group that wanted to acquire it. So, we thought it was the right time to acquire it. We decided not to let it fall into the hands of foreign capital, and this will enable us to organize the cement market. This is where we are heading to, and this will be positive for everybody. I base myself on your question to explain my stance regarding all of these points. And of course, I base myself on capital allocation, which is the result of our strategy.

Daniel Sasson, Analyst

Our next question comes from Daniel Sasson from Itau BBA.

Marco, Company Representative

Daniel, to complement the answer given by Benjamin, regarding the guidance, we went through a moment in steel between 2010 and 2013 of a large amount of tons. We went through a terrible period between 2015 and 2019 with steel at 10.4 to 12. In 2020, we began the ramp up. In 2021, we got to 15.8. And in 2022, the market is given, it will not be lower than 15.4. This is something that we should celebrate. Although we suffered these variations in the market and transportation and cost, the market remains at 15.4, and the import penetration is lower at 4 million tons. If we look at the markets, what is happening? Benjamin just mentioned the cement and long steel. That's what we're focused on. Civil construction has an excellent carryover of work that is happening. Infrastructure gives the signs of being more avid for new work. The segment linked to agribusiness, highway machinery, implements, they're doing very well with a growth of 12% to 18% in the case of buses. And in packaging, we're doing well. What is perhaps somewhat negative is the lack of components for the automotive sector and a slowdown in household items. Now, there's a channel that is suffering because of these drops in the economy and the erratic signals that we see day after day. Our guidance will remain the same. We're referring to 5 million tons for the domestic market, 3 million to Germany, 850 and Brazil, 250,000. I think this guidance scenario is consolidated as we already have sales that are 10% greater in the third quarter vis-a-vis the second quarter. We're working on our strategy. In the second quarter, we preferred prices over volume. In the third quarter, we're going to recover the international market, a drop in imports and we'll be more aggressive in the markets where we are, especially in the galvanized market.

Operator, Operator

Our next question comes from Carlos De Alba from Morgan Stanley.

Carlos De Alba, Analyst

Maybe this is repetitive, but just to make sure that I understood all the explanation. If we can summarize it. So, for the third quarter, you guys expect higher revenues on the back of higher volumes as you will destock iron ore and steel. Prices for iron ore probably will be lower in the third quarter. What about prices for steel? You had a very good realized price in steel in the second quarter, but we have seen at least for HRC, the benchmark has been coming down in recent weeks/months. So, what do you see in terms of prices for the third quarter in steel? And given that you'll be selling more volumes with higher costs that you incurred in the past quarters, does this mean that EBITDA will probably increase on a quarter-over-quarter basis because of the higher volumes, but your EBITDA margin will probably drop? I just want to make sure that I understand, in a sustained way, the message. Thank you.

Marco, Company Representative

Carlos, I'm going to repeat what I said about prices. In the second quarter, we preferred prices over volume. In the third quarter, we have a somewhat higher inventory. We have to destock, and part of this destocking has to be in the domestic market. We're counting upon a market improvement. The scenario is quite positive. And in the third quarter, we will have more stable prices with a significant drop of imports in the third quarter. In the case of CSN, we cannot forget that we have 120,000 tons of imported material coming into the country. 75% is part of the material that we manufacture. With a premium of 30%, you can act. You have to operate based on those volumes. In the third quarter, we have a higher sales volume already sold out in several sectors. We don't put all of our eggs in the same basket, an increase of 8% to 10%. And in the fourth quarter, we're counting on a recovery of prices at international level. All the Chinese steel plants, without exception, are working with a negative EBITDA. Europe and the United States are also having a profitability that is not very desirable in this sector. I think there will be a recovery. And in the fourth quarter perhaps we can see a recovery beyond volumes, a recovery for prices, but we will recover our volumes and maintain the prices very stable.

Carlos De Alba, Analyst

All right, excellent. Thank you. And just on the slab cost. If I understood correctly or heard correctly, you are targeting BRL 3,700 per ton. That is a significant drop from the 4,386 that you did in the second quarter. Is this mostly a reduction in iron ore and coking coal, or can you break down how do you expect to get to the 3,700, and by when do you think you're going to get there?

Marco, Company Representative

Yes. Carlos, those are the figures for the end of the third quarter, perhaps September, beginning of the fourth quarter. And of course, we're counting with the curve of the ships that have been acquired with different raw material coal, coke and iron ore. And they're also including a higher production. In my presentation, we produced 900,000 tons of slab this quarter. We should produce more in the third quarter, and we're going to maintain our fixed costs stable. This is the cost of slab loaded into our rolling mill. And these were acquired at specific moments during the last weeks at good moments and this will lower the average. Now, dilution of fixed cost and an increase in slabs will enable us to reach that level of 3,700.

Unidentified Analyst, Analyst

There are headlines that you've been discussing with Sao Marco bondholders. Could you let us know what exactly were the topics here? I guess, it's about making an offer, but I was thinking about what's your framework of thought, what's potential timing, and what kind of financing alternatives you're considering given the current high-interest rate environment? Thank you.

Marco, Company Representative

Thank you for the question. We need to consider the desires of the Sao Marco shareholders, and we respect that. Currently, there is a circumstance where a group of creditors might end up with a share in the company due to the debt conversion. We are in discussions with these groups, which is quite common in such scenarios. As a result, we have engaged an advisor to enhance our interactions. However, we do not have control over the timing or the outcome of this process. It is a very complicated situation with numerous factors involved. There is a low likelihood of this progressing, but given that we are working with a unique asset in the sector, we want to stay well informed. This is why we are pursuing these conversations.

Operator, Operator

As we have no further questions, we will return the floor to Mr. Marcelo Cunha Ribeiro, the CFO and IRO Executive Director, for the closing remarks. You may proceed, sir.

Marcelo Cunha Ribeiro, CFO and Investor Relations Executive Officer

Well, thank you all for the questions. Thank you for attending our call. We bid you farewell with a message that our expectation is for third quarter that will be excellent. Operationally, we will have a drop in inventories, a production that is better in terms of mining and steel and with the cement business doing its very best. Now, there is a very volatile and complex environment in terms of raw material and others, but we're going to do our best in terms of volumes, prices, and we are going to be very competitive. We hope to see you again soon at the call for our third quarter. Have a good afternoon.

Operator, Operator

The earnings release call for CSN ends here. We would like to thank all of you for your participation. Have a good afternoon. You can now disconnect.