Tenaris SA Q3 FY2023 Earnings Call

Thank you, Carmen, and welcome to Tenaris 2023 Third Quarter Conference Call. Before we start, I would like to remind you that we will be discussing forward-looking information in the call and that our actual results may vary from those expressed or implied during this call. With me on the call today are Paolo Rocca, our Chairman and CEO; Alicia Mondolo, our Chief Financial Officer; Gabriel Podskubka, our Chief Operating Officer; and Luca Zanotti, President of our US operations. Before passing over the call to Paolo for his opening remarks, I would like to briefly comment on our quarterly results. Our sales in the third quarter of 2023 reached $3.2 billion, up 9% compared to those of the corresponding quarter of last year, but down 21% sequentially, mainly due to lower volumes and prices throughout the Americas, lower quarterly shipments to offshore projects, and lower pipeline shipments in Argentina. Average selling prices in our Tubes operating segment increased 2% compared to the corresponding quarter of last year, but declined 5% sequentially. As anticipated, our EBITDA, excluding a one-off gain of $32 million, fell just short of $1 billion with a margin of 31%. The sequential EBITDA decline was mainly driven by the ongoing price declines in the Americas. Our net income for the quarter at $547 million was affected by non-cash charges of $144 million related to the remeasurement and recycling of CTA to the income statement of our direct and indirect investment in Usiminas. Cash generated by operating activities during the quarter was $1.3 billion, while our free cash flow for the quarter was $1.1 billion, with a further reduction in working capital of $415 million. Our net cash position at the end of the quarter rose to $3.3 billion. Our Board of Directors approved the payment of an interim dividend of $0.20 per share or $0.40 per ADR to be paid on November 22. The interim dividend is up 18% compared to the interim dividend we paid last year. In addition to the dividend, the Board of Directors also approved a share buyback of $1.2 billion to be executed within the next 12 months. Now, I will ask Paolo to say a few words before we open the call to questions.

Thank you very much, Giovanni, and good morning to all of you. As anticipated, our third quarter results were affected by, among other factors, lower onshore drilling activity and an ongoing adjustment in market price levels in the Americas and the lower level of shipments in certain regions following a strong second quarter. On the other hand, we had another extraordinary quarter for cash flow with a generation of $1.1 billion of free cash flow, making it $3.1 billion in the year-to-date. With this cash flow adding to our already strong financial position, yesterday, we announced the launch of our first share buyback program, together with an 18% increase in our interim dividend. The share buyback program, which is for an amount of up to $1.2 billion, will be carried out over the next 12 months. We consider that buying back our own shares would constitute a better use of our excess cash than our current liquidity investment. During the quarter, we invested $90 million in the acquisition of additional heat treatment and threading facilities in Houston, which will help us to debottleneck our US industrial system. We also acquired a small pipe coating facility located close to our Dalmine plant in Italy for $10 million and announced the acquisition of the larger Shawcor global pipe coating business. This remains subject to the abstention of regulatory approvals and is expected to be concluded by the end of the year. The expansion of our pipe coating operation at the global level will help us to serve customers with an integrated offer for complex and offshore line pipe projects. In North America, we expect a recovery in drilling activity as we look toward 2024. In the United States, the relatively low level of drill and uncompleted wells and crude oil inventories, favorable oil prices, and rising natural gas prices should support an increase in investment as oil and gas companies reset their budgets for the next year. With OCTG inventory declining from excess levels, the declining prices for several product items are starting to slow down. The Pipe Logix index can be subdivided into different product item groups whose performance is not uniform. For example, item groups such as surface casing and tubing, which are most exposed to low-quality imports, have fallen further than higher quality product item groups, such as production casing, which are largely produced by domestic producers. We expect that if inventory continues to come down, market pricing should start to stabilize by the end of the year. At the same time, we are increasing the level of differentiation through our Rig Direct service. By the end of 2023, around 85% of our OCTG sales in the US will be supplied under our Rig Direct service model, and 75% of those sales will be done with our new run-ready service included. This compares with 65% and 30%, respectively, at the end of last year. In Canada, we also expect drilling activity to pick up as we head into the peak winter drilling season. We are repositioning ourselves following the revision of normal values on Chinese OCTG imports made by the Canadian government earlier this year and an expected increase in activity in the Montney shale. In the Middle East, the Saudi market is growing particularly strongly, as Aramco is rapidly increasing gas drilling activity, both conventional and unconventional, and investing in pipeline construction under the Master Gas 3 plan. We recently won a tender with a value of $600 million to supply seamless casing and tubing with short delivery times. For this increased activity, as Aramco has reduced stock levels during the pandemic, our recently consolidated GPC subsidiary, which invoiced $52 million during the quarter, is positioned to supply the large diameter conductor casing used in most wells in Saudi Arabia. Our new premium trading facility in the UAE will begin operation this month. This will be the first industrial facility of its kind in the Emirates and has been built along with a special Tenaris University training facility to increase the local content provision under our multi-year Rig Direct agreement with ADNOC. Offshore drilling and pipeline construction activity is in an expansionary cycle. We have been quick to capture the first wave of this cycle and our sales to offshore projects will be 50% higher in 2023 than they were last year. Our position in Guyana and Brazil has been central to this achievement. In October, at the OTC event in Rio, Petrobras awarded us the 2022 Best Supplier recognition in the category of Goods for Drilling and Completing Wells. Our research and development area and technical teams continue to develop material and product solutions tested for the specific conditions involved in more complex low-carbon energy applications such as CCS, carbon capture and storage injection wells, and hydrogen storage wells. In October, we were awarded a contract to supply high-chrome alloy tubing for carbon injection wells for the EU-founded Porthos project in Rotterdam. The materials were selected to withstand the high corrosion risk and expected cryogenic thermal shocks. In Argentina, our first 100-megawatt wind farm has entered full operation and is delivering power through the interconnected grid to our operation in Campana. We have secured the opportunity for a second 90-megawatt wind farm and we will go ahead with a $214 million investment to be completed within 24 months. Both wind farms will provide cost-competitive electric power with a capacity factor of 55% and above, with no subsidy. With the investment in the wind farms and our ongoing investment in energy efficiency, we expect to meet almost 100% of our energy requirement in Argentina through renewable energy. Digitalization is central to our strategy. One investment that is currently coming on stream is a $20 million digital global programming and scheduling system that will help us to improve production lead times, cost, and compliance. With favorable market conditions ahead, we are strengthening our competitiveness and focusing on service and margin differentiation. We are now ready for any questions you may have.

Hi there. Thank you for taking my questions and congratulations on the good set of results. My first question is on the average selling price. As you pointed out, there are different categories that are seeing different movement in prices. And if I look at your average selling price in Q3, it's not that different from Q4 in 2022, marginally down, but not as much as the Pipe Logix. So the question here is, is there a growing disconnect between your ASP and the Pipe Logix, or is it just a matter of the time lag between the two and we will see your ASP actually falling in line with the Pipe Logix maybe in the coming quarters? And on this point, maybe if you can give us some color on where you see sales going in Q4 and in Q1 with the EBITDA margin? That's the first question. The second question is on the share buyback. Maybe if you can clarify when you're planning to start the share buyback and whether maybe Techint is going to participate or when we will know whether Techint is going to participate. Thank you.

Thank you, Alessandro. As far as your first question is concerned, the association between the Pipe Logix indicator and our overall price is influenced by many different factors. On one side, the majority of our prices are driven by different factors compared to the Pipe Logix. Some of the formulas take into consideration costs or different variables independent from the Pipe Logix. Even within the US and North America, which is more influenced by Pipe Logix, the formula we have with our clients reflects specific products within the Pipe Logix portfolio that in some cases are not moving in the same direction as the average of Pipe Logix. There are differences between, for instance, premium or complex products and more simple products. So I don't think we can derive a strict correlation between the Pipe Logix and the overall average price of Tenaris. Yes, we have a more strict correlation with our operation in North America, but North America is very important in our overall sales. So I will ask Luca Zanotti to add some color on this relation between the Pipe Logix index and the dynamics of our prices.

Yes, thank you, Paolo. Good morning, Alessandro. As Paolo was saying, when we look at North America and see how the demand is structured, we observe an increasing predominance of seamless heat-treated products. If you look at, for example, a key component of the demand, which is the production casing, which is more or less 40%, 45% of the total market, the great majority of this is seamless. When we combine this with the structure of the Pipe Logix and the price, you see that these items suffer less from the decrease within the Pipe Logix. To conclude, you should integrate the structure of the market and the way different items are moving within the Pipe Logix. Additionally, it's worth mentioning that when you look at the United States, our formulas with our customers are not necessarily 100% related to the Pipe Logix. We have other indicators and these indicators in this context are much less volatile than the Pipe Logix itself. I believe these are the two main reasons why there is not a perfect match between our prices, even in the United States, when you look at the Pipe Logix.

Then, Gabriel, you can comment on the wide range of prices and the differing dynamics that we have across various markets.

Yes, Paolo, thank you very much and good morning, Alessandro. Indeed, the price dynamics in international markets differ from those influenced by the Pipe Logix. Internationally, we are benefiting from increased demand in the Middle East and offshore markets, while at the same time, we have tight supply in premium products, sophisticated grades, sour service, or high chromium grades. These segments are not linked or influenced by the Pipe Logix. The required products and the competitive environment differ completely from that influenced by Pipe Logix. So, in international markets, we continue to see high-end market opportunities to enrich our mix and drive prices up. There is typically a lag of six to nine months in this part of the world from booking prices to deliveries, but we see a positive trajectory on international pricing into the end of this year and into 2024.

Thank you, Gabriel. And regarding the second question, the share buyback will be executed in quarterly tranches from now until within one year. We haven't received any specific information on this from our majority shareholder.

Okay, thank you. And just to follow up on the evolution of margins for the next couple of quarters, is there any additional color that you can provide?

Well, to the extent to which the Pipe Logix is influencing, at least as Luca was explaining, part of our sales in North America and in some cases also other markets, we will see this reflected in our margin with some delay. The decline that you have seen in this quarter will also be reflected in the next, and possibly depending on the evolution of the Pipe Logix in the coming months, November and December. We will see if this trend continues or not. To this extent, this will be reflected in our margin. As you have seen, last quarter we anticipated the margin in the range of 30%. This is where we are today. Considering all the factors, I think that we can expect slightly lower margins in the next quarter, but we will remain, let's say, between 25% and 30% over time. This is also our long-term view.

Okay, and potentially picking up from Q2 if Pipe Logix stabilizes. Is that fair?

It's difficult to predict. There are many factors that will influence demand and supply, let's say, during the first half of 2024. There are important activities, the level of drilling, the demand for pipe, and the level of imports are also relevant. Imports went down, but we have to see if this is a trend that will continue. In general, we perceive a reduction in the level of inventory in the market, which is positive for supporting the overall price level in the US.

Thank you very much for the color. I'll turn it back. Thank you.

Yeah, good morning. My first question is on the US, perhaps for Luca. I was wondering if you could comment on what you're seeing in terms of the import of products into the US. How is lower pricing impacting imports into the US?

Thank you, Arun. Luca, you can comment on this.

Yes, and I can tie back to what Paolo mentioned regarding inventory. We have seen imports decline, and this reduction is primarily driven by a decrease in imports from countries other than Korea that are complying with their quarterly quotas. Both ERW and seamless imports have decreased. Additionally, domestic production, especially in the ERW segment, has also declined, which in turn has helped reduce the inventory on the ground. However, as prices decrease, some importers will start to face the 25% imposed on Section 232, especially as they complete their quota. If we see a recovery in demand starting in 2024, this could impact the possibility of some very low imports coming in. However, we believe that the imports are high, and this is a challenge that the domestic industry is addressing.

Just a quick follow-up, if imports are declining into the US, could that affect international pricing if those imports find a new market?

Well, I don't think there is a clear overlap between the materials that companies are importing into the States and the international market. For instance, the demand for welded products outside the United States is very limited. I mean, the international demand is different. There could be some redirection of imports, but it is at a much lower scale than what is imported into the States. Additionally, this market is complex, where qualification and establishing the product for different companies takes time. In the US, it is easier for a producer with relatively limited experience and track record to penetrate or some segments of the low-end market.

Great. And, Paolo, I just want to get your quick thoughts on the Argentinian election. Obviously, there is a candidate proposing dollarizing Argentina, but just some quick thoughts. I know we still don't know the outcome yet.

We are in an election process. There will be a ballot on November 19. Whoever wins the ballot will assume the Presidency on December 10. I believe that whatever the outcome of the ballot, there will be a need in Argentina for an adjustment program that will necessitate a reduction of public spending, devaluation, and it is possible that economic activity may reduce to align some variables that are currently outside the norm for a country like Argentina. We will see. There is no clear indication on the results of the ballot and no clarity on the program that will be implemented after the new administration takes office.

Hi, thank you. Maybe following up to the last question, you had previously discussed some concerns about South America in the latter half of the year because of election uncertainty. Could you talk about how that evolves? Obviously, there may still be some uncertainty for Argentina, but what about the rest of the region? Your thoughts heading into 2024 would be helpful.

Well, I mentioned Argentina. After the elections, we expect that the new government will have to implement, as I said, an adjustment program that will impact the exchange rate and public spending. There will undoubtedly be to some extent a reduction in economic activity. However, any government will need to promote export and attract investment. Argentina has substantial potential for investment in oil and gas, agriculture, lithium development, and renewable energy, among other sectors. I believe this will be part of the program for either candidate. Additionally, the agricultural sector has faced significant difficulties in 2023 due to drought conditions, and this will help the next government in addressing the challenges of the adjustment process. In Brazil, the situation appears more stable; they are developing their oil and gas industry, with Petrobras having ambitious plans to increase production levels. Deals like the one we signed with Equinor indicate that private sectors are investing in Brazil on large projects, which include significant infrastructure elements that we are part of through our subsidiary, Confab. As for Mexico, it is logical that, following the new refineries coming upstream, investment in the energy sector will increase, supporting Pemex financially. However, it's also true that Pemex's financial situation is very challenging, and we are, like other oil service companies, facing some delays in payments from Pemex. It's critical for Pemex to expand its operations in the coming months while also reducing its payables to suppliers, including Tenaris. Regarding the rest of Latin America, in Colombia, after the election, we expect that some decisions in the oil and gas sector may be reconsidered. I think there could also be recovery in Colombia during 2024 and 2025 after a significant decline in 2023.

Okay, thank you for that, Paolo. I want to ask a couple more quick ones on the direction of business over the next couple of quarters. Volumes were down 17% in the third quarter. It sounds like you're anticipating volumes to improve in the fourth quarter. I'm curious if you think a million tons a quarter is the right number to consider for the fourth quarter and entering 2024, and if there are any regional comments around that.

Yeah, you're correct. This is what we expect. The situation in Argentina may influence some decisions on the pipeline and the timing of those between quarters, but fundamentally, we are in the range you mentioned. This is what we anticipate for the coming quarter.

Okay, great. And then the other one was just related to profit per ton. The guidance of 25% to 30% for the fourth quarter would suggest you might be over $800 a ton of EBITDA. The long-term average has been around $500, and there's another company stating that the normalized price or average margin is $500. Do you think you can maintain this $800, and why do you believe it would be better than the long-term average?

I believe there has been a structural change on both the market side and in Tenaris’s positioning. Today, the activity and investment in the US are much more accessible for Tenaris. We have deployed our assets significantly in the last five years, especially, but we began investing in the States in 2007 in substantial ways, which positions Tenaris differently within the important oil and gas market. Additionally, we have expanded our differentiated product and services. The Rig Direct program provides us with additional margins, and I believe we can defend this differentiation due to the Rig Direct model and the level of service we are adding to our product delivery, which was not the case five years ago. Our positioning in the Gulf and Middle East is also vastly improved due to our investments in Saudi Arabia and the new plant in the Emirates. The combination of these market changes and Tenaris's enhanced standing allows us to justify higher margin levels than the average of the last ten years.

Thank you very much.

Good morning. Just one question. With your Rig Direct program in the US, you have good insight into some of the larger operators' programs. I just wanted to see if you could comment on how you see future activity unfolding over the next three to six months.

Thank you, Luke. I think Luca can provide insights.

As I mentioned earlier, we anticipate increasing activity from current levels. When we look at a large portion of our direct customers, we see this growth aligning with the feedback from drillers already discussing their earnings. We expect activity to increase by 5-6% from current levels into the first quarter of 2024.

Thank you. One moment for our next question, please.

Hi, good morning. So if we assume the US rig count bottoms here in the next month or so, can you talk about how you see volumes trending over the next 12 months? The Middle East continues to ramp up, as you highlighted, Saudi and UAE. Offshore should be close to speed by midyear. I would think volumes in the second half of '24 should be up quite a bit compared to the second half of this year, perhaps even up double digits. Am I thinking about that trajectory correctly in terms of how you're viewing the market for volumes?

Thank you, David. It's difficult to guide expectations for such a long timeframe, as the world is moving quickly on various aspects. There are conflicts, and several issues are truly out of our control. We can perceive and see our horizon in the next couple of quarters, which we are trying to represent. However, it is difficult for us to project where we could be in the second half of 2024. Probably, the area where we can have a medium-term perspective is within offshore projects, which tend to be more stable over time. Once decided upon, they proceed. Gabriel, perhaps you can add some reflections on the second part of 2024.

Sure, Paolo. Good morning, David. Indeed, offshore drilling continues to increase. The number of rigs operating globally in offshore is even exceeding pre-pandemic levels, both in shallow and deep water. Every discussion we have around FID projections and cap projections indicates that this is a multi-year cycle. The level of activity is robust and will continue to grow. We have already observed benefits from this trend in our 2023 sales, as we expect at least a 50% increase from 2022 by the end of the year. We anticipate continuous growth. During the quarter, we noticed signs of increased activity in exploration, which is an important niche for us. We also received awards for exploration campaigns in Egypt, Angola, and offshore Colombia. Thus, we have a strong backlog in offshore, primarily in OCTG and pipeline with deliveries stretching into 2024 and even some projects reaching 2025. We see this as the early part of a multi-year cycle, and our acquisition of the coating facility in Italy, along with the Shawcor coating division announcement, showcases our confidence in this segment where we possess a differentiated portfolio and an established position.

Thank you, Gabriel. Still, let me add that we have some caveats. The global situation remains exposed to various issues that could lead to disruptions. The global price of LNG continues to be influenced by the situation in Europe, and oil prices may be affected by the Middle Eastern landscape. For instance, our operations in the eastern Mediterranean sand oil project have been canceled. Additionally, Latin America is experiencing election years, both in Mexico and now in Argentina. Hence, while our outlook is as described, we must also consider the potential for disruptions that undoubtedly exist in 2024.

Very much understood, Paolo. One final question regarding the buyback you announced today. Is this targeting solely the open float of shares, or will the closely held shares be participating in the buyback as well?

We don't know. We launched the program considering the return we can achieve from our cash by investing in the company compared to what we could obtain from managing liquidity. This is a key factor for our decision. As I mentioned, we'll have an intermediate bank to manage the acquisition in the upcoming quarters, likely starting next week, and we will see how it unfolds. I don't think we can add further on this.

Okay. Thank you very much, Paolo. I appreciate it.

Thank you. And we have time for one more question. One moment, please. It comes from the line of Jamie Franklin with Jefferies.

Hi there. Thank you for taking my question. I was just wondering if you could provide some insight into CapEx plans for 2024 and '25. Obviously, there's been the announcement of this second investment in a wind farm in Argentina, which is great to see. Beyond that, should we expect further bolt-on M&A, and where specifically would you be looking? Additionally, what about the possibility of adding seamless capacity internationally? Is that an option?

Thank you, Jamie. We plan to invest in CapEx in the range of $350 million in the first half of 2024. We expect a similar expenditure in the second half. Thus, we are looking at around $700 million in CapEx. Among these investments is, as you noted, the wind farm in Argentina. We completed the first wind farm in line with our budget, with only minor discrepancies. We view this as a priority for decarbonizing Tenaris, given the effective and competitive environment. We are also proceeding with the development of the second wind farm. Further, we are focusing on enhancements in our Argentine operations to reduce energy consumption in our steel shop, among other areas. We have also made investments in our Dalmine operations and in US facilities for enhancements. While we will consider consolidating our acquisition of Shawcor, requiring antitrust clearance, thus prompting potential additional investments, our current strategy does not encompass specific targets for M&A but remains open for strategic positioning across global regions. Tenaris must continue as a global leader, focusing strategically in all operational regions to strengthen our position effectively. However, we do not have particularly relevant initiatives at this time.

All right, thank you.

Thank you, Carmen. And well, thank you all for joining us on our quarterly call, and we’ll see you soon. Thanks.

Thank you, ladies and gentlemen, for your participation, and you may now disconnect.