Ternium S.A. Q2 FY2021 Earnings Call

Ladies and gentlemen, thank you for standing by, and welcome to the Ternium Second Quarter 2021 Results Conference Call. At this time all participants are in listen-only mode. After the speaker presentation there will be a question-and-answer session. Also please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Mr. Sebastian Marti. Thank you. Please go ahead, sir.

Good morning, and thank you for joining us today. My name is Sebastian Marti, and I am Ternium's Investor Relations and Compliance Director. Ternium released yesterday its financial results for the second quarter of 2021. This call is complementary to that presentation. Joining me today are Ternium's Chief Financial Officer, Mr. Pablo Brizzio; and Ternium's Chief Executive Officer, Mr. Máximo Vedoya who will discuss Ternium's business environment and performance. At the conclusion of our prepared remarks, there will be a Q&A session. Before we begin, I would like to remind you that this conference call contains forward-looking information and that actual results may vary from those expressed or implied. Factors that could affect results are contained in our filings with the Securities and Exchange Commission and on Page 2 in today's webcast presentation. With that, I'll turn the call over to Mr. Vedoya.

Thank you, Sebastian. Good morning. And thanks all for your participation in today's call. Ternium reported remarkable results in the second quarter of the year. We had record quarterly sales, margins, EBITDA, and net income. Looking ahead, I believe the current strong global steel market environment should continue to support our solid financial performance over the rest of the year. Steel prices in our region increased steadily to high levels over the last 12 months with strong steel demand and low inventories in the value chains. Prices are probably going to begin a downtrend at some point during the second half. However, I don't expect this to be a very profound downtrend. The main reasons for this positive view are a steel demand that remains strong, constraining the supply chains, news from China with growing export rebates aimed at limiting steel production and from Russia with taxes on steel exports. In this encouraging environment, we successfully started up our new hot rolling mill at Pesqueria on May 15, a monthly advance of our previous estimations. We are very pleased with these achievements and with the ramp-up of the line, which is also performing better than anticipated. As a result of this, we currently expect this new facility to enable us to increase our market offering of high-quality steel products by approximately 600,000 tons during the second half of the year from the 400,000 tons I mentioned on our last conference call. All of this should result in subsequently higher EBITDA levels in the third quarter of 2021. On the balance sheet side, in the second quarter, we continued to show significant cash generation, and we maintained a very low level of net debt even after paying out our yearly dividend in May. Let me go over our main markets now. In Mexico, the driver behind our sales growth expectations for the second half of the year is the industrial market. Steel demand in this market is very strong. Manufacturing industries like HVAC, electrical motors, and household appliances are experiencing record end-user demand and significant backlogs, which greatly increases their steel consumption. The auto industry in Mexico is also experiencing strong end-user demand, but it continues to be affected by the semiconductor supply chain disruption, a situation we expect should gradually subside over the following quarters. Additionally, we are seeing an increase in investment announcements in Mexico from these manufacturing industries. As our new hot rolling mill in Mexico is designed for the industrial market's product needs, the ramp-up of this facility is going to help us increase even more our participation in this market over time. The commercial market in Mexico, more related to construction activity, is currently not as strong as the industrial one, with no significant growth in infrastructure investment and softer demand from retail construction. In Argentina, we expect shipments to remain relatively steady in the third quarter after a strong second quarter of the year. In this market, we are seeing sustained domestic demand from building materials and higher activity levels in some industrial sectors such as automotive and agribusiness. On the other hand, the macroeconomic environment in the country remains unstable. Also in November, there will be mid-term elections in Argentina, which could introduce a higher level of uncertainty in the market. Turning now to the other market regions. As anticipated in our previous conference call, we continue to integrate our slab mill in Brazil with our facilities in Mexico and Argentina. This has resulted in a lower volume of slabs sold to third parties in the quarter, offsetting higher shipments of finished products sold in Mexico and the Southern Region. You can expect to see the participation of slabs in our sales mix to continue decreasing in the third quarter. One reason for this is that during the second quarter, the long-term slab supply contract we had with an Alabama facility expired. This was timed to coincide with the startup of our new hot rolling mill in Mexico, which is now requiring an increasing volume of slabs during the ramp-up. Before finishing my remarks, it's worth mentioning that the COVID-19 Delta variant, which is affecting the Northern Hemisphere now, is not widespread in South America. We have yet to see its impact on our market over the following months. Vaccination programs in the region have improved significantly over the last months, although the percentage of the population with full vaccination is not yet as high as it is in Europe or the U.S. So there continues to be a risk of further lockdowns or disruption in the value chain if the sanitary situation worsens. Additionally, I would like to draw your attention to the publication of Ternium's last sustainability report, which we issued in June. I encourage you to review it, as it shows our progress towards achieving our objectives in a sustainable way, describing the actions taken to achieve our goals in six areas: safety, environment and decarbonization, people, community, value chains, and business strategy. In conclusion, we expect to continue demonstrating a strong performance over the following quarters, as favorable global steel industry fundamentals should support solid high steel prices, even if they begin to soften at some point during the remainder of the year. With this, Pablo, please go ahead with the webcast presentation of our performance during the second quarter.

Thanks, Máximo, and good morning to everybody. Ternium's performance in the first half of the year has certainly been remarkable. It reflects the varied conditions prevailing in the steel market that Máximo has just described. We will see now how this condition allows the company to reach new record levels of profitability and results in the second quarter after a very strong performance in the first quarter of the year. Let's start by reviewing EBITDA and net earnings on Page 3 in the webcast presentation. EBITDA in the second quarter of the year reached $1.4 billion, with an EBITDA margin of 36% or $463 per ton, a new record high. These margin levels are higher than those of most of our peers probably at the world level. Although these out-of-the-ordinary margins are not going to be sustained over the cycle, I want to point out that Ternium consistently achieves higher margins over the cycle. Net income in the period reached $1.2 billion, or $5.21 per ADS. Looking out to the third quarter, we expect to achieve a new record EBITDA with higher margins and volumes, which we will analyze in more detail later on. Let's turn now to Page 4 to review steel shipments. When we compare our volumes on a year-over-year basis, we see a significant recovery in Mexico and the Southern Region in the second quarter of this year. As you know, last year, the second quarter activity levels were deeply affected by the COVID-19 outbreak. Now, on a sequential basis, shipments in Mexico and the Southern Region increased 2% in the second quarter of the year, remaining at elevated levels in a scenario of strong steel demand in Ternium's main markets. Looking forward, considering the strong demand for Ternium steel products in the U.S. and other regions, as well as the ramp-up of the new hot rolling mill in Pesqueria, we believe our shipments in Mexico will increase by approximately 600,000 tons, as Máximo already mentioned. In other market regions, you can see that the ordering of slabs shipped to third parties has continued to increase quarter-after-quarter. The reduction reflects the increased integration of Ternium's slab facility in Brazil with the company's industrial system. We expect this integration trend to remain in the third quarter. As a result, we expect a further reduction of the volume shipped to third parties. Now on the next page, you can see that combining these developments, we have consolidated steel shipments of 3.1 million tons in the second quarter of the year, relatively stable sequentially and 25% higher on a year-over-year basis. Moving on to the steel prices, Ternium's revenue per ton in the second quarter increased sequentially and year-over-year. This, together with a large reset of contract prices in Mexico, anticipates a further increase in Ternium's realized price in the third quarter. Turning now to the net sales, the combination of higher realized prices and stable shipments resulted in a 21% sequential increase in net sales in the second quarter to $3.9 billion. Compared to the second quarter of last year, net sales in the second quarter more than doubled. Let's now review the main drivers that led to a sequential increase in EBITDA and net income in the second quarter. The chart on the top shows that EBITDA mainly increased due to higher realized prices, which were partially offset by higher costs per ton, mainly due to higher raw material and purchased slab prices and increased maintenance expenses. As I mentioned at the start of this presentation, we expect a new sequential increase in EBITDA in the third quarter reflecting expected increases in shipments and revenue per ton, partially offset by higher costs per ton as the rise in the purchase prices of raw materials continues to flow through the company's inventories. The chart below shows that the sequential increase in income in the second quarter was chiefly due to higher operating income. In addition, results from our own operations in Usiminas improved. On the following page, we can see the same changes but for the first six months of the year. In both charts, the drivers of the increase in EBITDA and net income were the same as we just described for the second quarter. To finish the presentation, let me turn now to Page 8 to review our quarterly cash flow and balance sheet performance. Cash flow operations in the second quarter of this year was $628 million, even after a significant anticipated increase in working capital. In the third quarter, we expect a further increase in working capital, reflecting expected increases in realized steel prices and higher costs as previously discussed. Regarding free cash flow, the company generated $467 million after capital expenditures of $161 million in the quarter, enabling Ternium to slightly reduce debt after paying out a $2.10 annual dividend in May for a total amount of $412 million. Net debt stands at just $0.2 billion at the end of June, equivalent to 0.1 times net debt to last 12 months EBITDA. With that, I am concluding my prepared remarks. Thank you very much for your time and attention. We are ready to take any questions you might have. Please, operator, proceed with the Q&A session.

Your first question comes from Caio Greiner from BTG Pactual. Your line is open.

Hi, thank you. Good afternoon. So my first question is on capital allocation. This is probably the main question surrounding the investment case. Currently, the company is moving to net cash, maybe in a matter of weeks. I just wanted to understand how Ternium sees the growth versus dividends equation today. Because on one hand, the company is still ramping up Pesqueria, so we're not sure if you would be willing to kick off another project in the meantime. But if you are, what do you think you're most likely to invest in over the coming years? Would you see M&A as a feasible option, or would you rather go with organic growth? What are the company's priorities regarding this? If that involves investment where you currently operate, or maybe thinking about geographical diversification? I recall that some time ago, there were talks of building an EAF in Mexico; is that still the case? Additionally, if the company is not willing to kick off another project at the same time it ramps up Pesqueria, could we see Ternium being able to declare extraordinary dividends in the second half, or are we closer to seeing an official dividend policy being approved based on free cash flow generation? That's my first question. And my second question is really quick on EBITDA per ton. Ternium delivered EBITDA per ton levels above $400 per ton in the second quarter, that could potentially exceed $500 per ton in the third quarter. I just wanted to quickly understand where do you see EBITDA normalizing ahead, because I remember that a few quarters ago, you mentioned that EBITDA could probably normalize or margins normalize in the 15% to 20% range. Do you now see reasons to believe that long-term margins could be sustainable at those levels? Thank you very much.

Thank you very much, Caio. I will take the first question, and then Pablo will probably answer the second one. Regarding the capital allocation, organic growth, geographical diversification, let me try to summarize our thoughts and answer your question, Caio. You're right; we have a significantly strong balance sheet and we are likely to be net debt negative in the next quarter. This year, we plan to invest $600 million in CapEx, with around $1.3 billion allocated to working capital in the first half, continuing investments in the third quarter of about $300 million. We paid dividends of $412 million in May, the highest dividend in Ternium's history, almost doubling the previous high dividend. As we look forward to 2022 and onwards, regarding dividends, I believe that this new level can be sustained into the future, based on the current steel business environment. We expect extraordinary dividends, again something the Board of Directors should propose. But having said that, I can't rule out an extraordinary dividend. Regarding CapEx, we're not seeking geographical diversification and are concentrating on the Americas; we don't see investments far away from or in regions beyond the American continent. We are analyzing different projects for growth in business today, including the ramp-up of the new hot rolling mill in Mexico, which is significant for us and may lead to increased participation in the market as I mentioned. The USMCA rules will require us to expand upstream capacity in this region at some point down the road. I hope that covers everything in your first question, Caio.

Let me take the second part of Caio's question. Regarding the EBITDA per ton, we generated levels above $400 per ton in the second quarter, with expectations for higher EBITDA per ton in the third quarter. While it is not reasonable to assume that these levels will be sustained, we do not expect a significant reduction either. Long-term, we continue to work on achieving high levels of EBITDA margins and per ton, aiming to outperform our peers in any part of the cycle. Although we were previously discussing normalization in the 15% to 20% range, it seems feasible to exceed this level in the next year, assuming market conditions remain favorable.

Thank you very much, gentlemen.

You're welcome.

Hello, good morning, gentlemen. Hopefully, you're all doing well. A couple of questions, if I may. Máximo, when you mentioned the 600,000 tons increase, are you referring to overall volume or just the percentage of value-added volumes in the company's overall shipment? Additionally, could you give us an idea of how many slabs from the facility you expect to sell internally in Mexico and how many to external customers in the coming quarters?

Thank you, Carlos. We are doing well, and I hope you are too. The 600,000 tons increase I mentioned earlier refers to overall sales. I had initially said 400,000 tons would come from the new facility, but we have updated this expectation to 600,000 tons due to the ramp-up curve. Regarding slabs, in the third quarter, we expect to ship around 800,000 to 900,000 tons in total, with approximately 300,000 to 400,000 tons expected to go to third parties.

All right, fair enough. Regarding your comments on needing to invest in steelmaking capacity to comply with USMCA rules, are you considering only Mexico or the U.S. and Canada as well?

That's a very specific question, Carlos. We are analyzing the situation, but we don't have any announcements to make yet. We are considering that at least part of our investment may be made in Mexico, as our hot roll mill is located there, and our customers are probably based there. The USMCA rules of origin are focused on the automotive industry and they begin in 2027, providing us time to analyze all alternatives.

Fair enough, this is all hypothetical at this point in time, but would it be fair to say that an Electric Arc Furnace (EAF) might be a better option for you guys than a traditional blast furnace integrated facility?

That's for sure. We're not analyzing a blast furnace, that I can confirm.

Fair enough, thank you very much. All the best.

Thank you.

Thank you very much. I hope you're all safe and well. A couple of quick questions on demand and exports pertaining to your strategy for Pesqueria. First on demand, you mentioned that Mexican domestic demand for flat steel has been quite strong. However, we've received increasing calls suggesting that demand is on the weaker side in Mexico. Can you clarify whether you see yourself capturing market share or if the demand is still strong overall?

Thank you, Andreas. I will take that one. We are seeing both to be honest. The demand is increasing in Mexico compared to last year but not as much as it is increasing in Brazil or the U.S., where consumption is rising more significantly. Mexico is projected to close at around 10% steel consumption increase in 2021 compared to 2020. However, it’s essential to note the performance is very different between markets; the industrial market is very strong while the commercial side is weaker.

That makes sense. Maybe a quick follow-up there. You mentioned the growth from last year; could you provide insight into where we are this year versus pre-COVID in 2019?

It's almost the same. Last year, the apparent consumption decreased by around 8% to 9%. We're seeing an increase of approximately 10% this year, probably a little more. Overall, consumption in 2021 will be similar to that in 2019, with differences in product mix: demand for flat industrial products is much higher than in 2019, while construction product demand is lower.

That's clear; different demands across product types. I have a follow-up question regarding shipments from Pesqueria. Based on the recent price increases, do you anticipate exporting more than before, or will you capture more market share from imports into Mexico?

That’s a good question. I question your view on the price being more supply-driven than demand-driven. While capacity has decreased, the U.S. utilization rates are currently at pre-COVID levels, and Mexico is probably producing more. We are anticipating increased demand in the U.S., which could reach over 50% this year. This indicates a demand-driven increase rather than merely supply-driven. The reshoring trend is happening as we see considerable investments in various industries that consume steel. In essence, while some volume will go to exports, the majority will go to the Mexican market to replace imports and benefit from new demand.

Okay, that's very clear. Would you anticipate this trend to continue into 2022? Given the demand pent-up from 2020, will this growth persist?

Yes, I believe so. The GDP projections for the U.S., Mexico, and Canada suggest significant growth in 2022, not just in 2021. The market is quite favorable, and I think demand will keep increasing while exports also rise. Though there will be cyclical fluctuations, we anticipate that imports will continue to see reductions in the North American region. Current strategies in Russia and China aim to address overcapacity, which could beneficially affect the market.

That's very clear, I appreciate your insights. Thank you.

Yes, good morning, everyone. Thank you for the opportunity. My first question is on the U.S. infrastructure package. Now that there is more visibility on its different components, a few companies have already provided their estimates on the demand it could generate for steel. I wanted to ask if you have an estimate on what kind of demand this package could generate for you and the market as a whole. Secondly, on flat steel prices in the U.S., I wanted your perspective on the supply additions expected in 2022 and how that could impact pricing momentum. Do you anticipate the market becoming oversupplied, or do you see demand growth absorbing it?

Thank you, Caio. Regarding infrastructure, I don't have a specific estimate differing from what the steel industries in the U.S. have stated. Our main concern is that we aren't heavily participating in that market. However, it will likely benefit us because some U.S. steel producers export to Mexico and we compete with them directly. Concerning prices and increased capacity in 2022, while you mentioned 5 million tons of additional capacity, I do not see this leading to significant oversupply. Imports in North America remain high, and we anticipate demand will grow faster than previously thought. This should absorb the additional capacity.

Perfect. That's very clear. Thank you, Máximo.

You're welcome.

Thank you, Máximo. Two questions. Firstly, what would be the drivers for steel prices to trade at a new normal, higher than the old normal? You've mentioned changes in China’s behavior and their potential for exporting less. How would you respond to the idea of a higher for longer scenario for steel, especially if prices are reduced significantly?

Thank you, Thiago. I'll first address the slabs: I believe 300 to 400 tons shipped to third parties should be the new level from the facility in Brazil. Regarding prices, I acknowledge there will be a new normal for steel prices. Factors such as reducing overcapacity, particularly in China, and the need for significant investments to de-carbonize will influence this upward trend. Demand in North America is expected to grow as well. Therefore, I believe prices will stabilize at a higher level due to these pressures.

Okay, that's clear. I agree with your perspective. Thank you.

Thank you, Máximo and Pablo. I have two questions. The first is about your plans for the mining operation in Mexico. Could you give us an update on the situation there, especially regarding violence in the Michoacan region where the mine is located? The second question pertains to South American operations, particularly given the policy changes in China that may affect your position there. How do you view this in terms of your operations?

Thank you, Alfonso. Our mining operation in Mexico is currently producing at full capacity. Most of what we produce from pellets goes to our facilities, although we do export or sell some to third parties. Regarding violence in Michoacan, we are not experiencing any issues in our region despite being close to it. As for Brazil and South America, China’s policy changes may create opportunities for us, particularly since Brazilian imports have increased significantly. It may allow us to capture some market share as a result.

Okay, what about potential expansions or smaller investments in countries like Colombia? Do you see an investment case there?

We are not analyzing any immediate projects there. In Colombia, we are ramping up the new facility in Barranquilla, but there are currently no future investments planned. However, we will remain vigilant and analyze any opportunities that arise.

Fair enough. Thank you very much, Máximo.

You're welcome, Alfonso.

There are no more questions at this time. Turning the call back over to Mr. Máximo Vedoya.

Thank you all very much for participating today in our conference call and for your questions. Please keep in touch and do not hesitate to reach out if you have any comments or additional questions. Thank you very much. Have a nice day, and please stay safe.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.