Ternium S.A. Q1 FY2022 Earnings Call

Good morning. My name is Rob and I will be your conference operator today. At this time, I would like to welcome everyone to the Ternium First Quarter 2022 Results Conference Call. Sebastian Marti, you may begin your conference.

Thank you. Good morning and thank you for joining us today. My name is Marti and I'm Ternium's Global Investor Relations and Compliance Senior Director. Ternium released yesterday its financial results for the first quarter of 2022. This call is complementary to that presentation. Joining me today are Ternium's Chief Executive Officer, Maximo Vedoya; and the company's Chief Financial Officer, Pablo Brizzio, 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 the 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. You will also find any reference to non-IFRS financial measures reconciled to the most directly comparable IFRS measures in the press release issued yesterday. With that, I'll turn the call over to Mr. Vedoya.

Thank you, Sebastián. Good morning to everyone and thank you very much for joining us today. Ternium showed a strong set of results in the first quarter of the year. Shipments are recovering and margins decreased as expected, although they remained at high levels. Since our last conference call in February, the global steel business environment changed significantly as a result of the invasion of Ukraine and a consequent wave of international sanctions against Russia, not to mention the humanitarian tragedy this conflict created. In an already volatile steel market environment, the conflict in Ukraine brought even more disruptions as both of these countries are relevant participants in the trade of steel and related raw materials, creating scarcity of these inputs and consequently pushing up steel prices. Big iron, PCI, slabs and hot-rolled steel were particularly affected. As a result of these supply disruptions in the international steel markets, previously declining steel prices took a sharp turn up by the end of the first quarter and recently stabilized at relatively high levels. Let's review now the latest development in our main markets in this new scenario. In Mexico, we expect shipments to continue increasing in the second quarter of this year. There is currently a restocking in the commercial market in response to these new conditions in the market, although it remains somewhat slow. On the other hand, the industrial market continues to be healthy and we expect to continue growing in this market aided by the new hot strip mill in Pesqueria, increasing our market participation. The auto industry continued to suffer from supply chain disruptions, creating order backlogs that should support higher steel demand down the road. We are now more positive in our expectation for this industry during the second half of the year as we are already seeing some recovery in orders. The ramp-up of the new hot rolling mill in Pesqueria in Mexico is progressing as expected as we continue working on certifying our products with different industrial customers and gradually adjusting the facility and its logistics for a higher level of production. To complement the capacity offered by the new hot strip mill and to broaden our value-added product portfolio, we recently announced a new investment program at our Pesqueria industrial center. The program consists of a new cold rolling mill, a hot-dip galvanized line, a push-pull pickling line, and new finishing lines. The new investment program with expected startup of operation in the first half of 2024 should help us better serve our customers in the automotive, renewable energy, and home appliance industries and will support our leading position as a steel supplier in Mexico. This adds to the already announced expansion of our Shreveport facility in the U.S. state of Louisiana, with a second coil coating paint line expected to start up in mid-2024. Let me now turn to Argentina. For some time now, the Argentine market has been a very stable one, despite a high degree of uncertainty and this has not changed. Currently, steel demand remains healthy in the auto industry, construction, the agribusiness, and the energy sector. Based on what we can see for the next few months, shipments in the second quarter should increase a bit from last quarter. However, there are some factors that could affect steel demand further on, mostly related to the unstable macro situation in the country. We'd like now to make a quick comment regarding sustainability at Ternium and our ongoing projects. We are committed to the industry sustainable development and our efforts were recognized once again by the World Steel Association. Early this month, Ternium was selected as a sustainability champion for the fourth year in a row. This was on top of the safety and health excellence recognition for our safety management initiative also from World Steel. Also since our last call, we participated in a survey from EcoVadis on our ESG initiatives. EcoVadis is an ESG rating agency used by several of our largest industrial customers. In this survey, we attained a top 10% score in our industry. The rate obtained is already higher than the rate required by our customers for 2025. This inquiry was structured around four main topics: environmental, labor and human rights, ethical behavior, and sustainable procurement. Let me now wrap up these initial remarks with some final thoughts. We started the year with very good results and we expect to have an even better performance in the second quarter, but we should not lose sight of the fact that there is significant uncertainty regarding the performance of the world's economy down the road. The ongoing disruption from the war in Ukraine and the COVID-related lockdowns in China are a cause of concern. This, together with the current inflationary environment in the world and the beginning of a monetary tightening cycle, could affect the world's economic growth rate in the future. We believe we are very well positioned in this uncertain scenario. The transformation of our company since the acquisition of our slab facility in Brazil and the conclusion of our expansion projects in Mexico enables us to continue growing our market participation with an even better competitive position. In addition, we currently have a strong financial position and expect to have significant cash generation in 2022. This is a comfortable situation from which to face any volatility in the steel markets. This financial strength will allow us to continue to execute our dividend program with the next payment due in May and the enhanced payment for 2022's dividend due in November. Now with a longer-term view, I'm positive regarding the downstream investment program in Pesqueria. This initiative is consistent with our long-standing strategy to continually optimize our industrial system in order to capture future market opportunities. I expect it to strengthen our competitive position, enable us to replace the imports in the Mexican market and better serve our customers with a broader and more technologically advanced product portfolio. All right. I'll finish my remarks here. Please, Pablo, go ahead with your review of the quarter's performance.

Thanks, Maximo and good morning to everybody. The global steel scenario that Maximo has just discussed has had a relatively limited influence on Ternium's performance during the first quarter of the year. But naturally, its implication is expected to be more evident further on. Let's now examine Ternium's performance in the first quarter of 2022 and also review our guidance regarding the second quarter under the new scenario. Let's start on Page 3 of the webcast presentation. Slide 3 depicts Ternium EBITDA and net income in each of the last five quarters. By historical standards, EBITDA in the first quarter has been strong, although lower sequentially, as anticipated. The reason behind this is a decrease in EBITDA margins which reflected steel price correction from record high levels back in the second part of last year and a further increase in raw material costs. Looking forward, in the second quarter, we expect the company's EBITDA to rebound. We will analyze this in more detail in the coming slides. The strong operating performance in the first quarter led to net income per ADS of $3.95, also a solid number. On Page 4, let's review the performance of Ternium steel shipments in each market. In Mexico, in the first quarter of the year, we partially recovered the volume lost in the fourth quarter and looking forward, we expect shipments to continue improving in the second quarter. In the Southern region, shipments decreased sequentially in the first quarter, reflecting seasonality and weaker demand in Argentina. Looking ahead, we expect shipments in the Southern region to increase slightly in the second quarter. In the other markets region, volumes decreased slightly on a sequential basis, reflecting lower volumes of large shipments to third parties which was pretty much offset by higher finished steel shipments. In Page 5, you can see that combining this development, we arrive at consolidated steel shipments of 3 million tons in the third quarter, up 4% versus the fourth quarter. Based on what we have discussed, we expect to report in the second quarter a sequential increase in consolidated steel shipments. Let's now review steel prices and net sales. In the third quarter, revenue per ton declined 5% sequentially on lower realized steel prices, mainly in Mexico and the other market regions. The combination of sequentially higher achievements and lower revenue per ton resulted in stable net sales of $4.3 billion. Looking forward, we expect revenue per ton to rebound in the second quarter on higher realized prices in Ternium's main steel markets for the reasons already discussed. Moving to the next page. Revenue is now the main driver behind the sequential change in EBITDA and net income in the first quarter of the year. The EBITDA chart on the top shows the impact of lower revenue per ton and higher cost per ton which increased mainly as a result of higher raw material prices. These negative effects were partially offset by higher shipments. For the next quarter, we expect EBITDA to increase sequentially, reflecting higher steel shipments and margins as revenue per ton should increase more than cost per ton. The chart below shows the first quarter's sequential decrease in net income, mainly driven by lower operating and financial results which decreased mainly due to higher foreign exchange losses and a lower value of financial instruments. On the other hand, the effective tax rate in the first quarter was relatively low mainly due to positive deferred tax results at Ternium's Mexico and Argentina subsidiaries. To conclude with today's presentation, let's review, on Page 7, Ternium cash flow performance and financial position. Cash from operations in the first quarter was $692 million. These numbers include income tax payments in the quarter of $868 million and also a working capital release of $331 million which reflected lower steel inventory volumes as well as expected impact of higher steel prices and raw material costs. Income tax was unusually high in the quarter, mainly as a result of the payment of the income tax balance of fiscal year 2021 in Mexico and with a tremendous increase in profit compared to the previous one to 2022. Let me remind you that we paid income tax advances during the year that were based on the income tax of the previous fiscal year. In this case, during 2020, the year of the COVID-19 pandemic. So with strong recurring profitability in 2021, the income tax balance left to be paid in March 2022, for the results of the year 2021, resulted in a very high payment. With a stable CapEx, cash from operations in the first quarter led to a very solid free cash flow in the period, raising our net cash position to $1.6 billion by the end of March. Our current expectation is that Ternium will continue showing healthy cash generation during the rest of the year based on a CapEx estimate for the year of approximately $600 million. With this, we finish our opening remarks. Thank you very much for your attention. And we are now ready for taking your questions. Please, operator, proceed with the Q&A session. Thanks.

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

Hi, good morning, everyone. Thank you. My first question is regarding the current stage of the Pesqueria ramp-up. We haven't seen the volume increases we initially anticipated. In previous discussions, you mentioned plans for incremental shipments of almost 1.5 million tons in 2022 and 2023, but it appears that hasn’t happened yet. What needs to change for us to start seeing those additional volumes for Ternium in Mexico, and how does the import substitution thesis fit into this? Is the lack of progress solely due to higher slab prices, or are there other factors at play? My second question relates to capital allocation. Can you provide an updated CapEx estimate for 2022 and 2023? I'm curious about how the recently announced $1 billion investment will affect cash flow generation in the coming years. Additionally, you currently have a $1.6 billion net cash position. I’d like to know if we can expect more aggressive dividend payments in 2022 and 2023, and possibly into 2024, or if there are other short-term plans for the cash you have on hand. Thank you.

Caio, thank you for your two insightful questions. Regarding the ramp-up of the Pesqueria facility, I'm pleased to report that it is progressing well from a technical perspective. In the fourth quarter of this year, we produced approximately 500,000 tons, which aligns with our program. In the first quarter, we produced nearly 700,000 tons, and we anticipate almost 1 million tons, specifically around 900,000 tons, in the second quarter, followed by over 1 million tons in the third quarter. This aligns with our business plan when we made our investments. However, we did experience a slowdown in the commercial market in Mexico, leading to lower production from the facility. The commercial market in Mexico was quite weak in the fourth quarter but has shown slight improvement this quarter, and I believe it will improve further next quarter, as mentioned in my previous remarks. Therefore, our plan to increase production faced some delays. For this year, while we will reduce slab sales to third parties due to increased slab shipments from Brazil to Mexico, we expect overall volumes to rise by nearly 1 million tons compared to last year, primarily driven by Mexico and North America. This delay is attributed to market conditions. Now, addressing your second question about capital allocations, I want to highlight three key points. First, our capital expenditure for this year is projected to be around 600 million tons, which will increase with the planned $1 billion investment, mostly reflected in our balance sheet next year. Second, we are committed to maintaining our dividend, which was increased by 24% this year compared to 2020, and we plan to continue providing substantial dividends in the future. Finally, we have plans for additional capital expenditures in the near future. We must comply with USMCA requirements for melted and poured operations by 2027, which will necessitate significant future capital investments. These are the three main points I wanted to address regarding capital allocation, Caio.

Thank you very much, Maximo, just to make sure I understand. So the melted and poured investment that you're supposed to make in Mexico, this is supposed to be for the short term, right? Could we still see an announcement in 2022, or is this going to be coming for the next few years?

No, '22 or '23 but it should be in the near future, yes. We have a team analyzing the project. And as you know, the projects we announce once we have completely understood and very clear what is the technical solution and where to be.

Understand, Maximo. Thank you very much.

Yes, good morning, Maximo, Pablo and Sebastian. Thank you for the call. First question is, could you, maybe Maximo, remind us of what is the slab situation for Ternium as you ramp up Pesqueria, Churubusco, maybe lower than before? But you have given the situation in Ukraine and Russia and what is happening with the global slab market. What are your plans there? How much exposure do you think you have for this year and for next year as Pesqueria increases? And what are the alternatives that you see available to the company as you move forward? And then maybe to complement, Pablo and I'm sorry if I missed this, on working capital as you move forward. On working capital, very impressive results in the first quarter. Can you explain a little bit what is behind the fact that you released working capital in Q1? And also, what do you see going forward, again, given all the moving pieces that we're seeing in the market?

Thank you, Carlos. I'll take the first question since it's the challenging one, and then Pablo can address the easier one. You're correct about slabs. The situation in Russia and Ukraine is influencing the slab market significantly, as 30% of the world's merchant trade used to come from these two countries. Currently, Ukraine is not producing any slabs because most of its production facilities are in conflict zones, and some Russian facilities are off-limits to us due to sanctions. However, since we acquired the slab facility in Brazil in 2017, we have been increasing our shipments of slabs to Mexico. In the first year of operation, 30% of the slabs from Brazil were sent to Mexico, and this quarter, that figure rose to 85%. Given the current circumstances, the situation isn't overly constrained. Additionally, for our imports in Mexico, 90% are sourced from Brazil, while the remaining 10% comes from alternatives to Russia. I believe we can manage this with the new sources we are utilizing. I hope that answers your question, Carlos.

Maybe just to clarify, Maximo and thank you for those details. So this year, what is the balance of the slabs that you're expecting and maybe for next year, what is the balance of third-party slabs that you may need to purchase on a net basis?

On a net basis this year, I believe it's close to zero since it's slightly below 500,000 tons. Next year is expected to be a bit higher, possibly around 1 million tons. However, we are making some sales because, as we've discussed before, we find it advantageous to sell and then buy from other sources at a slightly lower cost. It's not a large volume, considering the slab facility is producing or will be producing nearly 5 million tons.

I will address the question regarding working capital. This quarter, we experienced a decrease in stock, which was beneficial as it allowed us to lower our inventory levels while facing rising prices for various raw materials. Additionally, there was an increase in our accounts receivable due to higher market volumes in the first quarter, particularly with shipments to the U.S. Furthermore, we saw a rise in accounts payable, driven by increased prices and volume demands linked to our new production capabilities at these elevated price levels. Overall, we released approximately $300 million in working capital during the quarter. Looking ahead, we expect accounts receivable to increase with heightened shipment levels, we aim to maintain our inventory levels, and accounts payable should trend back toward more normal levels. Thus, we anticipate a more stable working capital situation as prices continue to rise. It's worth noting that although this is not directly related to working capital, in terms of free cash flow, we allocated a significant amount for income tax payments in the first quarter, totaling over $700 million, which will not recur in the next quarter. While advances may exceed last year’s amounts, we expect a reduction compared to this quarter's tax payments. Overall, we should still see favorable results in free cash flow, though working capital may not contribute as significantly as it did this quarter.

Thank you, Pablo. If I may ask just another one very quickly. So next year, I think Maximo said, most of the $1 billion investment in Mexico will take place in 2023. So where do you see the CapEx in 2023 and maybe 2024, given that investment?

2023 probably is $1 billion.

And 2024 will depend on...

Yes, exactly. 2024, we need to wait a little bit, Carlos.

Thank you, gentlemen. I have two quick questions. First, how do you expect costs to change in the upcoming quarters? Second, Maximo, regarding the slab position you mentioned, did you say there will be a 1 million tons gap next year? Is this a structural gap considering the car is fully ramped up? If so, do you see potential opportunities to close this gap through mergers and acquisitions, or are you strategically comfortable with this short position? Thank you.

Thank you, Thiago. I'll address the second question first. Next year, keep in mind that Ternium's Brazil facility produced approximately 5 million tons of slabs, though its current production is around 4.6 million tons. We aim to increase this to maximum capacity. The Pesqueria facility, with the new hot strip mill, can produce about 4 million tons, but it hasn't reached that capacity yet due to its long ramp-up period. The Churubusco mill has a capacity of just under 3 million tons, leading to a current imbalance of 2 million tons if we were operating at full capacity in the Churubusco facilities. However, there are sales opportunities to explore, not just in Brazil but also from other sources that we would like to engage with. The hot strip mill at the Cubatão facility lacks upstream capabilities, so our future intention is to sell to other sources. Additionally, we need to comply with USMCA requirements by 2027, which means we will likely invest in achieving that compliance. Consequently, that balance may very well reach zero in the future. I hope I have answered your question, Thiago.

Yes. Okay. So in relation to the cost, clearly, what we will be seeing enter into the next quarter is the increased price of slabs the same one that we were describing recently that we will be buying. Remember the price of slabs increased also quite significantly. The price of coal increased, PCI and different raw material, basically, agri raw material increased prices. So we will start to see them through our costs during the second quarter and also especially during the third quarter. But what we have said during this mark is that we are expecting and as we saw in the market that prices of the finished products, steel prices will be higher than the impact of the different raw material cost increases. That's why we are expecting to see better margin enter into the second quarter. Clearly, costs will be higher.

Okay, that's very clear. If I may, I'm sorry, guys. Maximo, just to revisit the first question, do you anticipate starting that project on the slab side in North America within the next 2 to 3 years? Is that a reasonable expectation?

Yes, we need to move forward with this. We are currently analyzing the situation, as we mentioned in our last conference call. While we aren't ready to make an announcement yet, it's evident that our automotive customers are crucial for us. We sell over 2 to 3 million tons to them in the North American market and anticipate continuing this trend. Therefore, we must comply with USMCA regulations. To clarify, in five years, we don't plan to stop purchasing slabs; we will likely continue doing so, possibly sourcing from our Brazilian mill, which will sell slabs to third parties as we do now. However, the overall balance will likely be zero.

Good morning, everyone. Thank you. I wanted to explore the volume outlook further. I know you mentioned an improvement in the second quarter and noted that demand was somewhat low in the first quarter. However, I'm struggling to reconcile this with the year-over-year declines, especially since we experienced COVID-related impacts last year. If we consider Q2 and the 900,000 tons from Pesqueria, assuming flat year-over-year, we are looking at nearly 4 million tons in Mexico overall. Is this the correct way to assess the potential quarter-over-quarter upside, or is there something I might be overlooking? Additionally, I would appreciate some guidance on the tax rate, given the light first-quarter rate—I'm referring to the rate, not the payout. I understand the cash implications. Thank you.

Okay, Timna, how are you? Let me start with the tax issue and then address your question about volumes. Unfortunately, it is very challenging to predict exactly what the nominal tariff tax rate will be because it largely depends on the status of the relevant currencies. A currency revaluation leads to reduced taxes, while a devaluation results in a higher tax rate. This will depend on the market conditions at the end of the period. As you know, the overall tax rate for Ternium, excluding deferred taxes, is about 28%, reflecting a blend of rates from Mexico, Brazil, and Argentina. If we assume no deferred taxes, Ternium's tax rate should remain around that 28%. We noted various impacts from currency fluctuations during the first quarter, including revaluations in Mexico and Argentina and mixed revaluation and devaluation in Brazil. In Argentina, the devaluation was lower than the inflation rate, which affects the overall situation. I realize this may not be very clear, but the cash position is crucial in understanding the overall impact. Regarding volumes, I’m not sure I followed your calculations entirely, but let me provide my outlook: for Argentina, we expect to maintain the same volumes as last year. Initially, we felt pessimistic, but we are now observing an influx of orders, indicating a healthy market in Argentina, which we expect to continue at least for this quarter and the next. In Brazil, slab volumes will likely decrease, with shipments expected to drop by about half. In other markets, we anticipate a volume increase of over 1 million tons year-on-year compared to the previous period. In Mexico, the industrial market remains strong, although the commercial market, primarily related to construction and infrastructure, is not growing as well as expected. Overall, it’s a mixed market. I hope this addresses your questions, but please correct me if I misunderstood anything.

I think I was just simplistically saying a year ago, Q2, you produced almost 3.1 million tons. And if we just added simply 900,000 tons projected from Pesqueria, we'd be at 4 million tons. That seems like a big number relative to your Q1 side. I just want to say, is that the right way to think about the potential upside quarter-over-quarter or am I missing something?

Certainly. I was primarily discussing Mexico, and you're correct. There is a chance for exports, and we are actively working to enhance those opportunities. However, we haven't seen much volume yet. As I mentioned, if we significantly increase exports, we need to be careful not to expand into too many markets at once. But yes, we are recognizing that this is a potential opportunity.

Yes, hello and good day, everyone. The question that I have is regarding growth. And what we can see is that there is a good period of high cash flow generation and an opportunity to, let's say, we think the size of the company we're just discussing the investments in Mexico or in North America for more slab. So I think it would be very, very useful if you can provide some guidance on how Ternium is going to look 5 or 6 years from now in terms of production capacity, in terms of geographical exposure, what's going to happen in Mexico? Our plants in Argentina to figure or LATAM. I think to have like a map on how Ternium is going to look, thinking 5 or 6 years ahead? And probably it's not an answer right now but if you can help us to understand what the plan behind these investments? That would be very useful.

Thank you for your question, Alfonso. It’s a broad topic. Our growth path at Ternium focuses on the Americas. We expect some growth in Argentina, particularly in value-added products over the long term, which we plan to announce soon. We're also looking to expand in Brazil since our acquisition of the CSA facility has been very successful, and we now understand the market much better. Our customers are there, and we see potential for future growth. Additionally, we continue to grow in the North American market. We anticipate that volumes and the market there will increase. Despite new capacity being built in North America, there is significant nearshoring and reshoring occurring. The current geopolitical landscape, especially between the U.S. and China, is prompting many companies that rely on supply chains in Asia to consider moving to the U.S. and Mexico. Each month brings new investments from our existing customers or new clients entering northern Mexico. This presents a significant opportunity for us, which is why we are progressing with our new cold growth facility and galvanized projects, while also planning for compliance with USMCA and increasing our capital expenditures. Pablo, would you like to add anything to that?

Thank you, Maximo. I’d like to add to what Alfonso and you have mentioned. The goal at Ternium is to construct facilities that we are confident can operate at full capacity each year. I previously touched upon this in response to another question. Our intention is to have the facility operating at its maximum capacity. As we address the new hot-rolling mill, we are rapidly approaching full utilization of that facility, potentially at the expense of others, but we will ensure that one is fully utilized. This approach applies to the new capital expenditures we have already announced and those we are considering for the near future. This has been our methodology in the past, and it is certainly part of our plans moving forward. I hope this helps clarify your questions.

Yes. Thanks, Pablo. To complement, you're right. The energy reform did not pass. I'm just wondering if you can say anything about how this changes the energy strategy helps your energy strategy or business opportunities in the country?

Yes, that’s helpful, thank you.

Yes. Thanks, Alfonso. You're right. The energy reform did not pass, but there is still a lot of confusion about the electric industrial law that was passed a couple of months ago or six months ago. It was not clear and it was not declared constitutional. So, I believe there will be a lot of discussion about energy in Mexico in the coming months. In our case, we produce most of our own energy with a very competitive facility, and this will not change with the new law. Therefore, we are relatively comfortable with our situation. However, I don't foresee a significant amount of energy investment in Mexico in the near future until this energy industrial law is clarified and new investments can begin. I hope this helps clarify what is happening in Mexico.

Yes, thank you very much. So regarding the situation of being a USMCA compliant, clearly, I guess there are 2 choices. You invest in core steel capacity in one of the three countries or you try to buy something. Is there anything that is available that would provide that second alternative or you are really only analyzing at this point, a greenfield facility?

Thank you. And hello again, Carlos. No, we are not seeing that; we are seeing a greenfield facility, yes.

It will likely be electric or furnace, right, or definitely be an electric or furnace.

Yes, it would definitely be an electrical furnace. Yes, no doubt about it.

And if that's the case, would this come together with an expansion of your iron ore pellet facilities, or do you think that with what you have in terms of this of the iron ore mining side of it, you will be okay and member you just spend your pellet and DRI facilities?

Yes, it's not currently a mining operation. It will likely be a DRI facility. We are analyzing all the options to determine the best approach, which is why we haven't made any announcements yet. We are evaluating the most effective technical solution, and it's clear that the electrical furnace is the best option. We are not planning to invest in new pellet capacity in the near future or short term. Okay. Thank you all very much for your participation today and for your interest in our company. As usual, please contact us for any feedback or any additional questions you may have. Take care and goodbye. Thank you very much again.

This concludes today's conference call. Thank you for your participation. You may now disconnect.