Ternium S.A. Q1 FY2023 Earnings Call

Good morning. And thank you for joining us today. My name is Sebastian Marti and I am Ternium's Global Investor Relations and Compliance Senior Director. Ternium released yesterday its financial results for the first quarter of 2023. 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. After 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. 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, Sebastian. And good morning to everyone, and thank you for your participation in today’s conference call. Ternium recorded a good set of results in the first quarter of 2023 with an EBITDA of $0.5 billion. This is equivalent to $166 per ton and to a 14% margin. We also have had a healthy cash generation with free cash flow of $414 million in the quarter. Further on, Pablo will go more in depth on our performance in the first quarter. Let's review the business environment in our main markets beginning with Mexico. Apparent steel demand in the Mexican market remains healthy. In the commercial market, our restocking in the value chain, which began in the fourth quarter of last year, continues into the first quarter of this year, and we are not seeing signs of it finalizing yet. In the industrial markets, we are seeing steady steel demand with less volatility than what we see in the commercial market. The auto industry supply chain disruptions eased significantly, and most OEMs plan to increase production. On the other hand, manufacturing industries driven by the US housing market, like white goods and HVAC industries, are currently softer. We are increasing our market share, especially in the automotive industry, as the certification process of new products from the new hot rolling mill in Pesquería advances. As an example, in the first quarter of 2023, we shipped 2.1 million tons in the Mexican market. This is 0.5 million tons more than what we shipped in the first quarter of 2022 when the hot rolling mill was in the first stage of the startup. This is an increase of more than 30%, and we expect shipments to continue growing in this market in the second quarter. In addition, the downstream projects currently under development at this facility will enable us to complement this new capacity and go deeper into new value-added products to offer to the market. Since our previous conference call, we have also been making progress in our upstream project. This is the new slab mill we announced in February. Although we are not ready to disclose its exact location yet, we are very close to doing so. Something that has been calling investor attention lately is the increasing reshoring trend in the region. This is due to the need for closer and more reliable supply chains to serve the end market. Mexico is a beneficiary of this dynamic due to its many advantages, including its membership in the USMCA. It has an experienced and technically qualified labor force and offers shorter lead times and lower transportation costs to end markets. This is being reflected in demand for real estate in the country. According to the Mexican Association of Industrial Parks, the industrial real estate sector has a national occupancy rate of 97%. In the north of the country, the availability rate is even lower at 1%, resulting in a 99% occupancy rate. One of the latest and highest-profile investment announcements is Tesla's new factory in Mexico, which will be built in Monterey, our hometown. Let me now make some comments about Argentina, our second-largest market with 18% of total shipments. Our business in Argentina continues to do relatively well, although there is a considerable level of uncertainty in this market. Argentina is suffering from a very strong drought this year that is adversely affecting grain export revenue and consequently the central bank's hard currency reserves. This, coupled with a high inflation level and a significantly unstable macroeconomic environment, is expected to impact economic activity and steel demand in the country during the second half of 2023. I would like now to make a brief comment about our recent announcement regarding the increase in Ternium’s participation in Usiminas Control Group. Ternium has had participation in Usiminas since 2012 when it joined Nippon Steel and Previdência Usiminas in the Usiminas Control Group. During the past 11 years, Ternium and Nippon Steel have shared Usiminas management on an equal footing without either partner having the ability to impose a decision on the other. On March 30, we agreed with our Control Group partners to take on different roles. We will have a more direct involvement in Usiminas management and the implementation of its strategy, while Nippon Steel will maintain a say in all key decisions outside the ordinary course of business and will continue contributing their technology expertise to the company. Ternium is Latin America's largest flat steel producer and has a proven track record of successfully managing steel assets in the region. This puts us in a perfect position to assume, after more than a decade in the company, a leadership position in Usiminas. To implement this change, Nippon Steel agreed to sell to Ternium and our affiliate Pinheiro a portion of its participation in Usiminas Control Group, as well as to make some changes to the shareholders' agreement. We will appoint the CEO, a majority of the other members of the Board of Officers, and a majority of the board. Nippon Steel and Previdência Usiminas will retain one officer each. As for next steps, first, we will need the approval of CADE, Brazil's antitrust authority, to close the transaction. Until we have received CADE’s approval for the transaction, we cannot go further into our plans for Usiminas. Because of this, I hope you understand we won't be able to add in the Q&A section much more information on the matter than we have already disclosed. Turning now to ESG topics, we are proud to have been recognized last week as sustainability champions by World Steel for the fifth year in a row. This industry recognition demonstrates that we are on the right track in our efforts to make our operations more sustainable. One of the things I'm very proud of is that we are launching the construction of a new technical school in Santa Cruz, Brazil, near our Ternium lab facility. For this, we plan to leverage our experience from our technical school in Pesquería, Mexico. This technical school, in Pesquería, which is now in its seventh year of successful operation, was launched to educate high school students from our community using innovative teaching methods and the latest technology in both classrooms and laboratories. The results of these initiatives have been remarkable. These students, all of whom receive scholarships, come from underprivileged communities where the opportunity to attend high school is very rare. Today, more than 50% of graduates from this school are pursuing their university studies. We expect Brazil's new technical school to bring technical education with the latest learning tools and technology to close to 600 students with the start of classes in the first quarter of 2025. Over the years, the company has developed educational programs covering the entire school cycle, from elementary to postgraduate levels, helping children and young people fulfill their potential and become active contributors to society. We believe that Ternium's industrial projects can only be sustainable if the communities where we operate grow alongside the company, and education plays a key role in this overall strategy. Let me now make some final comments to close my prepared remarks. Even though there continues to be uncertainty regarding the macroenvironment during the second half of the year, I am confident Ternium will have a good performance in 2023. With our latest investments, we have positioned the company strongly, and there is more to come with the upstream and downstream projects under development. We believe Ternium will have ample opportunities to grow its business in the following years, and we are ready to take advantage of these opportunities. On the other hand, as you have heard us say many times in the past, we have always been committed to Brazil. This is one of the largest steel markets in the Americas, and we believe it will offer many opportunities to grow our business in the future. In this respect, we are very excited about the changes in the Usiminas Control Group. I believe our recent agreement with Nippon Steel will give us renewed dynamics from which to contribute to Usiminas's success, benefiting all of Usiminas's stakeholders. Okay, Pablo, you can now go ahead with your presentation on Ternium’s performance in the first quarter.

Thanks, Maximo, and good morning to everybody. Thank you again for participating in our conference call. Let's review in more detail Ternium's performance in the first quarter and our guidance for the second quarter. We will start on page 3 of the webcast presentation with Ternium’s EBITDA and net income. As anticipated, EBITDA, EBITDA margin, and EBITDA per ton improved sequentially in the first quarter of the year, leading to earnings per ADS of $1.91 in the period. Margins in the first quarter approached the company’s usual range, mostly as a result of cost deflation, as lower-priced raw materials continued flowing through the company's inventories. Looking forward, we expect the company's EBITDA to increase in the second quarter of this year on higher shipments and margins. We will analyze this in more detail in the coming slides. Let's move now to our achievements performance on page 4. In Mexico, Ternium steel shipments reached a new all-time high of 2.1 million tons in the first quarter of 2023, as Maximo already explained. Shipments were not only higher than what we had last year but also improved 10% sequentially compared to the last quarter of last year, reflecting Ternium's increased market share in this dynamic market. The sequential volume increase in Mexico in the first quarter was mostly offset by lower volumes in the Southern Region and other markets. In the Southern Region, shipments decreased 8%, mainly as a result of a seasonally weaker demand in Argentina, which we currently expect will normalize somewhat in the second quarter of 2023. In our market, the sequential decrease in steel shipments was mostly due to a lower volume of slabs shipped to third parties as the company further integrates its Brazilian slab facility with the downstream facilities in Mexico. In the next page, number 5, you can see that combining these developments, consolidated shipments in the first quarter were 3.1 million tons. Based on what has already been discussed, we expect consolidated achievements to increase in the second quarter of this year, mainly reflected in higher volumes in Mexico and somewhat in the Southern Region. Revenue per ton remained relatively stable in the first quarter, despite the increase in spot steel prices in the USMCA region. This was mainly due to the negative effect of lower prices on contracts in Mexico in this quarter, which reset prices with a lag, and lower realized prices in the Southern Region. In the second quarter, contract steel prices are expected to sequentially reset at higher levels. This positive development, coupled with the healthy spot prices, is expected to lead to a higher consolidated revenue per ton in the second quarter. Moving on to the next page, let's review now the main drivers behind the sequential changes in EBITDA and net income. The chart on top shows that the improvement in EBITDA in the first quarter was mostly the result of a lower cost per ton, while achievements and revenue per ton remained relatively unchanged. The decrease in cost was mainly due to lower-priced purchased land and raw materials acquired during the second half of 2022 that continued flowing through the company's inventories in the first quarter of this year. To a lesser extent, cost per ton also decreased due to lower energy costs, as natural gas prices decreased. Looking forward, Ternium expects adjusted EBITDA to increase sequentially in the second quarter as consolidated achievement, and revenue per ton increase, and cost per ton deflates a little further. The chart on the bottom shows that the sequential increase in net income was driven mainly by a higher operating result and, to a lesser extent, better income tax results. In the first quarter of this year, tax results included a deferred tax gain in Ternium’s Mexican subsidiary in connection with the 7% appreciation of the Mexican peso against the US dollar in the period. Let's review now on page 7, Ternium's cash flow performance and balance sheet. Cash flow from operations in the first quarter of the year was $612 million, including a working capital release of $218 million. Looking forward, we expect working capital to increase in the second quarter in sync with higher steel production, shipments, and prices. Free cash flow in the first quarter was $414 million after CapEx of close to $200 million. This drove Ternium's net cash position to $3 billion by the end of March. The CapEx level is expected to continue increasing in the coming quarters as Ternium announced its downstream project in Pesquería and the other projects that were announced in North America. With this, we conclude our prepared remarks. Thank you very much for your attention. Now we can take any questions that you may have. Please, Operator, proceed with the Q&A session.

Our first question comes from Caio Greiner from BTG Pactual.

Hello. Good morning, everyone. Thank you. My first question is about your North American operations. I wanted to explore a little bit more on demand conditions in North America. Demand conditions still seem quite strong in the short term, as you guys pointed out, with the auto industry remaining strong since some supply chain restocking. You mentioned that the second quarter is still expected to have even stronger volumes wise. I just wanted to explore a little bit more on the outlook for the second half of the year. Should we expect earnings and volume to continue rising going forward? Do you still believe that steel demand could be sustained at current levels for the entire year, or are there any pressure points that you see? If you could share an estimated volumes increase for the year in the Mexico market, that would also be helpful. My second question is on the Usiminas transaction. I know you said there is probably little that you can share with us at this point, but just wanted to see if there are any initial remarks that you can add to Maximo’s comments. Can you share what your plans are for the asset from this acquisition? Are there any priorities in the short and medium term? Are there any low-hanging fruit that you see that could be addressed in the short term? And I also wanted to understand if you could eventually see Ternium further increasing its stake ahead, maybe even consolidating the assets down the road. Anything that you can share regarding this Usiminas transaction would be helpful. Thank you very much.

Thank you very much, Caio. Let me start with the first question about demand. Yes, you're right; we are going to likely increase shipments in the second quarter of this year. This is mainly because the commercial market, as I said, is still in the process of restocking. In Mexico and the US, we are also gaining market share, and the industrial market is stable. So I think the second quarter looks promising. As for the second half of the year, we are still observing robust demand. We are not seeing indications that could change the current demand scenario. There are, as I mentioned, some sectors, especially those affected by housing, that are softening, but not to a degree that is very relevant. We are also seeing developments in the market that will likely increase demand. The reshoring trend I mentioned is evident throughout northern Mexico and partly driven by our customers, who are increasing their capacity and will thus consume more steel, as well as new customers coming from the region bringing production back from Asia. There is a forward trend where industrial customers are beginning to consume more steel as they enhance their capacity in the region. The only negative impact, in my opinion, comes more from macroeconomic concerns regarding interest rate increases potentially leading to a recession in the US. We have been discussing this for several quarters, and with each conversation, it seems the recession is delayed. Our customers currently work with an outlook where they expect a softening but do not foresee a significant recession. However, I want to emphasize that there is uncertainty stemming from the rise in interest rates and how it will affect all of our industrial customers. As I mentioned, we are only seeing softening in the housing market and that’s it. I hope that provides some insight into the demand outlook, Caio. Regarding your second question about Usiminas, if I understood correctly.

Yes, on the Usiminas transaction. I was just wondering if you can share any initial plans, any short-term adjustments or investment initiatives that you foresee as a result of this acquisition.

Yes, well, it's a very good question, Caio. However, as I mentioned in my prepared remarks, I prefer not to elaborate a lot on the future plans for Usiminas before CADE grants its approval to the transaction. As Ternium, we are committed to developing Usiminas, and we believe that the agreed changes in the control group will benefit Usiminas and all its stakeholders. On another note, you know that Brazil is a very important market for Ternium, and we have always been committed to this opportunity. We will certainly have a lot of work ahead of us once CADE approves the transaction. In my opinion, there is significant potential in Usiminas, and we believe, as do our partners, that we have the capacity to unlock that potential. To be honest, Usiminas has good mining assets, skilled personnel, and many opportunities for development. However, there are also significant challenges, such as realigning blast furnace number three, investing in coking facilities, further developing a sustainability strategy, and thoroughly analyzing all the mining operations, which in the medium term require investment to improve competitiveness and regain lost market share from last year. Again, I think that Ternium taking a leadership position in Usiminas will help with these challenges.

That’s very helpful, Maximo. Thank you very much. Just actually having a follow-up on the previous question. Can you share your estimates for volume increases for your Mexican operation for 2023 versus 2022? Can you give us an idea of what you are projecting at Ternium for the Mexican operation?

Well, yes, we expect an increase. I believe we are going to sustain or slightly increase the shipments that we had in the first quarter. The second quarter is anticipated to be a little bit higher. For the third and fourth quarters, we expect to continue that trend—not necessarily an increase but of maintenance. With that, I think we're looking at a 25% to 20% increase in shipments year-on-year. You need to realize that the hot rolling mill is not running at full capacity; it's currently at around 88% capacity utilization. Thus, we don't have a lot of room to significantly increase shipments, as we are also increasing production rates in the old mill. Therefore, while we do have some space, we don't have much capacity left to boost shipments dramatically.

Our next question comes from the line of Caio Ribeiro from Bank of America.

Good morning, everyone. Thank you for the opportunity. My first question is on your working capital trends going forward. I think there was a big working capital release this quarter, so I wanted to get some more color on what you expect in the coming quarters. Secondly, regarding USHRC trends, after multiple price hikes since late last year, it seems prices have somewhat stabilized lately, and lead times have started to shorten a bit. I wanted to see if you could provide some insight into what you expect in terms of price trends, specifically in the second half of the year and what you see as a sustainable medium to long-term price for USHRC at this point. Thank you.

Thank you very much, Caio. I'll start with the second part and leave working capital to Pablo. Regarding price trends, I have not changed my outlook much from what we discussed last quarter and in several previous quarters. There is a new floor or new normal for steel prices, which is much higher than the pre-pandemic levels. We saw new bottom prices last year, and as soon as they hit bottom, prices began to increase again. I think prices will remain stable or in a healthy situation for most of the year. As we discussed, prices are stabilizing at their current levels for hot rolled coil. As for the second quarter, probably, there will be some adjustment, but I cannot say precisely how much. My long-term reference for future pricing is a new normal range of around $900 to $1,000 as opposed to the previous $600 level. On the other hand, raw material costs have also decreased, including iron ore and carbon, as well as natural gas. Therefore, it is customary to expect some adjustment in the second quarter. The extent of that adjustment will depend on macroeconomic factors and the potential for a recession; if there is indeed a recession, that will inevitably have impacts. If not, I anticipate the current trends will continue, leading to fluctuations within a healthy price range. I hope that answers your question, Caio.

Yes, absolutely. Thank you, Maximo.

Regarding working capital, Pablo?

Yes. Hi, Caio, how are you? Addressing your question, clearly, we see that with the normal movement of shipments, especially the growth we are expecting in the North American market, particularly in Mexico, and the small growth we anticipate in the Southern Region market, there will be a need for additional working capital utilization. We do expect to see some price increases compared to the first quarter. Overall, while Maximo mentioned that we have seen some decreases in raw material prices, we expect to see a slight increase in working capital utilization. While we don’t see this being significant, our expectation is not to continue the trend from the last three quarters where we had several working capital releases, including a significant release in the last quarter of last year. We believe that we are entering a phase where we will be recovering a bit more working capital until prices and volumes adjust to this new level.

Our next question comes from the line of Timna Tanners from Wolfe Research.

Yes. Hey. Good morning, everyone. My first question is about the elephant in the room, which is AMSA not running. I wanted to ask a few questions first about that. I'm hearing reports that it could restart in Q3. Do you think that's reasonable? Hearing Mexico has the best price in the world for steel, it's attracting a lot of imports. Do you think those imports are sizable or modest? It sounds like you're saying in the second half you're going to keep producing irrespective, but I'm just asking about the balance between potentially those imports and AMSA restarting. How do you think about that?

It's a very good question, Timna. Thank you very much. To be honest, I don't have much insight into what is happening with AMSA beyond what everyone has probably heard in the press, nor do I know if AMSA will indeed restart in the third quarter. It is clear that they will not restart at their former capacity, especially since the blast furnace is down, which will likely take several years to restart fully. Imports play a significant role in the Mexican market, and we are competing with imports in both the Mexican and US markets. However, you need to understand that most of our customers, as they are relocating production to the North American market, are simultaneously trying to source more from us. I do expect a slight increase in imports, but I don't anticipate that increase to impact our ability to meet our shipping program as planned.

No, that's great. I appreciate the challenging situation. Okay, thanks. Then I wanted to ask if you can remind us about Pesquería's qualification process and how to think about the mix improving in terms of timing and magnitude if you could.

Well, remember, the Pesquería hot rolling mill has just started to show its qualification process this quarter. So part of these 500,000 tons you see when comparing the first quarter of 2022 to the first quarter of 2023 reflects that. When looking at steel consumption in Mexico, comparing 2022 to 2023, the overall consumption was flat. It's essential to note that the market conditions were comparable. After one year in the certification process, we are seeing increases in our market share towards the industrial sector. In the second quarter, we can expect roughly 100 and something thousand tons additional due to this qualification process, followed by smaller increases until next year when we engage in the next round of contracts with our customers. So, we expect a significant increase in this quarter.

Okay, great. I was also asking a bit about margin benefits, so maybe you could share your expectations where margins are headed. I know in the past, you've mentioned a typical range of 15% to 20%. We might be at the lower end now at 14%. Should we expect to be on the upper end of that range or provide any further color on this?

Yes, you're right. It's a very good question, Timna, and typically one we prefer not to answer explicitly. You are correct that we were at the lower end of our margin range at 14% this quarter. Our usual margin range is between 15% and 20%. I believe we will likely be in the upper side of that range next quarter, and possibly even a bit above that. I hope that gives you sufficient insight.

Our next question comes from the line of Thiago Lofiego from Bradesco.

Thank you. Good morning, gentlemen. Two quick questions. First, Maximo, can you comment on your slab integration dynamics for the coming quarters? What should we expect on that? And the second question, can you discuss the outlook for steel demand in Argentina? If you could quantify for 2023, that would be great. Thank you.

Thank you, Thiago. Regarding slab integration, as I always say, most of our slabs are directed to our own facilities. If you look at the shipment numbers, I think we only shipped 60,000 tons of slabs in this quarter, while more than 1 million tons of slabs went to our own consumption, either in Argentina or mainly in Mexico. Therefore, slab integration is almost at 100% today. Regarding Argentina, as I said, in the second quarter, we are still seeing demand similar to that reported in the first quarter; it’s a healthy demand for steel consumption. However, looking further ahead, that is not what we expect for the rest of the year. Various consultants are projecting a decline in Argentina's GDP for the whole year, and we believe that steel consumption in Argentina will likely decrease by approximately 2% to 3% for the entire year.

Our final question comes from the line of Carlos De Alba from Morgan Stanley.

Yes, thank you very much. Good morning, Maximo, Pablo, Sebastian. I have a couple of questions. One is on the cash situation. You clearly have a very strong balance sheet with $3 billion net cash, but I think about half of that is in Argentina, and I'm not sure if it is on a net cash basis or just the cash that you have in Argentina. Could you talk about the challenges that you may have, and other corporates may have in Argentina, to use that high level of cash in the country? You may already be investing as much as you possibly can, and your assets are in good shape. The economy is not really expanding, and the outlook is uncertain. So what options do you have to potentially use that cash outside of Argentina? If you could comment on that, it would be very interesting. My second question is about your mining operations in Mexico, where I know there is a potential mining law change that is currently in the Senate. Would this, if approved as the bill was presented to the Senate, have any impact on your business that you have looked into?

Yes. Carlos, thank you very much for both questions. Let me start with your second question about the mining law. You're correct; there is a new mining law that went through the House and is currently in the Senate. This could be discussed today. We do not anticipate major impacts on our mining operations. The way it has been framed, I don't think the mining aspects of our operations in Mexico will face significant challenges. There have been very constructive discussions between the mining sector and the Mexican government, and we believe we have made significant progress in ensuring reasonable adjustments are made. Although there are still technical issues that need to be clarified regarding the use of water, there seems to be a mutual understanding with the government that these issues were not intended as impediments. Thus, I don't foresee substantial issues moving forward regarding the mining law. Now, regarding the cash situation in Argentina, Pablo?

Okay, what a nice question to answer. So first of all, you're right about the situation in Argentina. It is challenging to manage cash or extract cash from the country. We have a significant level of cash in our Argentina subsidiary. One potential option we have utilized just this week is paying dividends. We recently announced that Ternium Argentina, our subsidiary, will pay a dividend of over $600 million in kind in bonds. That is one way of repatriating some funds from Argentina. Dividend payments are customary for us there. While there are specific rules that make the process unique compared to traditional countries, we aim to distribute cash to shareholders effectively. We continue to work on protecting the cash we have in Argentina against exchange rate fluctuations and inflation. Our focus is to mitigate risks while monitoring the situation to react when needed. The recent dividend distribution represents our effort to responsibly manage our cash position amidst a complex situation in Argentina.

Carlos, I hope that clarifies both questions. Thank you, everybody, for participating and for the insightful questions, as usual. Please feel free to contact us if you have any comments or further questions, and we look forward to speaking with all of you in our next conference call. Thank you very much.

Thank you, ladies and gentlemen. This does conclude today's call. Thank you for your participation. You may now disconnect.