Earnings Call Transcript - TX Q4 2021

Operator, Operator

Thank you for standing by. My name is Sheryl, and I will be your conference operator today. At this time, I would like to welcome everyone to the Ternium Fourth Quarter 2021 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session. Thank you. Sebastian Marti, you may begin your conference.

Sebastian Marti, Global Investor Relations and Compliance Senior Director

Thank you. Good morning. Thank you all for joining us today. My name is Sebastian Marti and I’m Ternium’s Global Investor Relations and Compliance Senior Director. Ternium released yesterday’s financial results for the fourth quarter and full year 2021. This call is complementary to that presentation. Joining me today are Ternium’s Chief Executive Officer, Mr. Máximo 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 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 two 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.

Máximo Vedoya, CEO

Thank you, Sebastian. Good morning and thank you all for joining us today. 2021 was an amazing year for Ternium. EBITDA reached $4.9 billion, close to four times the previous year’s level. Net income was $4.4 billion and earnings per ADS were $19.5, almost five times earnings in 2020. All of these are record levels. Last year Ternium also finished its latest expansion program with the start-up of its new state-of-the-art hot-rolling mill at the Pesqueria facility in Mexico and of the Ribera rolling mill greenfield projects in Colombia. On top of these very positive results, the company had significant cash generation with free cash flow at $2.1 billion, which took our balance sheet to a net cash position. Taking into consideration the company’s strong performance and a solid financial position, Ternium’s Board of Directors proposed a dividend for the year of $2.60 per ADS, equivalent to $510 million. This represents an increase of 24% compared to 2020 and it is the highest annual dividend on record, being more than double the annual dividend level the company paid pre-COVID pandemic. Another development is the company’s recent offer to acquire from Ternium Argentina, a minority participation in Ternium Mexico that Ternium does not own directly. This transaction is primarily aimed at streamlining our corporate structure. A simplified corporate structure allows for both a more straightforward management of our operations and an easier analysis of our performance and results by our stakeholders. The offer is still being analyzed by Ternium Argentina’s Board of Directors and if the deal is attractive, it would need to be put to the vote of its shareholders. I’ll turn now to the status of our main markets beginning with Mexico. Ternium’s shipments in Mexico decreased in the fourth quarter more than what we expected in our last conference call. Even though the fourth quarter of the year was officially weak, there were additional factors that intensified the sequential fall in volumes. During the first nine months of 2021, steel consumption grew significantly in Mexico in an environment of increasing steel prices. With the local steel industry working at full capacity, there was a large increase in input orders to cover the extra need of the markets. In the fourth quarter, where steel prices began to fall, imports arriving with a longer lead time as a result of supply chain disruption caused an increase in inventories and a decrease in apparent demand by the end of the year. In addition, an unexpected persistence of the semiconductor shortage for vehicle goods manufacturers continued impacting tonnage shipments, as the auto industry represents about a quarter of our sales volume. This was not the only affected sector, as other industrial customers have been dealing with a similar environment. Our current view is that steel imports into the region will decrease in part due to the significant steel correction over the last few months. Additionally, the normalization of the availability of semiconductors should support a recovery in apparent steel demand and an increase in Ternium volumes, something that we are already seeing in the first quarter of the year. The company is ready for such scenarios as its new hot-rolling mill in Pesqueria continues to ramp up with a 30 million tonnes of production milestone already behind us and with a whole new range of products at its disposal to gradually substitute inputs in the Mexican market. Let’s review now the situation of the Argentinean market. Shipments in Argentina have been steady during 2021, with a very healthy state level, especially in agribusiness, the automotive industry and construction, and we expect this to continue for the rest of the first quarter. Having said this, there is a high degree of uncertainty regarding Argentina’s macroeconomic environment in 2022. Although the country has recently agreed with IMSA on the proper roadmap to refinancing its debt, Argentina has very low levels of international reserves, a significant fiscal deficit, and slight inflation. If these imbalances are not addressed appropriately, instability in the main macroeconomic variables in the country could have a negative effect on Ternium sales in the market in the year ahead. I would like now to make a quick comment regarding Ternium’s sustainability initiatives. In the last quarter’s conference, I mentioned the company’s carbon capture and usage capacity expansion projects in Guerrero and Puebla facilities in Mexico. Since then we have completed the second phase of the project at the Guerrero facility, with the aim of increasing by 42% our current capacity. This will result in a total CO2 capture and usage capacity of over 400,000 tonnes per year in Mexico, equivalent to the yearly initial capacity of almost 90,000 tonnes. Let me remind you that the technology we have installed at our DRI facilities is by no means common worldwide. These DRI models are among the greenest in the world. We have also launched a project at our slab facility in Rio de Janeiro to increase its slab processing capacity, with the aim of reducing the CO2 emissions rate of steelmaking in these locations. In addition, Ternium reported its built-in organization strategy to CDP for the first time in 2020 and received a high score on the topic of climate change in line with the steel sector average. Ternium’s efforts to improve its safety performance were recognized by worldsteel with the safety and excellence recognitions, and diversity, equality, and inclusion continue to be strategic topics in Ternium’s ESG agenda. In December, The Human Rights Campaign Foundation certified Ternium for the second consecutive year as one of the Best Places to Work in Mexico for the LGBT community. Wrapping up, after an outstanding year in 2021, the company expects to deliver solid performance in 2022 in a business environment with gradually normalizing steel prices and margins. Ternium plans to leverage its new hot-rolling mill in Pesqueria and the apparent steel demand in its main market in the USMCA. These together with positive expectations for the future should put the company in a position to sustain attractive returns to its shareholders and to analyze opportunities for further profitability growth initiatives.

Pablo Brizzio, CFO

Thank you, Máximo, and good morning to everybody, and sorry for the inconvenience we had in the last. So, let me go back to the comment on the presentation that we have today and review Ternium's performance for the full year 2021 and then I will be analyzing the performance of the quarter. If you go to page three in the webcast presentation, in this slide, you can assess the magnitude by which Ternium’s performance in 2021 outpaced those of industry peers. Regarding consolidated steel shipments, volumes were higher year-over-year in 2021, although they remained below the levels achieved in 2018 and 2019. The reason behind this was significant volumes of slabs shipped to third parties that followed the acquisition of Ternium Brasil in September 2017, as you can see in the chart. Ternium progressed with the integration of the slab facility in Brasil, and these volumes eventually increased. The increase in finished steel shipments in 2021 reflected the ramp-up of Ternium's new facilities in Colombia and Mexico, and the recovery in steel demand. Looking forward, we believe that slabs shipped to third parties will stay at current or slightly lower levels, while finished steel shipments will continue growing as we increase our presence in our main markets, particularly in the USMCA region. EBITDA margin in 2021 reflected increases in steel prices throughout the year. The spot steel prices reached record levels in September 2021 and then started to decline. Yet, steel prices remain at very good levels, with enough space for healthy margins despite the increase in costs. Good profitability levels and continuous trends in steel demand support our expectation for an overall solid performance for Ternium during this year 2022. In the bottom right chart, you can review the increase in dividend in the last few years. For the current year, we are discussing 2021, the company has already paid an interim dividend of $0.80 per ADS in November last year. This means that, with the proposed annual dividend of $2.06 that Máximo commented on, if this is approved at the Annual Shareholders Meeting, the dividend of $1.08 in the dollar this year will be paid on May 11, 2022, with the record date on May 6, 2022. We expect to pay an interim dividend again in November of this year. Let’s review on page four the cash flow generation of 2021. Cash flow from operations was the strongest ever even after factoring in the working capital increase of the same month. A large area of increase in working capital was related to higher steel prices and it has an effect on the value of trade receivables and also the increase in raw material costs with an effect on the value of inventory. The net cash also reflects an increase in the volume of steel products related in part to the ramp-up of Ternium’s new facility and also due to the recovery of steel demand. Coming now to the free cash flow, the figures for 2021 were also the strongest on record. Capital expenditures in the year remain within Ternium’s usual rates. The company concluded its expansion plans during the first half of last year and for this year 2022, we expect Ternium capital expenditures to increase a little bit compared to last year, in the phase of approximately $600 million without considering any further expenses. Let’s turn now to Ternium's performance in the fourth quarter in the following page. EBITDA in the last quarter of the year was down sequentially, but remarkably strong by historical standards. The results lead to a net income per ADS of $5.08, also a solid performance. Looking forward, Ternium expects EBITDA to remain at healthy levels by historical standards in the first quarter of 2022. The sequential decrease reflects lower margin, partially offset by higher consolidated steel shipments. Moving now to steel shipments, let’s analyze the performance in each of our markets on page six. In Mexico, you can continue to see how the situation was already described affected volumes in the last quarter. Again, we believe that by nature, this is a short-term situation. In the southern region, steel demand will slightly decrease and in the other market regions, shipments increased sequentially, mainly due to higher steel shipments in all of Ternium's markets, partially offset by lower shipments of slabs to third parties. Looking forward, we think steel shipments will increase in the USMCA region in the first quarter of this year. The slab volumes, on the other hand, should decrease a little bit more in the coming year. In the next page, page seven, you can see that combined in development, we are able to consolidate steel shipments of 2.8 million tonnes in the fourth quarter, down 8% compared to the third quarter and the same period of the previous year, and so right now, steel prices and FX. In the fourth quarter there was a slight increase in revenue per tonne with increases in all of the markets, because of everything I have just described. In Mexico, contract prices sequentially increased in the fourth quarter; moreover, there was a slight decrease in average steel prices that began back in September. While there is market pressure, there was a positive impact from the higher participation of finished steel shipments over slabs, the overall lower spot steel prices in these markets. Looking ahead, we expect sequentially lower realized steel prices in the first quarter of the year, with revenue per tonne reflecting recent decreases in the spot prices, partially offset by longer-dated contracts that we expect as usual. Moving on to the next page, let me give you now the main drivers behind the sequential changes in EBITDA and net income. The EBITDA chart on top shows the impact on EBITDA of lower shipments and higher costs per tonne. Costs were higher as a result of increasing raw material and finished steel prices that, as usual, are reflected in our cost structure with accounting methods. These negative effects were partially offset by an increase in revenue per tonne as already discussed. The chart below shows that the sequential decrease in net income in the fourth quarter was mainly driven by changes in operating income and impacts from income tax. Now, to finish the presentation, let’s turn to page nine to review Ternium's cash flow and balance sheet performance on a quarterly basis. Cash Flow operations in the fourth quarter were strong at $1.1 billion, as working capital increased much less than in the previous quarter. There was an increase in inventory, and the volume of steel products in the quarter was partially offset by a decrease in trade receivables. The strong cash from operations and significant increase in free cash flow in the fourth quarter led to a net cash position of $1.2 billion by the end of the year. Our current expectation is that Ternium will continue strong healthy cash generation during 2022.

Sebastian Marti, Global Investor Relations and Compliance Senior Director

Thank you.

Caio Greiner, Analyst

Yes. Hi. Thank you. Good afternoon, everyone. So I have two questions. The first one, I wanted to explore your outlook for the first quarter. So in the release, you mentioned an expectation of the lower sequential EBITDA and I wanted to get a little more color on two topics regarding that, which is cost and realized prices. And so on costs, I was wondering if you can maybe share your expectations for the first quarter, if you still see rising cost pressure in your results and where’s the pressure mostly coming from? And on prices, I mean, we do have good visibility on your revenue per tonne one quarter ahead. So if you could just maybe share your impressions reflected through prices in North America. If you’re already seeing signs of a bottom anytime soon, it would be very helpful. And my second question on capital allocation, I mean, the company generated very strong free cash flow in the quarter, you guys are already at a $1 billion net cash position. And I think the main question here is, what can the company do to move back to a more efficient capital structure? We have seen your dividend proposal, I mean, and I was wondering if this is not the time to get more aggressive on cash returns, considering the company is in such a solid financial position? Are there any plans to maybe have a formal written down dividend policy, maybe even based on free cash flow generation? And if this is not the case, it would be great to hear management’s capital allocation plans for 2022? Thank you very much.

Máximo Vedoya, CEO

Thank you very much, Caio, and good morning. The first question is about costs. In the fourth quarter, costs increased by about $100 per tonne, primarily due to higher expenses for slab purchases, iron ore, coke, and metallurgical coke. As noted, these events are accounted for in fee for rates. For the first quarter, we expect only a small increase in costs, not a substantial one. Regarding prices, we previously indicated in several calls that we expected prices, especially in the USMCA region, to decrease due to a significant gap with the rest of the world. We discussed anticipating a new normal total price of around $1,000 per tonne. We are still observing this trend, although the decline was steeper than we initially expected. We believe this trend will stabilize soon, around this quarter or early next quarter, and we do not foresee a longer decline. In Europe and Asia, current prices are beginning to rise slightly, and raw material costs remain high, so we do not expect significant decreases beyond this point.

Pablo Brizzio, CFO

The second question was about capital allocation. Let me start with more comments and then I pass over to you to do further comments. Caio, hi. How are you? So, we have been, I think, the company has been drawing attention to reinforce the distribution of dividends and allocating to shareholders part of the return on cash generated during this year and try to come up with something that is sustainable over time. As we have described in our opening remarks from Máximo and myself, we have proposed, the Board of Directors proposed a dividend that really is an increase in dividend yield of 6% or more. And of course, because of the target 11% payout ratio is below the traditional one that we pay, but we have also introduced a biannual dividend payment. So an interim dividend around November and therefore the dividend announced now to be paid in May. In all, we have reconfirmed the increase of the level of dividend payments and as was mentioned during the opening remarks, it's more than double the level of dividend prior to the pandemic levels. And as we always mentioned, we have a current record of increasing and sustaining our dividends and this should be the case for Ternium in the coming year. So this is in relationship to dividend payment. And I guess that is important for Máximo to mention certain things in relation to capital allocation for the coming years.

Máximo Vedoya, CEO

I'm addressing your question about capital allocation. We are continuing to analyze growth projects and believe we have a strong operation in Brazil, Mexico, and Argentina with numerous growth opportunities. As reported in the Mexican press yesterday, we are in the final stages of launching a new expansion initiative at our Pesqueria facilities. This expansion will include our second hot-rolling mill, a third galvanizing mill, and several finishing lines. The expected capital expenditure is around $1 billion. This investment will enhance our ability to produce value-added products with the new Pesqueria mill. Currently, we have a 4.5 million ton state-of-the-art mill, and some of that output will be allocated to our rolling operations while the rest will enter the market due to our existing limitations. These new facilities will significantly increase our future capacity for value-added products. There are several other projects in the pipeline, and I hope this information addresses your question. I apologize for the lengthy response.

Rudolph De Angele, Analyst

Hello everyone. My first question is about the volumes in Mexico. I understand there were impacts from imports in the fourth quarter, and Máximo noted that inventory levels are rising in Mexico. How do you see the situation with imports and inventories evolving in the first half of the year, and when do you expect normalization? My second question is brief; is the increase in CapEx related to having a larger sustaining CapEx with Pesqueria, or is there something more to it? Lastly, regarding capital allocation, Ternium's history has been shaped by significant transformations, and the company now has a strong presence in key markets across the Americas, including Mexico, Brazil, and other parts of Latin America like Argentina. When you discuss future plans with your Board, aside from enhancing the Pesqueria plant, do you envision this as the final strategic direction for the company, or are there other ambitions such as expanding to new geographies or increasing value from existing operations as we look ahead? Thank you.

Máximo Vedoya, CEO

Thank you, Rodolfo. I want to discuss the volumes in Mexico and provide some clarity on what transpired and our outlook for 2022. As mentioned earlier, our steel consumption in Mexico saw a robust recovery. In 2022, apparent consumption increased by over 20% compared to 2021, while in the U.S., it rose by 22%. This surge in consumption occurred primarily in the first nine months of the year. As an industry, we were unable to meet all the demands from our customers, and our ramp-up at the Pesqueria facility began in July, which affected our capacity to respond in time. Customers on both sides of the border, in the U.S. and Mexico, started to import more than necessary due to a significant shortfall in imports. Typically, imports take four to five months, but due to supply chain disruptions and congestion at ports, some were delayed up to eight months. As a result, inputs expected in the second or third quarters did not arrive until the fourth quarter, impacting our customers' inventory replenishment. This was a common challenge across the region. Furthermore, the automotive industry also faced semiconductor shortages that disrupted production plans. We are beginning to see stabilization; inputs have declined in January, and we expect further decreases in February and March. Our order books for the first and second quarters are showing encouraging growth. Overall, we are witnessing a normalization of the situation, and we expect an increase in volumes from the first to the fourth quarters. In both the U.S. and Mexico, consumption is expected to grow in 2022, albeit at a slower pace than last year, with an anticipated increase of around 4% to 5%. Thus, volumes are starting to rise, and we are optimistic about managing imports more effectively with our enhanced capacity.

Pablo Brizzio, CFO

The second question was about CapEx. Yes. The second question was in relation to the level of normalized CapEx. If you look at the CapEx in the last couple of years, without considering the expansion plan that finished at the beginning of last year, we are basically only normalizing CAPEX of around $600 million per year. This is, of course, not only maintaining CAPEX, as you’re right, with the new facility, we have a bigger sustaining CAPEX, but this also includes some more projects that we always have and some announcements that we made in the past in the process of decarbonization or some safety initiatives that we have. So, on a regular basis, the $600 million is normalized CAPEX, and again, this is not including, as Máximo mentioned, the final stage of the new CAPEX plan that we have to implement.

Máximo Vedoya, CEO

Yes. Thank you, Pablo. As we always said, we are always analyzing opportunities and we have a track record of doing this in a very responsible way. If you ask today, we have nothing special in our pipeline today. But these things do arise, and we are always analyzing these opportunities.

Timna Tanners, Analyst

Yes. Hey. Good morning, everyone. Hope you’re doing well. I just wanted to follow up a little bit on the Pesqueria comments and understand it a little better. First off, I wanted to ask you about how you see the addressable market about the mill. There’s been definitely Ternium tonnes shipped into the U.S. makes perfect sense the U.S. has shipped to Mexico. But just thinking is that the addressable market in the entire North American market or is this just a temporary situation until the downstream is expanded? And then how do you think about the full production? In the past, you talked about ramping up gradually, but I just heard you say full capacity is that 4.5 million? Is that a little less that you’re shutting, just want to clarify that? And then finally, if you could just discuss the timing of when we should be expecting some of these lines to come on and the CapEx to come through? Thanks a lot.

Máximo Vedoya, CEO

Thank you very much, Timna. I will try to address all of your questions. Regarding our projects, we are primarily focused on the Mexican market, with some exports to the U.S. For context, in 2021, Mexico imported 9 million tonnes of flat products. Approximately 4 million tonnes were hot-rolled products, 2.5 million tonnes galvanized, and the remainder cold-rolled. This represents a significant market for us. Although the U.S. is also a key market, we do not plan to direct all our investments towards exports to the U.S. Some of our products will go there, and we anticipate some growth in that area. Some U.S. mills may also be looking to expand into Mexico. As for the hot-rolled mill in Pesqueria, we expect it to operate at full capacity, reaching at least 80% realization around July, August, and September. However, we will be slightly reducing production from the mill. Overall, we project an increase in hot-rolled production in 2022 by about 1.8 million tonnes, with part of that going to the market and some replacing imports from Japan. As I said, when I answer the first question, I think, was Caio, we’re in the final stage of this. It didn’t have yet the Board approval. Although, we discussed it in depth yesterday and probably going to be approved shortly, and we expect this is coming online in around three years. Some of them are coming a little earlier and others probably because of the equipment delivery a little bit later, but roughly three years.

Isabella Batalha Vasconcelos, Analyst

Hi. Good morning, everyone. I have just one question. I think most of the points have already been addressed. But also, in terms of capital allocation, I had some connection issues. So hopefully, I’m not making you repeat yourself. But just to understand, it seems that you’re going the organic growth line in terms of future capacity. But are you analyzing inorganic growth opportunities in the Americas, Brazil, or even in Mexico, in the U.S.? That’s my question, thank you.

Máximo Vedoya, CEO

Yes. Thank you, Isabella. As we always said, we are always analyzing opportunities, and we have a track record of doing this in a very responsible way. If you ask today, we have nothing special in our pipeline today. But these things arise, and we are always analyzing these opportunities.

Leonardo Correa, Analyst

Yes. Hello. Good morning, gentlemen. I hope you can hear me. Good morning, Máximo, Pablo, Sebastian. Thanks for the follow-up here.

Máximo Vedoya, CEO

Yes. Finally, Leonardo we can hear you well.

Carlos De Alba, Analyst

Thank you very much, everyone. Happy New Year. I have a follow-up question regarding the investment programs. specifically, what is the total expected investment in dollars for the finishing lines that would enhance the value of the new hot-rolled coil? Additionally, how does this impact the timing of a potential electric furnace in Mexico? Máximo, could you share your insights on how this investment might increase both the value added to your current operations and the crude steel capacity in the region? Furthermore, could you provide details on the product mix for your New Mexico operation, including hot-rolled coil, cold-rolled coil, galvanized products, and rebars? Given the fluctuations in prices, I believe this information is important. Lastly, do you have any updates on the transaction with Ternium Argentina regarding their stake in Ternium Mexico? What is the expected timing for these transactions if everything proceeds smoothly?

Máximo Vedoya, CEO

Okay. Thank you very much for your question, Carlos. Let me take the one, the first one, the investment. The investment we are thinking is $1 billion to this Pesqueria facility. The rationale behind this investment is that the market, I mean we have now the hot-rolled mill. We have the ability to produce any product in the hot-rolled mill. But also, the market is needing value-added products like cold-rolled, pickling or galvanized. This is the rationale, I mean, going up to the inputs of hot-rolled products, some of those also would come from the technical facility, remember, but also going to the rest of the inputs for usually in automotive and industrial customers.

Pablo Brizzio, CFO

The transaction has progressed as planned. However, without confirmation from the Ternium Argentina Board of Directors, the recommendation for the transaction and the approval of a dividend by the shareholders of Ternium Argentina is necessary. This will necessitate a shareholder meeting, which typically occurs about a month after the Board of Directors' approval or recommendation. And then after that, due to the complexity of the transaction and the different steps the transaction is taking, it could take an additional 15 days to 30 days for completion. So if the transaction is let’s say approved at some point in the next month, it will take in total around two months for this transaction to be fully performed. But we need to step, which is an important one is to have the recommendation from Ternium Argentina Board of Directors. So and this is something that the Board of Directors of Argentina did not take yet, and they are still considering the proposal.

Máximo Vedoya, CEO

Carlos, regarding the share of products in Mexico, last year's figures show that rebars and wire rods totaled 1.2 million tonnes. The capacity for galvanized and painted products is about 2.4 to 2.5 million tonnes for galvanized and 0.8 million tonnes for pre-painted products, which utilize galvanized materials. The remainder consists of cold-rolled and hot-rolled products. Overall, Ternium Mexico's total capacity is around 8 to 9 million tonnes. Currently, the total capacity for hot-rolled products stands at 10 million tonnes, and we are in the process of ramping up the hot-rolling mill in Pesqueria. Yes, and I’ve mentioned earlier how we run the full capacity at the painting line and the galvanizing line. Whatever you cannot use there, you could use hot-rolled coil.

Timna Tanners, Analyst

Yes. Thank you again and thanks so much for your candor. Appreciate it.

Máximo Vedoya, CEO

Thank you very much to everybody for the interest and for the very good questions. I really appreciate your participation, and as usual if you have any additional questions, any feedback, please don’t hesitate to call us. See you in around three months in the next conference call. Have a nice day. Thank you very much.

Operator, Operator

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