GCC SAB de CV

BMV:GCC

Earnings Call Transcript 2018-Q2

[Operator]

Good morning, and welcome to the GCC Second Quarter 2018 Earnings Call. Before we begin, I'd like to remind you that this call is being recorded, and that information discussed today may include forward-looking statements regarding the company's financial and operating performance.

All projections are subject to risks and uncertainties, and actual results may differ materially. Please refer to the detailed note in the company's earnings report regarding forward-looking statements.

At this time, I would like to turn the call over to Mr. Enrique Escalante, Chief Executive Officer. Please go ahead, sir.

[Hector Enrique Escalante Ochoa, executive]

Thank you, operator, and good morning, everyone. Joining me today are Luis Carlos Arias, our CFO; and Ricardo Martinez of Investor Relations.

In the second quarter, our operating results continued the steady improvement in sales and margins that GCC has delivered since 2013.

We also took a number of strategic actions during the quarter that will help us achieve our long-term goals effectively. We completed the acquisition of the Trident cement plant in Three Forks, Montana, which adds 11% to our U.S. cement capacity and extends our market footprint West and North in contiguous market.

At the same time, we sold nonintegrated ready-mix assets in the Oklahoma and Arkansas market, which paid for the acquisition with favorable net difference for GCC.

And finally, we refinanced all our bond debt, which will save an estimated $10 million per year in interest expenses and extends the final maturity of bill debt.

Our first-half operating performance and the M&A and financial factors will help make 2018 another benchmark year in GCC's transformation.

I will discuss the main drivers of our performance in the U.S. and Mexico and quickly review the M&A transactions we completed in late June. Luis Carlos will review the financial results and the debt refinancing. I will then discuss our outlook for 2018, in light of the M&A transactions and our current perspective on the business environment. We will then open the call to your questions.

First, GCC's performance drivers. Our markets are continuing to develop broadly in line with our previous estimates. Second quarter sales increased 7% and EBITDA grew 9%, with a 50-basis-point improvement in margin. The U.S. market remains very strong, with solid demand from the Canada border to the Rio Grande, although the weather was not as favorable in the second quarter as it was in the first.

The Permian Basin oil fields in West Texas continued to be very active. Since April 2006, the rig count in the basin increased almost 360% from 134 to 474 rigs. Cement demand includes both oil well cement for use in the [indiscernible] plant and also construction cement for the fracking sand facilities that are being developed in the basin, exported from the Samalayuca plant.

In New Mexico, public sector construction was the strongest segment. In Minnesota, residential construction was the strongest. In the Upper Midwest states generally, wind farm construction is continuing to be a very attractive market for GCC, although this was a region that was most affected by bad weather late in the quarter.

U.S. cement sales volumes were down 2.1% in the quarter, principally because of the weather-related delays in Iowa and North Dakota. For the first 6 months, cement volumes increased 6.1%. Ready-mix volumes were up 7.2% in the quarter and 2.5% in the first 6 months. In general, backlog in the U.S. for both cement and ready-mix continues to be very strong. We expect to make up the weather-related volume shortfall in the second half of the year.

Cement prices were up 4% year-over-year. The market is supporting price increases in the 3% and 5% range for both cement and ready-mix.

While demand is strong, frac sand position in certain markets is limiting the price increases that can be negotiated with clients. Ready-mix prices rose 2.5%.

The market in Mexico has proven to be a nice surprise. We did not see a sharp slowdown prior to the elections as some economists predicted.

Demand was supported by residential projects in Chihuahua industrial plant expansions and very strong mining sector demand. The [indiscernible] construction segment was also positive.

Cement volumes grew to 2.9% and ready-mix volumes decreased 3.3%, mainly because of different base due to big projects that we have last year. Cement prices rose 9.6% in pesos, and ready-mix prices were up 4.1%.

Increased export to the U.S. are increasing Mexico's capacity utilization and boosting margin. The Samalayuca and Juarez plants are running at more than 95% of capacity. Around 70% of the production of this plant was shipped to the U.S. in the quarter.

My second topic is the M&A transactions GCC completed. We discussed the transactions in depth in our conference call in June 26, so I will be brief.

The Three Forks plant represents an investment of $107.5 million and generated about $47 million in sales and $10.5 million in EBITDA last year. It has a capacity of 315,000 metric tons, and much of this correlate with the board's highest strategic priority for investment and capacity allocation, which is a regional cement capacity that expands our footprint and integrating our cement distribution network.

Now regarding the acquisition. Our focus is to ensure that we realize synergies from integration of our existing distribution network with the customers from Three Forks plant, which includes Western Montana, Idaho and Alberta, Canada.

We sold most of our Arkansas and Oklahoma ready-mix and transportation assets for $118.5 million. These were noncore assets that were not integrated with our cement production and consequently were low margin. Divesting them in the context of the Three Forks acquisition was a good opportunity, and meant that our leverage ratio did not increase on the acquisition. As a result, we continue to be ready to invest for future growth.

The Rapid City expansion is reaching completion, with the scheduled start of operations toward the second half. Construction was 95% advanced as of the end of June. As we have previously said, the exact date for starting operations depends on inventory levels when we can execute the timing with the existing lines, which requires a shutdown for several weeks. We will need to schedule the time so that it doesn't affect our ability to meet customer commitment.

We expect the Rapid City expansion, which represents a capacity increase of 440,000 metric tons, to make a material contribution starting in 2019. The regional capacity is also expected to produce logistic synergies and reduce variable cost by about $2 per ton produced.

Let me turn the call over to Luis Carlos to review the financial quarter results, the successful bank debt refinancing and other financial achievements. Luis Carlos?

[Luis Carlos Arias Laso, executive]

Thank you, Enrique. Good morning to everyone. Let me start by pointing out that our results reflect the reclassification of the Oklahoma and Arkansas ready-mix assets as discontinued operations. Prior periods sold have been restated in accordance with IFRS 5, including sales, cost, expenses and volumes.

The results of the Three Forks plant in Montana will be included starting in the third quarter. Our second quarter operating results were slightly below expectations because of the weather factors Enrique mentioned. Taking into account the first quarter's much greater than expected results however, means that for the first 6 months, our results are above guidance.

Second quarter sales grew 7% in dollars, with similar rates of growth in U.S. and Mexico. For the first 6 months, sales increased 11%. Cost increases were held to only 7% in the quarter and 8% in the first 6 months.

As a percentage of sales, costs decreased 2.0 percentage points for the 6 months, and operating expenses decreased 1.8 percentage points.

Consequently, the operating margin reached 19.2% in the first 6 months, an improvement of 3.8 percentage points year-over-year. The increase gross and operating margins reflect several factors: higher prices and volumes, operating leverage and lower electricity costs in Mexico. As a result, EBITDA grew 8.7% in the second quarter and 22% in the first 6 months. We continue to be highly focused on increasing margins. The market at the 6-month EBITDA margin increased 250 basis points to 28.8%.

Our EBITDA margin in Mexico reached an all-time record high of 44.8%, and U.S. margins were 24.7%, again the highest for a second quarter since the 2009 financial crisis.

Net financial expenses decreased 4%. Interest expense includes fees for the refinancing of bank debt and were lower as a result of the refinancing of the bond last year. As a result of these factors, income from continuing operations rose 2.2% in the second quarter and 82% in the first 6 months.

The discontinued operations line was a loss of $41 million, which includes the loss on sale of the Arkansas and Oklahoma ready-mix operations, plus their net aftertax result for [indiscernible] of sale.

Operating cash flow for the 6 months of 2018 was a positive $18 million compared to a negative $3 million last year. The $21 million favorable swing was a result of the strong growth in EBITDA and lower interest expense.

As regards the successful refinancing of bank debt, during the quarter, GCC paid in full its existing bank debt and entered into a new term credit facility with a significantly lower interest rate.

The new $400 million loan has a term of 5 years, with a variable interest rate spread of 1.25% to 2% over LIBOR, based on GCC's debt to EBITDA ratio. The initial margin will be 1.75%. In addition, the agreement includes an unsecured $50 million revolving line of credit that as of to date, has not been used.

As part of the refinancing, GCC reduced the amount of term credit facility by a net of $33 million. The level of our cash balances makes it possible without affecting our liquidity because of the $50 million line of credit and was also partially offset by the $11 million net favorable difference between the sale and purchase prices of the M&A transaction.

The net interest saving from the refinancing is approximately $10 million per year. GCC's leverage ratio, which is to finance net debt over EBITDA decreased slightly from the December level to 1.82x in June 2018 and is significantly below the June 2017 level of 2.56. By any standard, our leverage and other debt ratios are well below industry average.

S&P recognized our operating performance and sound financial management by raising our corporate grade rating to BB+, with a stable outlook, which is our second ratings upgrade in less than 12 months. The liquidity at the start increased from an average daily trading volume of 139,000 shares last year to 495,000 shares in the second quarter. In addition, the stock price has increased around 40% year-to-date.

As a result, last year the stock was included for the first time in the MSCI family of stock indexes. GCC is now a component of such widely used benchmarks as the MSCI Mexico Small Cap, Emerging Markets Small Cap, Emerging Markets Latin America IMI, among others.

I will now return the call to Enrique.

[Hector Enrique Escalante Ochoa, executive]

Thank you, Luis Carlos. My final topic is GCC's outlook for 2018. We are revising our guidance for the full year based on the strong first half performance, somewhat better visibility on the Mexican market and also to reflect the Three Forks cement acquisition and ready-mix asset sales.

GCC is currently expecting 2018 cement sales volume in the U.S. to increase 9% to 11% compared to 2017, and ready-mix volumes to grow 1% to 3%. On a like-to-like basis, cement volume growth is now expected to be 2% to 4%, which is slightly over the PCA's forecast for our market.

We expect U.S. and Mexico prices to increase 3% to 5% year-over-year in local currency for both cement and ready-mix. The Mexican market is, as I mentioned, performing somewhat better-than-expected, despite the election year and trade negotiations uncertainty. We now expect sales volume for cement to grow in the 1% to 3% range and for ready-mix to remain flat.

As a result of these factors, GCC now expects consolidated EBITDA to increase by 11% to 13%. Our estimates for capital requirements remain unchanged. CapEx will be about $120 million, half is for the expansion of the Rapid City plant and half for maintenance. Working capital requirements are expected to increase slightly compared to 2017.

Finally, GCC also expects that as a result of our operating performance and capital requirements, net leverage will continue to decrease. We believe we will end the year with a net debt to EBITDA ratio in the range of 1.4 to 1.6.

Our second quarter and 6 months demonstrates how GCC is continuing to generate value for our shareholders and other stakeholders. We continue to increase sales, EBITDA and EBITDA margin and return on investment capital, ROIC.

The new cement plant in Three Forks, Montana is an important acquisition that extends our market footprint and integrates well with our existing cement network. The asset sales removed some noncore assets that were a drag on our performance.

The best refinancing significantly lowers financial costs and further strengthens our capital structure and leverage profile. We have the operational and financial flexibility to navigate any external challenges we would face in our market. Even with the Three Forks acquisition, and the soon-to-be-completed Rapid City expansion, we are well positioned to continue to invest to continue growing in a profitable manner.

This concludes our remarks. And at this time, we are ready to take your questions. Thank you, operator.

[Operator]

[Operator Instructions] We'll take our first question from Mauricio Serna with UBS.

[Mauricio Serna Vega, analyst]

I guess, I just wanted to talk a little bit about the U.S. margins. I mean, we did see, if I made the math correctly, some pressure in the margins there. Just wanted to get a little bit more details on the cost. You did mention some freight cost from the exports from Mexico to U.S. facilities, the U.S. territories. Is that something we should expect in -- throughout the rest of the year, that it could continue pressuring? And how much did that actually represent of the cost headwinds? Also, I mean, if you could maybe just provide a little bit more detail on what you're expecting for the second half of this year in Mexico? I know you raised your volumes guidance, but what are you thinking in terms of the different factors for the second half of this year? And finally, you mentioned also that there are some potential synergies with the acquisition in Montana, so I just wanted to get a little bit more detail on how much are you expecting to achieve in terms of synergies and over what period?

[Hector Enrique Escalante Ochoa, executive]

Thank you, Mauricio. While we look for the numbers, specifically to your first question, let me address the second and third question. For the second half in Mexico, mainly, we will continue to see growth in the mining sector. It's been a very strong and we have several new projects where we're shipping in excess of 18,000 tons for a couple of projects in the second half. So that's going to continue very strong. Having said that, we're seeing some commercial projects come to life with the construction of several high-rise apartment towers and some large developments both in Chihuahua and Juarez like [indiscernible]. Synergies in regards to Montana, that's something that we are currently addressing. We don't have a specific number yet, and we're working on that. To remind you that we've just -- we're able to see recently their list of customers, and we're working on that to see how we can improve our logistics, especially coming from the Rapid City expansion. On the first question, actually, it was more of a business mix during the -- in the first part of the year, and the ready-mix operation in the U.S. was a larger part of the mix than in the previous year. As you know, the ready-mix operation has a lower margin. So that's the main explanation.

[Mauricio Serna Vega, analyst]

Okay. And I guess, I mean, as you mentioned something like Rapid City, as it comes into line, we might have some pressure also that -- in the second half of the year because of the -- we'll have to shut down for some time. So should we expect maybe some margin pressures in the second half of the year when you initially start operating the Rapid City expansion?

[Hector Enrique Escalante Ochoa, executive]

No. Not, not really. I mean we have all the inventory already in hand or in the production schedule, so we can satisfy all customer, I mean, need. Basically the same margins that we're talking today. So there's not going to be an impact short term in margins because of the startup of the plant in the following week.

[Operator]

And next, we'll go to Dan McGoey with Citi.

[Daniel McGoey, analyst]

Enrique, you mentioned in your remarks some of the price competition in the U.S. limited or some of the price competition in the U.S. limited increases. I wonder if you could expand on which markets in particular. And then also looking towards future investments. As you mentioned, Three Forks was largely financed with divestitures, so the leverage is quite low. Can you give an update on your priority list for additional future investments after that?

[Hector Enrique Escalante Ochoa, executive]

Okay. Thank you for the question, Dan. Let me address first, I mean, the price competition that we are seeing is basically we've seen some pushback very, I mean, specific customers in Colorado and also in the Twin Cities market. So more than anything, those 2, are in larger Metro area. And my concern that...

[Daniel McGoey, analyst]

Sorry, that was specifically in the concrete division. I think you might referring to it as well, right? Or was that cement, too?

[Hector Enrique Escalante Ochoa, executive]

No, that was cement. That was cement, Dan. In concrete, we didn't -- we were experiencing some also very hard, I mean, price competition, exactly on the area where the asset that we sold. So that shouldn't really affect us going forward. In terms of investment, after the Montana acquisition, we continue to be, I mean, very focused on our strategy that we have, I mean, communicated, which is to continue growing cement in the U.S., preferably in contiguous areas that we can, I mean, where we can realize synergies through our network. So as you know, Dan, I mean, there are not so many plants around the area, but we continuously talk to those plant owners, I mean, price development, I mean, an opportunity. In addition to that, ultimately, we're also following any potential opportunities outside of the area, and that's the priority.

[Daniel McGoey, analyst]

Sorry, Enrique. Aside from acquisitions, I know in the past you've talked about potential expansion either at Permian or Samalayuca, which is now fully utilized and then also at Juarez, I mean, does the integration of Three Forks make you less inclined to proceed with any of those? Or are those on your sort of radar screen short term?

[Luis Carlos Arias Laso, executive]

No, we're not slowing down that process. On the contrary, we're trying to accelerate as much as we can the analysis and evaluation of the 3 possible plant expansions that we see for the near term. So we're comparing our models to see which is -- which one -- which will develop in the higher returns for the company. In addition to, the best -- I mean, strategic market protection. And so by the end of this year, we plan to, I mean, to be very close to decide which is going to be our next expansion. And since we continue to see a strong market in the U.S. for the following years. We're losing capacity, I mean, previously, and we are preparing to be ready for the next expansion.

[Operator]

And next, we'll go to Cecilia Jimenez with Santander.

[Cecilia Jimenez, analyst]

I had actually a follow-up question on the synergies related to Montana. And it's basically, what's the time frame you are expecting to actually materialize those synergies? That will be my first question. And the second one has to be related to Mexico operation. What utilization rate you are expected to the end of the year in Mexico? And particularly in the Chihuahua plant, which I believe is the one, running at the lowest utilization rate? That will be from my end.

[Hector Enrique Escalante Ochoa, executive]

Thank you, Cecilia. I'll try to address the questions in the order you presented them. Synergies in Montana, we are, as I said, I mean, analyzing now customer by customer and meeting, I mean, especially the customers in Canada that were not disclosed to us in due diligence. And the plant, fortunately, as you know, sold out. So making changes in the distribution network is going to take some time to decide, I mean, how to optimize, I mean, customer by customer and what movement we have to make in the network. That's a probably a longer answer to your question, but I believe that we're not going to be able to really materialize anything here until 2019 because the rest of this year is precisely complying with the commitments that we have with the customers. And being that it's sold out, and the Rapid City expansion is not ready yet, it's not going to see that happen until early next year. In terms of the Mexico operations. I can tell you that this second half of the year, I mean, all the plants in GCC in Mexico are going to be running at full capacity. We started up fuel #3 in June to precisely complement shipments up north, and we are planning to start all the other kiln that is a small kiln that it's in Idaho and Chihuahua kiln #2, and that's going to be ready during the fourth quarter of the year. So all kilns are going to be running full speed ahead.

[Cecilia Jimenez, analyst]

Maybe if I can make a last question regarding also Mexico operation. I believe there is -- has been some expansion margins related to lower cost. Could you tell us or could you share with us how sustainable that is in the medium term? Or where do you see, particularly energy cost and electricity cost in Mexico stabilizing?

[Hector Enrique Escalante Ochoa, executive]

Good question, Cecilia. It's going to be a challenge to maintain, I mean, the margin exactly where it is to date, precisely because electricity is going up. We just, I mean, received a notification of a 10% price increase on the electricity. And we don't know what to expect yet for the rest of the months of the year. So even though, I mean, the level -- it's low compared to historical, I mean, standards, it's going to go up in the second part of the year. So it's going to imply pressure on the margin.

[Operator]

And next, we'll go to Eric [indiscernible] with Merrill Lynch.

[Unknown Analyst]

So my question is, now that you're being focused on increasing exposure to U.S., and this being the first quarter with the CRH acquisition, with a 2% drop in volumes. Can you please dissect further where you see growth in volumes in the U.S. for the second half of the year and probably for 2019?

[Hector Enrique Escalante Ochoa, executive]

Yes. Basically, the second half, Eric -- first, thanks for the question. Basically, the second half, we have enough backlog to carry us, I mean, through the year in the U.S. And so that means there's basically no change in the segment composition for the rest of the year. For 2019, we expect, basically, all segments also to, I mean, to perform well. Perhaps we're going to see a little bit of increase derived from infrastructure work on highway pavement as a result of the new highway build that as you know was approved, I mean, a couple of years ago and is now going to start really, I mean, resulting in projects. So that's probably, I mean, a slight change going forward. We don't see any very significant segment that is going to go faster than others compared to this year.

[Unknown Analyst]

So the oil cement segment would continue to grow steadily? Or we would see that decreasing going forward?

[Hector Enrique Escalante Ochoa, executive]

Right now oil well cement, we continue to believe it's going to be, I mean, maintaining its current levels. Actually, that's one of the reasons why we're firing up, I mean, kiln #2 here in Chihuahua at the end of the year, because we see an opportunity to ship more oil well cement to the Permian Basin. That's -- I cannot say the same for construction cement in the area, given that construction of the 20-floors fracking sand plant during this year, that's an event that is not going, obviously, to next year. So there will be some demand decrease from those projects in the Permian Basin. But again, I mean, the cement for oil well drilling is going to continue to increase for us given there is unsatisfied demand in the area.

[Operator]

[Operator Instructions] Next we'll go to Adrian Huerta with JPMorgan.

[Adrian Huerta, analyst]

Two quick questions. One is, if you can just tell us where you did price increases in the U.S. during the quarter? And the plan that you have for other increases in the year? And the second question is, when you give guidance for volume growth in the U.S., what level of utilization are you assuming for the new cement plant that you acquired?

[Hector Enrique Escalante Ochoa, executive]

Adrian, thanks for the questions. Price increases in the U.S. took effect mostly in April 1. So it was, I mean, an announcement between $6 and $8, depending on specific markets. And again, I mean there's been some, I mean, focus where we've had some pushback from one competitor. But overall, I think, it's going well, and we should end up very close to the guidance that we just gave you. In terms of a second increase for the U.S., we don't see it possible in the next months, except for, perhaps, in some of the oil well cement that we are, I mean, shipping to the Permian Basin, given the strong demand of the -- for the product. In terms of level of utilization of the Montana plant, we'll continue to be, I mean, completely full. So it's not only a sold out plant. And basically, [indiscernible] around the plant in Mexico are going to be running at full capacity. The second half, the same is true for all the U.S. plants. All our kilns in the second half will be, I mean, completely at full capacity. So in summary, during the second half of the year, all kilns of the company will be running, except for the Rapid City [indiscernible]

[Operator]

And next, we'll go to Alejandra Obregon from Morgan Stanley.

[Alejandra Obregon, analyst]

I just wanted to follow up on Mexico. You were saying that growth comes from the mining sector and commercial projects. But I was wondering if you could give us some color on infrastructure. I know you mentioned that this could be some of the drivers for 2019. But I was wondering if you could tell us if you have seen some particular trends changing on the permitting side, perhaps, in 2018? And aside from this project that you're mentioning, do you expect some different trends in infrastructure going forward?

[Hector Enrique Escalante Ochoa, executive]

Thank you, Alejandra. Unfortunately, Alejandra, we're not too bullish on infrastructure in Mexico. The state government is running a big deficit, as you all know. And that doesn't seem to be changing any time soon. Besides, I mean, the results of the election, we don't know what to expect in terms of support from the new current government to the state. So we will have to see us as the year develops in the next coming months. I'm not sure I got your question in terms of permitting. Can you repeat it, please?

[Alejandra Obregon, analyst]

Yes. Yes, actually you just answered. I was kind of wondering if the new administration has changed anything in terms of concessions and permitting. But you actually just answered. But maybe a follow-up on Mexico as well. In terms of pricing, have you seen any different trends or dynamics for competition in the region? That will be very helpful.

[Hector Enrique Escalante Ochoa, executive]

Similarly through some of the markets in the U.S., we have made some adjustments to meet competitors' pricing, I mean, more aggressive pricing in the state. We were losing a little bit of market share, so we put a stop to that and make some, I mean, adjustments with specific customers. We don't see that as a trend or anything that could, I mean, evolve into pricing for the rest of the year. We think that's already assimilated in the market.

[Operator]

I'm showing that we have no further questions, I'd like to turn the call back over to our speakers for any additional comments or closing remark.

[Hector Enrique Escalante Ochoa, executive]

Well, thank you all for your participation in the call today. We look forward to seeing many of you in the coming months. And of course, as always, do not hesitate to contact us should you have any additional questions that we need to address. Thanks a lot.

[Operator]

And that does conclude today's conference. We thank you for your participation. You may now disconnect.