GCC SAB de CV

BMV:GCC

Earnings Call Transcript 2018-Q3

[Operator]

Good morning, and welcome to the GCC Third Quarter 2018 Earnings Call.

Before we begin, I would like to remind you that this call is being recorded. 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 earning 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.

[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.

GCC's third quarter and 9-month results showed continued success in implementing our expansion plans in an environment of steady demand growth and a favorable pricing environment in both the U.S. and Mexico. Our results also demonstrate solid operational execution and the benefits of the debt refinancing that we've carried out this year and last. We generated $84 million in EBITDA in the third quarter, which is a new quarterly record. Free cash flow generation reached $76 million in the quarter. GCC is on track to meet our full year updated guidance for EBITDA growth of 11% to 13%.

I want to highlight quite significant achievements in the quarter. Number one, we reactivated 2 cement kilns in Chihuahua to meet growing demand. All of GCC's kilns in our 8 cement plants will be operating very soon. Number two, the integration of the Trident plant in Montana we acquired in June is proceeding very well. Number three, we completed construction of the Rapid City expansion and started the tie-in process. Once the tie-in is finished this quarter, Rapid City's installed capacity will increase to 1.1 million metric tons. Number four, net financial expenses fell almost 40% as a result of the refinancing of our bank debt and bonds in prior periods. Number 5 and lastly, GCC shares were included in the IPC's blue-chip index of Mexican stocks. This is one of the many positive results of our initiative to increase the attractiveness of GCC shares as an investment.

We will comment on each of these points, and I will discuss the main drivers of our performance in the U.S. and Mexico. Luis Carlos, will review the financial results. We will then open the call to questions.

First, GCC performance drivers. Our markets are continuing to develop broadly in line with improved guidance estimate we provided last quarter. Third quarter sales increased 11% and EBITDA grew 9%. The U.S. market remains strong with solid demand from Canada to the Rio Grande. Backlog for both cement and ready-mix continues to be at a high level. We're basically sold out for the rest of the year.

The Permian Basin oilfields in West Texas remain our most dynamic market. And the number of active drills -- drilling rigs continue to increase. The Odessa plant is supplying demand for oil well cement and exports from the Samalayuca plant are supplying demand for gray Portland cement. The Queretaro market remains very strong as a result of general economic growth, demand for housing and state sponsored infrastructure projects. In the northern region, the development of poultry and pork processing plants and wind farms are the main demand drivers.

U.S. cement sales grew 12% in the quarter, mostly because of the addition of the Trident plant in Montana. On a like-to-like basis, sales volume has increased less than 1%. This reflects weather-related delays in September and some project delays. Construction labor charges are becoming something of a bottleneck in some markets.

For the first 9 months, cement volume increased 9%. On a like-to-like basis, excluding Trident plant, the increase was 3.7%, higher than the last preseason national forecast of 3.2%.

Ready-mix volumes were up 2% for the quarter and the first 9 months. Cement prices for the 9 months were up 3%. In September, GCC advised our customers of a $9 per metric ton price increase, effective April 1, 2019. Ready-mix prices also rose 3%.

The market in Mexico continues to surprise us on the upside. Most of the demand is coming from expansion of existing maquiladora facilities in Juarez and middle-income housing projects in Chihuahua and Juarez. The mining sector was not as strong as previous quarters mostly because of wet weather in the mountain, but it continues to being an important source of demand.

Mexico cement volumes grew 6% and ready-mix volumes decreased 3%. Cement prices rose 10% in pesos and ready mix prices were up 8%. We're also seeing a stronger pricing outlook in Mexico, and one of our principal competitors recently announced a 7% price increase. Higher exports to the U.S. continued to increase Mexico's capacity utilization and boost margin. The Samalayuca and Juarez plants are running at capacity and around 70% of their production was shipped to the U.S. To meet higher demand on both sides of the border, we reactivated two idled kilns in Chihuahua with a combined capacity of around 300,000 metric tons. One kiln produces Portland cement and started production in late June. The regional volume will serve the Mexican market and permit even more of the Samalayuca production to be export. The second kiln is going to produce oil well cement and became operational in late October. We expect to export all the additional oil well cement starting at the beginning of next year, we want this cement tested by our customers and certified.

The work to reactivate the two kilns generated extra labor and maintenance expenses in the quarter. Two other factors also affected cost. Logistics expenses rose because of the need to build inventories before the Rapid City shutdown and longer shipping distances. In addition, CFE, the Mexican state-owned power company, made some sharp increases in electricity rate.

So these three factors, reactivation expenses for the two Chihuahua kilns, increased freight and electricity rate increases in Mexico were the main reasons for the EBITDA margin decrease by 40 basis points in the third quarter. For the 9 months, EBITDA margins reached 29.3%, which is an increase of 130 basis points year-over-year and very much in line with our expectations.

Let me now turn to update some of the integration of the Trident plant and the Rapid City plant expansion. The Trident plant in Three Forks, Montana had its first full quarter of operations as part of GCC in the third quarter. The plant is operating at near its full capacity of 315,000 metric tons. We installed a new burner in the kiln, which increases energy efficiency and reduces emissions, and we don't currently see the need for other significant investments in the production process. Now that the transaction is closed, management's priority is to go to know our new customers, including those in Canada, optimize distribution logistics and extract all possible synergies. I have personally had a number of meetings with Trident customers, and we are quite happy with the way discussions of future orders are going.

We completed construction of the Rapid City expansion in mid-September. We expect the 440,000 metric ton capacity increase to make a material contribution starting in 2019. The additional capacity will provide some relief to our particular sold-out cement system. In the short term, the expansion will allow us to reconfigure our logistics systems and seek out new customers that, as of now, we could not supply. The Rapid City expansion will also reduce the plant's variable cost of production by around $2 per ton.

I will now turn the call over to Luis Carlos to review the quarter's financial results.

[Luis Carlos Arias Laso, executive]

Thank you, Enrique, and good morning to everyone. Let me start by reminding you that the results of the Trident plant in Montana were consolidated effective starting July 1. Our results also reflect the reclassification of the Oklahoma and Arkansas ready-mix assets sold in June as discontinued operations. Prior period results have been restated in accordance with IFRS-5, including sales, costs, expenses and volumes.

Third quarter sales grew 11% in dollars. U.S. revenue increased 12%, while Mexico revenues also increased 12% in pesos. But the depreciation of the peso lowered this growth to 5% in dollars. For the first 9 months, total sales increased 11%. Higher variable costs were partially offset by a reduction in fixed charges. As a percentage of sales, cost decreased 0.2% in the third quarter and 1.3 percentage points for the 9 months.

Operating expenses as a percentage of sales decreased 0.5 percentage points in the quarter and 1.2 percentage points in the first 9 months. Consequently, the operating margin reached 23.1% in the quarter, up 0.7 percentage points and 20.8% in the first 9 months, an improvement of 250 basis points year-over-year.

EBITDA grew 9.2% in the third quarter and 16.3% in the first 9 months. The third quarter EBITDA margin was reduced by 40 basis points principally because of the three-cost factors Enrique already mentioned; higher U.S. transportation costs, reactivation of two kilns in Chihuahua and higher electricity rates in Mexico. The 9 months EBITDA margin increased 130 basis points to 29.3%.

Net financial expenses fell 39% from $15 million in last year's third quarter to $9 million as a result of the refinancing of all of our debt. As a result of these factors, net income from continuing operations rose 49% in Q3 and 63% for the first 9 months of 2018.

Operating cash flow for the first 9 months of 2018 was $106 million compared to $75 million last year. The $31 million increase was principally the result of the strong growth in EBITDA, reduced working capital needs and lower financial expenses. The EBITDA to operating cash flow conversion rate was 53% for the 9 months. The net debt to EBITDA leverage ratio decreased to 1.61 in September 2018, much lower than inventory average levels.

In addition to our financial results, I am proud to say that we continue to make GCC a more attractive stock for investors. Trading liquidity has increased by a factor of around 7x since the re-IPO. We are now both -- in both the Mexican Stock Exchange's IPC index effective September and the MSCI indexes effective last June. We have been very focused in increasing the number of investors who know our story. We now have 11 sell-side analysts covering our stock compared to just 4 at the start of 2018. Several more are expected to initiate coverage in the coming months.

I will now return the call to Enrique.

[Hector Enrique Escalante Ochoa, executive]

Thank you, Luis Carlos. Before we open the call to your questions, I would like to note the passing of Federico Terrazas Torres, who was GCC's Chairman of the Board for 20 years -- 23 years until 2013, and who continued as a board member, last month at age 86. It was his leadership where we got and began its -- GCC's international expansion. And he firmly feels and believes that dedication and persistence were a good formula for achieving success, both in business and in life. We are proud to carry on his legacy.

Let me close by reaffirming that our results are in line with the updated guidance we had provided last quarter. The markets are evolving as we expected with volume growth in both the U.S. and Mexico, and good stacking environments on both sides of the border. But we're not yet providing guidance for 2019. Further volume and price increases appear well supported by the business and economic environment in our market. With our low leverage and strong cash flow generation, GCC is well-positioned to continue investing in profitable growth. We're in the final stages of evaluating the options for expanding cement capacity at our existing plant.

This concludes our remarks. At this time, we're ready to take your questions. Thank you, operator.

[Operator]

[Operator Instructions] And we'll take our first question from Carlos Peyrelongue with Bank of America Merrill Lynch.

[Carlos Peyrelongue, analyst]

My question is related to U.S. cement volumes. On a like-to-like basis, I believe volumes on the third quarter were flat. During the second quarter, they were slightly down. You mentioned that demand remains strong, but we're not seeing that in the numbers yet. Can you explain why that is? And should we expect volumes to start growing? Or is there a capacity limitation that you see that will not allow you to grow volumes until it becomes effective, the new capacity that you expanded in Rapid City?

[Hector Enrique Escalante Ochoa, executive]

Carlos, thank you for your questions. On a like-to-like basis in the third quarter, where we said it grew only around 1%, it's basically weather-related as I explained, we had weather in different regions of the country. Mostly, in all of them are different ones in time during the quarter. So this is the main factor that delayed on the shipment that we have in backlog. So we don't see it as a demand problem. There were certainly a couple of projects that delay also, I mean, in the stocking up, but the demand it's -- we see it as a solid demand. In terms of supply, we're ready to fulfill all the orders and all the demand that we have, I mean, the books for the last quarter of the year. We don't have a supply capacity at the moment and the Rapid City plant is going to be ready online, I mean, for the increased demand of next year.

[Carlos Peyrelongue, analyst]

So that means that if the weather holds, fourth quarter, we should start seeing volume growth again? And there will enough capacity both for the first quarter to be fueled and also next year? For volume growth being...

[Hector Enrique Escalante Ochoa, executive]

Yes. The only concern and possible limitation for the fourth quarter that we have is the weather. We need -- I mean the next 8, 9 weeks, we need the sun shining out there. If that happens, and we've had -- I mean good winters like last year, we will be able -- easily to fulfill, I mean, our expectations on what we have given guidance. And for next year, too, we expect, I mean, the Rapid City plant, as I said, I mean to be ready. And with the additional capacity that we turned on from the Chihuahua kilns, the system is ready, I mean, to take on additional growth in '19 -- in 2019.

[Carlos Peyrelongue, analyst]

2019, okay. Great. And last -- just a follow up on this -- the tied-in that you did on the Rapid City plant, did that affect either positively or negatively volumes? I believe it didn't, but I just wanted to confirm that there was no impact on volumes related to the temporary shutdown that you did.

[Hector Enrique Escalante Ochoa, executive]

No, no. There was no impact. There was a strong impact in freight costs because of moving cement for that area during the shutdown.

[Carlos Peyrelongue, analyst]

But not in volumes?

[Hector Enrique Escalante Ochoa, executive]

But that -- yes, not in volumes.

[Operator]

And we'll take our next question from Dan McGoey with Citi.

[Daniel McGoey, analyst]

Enrique, I wanted to go back to -- I think you made a comment, Rapid City expansion you expect to reduce costs by about $2 per ton. And is that specifically on just the production at that plant? Or is that on a consolidated basis and whether or not it considers some of the cost synergies from sending cement shorter distances? So if you can just maybe elaborate a little bit on the overall expected cost savings as that comes onstream? And then if you can also touch on, I think you mentioned $9 price increases for April, whether or not you'll implement that in all markets simultaneously and why not starting earlier in the year, perhaps in the first quarter?

[Hector Enrique Escalante Ochoa, executive]

Thank you, Dan. And the first question, the Rapid City cost reduction of $2 per ton is exclusively, I mean, for the Rapid City plant. And this is just because of, I mean, higher efficiency that we're going to have with the new capacity. On your second question, the $9 price increase was announced for April. Unfortunately, I mean, some other competitors announced also, I mean, quasi-simultaneous price increases for April, which limited our ability to increase the demand for some customers in some regions during the first quarter. It is across the board. It is -- we announced that it's in every region where we are.

[Daniel McGoey, analyst]

And just a follow-up on the first question. If we think more sort of comprehensively about the impact on Rapid City with the savings on freight and distribution, can you just pinpoint a little bit more what type of margin benefit you'll expect for 2019 as that comes onstream?

[Hector Enrique Escalante Ochoa, executive]

We will get back to you with more specific numbers, Dan. But definitely, I mean, there will be savings in trade costs because we're going to pull back a lot of this demand that the Pueblo plant is shipping up north towards Colorado and surrounding markets. And so we'll get back to you with specific, I mean, freight savings, I mean, for the first and second quarter of the year.

[Luis Carlos Arias Laso, executive]

And of course, when we talk about the guidance next year for 2019, we will, of course, in that guidance, include the effect of those savings.

[Operator]

And we'll take our next question from Mauricio Serna with UBS.

[Mauricio Serna Vega, analyst]

First, I would like to ask about the cost headwinds that you faced this quarter. Some of them seem to be kind of nonrecurring, specifically the one related to the reactivation of the kilns, and the shutdown -- temporary shutdown on Rapid City. So I just wanted to ask if you could quantify that just to see how much that could affect in the next quarter or even upcoming quarters? Should it be something that we continue seeing? Or is it just a one-time thing? Maybe if you could also talk about if you -- some type of synergies -- the amount of synergies that you've identified from the Trident plant from headline figures that -- or your target that you're thinking? And also very lastly on the South Dakota plant. Now that also we've seen a vague increase in oil prices, but that also trigger for you guys to start producing like oil well cement in that region?

[Luis Carlos Arias Laso, executive]

In the -- in regards to your first question, the only type of cost that we see -- that we're going to have in the following months and quarters is, of course, the electricity rates in Mexico. As you all know, those have -- had increased quite significantly in our case. Our rates have been increasing due to -- more than 60%. So that's the only type of costs that will be -- have to manage through the next month -- next months and quarters. In regards to the other ones, as Enrique was explaining, once we have the kiln 6 producing cement, we're going to have lower freight because of the cement that we're shipping up north. All the maintenance and labor expenses that we have to incur for the -- towards starting up of the kilns in Chihuahua, that's already done. So then only power rates are the costs that we'll have to manage in the future.

[Hector Enrique Escalante Ochoa, executive]

Mauricio, turning to your second question on synergies at the Trident plant. As we mentioned in the previous call, most of the synergies that we expect are on the logistic sales and distribution system. And so far, we have identified around $3 million of incremental EBITDA that we can realize from sales in Canada. So that's the plan so far and as I mentioned in the -- during the conference we've been meeting with them, I mean, mostly, all of the customers in Canada, which before we didn't know who they were, if you remember, because of antitrust concerns during the acquisition process, so now that we own the plant, we have been meeting with all these customers. And based on their expected future demand and the distribution cost that we are expecting, around $3 million, it's more or less what we have identified. In terms of the South Dakota plant and oil well cement increases for the Bakken basin, we're ready. The Rapid City plant is -- has been, I mean, traditionally and for years, I mean, shipping oil well cement to the Bakken and as the demand increases, I mean, we will continue, I mean, increasing also our shipments of oil well cement to the Bakken. So that's a bright spot. We don't expect yet, I mean, obviously, I mean, the level of demand that we have experienced in the Permian Basin. But for sure, I mean, on an incremental basis, the Bakken can be a bright spot for 2019.

[Mauricio Serna Vega, analyst]

Got it. So just to be clear, right now this is not happening yet? This is still not doing oil -- you're not doing oil well cement yet from Rapid City? And just if we -- I may come back to the -- again coming back to the first question, just if you could quantify the extraordinary expenses from the kiln reactivation, I guess, that's done and also from the shutdown just as to get a sense on how much of the expenses that affected the margins this quarter are nonrecurring?

[Hector Enrique Escalante Ochoa, executive]

Yes. On the Rapid City, I mean, oil well cement, now, let me be clear. We are and have been, for many years, producing oil well cement in that plant for the Bakken. The demand decreased sharply, I mean, in the last couple of years, as you know, we're still shipping some, I mean, oil well cement to the area. But the potential of our significant increases is out there, so we're ready to take on that potential market increase. In terms of the nonrecurring expenses, basically the kilns in Chihuahua took a couple of million dollars in CapEx, but it's obviously not going to be recurring. But also as Luis kind of mentioned some maintenance and additional labor expenses of about $1.4 million in the year. The only thing that is going to be obviously recurring in the future along with the new production is just the labor required to operate those kilns.

[Operator]

And we'll take our next question from Adrian Huerta with JPMorgan.

[Adrian Huerta, analyst]

Two questions. One is on the electricity cost in Mexico. If you are basically -- draw a link to the CFE price increases or if you have any strategy to try to fix that prices in Mexico? And then the second question is, if you can just comment on the change on energy cost per ton in the U.S. on a quarter-over-quarter basis?

[Hector Enrique Escalante Ochoa, executive]

Adrian, thank you for the questions. On the first one, on electricity costs in Mexico, we have been working the whole year mostly the second quarter on our future strategy for power in Mexico. We're on the basic rate today with the CFE, and we're very close to have our conclusions at the end of this quarter in terms of what's going to build a strait to the -- to get in the market. We expect to find some short-term contracts that will give us an advantage as -- while we define our long-term strategy. But definitely, it's under works, and we expect that this again, to be ready at the end of the year. We're working with, I mean, some very, I mean, sophisticated consultants in Mexico, I mean, to help us define, what are those short-term, I mean, potential contracts that we're going to talk on. Number two, the energy cost increase in the U.S., I mean, Luis Carlos, I mean, looking at the information here. But in terms of energy costs, Adrian, just remember that we have our own coal mine where we supply most of the plants. Up north, we have, in Dakota, a very good source of another coal that comes from a third party. And in the Odessa plant, we use the natural gas, which is abundant there. So basically, we didn't have any issues in terms of increased energy cost. We are not exposed to pet coke as other competitors are. So we are -- we don't have any issues there.

[Luis Carlos Arias Laso, executive]

In terms of power, it's been very stable in this year in most of the regions where we are.

[Operator]

And we'll take our next question from Nikolaj Lippmann with Morgan Stanley.

[Nikolaj Lippmann, analyst]

Just a very quick question here on the competitive outlook for the U.S. and it's encouraging to hear about the $9. But can you expand a bit on how you're seeing the situation with Ash Grove post the -- or around the change with GIH? And then particular around the Denver or Colorado area, what you have seen vaguely and what makes you confident about the $9?

[Hector Enrique Escalante Ochoa, executive]

Thank you, Nikolaj. We don't see any -- today any pushback in the price increase. We think it's going to be, I mean, a solid increase in most of the markets of where we are. Nor do we expect any different reaction from Ash Grove now that it belongs to CRH. On the other hand, I think that, I mean, given obviously, I mean, the size that we have seen in the other segments like ready-mix and asphalt in -- from CRH would be -- it's a company that looks at market in a very stable way. And then it usually supports, I mean, prices with the market. We don't believe there is going to be any radical changes there in the traditional Ash Grove strategy. In Denver, we continue to see an economy that continues to grow, I mean, they're very stable. And we expect the demand also to continue to be, I mean, basically at the levels that we have today. If you have been recently in Denver, I mean, people joke a little bit about to see where do they see the next string up in terms of construction, it's been very dynamic, and we don't see, I mean, in the short-term a sharp decline there.

[Operator]

And we'll take our next question from Chelsea Colón with Aegon.

[Chelsea Colón, analyst]

I just have a couple of questions. Can you explain why on a U.S. like-to-like basis the price increase was 3.5% year-over-year, but it was only 1.7% on a reported consolidated basis with the acquisition? And then secondly, can you comment further on your potential future expansion plans?

[Hector Enrique Escalante Ochoa, executive]

Thanks for the questions Chelsea. Let's start with your question on prices. Yes, on a like-to-like basis, we've outrun 3.5%, I mean we expect it to be around -- between and 4% and 5%. And as we explained in previous calls, we had some -- in some areas some push back from some competitors, which have eased over the last second half of the year. But if you remember, we had to let the -- I mean, prices, I mean, down to its competitiveness in some areas, including the Permian Basin with the regional increased capacity of our competitor plant in the area. Not only us, but also in other markets where we had, I mean, specific customers where we needed to make sure we remain competitive. That's the reason why we were -- we are at 3.5%. In terms of the 1.7%, there is a mix effect here, obviously, with the addition of the Montana plant. I mean, we have lower price in terms of the Canadian market. And so that's part of the explanation there why we are at 1.7%. I'm sorry, the second question on the expansion -- on the expansion plant, we've also comment that we are in the final stages of analyzing, I mean, which plant we're going to expand next. We're very close, I mean, to make that a decision. In the case of the Chihuahua plant, for example, we're looking in more detail at another offer from another equipment technology supplier because we're looking at an option of instead of just expanding the plant in projects like Rapid City, even to go to an additional new line. So that's why it has taken us a little bit more time there to understand what's the best option for GCC. But we're very close, I mean, next -- early next year, we should be very close to make a decision.

[Operator]

And we'll take our next question from Francisco Suarez with Scotiabank.

[Francisco Suarez, analyst]

The question relates with a parental shipments of cement used for oil wells. If I'm correct, you actually do that in West Texas, but you are not doing that in New Mexico. Is there any chance to actually send more shipments to -- for oil wells? And if that is actually the case, from which facility you might be able to do that? In other words, what kilns might be ready to do that to increase your direct exposure to oil well cement?

[Hector Enrique Escalante Ochoa, executive]

Thank you, Francisco. A good question, and we, I mean, always refer to the Permian Basin and to West Texas, and perhaps, strongly. And we should have been more clear before, because the Permian Basin also includes the eastern parts of New Mexico, where we are also shipping oil well cement both from the Odessa plant and now from the Tijeras, New Mexico plant. So New Mexico is also covering everything that we referred to in terms of oil well cement. In terms of more shipments, as we explained, I mean, the kiln in Chihuahua is going to be the kiln number 2 dedicated completely to ship cement to that area, both New Mexico and West Texas.

[Operator]

And there are no further questions at this time. Mr. Enrique Escalante, I would like to turn the conference back to you for any additional or closing remarks.

[Hector Enrique Escalante Ochoa, executive]

Thank you for your participation in today's call. We really appreciate it, and we look forward to seeing many of you in the coming months. As always, please to do not hesitate to contact us, if you have any questions -- additional questions that we did not answer today. Thank you, operator.