GCC SAB de CV

BMV:GCC

Earnings Call Transcript 2021-Q3

[Operator]

Good morning, and welcome to GCC's Third Quarter Earnings Call for 2021. [Operator Instructions] I would now like to turn this call over to Mr. Ricardo Martinez, Head of Investor Relations. Ricardo, you may begin.

[Hector Enrique Escalante Ochoa, executive]

Good morning, everyone. Thank you, operator. This is Enrique Escalante. Ricardo is having some connection problem. So he is dialing again. So I guess I cannot start while he gets connected. As a reminder, of course, I mean, Luis Carlos Arias will be also joining me for this call, our CFO. In today's call, our remarks contain forward-looking statements about the company and about its future business and financial performance. There are -- these are based on management's current expectations and are subject to risks and uncertainties.

You can find more information about risks, uncertainties and other factors that could affect our operations, results and our most recent filings with the Mexican Stock Exchange. It is important to note that these statements include expectations and assumptions related to the impact of the COVID-19 pandemic. As in Slide 2, our forward-looking statements provide information on risk factors, including COVID-19 that could affect our financial results. In particular, there is significant uncertainty about the duration and contemplated impact of the pandemic. This means that this results could change at any time and the impact of COVID-19 on the company's business results and outlook is a best estimate based on information available as of today.

Let me double check if our team has already been able to connect. I guess they are with us now, so I'm going to start with my remarks. GCC's third quarter and 9-month results reflect robust construction activity in both the U.S. and Mexico. Coupled with a tight supply-demand balance in the U.S. cement market, which created a positive price environment. As economic growth and steady recovery in some segments continue, the substantial backlog that we anticipated at the beginning of the construction season has been materialized. However, supply chain challenges, higher energy costs and labor shortages continue to hinder the speed and magnitude of construction projects.

For the first time in about 15 years, average count at GCC is producing as much clinker as possible, either for construction or for oil well cement. Our operations team are focused on maximizing production, maintaining operations and increasing terminal throughput. We are confident that GCC is on track to meet our full-year guidance, having already achieved the leverage ratio target for the year.

Let me now briefly discuss market conditions. Key highlights from our performance as well as how we are dealing with the current and upcoming challenges and opportunities. Luis Carlos, our CFO will follow with GCC's financial performance and organic growth projects. He will then turn the call back to me for closing remarks. Finally, we will take your questions.

First, U.S. market conditions on Slide 4, please. The third quarter started slowly but gained traction during the second half of the year. However, the U.S. market continues to be broadly in-line with the increased guidance estimates we provided last quarter. In the cement business, volumes grew 10%, while ready-mix declined 23%. This is because of a difficult year-on-year comparison of winding farm projects in our North Central region that did not repeat this year at the same pace. On an accumulated basis, cement volumes rose 6% and ready-mix declined 22%. As a result, sales in the U.S. increased 12% in the quarter and 7% year-to-date.

In West Texas, we continued to build customer loyalty in the Permian Basin market. The surge in oil prices boosted demand for oil well cement, which has almost reached pre-pandemic levels. Volumes returned much faster than anyone expected. In a rapid response to supply the growing demand, both teams are running at our Odessa Cement plant, complementing our offer with one team at the Chihuahua plant to produce this type of cement. The Permian market remains very good as a result of general economic growth, infrastructure projects, robust residential activity and warehouse construction.

In South Lake City Yutan, our cement volumes have grown 2-fold against last year's levels. This area is now one of the hardest market in the whole country. Aligned to our strategic plan for the Portland, we will build a new cement terminal to strengthen our distribution and storage capacity in this market. Moving up to the northern region in the Dakotas and Aloha, the development of mid- processing plants and agricultural products are the main drivers for demand. Montana is already sold out. In order to increase the trialing plant profitability, more of the product is there in the U.S. rather than being exported to Canada. To sum up things, U.S. construction activity remains robust. Our distribution network has allowed us to increase shipments as we leverage availability from the last expansion of our Rapid City plant and imports from Mexico.

In terms of U.S. cement pricing on the Slide 7, in the spring, we informed our customers of our second price increase of $6 per short term in August. The price took effect in most of our markets. As a result, prices rose 10% during Q3, and we have been able to increase average prices by 8% year-to-date. In regards to pricing for 2022, based on cost inflation pressures and market conditions, we announced an additional 6% to 8% price increase to a short term in construction cement, that will come into effect January 1st.

For oil well cement, we announced a $15 per ton price increase effective April 1st. Looking ahead, pricing conditions remain very favorable, given the tight supply and demand dynamics, the high plant utilization levels in the cement industry and the need to compensate for cost increases. We remain optimistic about early signs that U.S. price increases could move from 1 to 2 increases per year, plus moving the effective date back 3 months from April to January in most markets.

Turning to Slide 8, in regards to our sustainability strategy implementation. We are currently working on our primary goal of reducing net C02 emissions to 22% by 2030, reaching the equivalent of 576 net kilograms of CO2 per ton of cementitious materials. This goal has been supported by the science-based target initiative, and we expect to receive their final validation by January 2022. In order to fulfill our 2030 goal, we are working on to improving combustion and energy practices in our plants, increasing the use of alternative fuels, lowering use of coal in global natural gas and increasing production of blended cement. On the last point, during the quarter, we have announced a strategic decision. Early next year, GCC's Montana cement plant will fully convert to Portland-limestone cement or PLC, a high-quality cement that lowers the carbon footprint, while still providing the strength, workability and durability as regular Portland cement.

We plan to expand production of PLC cements to more of the U.S. plants in the near future. This is an important milestone in our blended cement efforts to reduce our clinker factor and expand the range of sustainable products. Another effort to implement sustainability best practices and further strengthen our profitability is to reduce GCC's exposure to energy price inflation. For this, we are increasing renewable energy consumption. On a year-to-date basis, 14% of GCC's total electricity consumption comes from renewable sources. We are on track to increase the use of clean energy with a 10-year solar contract at the Odessa plant, a fixed price agreement that will start in July 2022.

To finish this topic, I'm proud to share with you that GCC joined an ambitious journey to achieve carbon neutrality across the cement and concrete value chain by signing onto the TCA and the Global Cement and Concrete Association road maps to carbon ecology. The road map demonstrates how the cement and concrete industry can collectively address climate change, decrease greenhouse gases and eliminate barriers that are restricting environmental progress.

Turning to our Mexico operations on Slide 11. This market continues to surprise on the upside. We again delivered strong quarterly results on the back of high-volume growth in ready-mix. The cement business had a minimal increase because it was affected by a hard comparison based against Q3 last year. When bag cement sales increased due to quarantine and work from home situations. To meet the higher demand on both sides of the border, our Chihuahua cement plant is running with its 3 teams. 2 teams are producing construction cement and another one, oil well cement. These older teams require additional labor and have a lower efficiency, thus, showing a slow growth rate on our EBITDA margin.

Market dynamics didn't change substantially from what we saw in previous quarters, where industrial maquiladora plant, warehouse construction and robust mining projects gross sales volumes. In the city of Wates, the middle-income housing segment also continued to show a strong demand. The self-construction segment is returning to normal levels. As a result, sales in Mexico's division increased by 12% in the third quarter, supported by an increase in cement volumes of 1% and 18% in ready-mix volumes. On a year-to-date basis, sales increased 21%, while volumes rose 8% and 21%, respectively.

Let me now turn the call over to Luis Carlos, our CFO, to continue discussing this quarter's financial results and organic growth projects. I will then return for closing remarks.

[Luis Carlos Arias Laso, executive]

Thank you, Enrique, and good morning, everyone. Turning to Slide 13. Our quarter results were solid. Consolidated net sales increased by 12%. During Q3, we saw a sharp increase in ready-mix in Mexico and cement volumes in both countries, coupled with a very positive pricing environment in the U.S. These gains were offset by a decline of 23% in U.S. unit volumes, which we expected as a result of a difficult year-on-year comparison of not working projects in a North-Central region.

On Slide 14, cost of sales as a percentage of revenues decreased 0.7 percentage points to 65.5% in the quarter. This reflects better prices in both countries and operating leverage as well as a greater share of higher-margin cement sales compared to ready-mix sales. SG&A expenses as a percentage of sales increased 0.7 percentage points in the quarter to 7.5%. This was mainly due to the absence of 2020 savings associated with the expense reduction plan and the appreciation of the Mexican peso relative to the U.S. dollar. As a result, as we can see on Slide 15, EBITDA increased 10% in the quarter, while the EBITDA margin was 34.9%, a decline of 0.6 percentage points quarter-to-quarter.

On a year-to-date basis, the EBITDA margin increased 0.7 percentage points to 30.9%. We are satisfied with the increase in profitability, even though we are facing an inflationary environment and having high energy costs, our results show that we are controlling cost of sales and SG&A effectively. In addition, we are saving additional expense this year. As a reminder, in 2021, we are compensating $14 million of costs and expenses that were saved last year. That number is the difference between last year's total savings and 2021 permanent savings due to the financial investments done during the COVID-19 crisis.

One of GCC's key differentiators in the credit environment of high energy cost is that our coal mine in Colorado provides a significant source of fuel for our cement plants. That lowers our cost and reduces exposure to gas and coke price hikes. In another effort to reduce fuel price exposure, we signed a 1-year contract to fix natural gas price of $5 per million of BTUs for our Odessa cement plant, which runs solely on this fuel.

Turning to Slide 16. Net financial expenses totaled $6 million due to a positive foreign exchange effect and GCC's cash position and lower debt balance, partially offset by an increase in effective interest rate. As a result, earnings per share and company net income increased 12% to $59 million during the quarter.

Moving to our cash generation on Slide 17. Free cash flow was $95 million in the third quarter 2021 compared to $105 million in 2020. This translates into a free cash flow conversion rate of around 87% in the third quarter. This was mainly driven by higher working capital requirements and maintenance CapEx, partially offset by increased EBITDA generation as well as lower interest expenses and cash taxes. I would like to point out GCC's improvement in controlling payables, receivables and inventories. Based on the last 12 months of sales, we reduced days in net working capital from 65 to 53, a total reduction of 12 days.

Turning to our balance sheet, it is ready for growth. We ended the quarter with $632 million in cash and equivalents. And at the end of September, our net debt-to-EBITDA ratio dropped to minus 0.2x or equivalent to $56 million net cash. I would like to point out that we achieved our full-year guidance in this ratio, reaching negative net leverage one quarter earlier than expected. By any metric or standard, GCC's leverage and debt ratios are remarkable. After paying all debt liabilities, we are one of the few players in our whole industry with net cash in balance.

Moving to our organic growth points on Slide 19, as Enrique already mentioned, market trends remain positive, with some regions to reaching full capacity. Some customers have been put in allocation, and we have been forced to pass on some projects. Despite supply and demand situation remains despite funding levels remaining flat in the 15 sorts transportation programs such as the FAST act and with that a new Infrastructure Bill in place. We believe the Infrastructure Bill will be approved in the near future. The Portland Cement Association estimates the $550 billion in new spending, including the Infrastructure Investment and Jobs Act will result in approximately 48 million metric tons of increased cement consumption over the life of the program.

To provide context on the magnitude of this additional funding and considering it at face value, if everything is consumed within the 5-year length of the bill, cement consumption will be 9% higher than 2020 levels annually, not considering growth in any other sector. In our opinion, these estimates cannot be taken at 100% face value because dollars targeted for construction will be subject to state and local regulation. Inflation will gradually diminish real spending power and project timing has to be considered.

Regardless, all things considered, estimated cement consumption in the coming years associated with the bill is still sizable. But it will take time. We estimate an 18-month to 24-month time gap between bill approval and the actual incremental demand for our product. This time gap will allow us to prepare GCC for what is expected to be a new phase of the industry cycle. Therefore, we will invest between $450 million to $500 million in the next 3 years to increase cement capacity and improve our logistics and distribution network.

Time is of the essence. We are currently working on 3 main organic growth pots, as previously mentioned. First, we will build a new 1.1 million metric tons and inline. We are in the final stage of defining the project location. We expect this new capacity coming online by 2024. Second, a debottlenecking project at our Samalayuca plant will add roughly 200,000 metric tons of cement per year by first quarter 2023. Third, logistics investments to strengthen our cement distribution network in the Minneapolis, St. Paul, Minnesota and [indiscernible] areas with 2 new distribution terminals. With these projects, which have double-digit return on investments, our main bottlenecks in production and shipping capacity will mostly be resolved. We will keep you posted about the progress of these projects.

Regarding inorganic growth, we do not find an appropriate asset that can be plugged into our connected system in the near future. We will pay down debt in the first half of 2022. As a last comment, our 2024, $260 million bond became callable in June. We continuously analyze the global bond market to determine if we can further strengthen our GCC's balance sheet by lowering the coupon and/or extending the maturity profile.

With that, I will now hand the call back to Enrique to charge his closing remarks.

[Hector Enrique Escalante Ochoa, executive]

Thank you, Luis Carlos. Turning to Slide 22. Let me close our call by reaffirming that we are pleased with the results delivered as of today despite cost pressures and supply chain challenges. Our results are in-line with the updated full-year guidance disclosed last quarter, while the net debt EBITDA target has already been achieved. We expect this robust performance to continue into the fourth quarter, assuming of course, that favorable weather remains.

As you may recall, in the last 2 years, we experienced an extended construction season, allowing us to continue shipping until year-end. While we are not yet providing guidance for next year, in the near future, our cement business looks promising across the border. The business and economic environment in Mexico and Devin both support additional volume and price increases. Furthermore, if the Infra Bill materializes, the industry will continue to grow for several more years. And GCC is very well-positioned to take advantage of the positive momentum from our industry. With that, this concludes our prepared remarks. And let me now turn to you-- turn to your questions. Operator, Please go ahead.

[Operator]

[Operator Instructions] Our first question comes from the line of Adrian Huerta with JPMorgan.

[Adrian Huerta, analyst]

Just quickly, first on the CapEx that you mentioned the plan for the next 3 years. At least the 1.1 million and the 200,000 in Samalayuca are these clinker capacity or is just cement, I'm assuming into clinker. And the second one is just quickly on the guidance. I mean, I understand that it's difficult to be changing the guidance every quarter, etc. But given that there's only 1 quarter left and the range that you have on EBITDA expectations for the full-year, the lower-end looks pretty bearish with a 6% decline on EBITDA. How do you feel about the low-end of the guidance that you have on the implied 4Q EBITDA based on that?

[Hector Enrique Escalante Ochoa, executive]

On the CapEx side first, we're talking about cement, cement capacity. It's 1.1 million, plus 200,000 plus that's additional cement capacity. In terms of guidance, you're absolutely right. When we did our guidance, I mean, of course, we were-- I mean, still, I mean, far away from the full quarter in the winter. So we approach this winter and weather being so good so far, I think that we're going to be on the higher-end of our guidance, definitely. I mean we will need to have a very harsh and early winter which we're not seeing and in order for us to fall back in volume. So I'm basically, I mean, saying that most likely, we will reach the higher part of our guidance.

[Adrian Huerta, analyst]

And just to clarify on what you said on the additional cement capacity. Does that include some clinker capacity as well?

[Hector Enrique Escalante Ochoa, executive]

Absolutely. I mean all of that it's in cement, but it's because of increased clinker capacity…

[Operator]

Our next question comes from the line of Nikolaj Lippmann with Morgan Stanley.

[Nikolaj Lippmann, analyst]

Just one question here. We're seeing kind of a return-- in the United States in terms of demand, we're seeing a return of the rest. 2021 was very driven by housing. And when we look at the aggregate data, we can see some of the verticals that were kind of weak during the last 2 years, starting to come back. And the question is, to what degree are you seeing the lease office commercial space come back in your market? And to what degree? Is it still very much driven by housing? And I think I have good color on oil, so -- but much more focused on some of the lease hotels and other very weak verticals, if you don't mind, giving some color there.

[Hector Enrique Escalante Ochoa, executive]

Precisely, I mean, yesterday, after our Board meeting, I was discussing here with my team in the U.S. about the commercial sector. So yes, I mean, the housing market continues to be very strong, mostly everywhere. I mean, we're doing business in the U.S. In terms of commercial, it's still a mixed forecast, I mean, our internal forecast from our sales team, but it's very, very strong. It's everything related to warehousing in mostly everywhere. We're not seeing much demand on verticals, obviously, I mean, office and buildings, hotels, I mean, yet. So I would -- I mean, I would say that we're leaning basically towards the industrials in the commercial sector.

[Operator]

Our next question comes from the line of Vanessa Quiroga with Credit Suisse.

[Vanessa Quiroga, analyst]

So it's regarding maybe just bringing down more on housing. How -- what's your current outlook for different markets in the housing sector, given what you're seeing as we approach 2022? And also, if you can talk a little bit about your sales to third parties of coal. And how much are you using internally? How much are you selling to third parties and how are prices looking for that?

[Hector Enrique Escalante Ochoa, executive]

Vanessa, thanks for the question. So I'm going to answer first, I mean, your question about coal, where we -- I mean, look for more specific information on the housing part. We basically sell from our mine about 50% for internal consumption and about 50% for -- I mean, third parties. So the -- and mainly other I mean cement companies and lime producers. And prices, of course, are -- I mean, going up, I mean, our sales are based on multi-year contracts. So we're not looking at price increases in every contract. That goes on a customer-by-customer basis based on time.

But we've definitely experienced a higher, much higher demand from our customers because, of course, of the high gas prices and declining coal prices that they are experiencing. So everything is looking, I mean, good for us in that business segment. Let me see. We have -- and the answer for you in terms of customers. I was telling Nikolaj, I mean, we're experiencing basically a very robust increase and strong demand for housing everywhere we are. And I'm going to turn it to Luis Carlos to give you a specific number of the latest statistics there.

[Luis Carlos Arias Laso, executive]

Thanks, Enrique. If you see the numbers on the growth that the housing sector has experienced in past years, we see double-digit growth in 2020, double-digit growth in 2021, and then most of this growth, a little bit below 4% in 2021. And in the coming years, the housing demand is relatively flat or very low growth, but then you go through the commercial, which goes back to the mix question, then commercial buildings or non-rental buildings begin to pick up the result. So it's a normal trend that we have seen in other years where housing growth, strong incomes and then, there comes the non-differential construction after that.

[Operator]

Our next question comes from the line of Francisco Suarez with Scotiabank.

[Francisco Suarez, analyst]

The question that I have is related with blended cement versus Portland ordinary cement. Can you remind us in which states you already have permission to sell a blended cement? And also, if you can clarify, if you can say, in 2 years from now, how much your overall installed capacity can actually increase by reducing the clinker factors?

[Hector Enrique Escalante Ochoa, executive]

Thank you, Francisco. Yes. Basically, we're looking at -- I'm going to answer your second question first, in terms of the capacity increase. So we're starting, I mean, more importantly, with the Portland-limestone cement, which is obviously the addition of limestone to the clinker. And that in itself, I mean, it's approved mostly everywhere where we do business, in every state. And it's more a matter now of market acceptance and we're doing this process to our sales force of getting, I mean, very close to all our customers, so they can, I mean, test, I mean, the product and make sure that they are comfortable with what we're supplying in terms of the performance of the product.

We think that we can reach up to 10% incremental capacity on a conservative basis in the next few years. We could go up to 15%, but that's going to take probably a longer period of time. So in summary, I would say, short term 10% additional. And I think that we are approved basically in every state where we're doing business. I mean I can reconfirm that to you, there is still some state that is still on the testing side on the approval side, but I think that mostly where we are it's now approved.

[Francisco Suarez, analyst]

And if you -- do you see room for other types of blended cement coming through as well, perhaps is in porcelain or using slack or something like that?

[Hector Enrique Escalante Ochoa, executive]

Yes. And actually, we are already using and selling porcelain cement in 2 states and in Mexico and some in Colorado. We have, I mean, one product that we're producing in our Tijeras plant based on a porcelain material from the U.S. and with another product that we're producing in our Tijeros plant based on a porcelain material from Chihuahua state. Both products are being tested and sold now in the U.S. in those states. So it's looking well. That's a more slower process compared to the PLC to the Portland-limestone cement.

Because, of course, it's required, I mean, to locate and source these natural porcelain which are not I mean very naturally occurring in the areas where we're doing business. But we're -- I mean, we have a team specialized and dedicated to finding those types of natural porcelain. So as part of our next year portfolio in a second priority compared to the plc. And-- just to complement because response in all the markets where we participate, we have the approval of blended form.

[Operator]

Our next question comes from the line of Alberto Valerio with UBS.

[Alberto Valerio, analyst]

I would like a follow-up on Vanessa's question about the NH costs. I would like to know if it's possible to get a measure of how much you have edge with your coal mine of total of your energy costs? And for how long do you have this contract it's 1-year, but it's 1 year from now or you already passed some time from the initial start of the contract? My idea is it should have an idea of how much -- by how much you need to increase price for offset this level of serving NH price that we have now.

[Hector Enrique Escalante Ochoa, executive]

I'm going to answer the question. I couldn't hear very well. I mean the first question. Can you repeat the first question, please?

[Alberto Valerio, analyst]

Sure, sure, sure. The first one is just to have an idea of how much hedge you have with your coal mine of total of your NH costs. So by how much your mine can hedge your full-year cost?

[Hector Enrique Escalante Ochoa, executive]

Okay. Basically, I'm going to tell you, I mean, the plants that are running on our coal, it's all the Chihuahua plants, the 2 plants in the state of Chihuahua. Our New Mexico plant, our Colorado plant are running on our mine coal. So from there, you can see that at least 50% at least of our total production, I mean it's produced with our own fuel. So the headwind there will be on a percentage basis, at least 50% of our total consumption. Now the Rapid City plant runs on Power River Basin coal, which is a very cost-competitive coal and it's, of course, much closer to that plant. And so that's also a very good cost and we have a long-term contract there.

So the only 2 plants that are I mean, exposed are I mean, to other fuels, of course, I mean the Trident plant and the Odessa plant, which are not our largest plant, as you know. And those ones are a little bit more exposed to natural gas. As we already mentioned, in the case of Odessa, we do some signed agreements to fix, I mean, the cost of gas at least for the foreseeable future of next year. So our exposure, I will continue to say, but it's very low, I mean, to energy a few flotation and do very well I mean, shelter there and maintain this competitive advantage against the whole, I mean, the whole industry. In terms of the contracts, as I was mentioning, I mean, these are multi-year contracts, sometimes it's 1 year, 2 years or 3 years that usually what we had in the recent past.

So again, not all of them mature at the same time. So we're in this process of renewing them as they are due. And what I can tell you is that there was so much demand in Colorado that we don't see any problem in renewing this contract probably on a longer-term basis, I mean, 2 years, 3 years or 4 years and with the sizable price increases as they can again do for renewal. I think that as long as gas prices continue and coke, the terminal prices continue with the same current level or same trends, I mean, our mine is going to be very favorable by these market conditions.

[Alberto Valerio, analyst]

So for next year, we might expect a slight increase in margins with this price increase.

[Hector Enrique Escalante Ochoa, executive]

Yes, definitely.

[Operator]

[Operator Instructions] Our next question comes from the line of Vanessa Quiroga with Credit Suisse.

[Vanessa Quiroga, analyst]

You talk about the capacity expansions. Can you update us on what has been your decision process since the last quarter to decide or to carry out the increase in capacity and what has basically been that progress in the decision-making sense. Since less than we discussed it on this call.

[Hector Enrique Escalante Ochoa, executive]

Yes, Vanessa, thank you for the question. And we don't have the final location yet. It's a pause between 2 sites and one in Mexico, one in the U.S., the progress has been that we have been receiving tenders, I mean, from the 4 major equipment suppliers worldwide. And we are at this moment and during the rest of this year, comparing those. And again, the construction cost, we're talking to our contractors and based on this last quarter, management will be going to decide for one of the 2 sites. And we're doing this in a way which we don't delay, I mean, the startup of construction or erection of the new activity. So probably the -- not probably, I'm thinking that it's quite sure that we're going to be able to disclose that to you, I mean, in the next call. But the process continues to progress in target, so we don't lose any time there. Thank you, Vanessa.

[Operator]

Ladies and gentlemen, we have reached the end of today's question-and-answer session. I would like to turn this call back over to Mr. Ricardo Martinez for closing remarks.

[Ricardo Martínez, executive]

Thank you, operator. Once again, thank you to everyone for your interest in GCC and for joining us today. We appreciate your questions this morning and look forward to talking with you again in the months ahead. This concludes our conference call, but our team is, of course, available for any follow-up questions you may have. Goodbye, and stay safe.

[Operator]

Thank you for joining us today. This concludes today's conference. You may disconnect your lines at this time.