GCC SAB de CV

BMV:GCC

Earnings Call Transcript 2017-Q4

[Operator]

Good morning, and welcome to the GCC Fourth Quarter 2017 Earnings Conference Call. Before we begin, I would 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 conference 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 other members of our finance team. We have a lot to talk about this morning, mostly good news. GCC has an outstanding fourth quarter and strong full year results. At the beginning of 2017, we said we expected to improve our EBITDA margin by at least 150 basis points. Our actual full year result was an increase of 180 basis points. We also reached our 2x EBITDA leverage objective at year end. The leverage ratio fell to 1.86x at the end of 2017.

We begin 2018 with a promising business outlook, particularly in the U.S., where we foresee solid increases in the demand and cement prices. I will start by discussing the main drivers of our performance in the U.S. and Mexico. Luis Carlos will review the financial results, and I will then discuss our outlook for 2018. We will then open the call to your questions.

First, GCC's performance drivers. Our U.S. operations benefited from our robust demand in most of our markets. We are seeing the greatest demand growth in the Permian Basin oil fields in West Texas and New Mexico, construction in Minnesota and Minneapolis-Saint Paul metro area. Continued strength in Colorado, particularly in Denver and the Front Range across all customer segments. We also see some signs of recovery in North Dakotan back-end oil region as a result of the upturn in oil prices.

This underlying demand growth was boosted by good weather well into December. Rainy summer weather created some construction delays in July and August. We saw a complete reversal in the fourth quarter. This enabled our clients to get back on schedule and, in some cases, do more work than planned. U.S. cement sales volume increased to 8% in the fourth quarter and 29% in the full year. Let me add that Rapid City expansion is on budget and on schedule. Construction was 75% done at year-end and will be completed in the first half of 2018. We expect to start operations at the beginning of the third quarter.

During the fourth quarter, we also secured the modification to our federal co-leases for the Colorado mine, adding another 7 years of reserves. And GCC acquired 19 years of additional limestone reserves for the South Dakota plant. In Mexico, we saw several large commercial projects generating demand. This includes a new Heineken brewery, a glass bottling plant and a Mead Johnson factory. These projects boost volumes and also improve the overall mix of products sold. And in Southwest Chihuahua, a [ bioactive ] mining projects continue to feed demand. This made up for a relatively soft performance early in the year and the continued lack of public sector projects.

Mexico cement volumes grew 6% and ready-mix volumes increased 15% in the quarter. We also improved our operational performance, especially with transportation and fuel expenses. As we have said previously, earlier in 2017, we decided to dedicate 100% of the production of the Odessa, Texas plant and a portion of the Tijeras, New Mexico production to oil well cement. This meant we work in our transportation and distribution network to meet demand for construction cement in West Texas market with additional shipments from Samalayuca and Pueblo Colorado. As a result, the utilization rate of these 2 plants reached 90% and 87%, respectively. We succeeded in the balancing our transportation mix between rail and trucks and optimize our logistics and scheduling in a way that were used to oil plants and freight cost per ton by about 17% in 2017. We also -- this year also continues to increase the use of alternative fuels in the Pueblo plant. We use shredded tires for parts of Pueblo's thermal energy need, with a near-term goal of reaching a [ 20% ] substitution rate.

As of December, Juarez reached an alternative fuel substitution rate of 48%; Samalayuca, 36%; and Chihuahua, 14%. We're in the process of obtaining permits to use alternative fuels in the Rapid City and Tijeras plants. The better mix of transportation and reduced fuel costs from using alternative fuels were among the factors that helped to expand EBITDA margin.

Let me turn the call over to Luis Carlos to review the specific financial results. Carlos?

[Luis Carlos Arias Laso, executive]

Thank you, Enrique. Good morning to everyone. As Enrique noted, our fourth quarter results were well above expectations. Consolidated net sales increased 28% in the quarter with growth coming from both the U.S. and Mexico.

In the U.S., strong backlog and good weather meant that the U.S. volumes surged. Cement sales volumes increased 30%. Excluding the acquisitions, volumes were up 5%. Average dollar prices rose 6%. U.S. ready-mix volumes rose 10%, principally because of the 2016 acquisitions and demand in the Texas market, while prices were up 2% year-over-year. Excluding acquisitions, concrete volumes decreased 1.5% because of slowdowns in some other regions.

In Mexico, fourth quarter cement sales volumes increased 6%, while prices rose 11%. Ready-mix volumes rose 15% and prices increased 7%. As Enrique noted, the increases were driven by demand from the self-construction, mining and commercial segments. There continues to be a near-complete absence of public works projects.

As a percentage of sales, consolidated cost decreased 4.1 percentage points, and operating expenses decreased 2.3 percentage points. As Enrique mentioned, these cost and expense reductions relative to sales enable the EBITDA margin to expand by 570 basis points. The margin expansion reflects different factors: Higher prices and volumes; increased operating leverage; the improved operations, including substitution of alternative fuels; and federalization of freight costs.

EBITDA grew 58% to $71 million with a 29.9% margin. Our EBITDA margin in Mexico reached 37.6%, and our U.S. margins reached 27.4%, a new high since the 2008 crisis. For the full year 2017, EBITDA grew 32.3% and reached $250 million, and the EBITDA margin expanded 180 basis points over 2016 levels and reached 27%.

Fourth quarter 2017 free cash flow reached $65 million, an increase of 24% of the prior year period. For the full year, free cash flow grew to $112 million or 4% of 2016. This increase was a result of the strong growth in EBITDA that more than offset increased interest expense from the financing of the Texas and Mexico acquisition, and a higher level of maintenance CapEx, also mostly the result of the acquisitions.

GCC's leverage ratio, which is defined as net debt over EBITDA, decreased from 2.57 again of 2016 to 1.86x in December 2017. I will now return the call to Enrique.

[Hector Enrique Escalante Ochoa, executive]

Thank you, Luis Carlos. My final topic today is GCC's outlook for 2018. We expect to build on our successful 2017 performance in the coming year. Customer demands appears likely to remain solid in most of our U.S. markets. The Portland Cement Association forecast for 2018 implied an average expected volume growth of about 2% in our market. This is mostly driven by demand in the oil well, residential and commercial construction segments. We should see some [ flat-act-related ] projects taking shape toward the end of the year. GCC is also currently bidding on supplying several wind-powered projects and soil stabilization projects. We remain cautiously optimistic of additional demand resulting from the recently announced infrastructure plan. Based on the [ DTA ] forecast, GCC's outlook is for low single-digit growth in the U.S. cement and ready-mix volumes. The balance of supply and demand in the U.S. is also favorable, so we expect another year of price increases in the 3% to 5% range for both cement and ready-mix.

The outlook is more uncertain in Mexico because of factors we are all familiar with. The impact of the National Election in July 2018 and the ongoing NAFTA trade negotiations are hard to predict. Nonetheless, our current view is cautiously optimistic. The private sector in the export-oriented economy that dominated Chihuahua has shown its resiliency and adapting to the new environment over the last 15 months. Rising competitive prices boost the mining sector. As there has been no public works pending in the state for the past 2 years, there is no downsize risk in this market segment.

GCC's central forecast is for Mexico cement and concrete volumes to be flat, and for prices in peso terms to increase in the mid-single-digit range. On a consolidated basis, GCC expects EBITDA to increase by mid-single digit. In terms of CapEx, GCC's budget is $120 million. This is divided almost 50-50 between the remaining investment in the Rapid City plant expansion and major maintenance expenditures. We don't see significant changes in working capital needs. Our expectations is for working capital to decrease slightly.

GCC has already surpassed our goal of bringing leverage below 2.0x. This is the board directive for the long-term, steady-state leverage minimum -- maximum, I'm sorry. This is what gives us the flexibility to pursue attractive growth opportunities that meet at our strategic criteria.

If we make acquisitions in the future, leverage may temporarily go above 2x, but only with a clear path to bringing it back below that level.

And in closing, I want to say that GCC's exceptional performance in 2017 has clearly been a team effort. I give my thanks to all of our employees for their skills and dedication in achieving or surpassing our business objectives. GCC has a sound business model. We are building a strong consistent operational and financial track record. We have a solid capital structure and leverage profile. We will position to take advantage of new market opportunities and navigate any external challenges we could face in our market. I'm confident that we are on the right path that will increase and deliver the highest value to our shareholders and other stakeholders.

This concludes our remarks for today's call. At this time, we are ready to take your questions. Thank you, operator.

[Operator]

[Operator Instructions] And we'd take our first question from Pablo Ricalde with Bank of America.

[Pablo Ricalde, analyst]

I have some questions on your EBITDA growth guidance. Based on your volume and price assumptions, I was expecting something slightly higher. So I don't know if you could provide some color on what are you expecting in terms of energy costs and FX.

[Hector Enrique Escalante Ochoa, executive]

Pablo, thank you for your question. As you all know, our multi-annual objective is to continue to increase margins in this year at the rate of between 150 and 200 basis points per year. I have to say that we have a conservative outlook for 2018, and we remain cautiously optimistic these years that we can achieve a little better results, but we prefer to be on the conservative side. And the main reason for this, of course, I mentioned the Mexico uncertainty and volatility, increasing freight costs resulting from not enough drivers in the U.S., especially during the high peak project construction season. And also natural gas prices have continued at a very low level that are affecting the decrease of EBITDA in our coal business. So those 3 factors are incorporated in our forecast, and that's why we are not seeing higher EBITDA increase for 2018. I have to say, however, that these 3 aspects that I've mentioned have, of course, upside potential that can result in higher EBITDA and higher margins of EBITDA.

[Pablo Ricalde, analyst]

Okay. Useful. And I don't know if you can share the FX assumption you're using for your Mexican operations?

[Hector Enrique Escalante Ochoa, executive]

We are assuming MXN 19 per load.

[Operator]

Our next question comes from Dan McGoey with Citigroup.

[Daniel McGoey, analyst]

I wonder if you could recap the price increase announcements that you've made thus far, if there -- in select markets or in all of them, and what level of announcement you've sent out. And then secondly, if I can ask on the coal business in the U.S., the margin expansion that you experienced both year-on-year and sequentially has been impressive. I was wondering how much of that may have been contributed from the sharp increase in coal prices. Can you give an idea of what that contributed to the result in the fourth quarter?

[Hector Enrique Escalante Ochoa, executive]

Okay. On the first question, Dan -- first of all, thank you for both of your questions. On the first one, I'll start with the Mexico first. In Mexico, we announced prices for back cement in a range between 4.5% and 5%, and that was starting of the year. For both cement, we are between 6% and 6.5%. Both price increases in both product segments are going well. And we don't expect to have really much pushback on those price increases. We achieved those -- we will be probably a little bit ahead of expected inflation, which is what we are -- we wanted to achieve this year as a minimum. For the U.S., our price increases, depending on the market, and as you mentioned, on selected markets, are ranging from $6 to $8 per ton. With some orders, specific markets were -- are trying to achieve up to $10 per ton. We definitely believe that given that some of the increases were announced for January, but the bulk of them for April, we will end up with above $6 per ton. As for your question on the coal effect on our margin in the fourth quarter, we don't see any effect coming from coal, definitely. We are producing at the same cost, which is what we take into consideration for -- for the decision to operate on call or switch the plants to gas. In the fourth quarter, we continued with all the plants in coal, which was better for the company. It would not change in the transfer of coal price. So there's no effect in our EBITDA derived from that.

[Daniel McGoey, analyst]

Great. And then on the price of -- the one that were for the U.S., the price increases in January, which markets were those? Or what percentage of your U.S. business saw price increases in January?

[Hector Enrique Escalante Ochoa, executive]

In January, we announced price increases in the regions of New Mexico, El Paso, Texas. Basically, the rest, it's coming in April.

[Operator]

[Operator Instructions] And we'll take our next question from Mauricio Serna with UBS.

[Mauricio Serna Vega, analyst]

I want to talk a little bit about the guidance. Going back to the price increase in Mexico, I wanted to your sense, since rest of the market has announced like bigger price increases, do you see relatively -- like a scenario for a pushback on that, and that's why you're assuming a more conservative approach? And just -- what you were guiding on EBITDA, just going back to the previous question also, this means that this -- for this year, we would expect a slower or maybe just flattish EBITDA margins? And finally, just more on the strategic, I saw that the press release now was published in U.S. dollars. So I think that's a very good move. So how -- does this mean like we could continue to see the company taking steps, like for instance, to eventually have the ADR -- an ADR listed in the U.S.?

[Hector Enrique Escalante Ochoa, executive]

Thank you, Mauricio. Let me comment first on your question on Mexican prices. We obviously, in Chihuahua, have a very robust price. So we believe that the increases that we make here will continue to protect our market share in this space. Going above the prices that we are increasing, we believe there is going to be appetite or increased appetite for cement in other parts of the country to reach the state. So that's -- and besides that we have a very robust price increase in 2017, as you know, so we feel very comfortable with this prices we announced. Then we go to your last question first, and then we'll -- I will get back to the guidance on EBITDA. No, we have not decided to issue an ADR or anything like that in the U.S. What I can tell you is that like many companies, we're always looking at alternatives and are always making the right analysis for the company and its investors. But at this moment, we have not decided to release GCC in the U.S. Going back your guidance on EBITDA, as we said, it's in the single digit for the company as a whole. I read your question was relative to the company as a whole, or you were asking specifically about Mexico?

[Mauricio Serna Vega, analyst]

No, the company as a whole.

[Hector Enrique Escalante Ochoa, executive]

I'm not sure if I answered your question with the EBITDA.

[Mauricio Serna Vega, analyst]

Just does it mean that, probably this year, we're going to see like a slowdown in EBITDA margin expansion? Or -- because it seems, assuming like we have pricing and volumes, it looks like we would see -- pretty much seeing an EBITDA growing in line with sales?

[Hector Enrique Escalante Ochoa, executive]

Most likely, it's in line with sales, and that's why I mentioned at the beginning that there's some possible upside potential. However, we want to remain at the conservative price, especially in Mexico, as I mentioned, because of that uncertainty and volatility. So that's why we're forecasting flat volumes and only above inflation price increases. That's where the growth is basically going to come in the EBITDA in Mexico.

[Operator]

And our next question comes from Froylan Mendez with JPMorgan.

[Froylan Mendez, analyst]

I wanted to understand a little bit more the margin expansion that was abnormal, in my view, for fourth quarter. Could you give us a little bit more color on how are the utilization rates of the different plants across the system, if you're seeing something there that is allowing for additional margin expansion, especially maybe Odessa and Samalayuca? That's my first question. My second question is on your acquisition outlook. Given the strong free cash flow generation, we are at a level similar to when you did the previous acquisition. Should we expect be expecting or are you getting closer to anything more concrete in that sense? Or is it more to increase dividends or start a buyback or anything there? And finally, sorry for being repetitive here, but if you're keeping the 150 to 200 basis point multiyear expansion target, does that mean that if margins stayed flat this year, would -- should we expect these catch-up to be done in 2019 and maybe coming from the expansion on the Rapid City? Or how -- where will the margin expansion come going forward, and if 2018 is a one-off year, in your view?

[Hector Enrique Escalante Ochoa, executive]

Thank you, Froylan. Well, we have multiple questions from you here, so I will ask Luis Carlos to give you the more specific margin expansion for the last quarter of 2017, but I will keep up with those numbers. Let me try to answer the rest of the questions. In terms of utilization rate, as I mentioned, we're -- in the U.S. plants, I can tell you that in Odessa, we're a full capacity. And as you heard, Pueblo is running close to 87% capacity, and Samalayuca, 90% capacity. And I mentioned Samalayuca because of its important input in our U.S. market. Rapid City is running at full capacity. Obviously, we're coming up with 440,000 additional tons in second part of the year. That will be placing the market slowly and responsibly. But having said that, basically, our U.S. plants, except for the 440 additional thousand tons are around 90% of capacity already this 2018. This, of course, goes into your third question about our outlook from margin expansion because of that. Yes, we are very optimistic that in the U.S., prices are going to continue to be robust. I wouldn't discard uncertain markets being able to announce the second year -- a second increase for the year. We're not putting that into our guidance at this moment. We're going to decide as we go, and we see the performance of each individual market. But there are some markets that are definitely very tight. And one of them is, of course, West Texas oil basin in the Permian Basin. In terms of the acquisition outlook, there's nothing today that we can talk about. But of course, we'll continue looking for opportunities according to our strategy to expanding cement, expanding cement in the U.S., and expanding cement in the U.S. is possible near the region where we currently operate so we can take advantage of the senior years with our logistics systems there. We don't have plans to increase dividends beyond what the company normally pays out. And we'll prefer to keep -- lower our leverage ratio and build the cash to be ready for the next acquisition or growth opportunities that we can welcome. The expansion on the margin of the 150 to 200 basis points per year, yes, definitely, it's a long-term objective. 2018 may be a little bit slower, if none of the 3 aspects that I mentioned were being cautiously optimistic change, namely again, Mexico, freight cost increase because of lack of drivers, and natural gas prices affecting the coal business. But as some of those change, we will be able to help improve the margins beyond what the price increases are going to do for us this year. And the Rapid City expansion, we don't expect to have as much of an impact on the EBITDA margin this year because, as I said, we're going to absorb slowly that capacity into the market, so we don't create big disruptions. And that means that the freight savings coming from that new volume are going to be much realized mostly in 2019. With this, I'm going to go back to Luis Carlos for him to give you specific drivers for the volume expansion in the last quarter.

[Luis Carlos Arias Laso, executive]

Thanks, Enrique and hi Froylan. Yes, on the 570 bps increase in the margin for the quarter, of course, volumes and prices played a huge factor. We've had a long construction season during the fourth quarter because we had a very good weather, as Enrique explained in his remarks. And yes, the utilization rates were a -- definitely helped the operating leverage. Just as an example, the Samalayuca plant, utilization rates in 2016 was around 50%, and we ended up last year, 2017, with 90% utilization. So of course, that helps a lot in having the operating leverage to have this huge margin expansion.

[Operator]

And our next question comes from Jose [indiscernible]

[Unknown Analyst]

I just would like to ask you if the change in the corporate tax in U.S. is going to benefit your plans that you have there. And by how much is your estimate in the bottom line?

[Luis Carlos Arias Laso, executive]

Thank you, Jose. Yes, well, the effect of the change in the tax rate, of course, helps the company. We have -- we do have NOLs coming from the tough years. So we're going to see that benefit eventually when we deplete those NOLs. But definitely, yes, it is a plus for us, of course, because of all of our operational [ years ].

[Operator]

And our next question comes from Gordon Lee with BTG.

[Gordon Lee, analyst]

Two quick questions. The first on the U.S. I was wondering if you could tell us, across the different regions in which you operate, which of the markets that you think our tightest from a demand and supply standpoint? And the second question on Chihuahua. I was wondering if beyond -- let's say, beyond 2018, if you would look sort of at the pipeline of projects on the private side, how meaningful do you think the pipeline is if there is a favorable resolution to the NAFTA question? And on the public side, how confident are you or how do you feel about some of the progress on the fiscal consolidation that the new government has taken? And would you expect the state by 2019 to be able to start spending again?

[Hector Enrique Escalante Ochoa, executive]

Thank you, Gordon. First, on the question in the U.S. regions. Definitely, the Permian Basin and the West Texas market, it's super tight, and we expect it to continue for the full year. Actually, we are analyzing our plan with us, some older accounts that are not fully utilized here in Mexico to see if those could be also a solution to -- for us to ship more cement into that market. As I mentioned, oil prices are also having now a positive effect on the back-end, although that is not a tight market. The -- by no means today, which -- we were thinking that it could be a good surprise in our market. Colorado continues to be, I mean, very busy. It's not completely tight because there are still some idle capacity there at the Holcim plant. And as we start up the Rapid City plant, that volume, that's where it, for us, is going to show up in Colorado because of shipments from Pueblos that we're going to start bringing back to home. So there's going to be, I mean, enough to supply in the market, but still -- that market is very, very dynamic. I just met with some customers there last week, and they all seem to expect a busier, very comparable to what they saw in 2017. Minneapolis-Saint Paul, we also had comment from a customer, a very important customer, in the Twin Cities' market that they are expecting a much better year. I think that will be the order in which we see at the dynamics of the market. I think there is room for improvement still in Mexico in the El Paso, Texas area, and some other less important markets for us. In terms of your question for Chihuahua. Definitely, the 2018 pipeline is not, you used the word meaningful. I don't think it's meaningful. I think it's, things are, just looking okay, but we don't see any big significant projects, or we -- nor we have any significant project in the horizon. Yesterday, I was informed of another 2 large condominium towers, one in Chihuahua and one in Juarez that were about just permitted. So that's also a good sign that in the commercial and residential business there's going to be, I mean, activity. In terms of the maquiladora industry, there's expansion -- there's definitely a big expansion on Vestas that it's building a lot of additional space in Juarez, producing which workforce are working on today. There is another company that is building a manufacturing business. It's a speculative building. So it's already a sign that there are people believing that irrespective of the end result of NAFTA negotiation, there's going to be more demand for manufacturing in the Juarez area. In terms of public construction from the state government and -- yes, I do believe that the physical condition of the state is going to improve. Also yesterday, I was informed of some additional [indiscernible] won, but projects funded by the state government in Juarez for this year. So for 2019, I definitely expect, I mean, an improvement in terms of the potential for infrastructural work from the state government. As you probably heard in the news, the issues between -- the federal government and the state government in terms of federal funds, we're already settled. And that's a -- also an indication that things are going to continue to progress in the right direction here.

[Operator]

[Operator Instructions] And we're going to take our next question from Pablo Ricalde with Bank of America.

[Pablo Ricalde, analyst]

I have a follow-up question on oil-related segments. Yesterday, Martin Marietta announced that they want to become an active player on oil-related cement. So my question is, how are you seeing the competitive landscape in the sector and if you are seeing any additional new players coming into the sector?

[Hector Enrique Escalante Ochoa, executive]

Thank you, Pablo. No. What you said doesn't surprise me. There is so much activity in the Permian Basin, and there is unfilled demand that I have been hearing for many months now that Martin Marietta has an interest in becoming a player there. I think that, of course, we will always have the main competitive advantage by being right there and having to -- basically have no freight to deliver the cement to that basin. Also, this is traditionally a preferred product that will be coming from the Odessa cement plant because of the quality and the chemistry of the product that has a proved history and a good track record of working very well for all the major oil well service companies. So I think there is obviously appetite from others, but we're very comfortable with what we're seeing there.

[Operator]

[Operator Instructions] And there appear to be no questions at this time.

[Hector Enrique Escalante Ochoa, executive]

Well, there are no more questions. We want to thank everyone for your participation in this call today. Of course, if there is any further questions, we will be very glad to answer them. And just talk to here to Ricardo and Luis Carlos, and we'll answer all of them. Thank you very much for your participation. Thank you, operator.

[Operator]

Thank you. And this concludes today's call. Thank you for your participation. You may now disconnect.