Grupo Industrial Saltillo SAB de CV

BMV:GISSAA

Earnings Call Transcript 2018-Q1

[Operator]

Good day. My name is Maureen, and I will be your conference operator. At this time, I would like to welcome everyone to the Grupo Industrial Saltillo's Earnings Conference Call. [Operator Instructions]

I will now turn the call over to Patricia Cruz with i-advize. Please go ahead.

[Patricia Cruz, executive]

Good day, everyone, and welcome to Grupo Industrial Saltillo's First Quarter 2018 Earnings Conference Call. This call is for investors and analysts only.

Joining us today from GISSA are Mr. José Manuel Arana, Chief Executive Officer; Mr. Mario Guzmán, Chief Financial Officer; and Mr. Saúl Castañeda, Investor Relations Director. They will be presenting the company's performance as per the earnings release issued yesterday after the close and going into discussion of results through a presentation. If you did not receive the report or the presentation, please contact i-advize in New York at [phone] and we will e-mail you immediately, or go to GISSA's website www.gis.com.mx under the Investor Relations section.

Let me remind you that forward-looking statements may be made during this conference call, and they are based on information that is currently available. Please refer to the earnings release for a more detailed and full disclaimer. Also, all figures discussed are in Mexican pesos unless otherwise stated.

It is now my pleasure to turn the call over to Mr. José Manuel Arana, Chief Executive Officer of GISSA to begin with the main highlights and a strategic overview.

José Manuel, please go ahead, sir.

[José Manuel Arana Escobar, executive]

Thank you, Patty, and welcome everyone this morning to our conference call. 2018 marks an important year for GISSA, as we celebrate our 90th anniversary. It was back in 1928 when Mr. Isidro Lopez decided to kick off the start of a project that for many didn't make sense at that time. He began experimenting with oilseeds transforming them into all sorts of pots and pans, what eventually became Cinsa. He was a visionary man. With Cinsa, he began building what would become a global and leading company that GISSA we all know today.

There is no doubt that our globalization strategy has been the catalyst of our fast-paced and profitable growth. Following this road map, we have taken solid steps to build a company that offers competitive advantages for the automotive and construction industry not only in Mexico but on a global basis.

Our evolution continued this quarter as we reached a major milestone in this strategy. A few days back, we announced our decision of consolidating our 3 Auto Parts businesses, CIFUNSA, ACE and INFUN into one unit named Draxton. Draxton allows us to be fully in line with the industry's value chain from R&D, codesign, casting and machining, with a wide range of technologies, processes and materials to efficiently produce complex auto parts, including brakes, powertrain and suspension systems. It also gives us great commercial operating and marketing advantage to better serve our clients.

Since 2017, we have seen benefits driven by this globalization strategy, where Draxton has delivered significant savings in the cost of raw materials, such as ferroalloys, sands and filters among others. Machinery and tooling, no supply for China.

During 2018, we have been achieving benefits of synergies in engineering, process improvement, product design and sales across all the Auto Parts business units. We will inform about the progress of synergies in further communications.

Throughout the years, we have assembled a passionate, smart, capable team focused on creating a culture that adds value to our clients, shareholders and employees. However, we are aware that these changes made in Auto Parts requires additional efforts in aligning our theme in order to increase productivity and accelerate efficiencies. That is why we developed the GIS Competency Model. This model is a behavioral guide made to align GIS towards our vision, and vision inspired the development of each member of our great team.

Now let me spend a few minutes reviewing our operating performance for this quarter.

These first 3 months presented several complications that mostly affected volumes sold in the U.S. and Mexico, yet management's ability to overcome challenges helped GIS report similar levels as last year in consolidated revenues at MXN 4.5 billion for a 9% growth in dollarized terms. Our EBITDA was down by 10% to MXN 741 million, only 3% down measured in U.S. dollars.

These results come from the consolidated effect of our 3 business units. So allow me to go over the main highlights of each of them.

First of all, Draxton. Now serving over 50 customers throughout our facilities in 6 countries. Posted double-digit growth of 14% to $176 million. These results are mostly attributable to the positive performance in Europe and Asia, thanks to higher aluminum volume sold. Nevertheless, it is important not to underestimate our efforts in NAFTA. Despite continued uncertainties in the region, operations in Mexico and in the U.S. managed to post a slight increase of 6% when measured in dollars, helped by the favorable effect of price and product mix. EBITDA levels for Draxton remained unchanged compared to Q1 2017. This quarter was largely eased by savings in energy consumption and reduction in fixed expenses.

As rooted in our 3 main foundations in GIS, we see continuous improvement. For Q1 '18, I can name 3 relevant examples of our commitment to this mindset.

First of all, and maybe the most significant one, is the Auto Parts new installed capacity exceeding 550,000 tons of iron casting, 10,000 tons of aluminum casting and 15 million machined parts that allow us to supply global platforms.

The second one was achieved in Poland. This year, we implemented a new standard that allows systematic workflow in terms of employee health, safety and working conditions. The success has been such that on February 28, we were awarded ISO 18001:2004 certification.

And third, we proudly opened a new machining plant in San Luis Potosi under the name of GISEderlan with an installed capacity of up to 3.5 million units. These new operations follows our strategy of process integration and increased added value.

In 2018, our efforts will be aimed at productivity and extraction of synergies aforementioned. I'm very confident that we will begin to see the benefits from this integration on time.

Now moving into Construction. In line with our Premium segment's positioning strategy in the ceramic tile industry, Vitromex opened an additional boutique under the luxury brand, Arko-Lafaenza. This format strengthens our presence in the large format category, which reported profitable growth trends in the Mexican market.

Now the U.S. market faces difficulties as we continued to make adjustments in our product portfolio that reduced supply levels in our distribution network, thereby affecting our capability to adequately serve the market. As such, Vitromex posted a revenue decline of 15%. In the last quarters, EBITDA levels for this segment had suffered from several external events that highly impacted cost. Nevertheless, GIS is committed to turning around these operations.

At the end of last year, we launched an aggressive plan to improve operations and reduce fixed costs. It pleases me to say that little by little, we start to experience the 180 degrees change that we have been working towards. In Q1 of '19/'18 EBITDA reached MXN 18 million, a significant improvement from a negative MXN 39 million reported in Q4 of '19 (sic). This can reinforce that all the actions that we're implementing are turning this business around.

We are currently in the process of strengthening our relationship with our largest customers through CapEx in process productivity improvements, replacement and maintenance of equipment that will make us much, much more productive and will reduce our cost of production; product renewal, the launch of new product lines; leaner and more horizontal structure allowing customers proximity; commercial team reinforcement, mainly in the United States; sell and deliver strategy under very strict planning process; focus and base value to find the adequate portfolio mix.

And last, but not least in the Houseware sector, seems a steady growth pace so far has, without a doubt, come from the opportunities to improve efficiencies. Although revenues increased slightly by 1%, we posted a strong EBITDA growth of 41% and EBITDA margin up 3 percentage points. This growth derived from a favorable price impact in the majority of our categories, a new line recently added, better product mix, operating efficiencies and cost savings.

Before I conclude, I would like to thank Mario Guzmán for his great efforts, who has taken us in many ways to a different level of organization. Thank you, Mario, and to give a warm welcome to Jorge Mercado, our new CFO. Jorge brings more than 25 years of experience in the banking and stock market sectors where he has transformed corporate cultures to achieve productivity, efficiency and profitability.

I would like to give the floor to Mario so that we can discuss the financial performance of the company. Go ahead, Mario.

[Jorge Guzmán, executive]

Thank you, José Manuel, and good morning, everybody. Before I dive into the results for the quarter, I just want to thank you José Manuel for your kind words and good wishes as well as GIS for the opportunity to work with this outstanding team. It has been an honor to be a part of this company, and I'm certain that we will continue to see great things happening in our businesses. To Jorge, a warmest welcome and best wishes. I can't think of anyone better than him to lead the company going forward in the financial strategy. Welcome again, Jorge.

Let me turn now to our results. A comparison versus first quarter 2017 is challenging since that quarter a year ago was the best in terms of EBITDA, at least in the recent history of the company. On the revenue side, we had some positives and some negatives that ended out canceling each other.

In terms of volume, Draxton, the Auto Parts business, maintained its overall volume parts and increased in business in aluminum. The exchange rate versus the U.S. dollar reported lower values due to the appreciation of the peso, while on the other hand, our business in Europe when translated into Mexican pesos represent a higher sales. Finally, offsetting the lower volume in Construction and Housewares, we had a general improved pricing and product mix in Draxton and Housewares.

Going now to EBITDA. We reported MXN 741 million this quarter versus MXN 827 million a year ago. The mix of currency effects represented a negative of around MXN 30 million. And the volume reduction in Construction essentially accounts for the difference. While the reduction in EBITDA in pesos is 10% quarter-versus-quarter -- quarter-on-quarter, when translated into U.S. dollars, the shortfall is only 3%. The rounded figures are $39 million of EBITDA today. This was $41 million of EBITDA a year ago.

Finally, a remark on the relevance of our JVs, Evercast, GISEderlan and InfunEderlan. We do not consolidate them as per IFRS, but the pro forma results fully including the contribution of these JVs shows a significant generation of EBITDA. Our pro forma comparison shows an EBITDA for the quarter of MXN 855 million for this year and MXN 919 million for the first quarter of 2017. The contribution to this quarter EBITDA from the JVs amounts to MXN 114 million.

Net income for the quarter is MXN 473 million versus MXN 796 million a year ago. There are 2 nonoperating effects that will normalize in sales with the passage of time during this year.

During the first quarter of 2018 and 2017, we had a positive foreign exchange gain on the financing costs because of revaluation of the peso. The impact in 2017 was larger than the impact this year. The net difference after tax of this effect represents around MXN 130 million that help to explain a significant part of the difference.

Also, this year, as we have reported in the past, we are reflecting mostly the increase in depreciation and amortization related to the intangible assets and the step-up in the fixed asset base of the Infun acquisition. The after-tax impact on the bottom line for this quarter is MXN 40 million. These 2 factors represent almost 50% of the difference, within 12% on the net income level.

On the debt side, we are reporting MXN 6.3 billion of net debt at the end of this quarter versus MXN 6.6 billion a year ago. And the net leverage remains at the levels of 2.2, 2.3x EBITDA.

Going further into the performance by each segment. I would like to begin with Auto Parts, which is now Draxton. I would refer you to figures in U.S. dollars. As José Manuel mentioned, we took an important step towards consolidating the unit level strategy and from now on, we would reflect the CIFUNSA, ACE and INFUN as Draxton within our financial reports.

Draxton exceeded our expectations for the quarter. Our [indiscernible] and operations this quarter where they [indiscernible] crankshafts manufacturing in Irapuato, Mexico, the business of powertrains and chassis in Teruel, Spain and brakes in Brno, which has recently started molding line in the Czech Republic. The revenues in dollars were up 14% to $176 million, also helped by record price and product mix and the positive euro versus dollar parity effect.

EBITDA reported the same $34 million of first quarter 2017. EBITDA could not replicate the growth of sales due to some delays on the implementation of the raw materials pass-through to selling price, continued pressure on material cost and energy and the appreciation of the local currencies in Mexico, Poland and Czech Republic that impacted the cost structure of those operations.

Turning now to the Construction segment. In first quarter 2018, Vitromex revenues decreased 15% to MXN 881 million, resulting from lower volumes sold, specifically in the U.S. market as adjustments made in our product portfolio prevented us from offering our distribution network to the normal supply level.

On the upside, our cost-cutting initiatives implemented since fourth quarter of last year are starting to bear fruit. EBITDA totaling MXN 18 million, benefited from MXN 15 million in savings in fixed cost, which included marketing, personnel and maintenance costs, among others.

Although business of the Calorex which we are consolidating now, this business posted double-digit growth of 36% in EBITDA. As you know, the divesting process in Calorex is still subject to approval by COFECE, the antitrust regulator in Mexico. Back in March, we ingrained some observations by COFECE and we are addressing those observations in order to complete the transaction. We will inform the market of any new development.

Finally, let me comment on the Housewares segment. Cinsa increased revenues by 1% to MXN 371 million. Despite facing a slowdown in economic activity, this segment's EBITDA and EBITDA margins for first quarter '18 both significantly improved. The absolute EBITDA increased to MXN 32 million, that's an improvement of 41% and the margin improved 3 percentage points to 9% due to better product mix, operating efficiencies, better pricing and lower cost in peso terms of the imported inputs. The ongoing efforts on cost control helped to offset high raw material price.

Now, in terms of CapEx, for 2018, we have assigned a total of MXN 2.1 billion, broken down as follows: MXN 1.25 billion will go to Draxton, including technological updates, maintenance and capacity increase, both in casting and machining across all the geographies of this business. We've reallocated MXN 750 million to Vitromex to pay for some equipment refurbishment, debottlenecking of capacity and compliance with environmental regulations. And finally, the remaining MXN 100 million will be invested in Cinsa to improve process and competitiveness.

The planned investments are in line with GIS' strategic plan, focus on improving competitiveness and profitability in the Auto Parts, now Draxton business, and the Construction segments.

Talking a little bit about debt, and net debt, as I already mentioned, for first quarter 2018, totaled MXN 6.3 billion, while net debt-to-EBITDA ratio was 2.3x. In accordance with resolutions adopted by the Board of Directors at yesterday's meeting, the company will propose to its shareholders a dividend payment of MXN 1.12 per outstanding share, of which MXN 0.60 will be paid on May 7, 2018 and the remaining MXN 0.52 on November 5, 2018. This proposal is subject to the approval at GIS' next annual ordinary general shareholders' meeting, which will be held on April 26.

Once again, thank you all for your attention. I will now ask the operator to open the floor for the Q&A session.

[Operator]

[Operator Instructions] We will take our first question from Alejandro Chavelas with Actinver.

[Alejandro Chavelas, analyst]

Just to get a quick view on if you could tell us that when do you expect Vitromex operations or Vitromex margins to normalize and 2% margin for the quarter was definitely very low. And so when would you expect normal margins? Or what would be your expectation for the rest of the year for Vitromex? And also, if you could comment on the -- you mentioned certain changes in your product portfolio, if you could provide some more visibility on what this imply with the change in the product portfolio of Vitromex?

[José Manuel Arana Escobar, executive]

Yes, Alejandro, this is José Arana. On the first question related to our expectation on bringing the business back to where we would like to be, as you compare, Q1 of 2017, for many reasons, was a very good quarter due to volumes and in addition to that, lower cost basis for -- one of the main inputs is gas, and gas and electricity has increased as well as all of the components that are the basic components to create the different shapes and the painting of the tile. That is quoted in U.S. dollars primarily. And what we expect throughout these improvements is by the end of the year, we should be coming back to our profitable standard, which is not our goal. Our goal is to be close to the best competitors. You can see in their earnings reports, the ratings or the performance. So we are aiming to be very close to our competitors in 2019, but the pace and all of the actions to be implemented primarily all this CapEx is more than 150 projects that are carefully identified, and we have reinforced our people to be able to execute each one of these projects. On the product line, the main product line is in the U.S. and basically, each one of the customers, primarily the big boxes, expects to have a renewal every 3 to 4 years. We extended that period because we did not develop the product line. So we -- our goal is that every year, we should be replacing 25% of the sales by new products. By early next year, we will be in that rate of exchanging or replacing 25% in the U.S. with new products.

[Operator]

Our next question comes from Alejandro Azar with GBM.

[Alejandro Azar Wabi, analyst]

If you could expand a little bit more on why Europe and Asia within Draxton reports profitability pressures.

[Jorge Guzmán, executive]

Well, essentially, what we are -- as you know, we are able, depending on the geography, to pass-through to the selling price the cost of some of the raw materials and in some cases, the cost of electricity. We -- there is a time lag between the impact on our P&L and the time we can pass-through that impact to the market. And that's the main reason behind that, especially in the braking system. There is another factor that has been going on for the recent past, and it's the relative revaluation of the Poland zloty and the Czech crown. They have been revaluating and bringing some pressure into the cost structure in our operations in Czech Republic and Poland. I would say those are the 2 factors that have hit the P&L in this first quarter. And we see them as transitional since they -- the structure will eventually catch up and also, the currency factor is something that will not necessarily be there for the long term.

[José Manuel Arana Escobar, executive]

Yes. In addition to what Mario said, in NAFTA, it's very common to have quarterly adjustments with customers in the Auto Parts sector. And in Europe, the adjustments are yearly, not quarterly. It takes a year for us to turn that cost -- incremental cost to the customer within the formulas that we have.

[Alejandro Azar Wabi, analyst]

So we should expect -- because I didn't understand because the year already finished and you mentioned you have a time lag on the surcharges, so the next pass-through would come at the end of 2018? Or...

[Jorge Guzmán, executive]

Well, in some of our businesses, we have been successful in renegotiating that clause to move it on a quarterly basis. So it's an ongoing process.

[José Manuel Arana Escobar, executive]

Yes, it's an increment of Q1 of '18. We will not able to turn that around until Q1 of '19.

[Operator]

[Operator Instructions] It appears there are no further questions. I would like to turn the program back over to our speakers for any additional or closing remarks.

[José Manuel Arana Escobar, executive]

Well, thank you very much once again for the continued interest in GIS. Please don't hesitate to contact us if you have any further questions or any follow-up. You guys have a great day, and thank you for your time.

[Operator]

Thank you. This does conclude today's program. You may disconnect your line at any time and have a wonderful day.