Grupo Industrial Saltillo SAB de CV

BMV:GISSAA

Earnings Call Transcript 2022-Q1

[Operator]

Good day, everyone, and welcome to GIS First Quarter 2022 Earnings Conference Call. Joining us today is GIS's President, Mr. Jorge Rada; GIS Chief Financial Officer, Mr. Saul Castaneda; and GIS Investor Relations Manager, Mr. Arturo Morales. Please be advised that this call is for investors and analysts only.

During this call, they will be discussing GIS performance as per the earnings release issued on Thursday. If you did not receive the report, it is available at www.gis.com.mx in the Investor Relations section. We encourage you to follow along with the onscreen presentation. [Operator Instructions]

Let me remind you that forward-looking statements may be made during this conference call. These are based on information that is currently available and is subject to change due to a variety of factors. For more detail and a complete disclaimer, please refer to the earnings release. Also, all figures discussed are in U.S. dollars, unless otherwise stated.

It is now my pleasure to introduce the GIS team, Mr. Jorge Rada will lead off the call.

[Jorge Garza, executive]

Good morning, and thank you all for joining us today. On behalf of GIS, we hope that you and your families are in good health.

During the first quarter of 2022, the main economies had a strong start despite the challenges and disruptions observed in previous quarters. But the conflict between Russia and Ukraine increased volatility again. GIS was able to reverse the trend seen in the second half of 2022 and recover margins through several strategies throughout the businesses.

The Russian-Ukrainian conflict is in an already sustained supply chain due to the COVID pandemic and an ongoing shortage of semiconductors and brought additional impacts to the automotive industry as follows: first, further volatility in raw material prices, which were already starting to stabilize. To mitigate this, we have deployed several efforts to enhance productivity and operating efficiency and have been working on formula adjustments with customers to shorten the metal lag; and second, increasing energy prices in Europe, in some cases, up to 5x, impacting the profitability of many industries. This weighs on our operations, but in a lesser extent than in the previous quarter.

This strategy will include the cost of energy into our pricing deflation formula will allow us to mitigate this impact going forward. Regarding supply of semiconductors, we are observing that it continues to normalize, leading to higher vehicle production and sales compared to the last quarter. The backlog vehicle demand remains strong and distributor inventory levels are still under 25 days. Vehicle production is expected to grow in 2022 in spite of the shortage of other components manufactured in Ukraine and Russia.

In the first quarter of this year, Draxton achieved record sales volume on the back of the contracts won in the last 2 years that started operations during last month. The commercial performance of Draxton continues last year's stage and recorded 21,000 tons in contracts -- new contracts for the quarter, which are worth over $35 million in annual sales at peak volume.

Due to this performance and the industry solid fundamentals as well as the positive outlook for vehicle production in North America, we decided to make an additional investment to increase the casting capacity at Drax facility Potosí, adding 30,000 tons to the total installed capacity. These investments, together with the one we announced last year, will add 60,000 tons of capacity to Draxton North America, worth approximately $100 million in annual sales and will be mostly focused on components compatible with electrified vehicle platforms.

I will now hand the presentation over to Saul Castaneda, our CFO.

[SaúlCastañeda de Hoyos, executive]

Thank you, Jorge, and good morning, everyone. I hope you and your families are healthy and safe.

Revenues for the quarter reached $298 million, sourced by 20% year-over-year. This increase was driven by higher sales volume and the indexation effect of energy and raw material prices at Draxton. This [ domestic ] impact shows an improved product mix, coupled with a strong domestic consumption.

EBITDA for the quarter was $32 million, 53% higher than the fourth quarter 2021, an important inflection point versus second half of 2021. This figure was 20% down year-over-year considering first quarter 2021 was a record EBITDA period for GIS and not yet affected by semiconductor shortage and volatility in our main cost elements.

First quarter of 2022 reflects the impact of further increases in energy prices in Europe and also higher raw material prices. Most of these effects will be adjusted and recovered through indexation formulas during next quarter.

As we continue to move forward with this energy indexation strategy, profitability in the following quarters will experience greater [indiscernible]. We closed the quarter with a net leverage rate of 1.8x and no debt service payments required for 2022.

On March 29, the Annual General Meeting approved the payment of a cash dividend of MXN 1.41 per share to be settled into discount, resulting in a dividend yield of 5.2%, way above the market average of around 3%.

Including the recent announcements, GIS will have invested $170 million by 2023 to increase our businesses capacity and moving forward into value-added processes that will increase profitability.

Draxton North America, will have 50,000 tons of additional casting capacity worth around $100 million in annual sales, will triple the machine capacity and will introduce the plating process to advance waiting value-added processes in the region.

In Europe, Draxton will increase its machine capacity in Spain, mainly for differential cases. In the other hand, Vitromex will install 2 additional lines in San Jose for kiln that will bring an extra 5 million square meters to its total capacity, enabling the businesses to better serve the industries and pursue further growth.

I will now hand the presentation back over to Jorge Rada.

[Jorge Garza, executive]

Thank you, Saul. Well, shifting now to the automotive industry developments.

In North America, despite the volatility arising from global supply chain disruptions, vehicle production show signs of recovery when compared to the fourth quarter of last year, growing 6%, and is expected to increase 13% this year to help restock inventories and meet the regions pent-up demand.

Regarding Europe, vehicle production during the quarter grew 5% versus the previous quarter. The outlook for this year is around a 4% increase in vehicle production that will reverse the downward trend in inventory levels seen in the past quarters.

China had the highest growth in sales in vehicle production during 2021. The first quarter of this year posted a decrease of 19% versus the fourth quarter last year. Mainly related to the trade zero COVID-19 policies and the several disruptions in the supply chain. For this region, vehicle production is expected to grow around 1% during the year.

Now moving to Draxton's performance. Draxton achieved record sales volume during the quarter, even though the volume was still impacted by the disruptions in the industry. This achievement was largely driven by the programs won in prior years, reflecting a significant successful commercial effort and the competitive position of the business. Further volume expansions are expected as the industry normalization moves forward in 2022.

The normalization of semiconductor supply remains on track with analysts expecting to continue into 2023. Although, the conflict between Russia and Ukraine would trigger further disruptions in the region. Vehicle production is expected to continue growing in 2022.

Also, the volume of machine parts continued to increase, in line with our strategy to increase our participation in value-added processes. First quarter this year, sales were up 23% versus the previous year, mainly due to higher casting and machining volumes as well as higher raw material prices, which are passed through via indexation formulas.

EBITDA for the quarter reached $26 million, 77% higher than the fourth quarter of last year. This figure was 26% lower than last year, a quarter not yet impacted by semiconductor shortages and energy and raw material price increases.

As I previously mentioned, we are working to include the additional energy costs in the price formulas, and very soon, we will benefit from the energy indexation in virtually all our products. This strategy, while the expected normalization in semiconductor supply will boost Draxton's profitability over the following quarters.

During the quarter, Draxton continued with last year's trend and achieved new contracts for 21,000 metric tons per year, which are worth over $35 million annually. More than 90% of these volumes awarded are compatible with hybrid vehicle platforms and over 70% are compatible with full electric vehicles.

Now moving to Vitromex. Vitromex's revenue grew by 13% in a year-over-year basis, driven by a dynamic domestic market and the efforts to boost exports to the U.S. and other geographies. We were able to take advantage of the previous capacity update and reconfiguration made last year, which supported our sales growth. The business is also advancing towards a better product portfolio that incorporates a variety of medium and large form of pipes.

In the quarter, EBITDA grew 12% to reach MXN 144 million with a 13% margin. The profitability recovery program has allowed us to continue improving our operating indicator significantly and to achieve steady double-digit EBITDA margins. We still have plans to further expand margins through greater production efficiencies, a better product mix and additional capacity reconfiguration towards a former segmented manufacturing.

The previously enhanced CapEx continue as planned. This export capacity will allow us to expand our footprint and support a consistent service level for all of our customers.

Now regarding Cinsa. Top line grew 8% in the first quarter versus the previous year as a result of the efforts to increase our share and improved product mix in the domestic market. Although 2021 showed significant growth for the business, both the domestic and export markets are now showing signs of more moderate consumption.

EBITDA for this period was MXN 45 million, a 9% margin. Profitability continues to be supported by the commercial efforts as well as operational and administrative initiatives to mitigate the impacts related to higher raw material prices.

With this, I conclude my remarks for today. Thank you all for your attention. And now we can begin with the Q&A session.

[Operator]

[Operator Instructions] Our first question comes from Carlos Alcaraz.

[Jorge Garza, executive]

Go ahead, Carlos.

[Operator]

[Operator Instructions]

[Carlos Alcaraz Pineda, analyst]

Congratulations for the results. I have 2 questions. The first one is what is your perspective from the supply chain, given the current situation in China? And the second one is what percentage of Draxton contracts are indexed to energy prices?

[Jorge Garza, executive]

Well, Carlos, thank you very much. Regarding the supply chain situation in China, we don't have a clear vision at the moment of what is going to happen because it is clear that the Shanghai, the city and the port are, let's say, operating more or less at 50%. So we have seen congestions in the logistics. At this moment, we have not seen a direct impact on our volumes, but we are talking to all the customers to be very close to them and try to understand what is going to be the impact.

Definitely, there is going to be an impact, for sure. It will depend how long the restrictions will remain. We hope that the situation -- because of the pandemic, this variant of the Omicron supposedly is not so, let's say, bad or negative or strong as it was in the past. A lot of the population in China is vaccinated. So hopefully, the government will start to release a little bit of restriction soon. However, it's very difficult to predict.

Regarding Draxton indexation formula, I can tell you that we have been very successful recently in the first quarter to negotiate with the customers formula indications. Then what we see is that we are now over 90% protected with indexations, with the customers, and we expect to have 100% of the contracts already indexed.

This will have -- and anyway, some kind of lag because it is very difficult to negotiate that the prices of this month will recur this month to the customers. So we negotiated more or less indexation formula with 3 months delay, okay? But that's much better than having nothing or that much better than having, let's say, indexation that is annual because with this kind of price increases in the energy it was really necessary to sit down with customers and try to get this kind of agreements.

So in the first quarter, we are still -- we already started with indexation. We are charging with prices of energy of the last quarter of last year. So now in the second quarter, we are going to be charging prices of energy based on December, January, February and so on. So we will see a normalization of the margins as the indexation formula stabilized. And if the prices of the energy don't grow anymore, and they stabilize, then it will come back to normal margins.

[Operator]

Our next question comes from Laisha Zaack.

[Laisha Zaack Carrillo, analyst]

Regarding Vitromex margins. You see them -- do you believe that the margins will -- these trends that you mentioned, do you think that the energy prices and the volatility that you're mentioning, going to affect the margins of Vitromex throughout the year?

[Jorge Garza, executive]

No. Actually, the good thing is that energy in Mexico is not being affected like it has been in Europe. There is some relatively small increase in gas, natural gas prices. However, this is not so dramatic as it has been in Europe for other -- for the Draxton business, for example.

So what we are doing is that we are doing a lot of actions to improve our costs and also our product mix. So what we foresee for the rest of the year is a trend that will improve the margins even though the -- some costs are really going up like raw material, for example.

There are some raw materials that definitely have been going up in prices. And the market is allowing to transfer some of these price increases to the consumer. All the competitors are going the same. But of course, we are working on different strategies to try to contain these costs and reduce internal caused by efficiency programs.

So what we see is that by the next quarter, we will continue to increase margins, especially because we are implementing very strong efficiency programs in a couple of the plants. And an important point is that we are trying to change the product mix to include larger format tiles, which are with better prices and better margins.

[Laisha Zaack Carrillo, analyst]

Quick follow-up. Do you believe that there's going to be any further price increases this year as we saw during last -- a couple of months of last year?

[Jorge Garza, executive]

I think there is some high probabilities that the prices will continue to go up. Inflation is being high and raw material prices are going up. So I think in general, the industry will continue to transfer as much as possible these price increases to the consumer, not only Vitromex but the whole industry. Saul, you want to say something.

[SaúlCastañeda de Hoyos, executive]

Yes. Thank you, Jorge. I would like to go back, Laisha, to the first part of your question. And just to remind you and the audience. It is important to highlight that regarding natural gas, we hedge the help of our needs, and we have that policy to give certainty and stability to our operations just to have that in mind.

[Operator]

[Operator Instructions] Our next question comes from Alejandro.

[Unknown Analyst]

I have 3. The first one is the product mix or if you could give us some color on how that is unique in your operation in Draxton. This relative mean to your wins or your clients leading off to the volume that they are asking, I don't know, 3 months, 6 months ahead to see how supply chains are improving? That's the first one.

The second one is I noticed you talked about margin normalization in Draxton and also, you showed EBITDA per ton figures, which would be a normalized EBITDA per ton figure that you have in mind given the current situation. And where do you see it growing once volumes come back in the next couple of years or months? And I'll wait for the third.

[Jorge Garza, executive]

You will wait for the third one. Okay. Well, let me tell you something. The first quarter was a very good quarter for volume. Actually, we are announcing based on reported figures, the first quarter of this year was a record period, a historical record for Draxton worldwide. And I think that in North America, we are seeing very strong volumes because the war is not in North America. The war is in Europe, okay?

So the restrictions and the supply chain issues are affecting more the European market and the European OEMs at the moment. We are working very, very hard to try to replace supply, that is coming from Ukraine. Definitely, the demand of vehicles in that region, Russia and those countries, especially in Russia, is going totally down, right?

But however, we see that there is a pent-up demand in western parts of Europe. However, we see volumes being affected a little bit. We see maybe the 10% reduction now in the forecast for the year compared to the pre-Ukraine war. I don't know if I'm being clear. I mean, if we make a forecast before the war started and we see the forecast of vehicle production now, it has being down in Europe, about 10%, okay?

Well, coming back to the margin in Draxton is the question. I think we show these numbers because with the prices of the scrap and the prices of the energy that will be indexed in the prices of the products, you will start to see margins as a percentage going down because prices are going to be higher, but that's going to be more or less artificially.

Artificially, I mean that the raw materials are going up and the customers are going to pay for that. It means prices are going to be higher and the margins in percentages are going to be lower. But we wanted to see that in absolute numbers, the margin per ton is the one that we are looking for at the end, okay?

So we expect very soon to come back to margins that are more in a $300 per ton, okay? And this is a number that we should be looking for.

[Unknown Analyst]

With higher than $300 per ton. And that's only iron, right?

[Jorge Garza, executive]

As aluminum [indiscernible] from business, but it's very, very small. So we basically talk about iron markets.

[Unknown Analyst]

Great. And my last question, for Saul, probably on the long term. You mentioned record volumes, especially in North America and you have shown a volume growth in the past years ahead of the market from what we have to do with near shoring. But my question is despite all the growth and all these expansions that you made in -- that you're going to make in the next couple of years, do you see the growth given this restoring from Asia and Europe to Mexico on your products?

[SaúlCastañeda de Hoyos, executive]

Sure. Actually, I mean the 2 investments that we have announced are especially because of that because we see that Mexico with USMCA has been receiving a lot of investment because some of the OEMs in Mexico need to increase a lot of content to be -- to make sure that the cars or the autos or the vehicles they made are considered regional, okay? So they are trying to bring more and more components to be produced in Mexico, not only component, but systems.

If you see the volume of cars produced in North America, Mexico, U.S. and Canada, maybe the total number of vehicles is not growing, but the production of auto parts in Mexico is definitely growing. And this is what we are seeing. We see a lot of -- we have the order book already with contracts. And we are still quoting additional programs because there is going to be more localization of production from other countries to Mexico. And that is very good, I would say, I don't want to say that we are going to invest more than this line that we are announcing right now, but definitely, we see a very good trend in volumes for North America.

[Operator]

[Operator Instructions] There are being no further questions. I would like to give the floor to Mr. Castaneda to close the conference.

[SaúlCastañeda de Hoyos, executive]

Thank you. And thank you, everyone, once again for your interest in GIS. Please don't hesitate to contact us if you have any further questions. And we hope you stay healthy and safe. Have a nice day.

[Jorge Garza, executive]

Thank you. Thanks.