Grupo Industrial Saltillo SAB de CV

BMV:GISSAA

Earnings Call Transcript 2023-Q1

[Operator]

Welcome to the GIS First Quarter 2023 Earnings Conference Call. Joining us today is GIS Chief Executive Officer; 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, management 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 on-screen presentation. All lines have been placed on mute to prevent any background noise. There will be a question-and-answer session after the speakers' opening remarks and instructions will be given at that time.

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 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. Our performance this quarter was once again reflects the resilience and adaptability of our businesses. Despite the persistent challenges in the macroeconomic environment, revenue and EBITDA maintained a positive performance, driven by Draxton's outstanding commercial strategy that reaffirms our business vision to further strengthen our participation in the automotive industry. In this context, Draxton, once again, reached an all-time record in sales volume for both casting and machining at a global level. Following the solid base of new programs won, the steady recovery of the automotive industry, the capital deployment oriented to expand our installed capacity and the incorporation of higher value-added processes.

Shedding broader color. The new contracts won in the quarter are equivalent to approximately $40 million of annual revenue to be launched over the next 18 to 24 months. Regarding the automotive industry, North America and Europe show incremental production and sales of vehicles despite high selling prices, low inventory levels in some models and persistent limitations in the supply chain. And on the investment front, the first phase of the casting capacity addition in San Luis Potosi is already operational. The other announced expansions are underway and as scheduled. These investments will allow us to incorporate value-added processes to further unwind value generation.

All in all, the aforementioned factors, together with our solid financial position, enabled the company to fully capitalize on the arising opportunities such as the nearshoring and the industry's normalization pace.

As you probably already know, at the beginning of March, we successfully completed the sale of Vitromex to Mohawk Industries for $299 million, thus strengthening our balance sheet. This divestiture, coupled with the startup of expansion projects in Europe and North America, lay out the strong foundations to further strengthen Draxton's position in the automotive industry. 2023 will be a crucial year for GIS. We will be working on the launch of new casting, machining and plating capacity, aiming to tap into the market dynamics, nearshoring trend and further penetrate into other markets. This year's CapEx programs reflect our commitment to keep growing.

With the advantage of our current financial position, we will continue to analyze the market for potential needs of additional casting capacity and/or other opportunities that may come along.

With this, I will now hand the presentation over to Saul.

[SaúlCastañeda de Hoyos, executive]

Thank you, Jorge, and good morning, everyone. GIS financial results continue reflecting the outstanding performance of our commercial strategy with record volumes at all Draxton geographies, the ramp-up of new casting capacity at San Luis Potosi and the recovery of the automotive industry in North America and Europe. First quarter revenue totaled $260 million compared to $242 million in the first quarter 2022, driven by record sales volume in both automotive casting and machining in addition to the effect of higher indexed raw material and energy cost on sales.

During the first quarter, EBITDA totaled $28 million compared to $26 million in the same period of 2022, supported by incremental sales at Draxton and SG&A savings. It is important to highlight that GIS was able to maintain EBITDA despite the impact of Mexican peso appreciation, higher raw material costs and Draxton expenses related to launching of new products and ramp-up effects. During March, GIS made debt prepayments for almost $120 million, therefore, outstanding balance totaled $260 million at the end of March 2023. Furthermore, net debt was negative for $13 million due to the net proceeds obtained from Vitromex divestiture.

During April, GIS paid a cash dividend of MXN 5 per outstanding share and made the full prepayment of its local notes, [indiscernible]. On a pro forma basis, considering these effects, net leverage will stand at 0.6x.

Regarding expansion programs, during this quarter, the first phase of the additional capacity at San Luis Potosi was launched. On the other hand, second phase of the expansion and the new value-added processes in Mexico and Europe remain on track just as planned. During the quarter, Draxton obtained new programs for approximately $40 million, allowing us to further capitalize on the ongoing recovery of the automotive sector. Estimated 2023 CapEx amounts to $130 million, which includes investments related to the casting and machining capacity expansion projects announced in previous quarters. As well, the development of value-added processes and other maintenance expenses.

I will now hand the presentation back over to Jorge.

[Jorge Garza, executive]

Thank you, Saul. Shifting now to the automotive industry developments. Starting with North America, vehicle production was up 6.8% year-over-year, reflecting the region's recovery on the back of reduced semiconductor shortages. Vehicle sales posted an annual increase of 5.9%, same that are expected to grow further over the year, driven by higher inventory levels and the offer of incentives from OEMs. In Europe, production and sales increased 11.3% and 10.5% respectively on an annual basis due to the environment in semiconductor supplies and decrease -- the improvement, sorry, in the semiconductor supplies and decrease in energy risks. This quarter was the best perform period since the outbreak of the semiconductor prices and the trend is very likely to continue.

Regarding China, production and sales were down 9.6% and 11.9% respectively, on a comparative annual basis, impacted at the beginning of the year by the increase in COVID-19 cases in addition to the Chinese New Year and culmination of government incentives for vehicle sales. However, as of quarter end, performance improved, driven by regional incentives and stimulus from the OEMs.

Moving on to Draxton's performance. Draxton achieved records casting and machining volumes during the quarter, thanks to the introduction of new programs and the gradual recovery of vehicle production, with 13% increase on casting and 56% on machining volumes. In North America, casting and machining volumes increased 6% and 76% year-over-year, making significant progress in the strategy of incorporation of value-added processes, which will soon include plating. While in Europe and Asia, casting and machining reached record figures with growth rates of 22% and 34% respectively, driven by the incorporation of new commercial vehicle programs and recovery of light vehicle production in the region.

Draxton's revenues in the quarter increased 11% year-over-year, mainly due to new products and effects of higher raw material and energy costs on prices. Revenues by region were $111 million for North America and $129 million for Europe and Asia, growing 3% and 19% in an annual basis, respectively. EBITDA increased 3% totaling $26 million following higher volumes, increased participation in value-added processes, lower energy prices in Europe and indexation of higher raw material prices, foregoing softened the impact of the exchange rate fluctuations and higher raw material costs as well as other expenses related to the launching of products and the ramp-up of new product lines.

During the period, Draxton captured new programs for approximately $40 million, continuing the favorable trend of last quarters. In this sense, nearly 80% of these programs are compatible with hybrid platforms and totally electric vehicles. The first line of additional capacity in San Luis Potosi just started operations and will support the continuous volume growth, and later, throughout the year, the second phase of this expansion will initiate as planned. The installation of the additional machining and first plating capacity is going as planned.

I would like to give you further details about the new process we are incorporating into our value chain, which is the plating. In this process, a thin layer of metal coats as substrate to our auto parts through an electric current, providing our products with additional corrosion resistance and strength. Consolidating this process into our commercial offer will open new opportunities for us and confirm our commitment to our customers.

Now regarding Cinsa. Revenues for the quarter decreased 11% due to the contraction in consumption of household goods in domestic and international markets. EBITDA for the period was MXN 40 million, 2% lower year-over-year. Price alignment with the market, new products designed, improved customer service and commercial, operational and supply efficiencies have partially offset the negative effects of market contraction and inflation pressures. For this year, we will continue to focus on the achievement of incremental revenues in the United States and speed up market penetration in other markets towards our proprietary brands in Graniteware along with an increased productivity and further efficiencies.

During 2023, we celebrated the 95th anniversary of GIS. In 1928, Mr. Isidro López Zertuche, a visionary entrepreneur, acquired his first press to produce aluminum pots and pans that he later sold in his hardware store. He never imagined that this would be the foundation of Cinsa and the beginning of a global company. Today, we are a company with a team of over 5,400 people in 6 countries, engaged with our vision and values as well as to growth to become a dynamic, profitable, sustainable and socially responsible global company. Also, this year, we celebrated the fifth anniversary of Draxton's corporate identity, through which we have unified 5 different companies and cultures into one global player of the auto industry. Through these 5 years, we have accomplished many goals under our philosophy of 1 team, 1 vision.

We have positioned our business through the diversification of our product portfolio, attracting new customers and taking advantage of our capabilities to grow and capitalize on the industry dynamics. We will continue to develop our team in order to see growth in the following years.

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

[Operator]

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

[Carlos Alcaraz Pineda, analyst]

Thank you very much for the call and congratulations for the results. Carlos Alcaraz from Apalache Análisis speaking. I have 3 questions. The first one is regarding new business. The expansion of San Luis Potosi will allow you to attend this higher volume that you have captured today? Or are you analyzing any acquisition to solve it?

The second one in that sense, my second question is about the commercial aspect. In which region will you be looking to capture new business in the coming months now? And finally, what percentage of installed capacity are the plants in Europe and Asia are working at?

[Jorge Garza, executive]

Utilization capacity?

[SaúlCastañeda de Hoyos, executive]

In Europe.

[Jorge Garza, executive]

Okay. Carlos, thank you for your question. Well, regarding the first question, the question is if the investment in San Luis Potosi is to attend a recently acquired business? Well, the answer is yes. We normally invest in capacity once we already have a very, let's say, firm vision of the volumes that we have acquired or will acquire. Normally, we already have the contracts. And if we have the contract, we need to match this contract with new capacity or additional productivity increases so we can really face these new volumes. So when we talk about the first line in San Luis Potosi that is already up and running, this capacity is to attend existing contracts, this contract were acquired a few years ago. And in these last 2 years, we have been developing together the new products with the new capacity. So the plan -- this line is going to be pretty much full pretty soon this year.

The second line in San Luis Potosi, which is we call it Line #7, is going to be up and running by the end of this year. We expect to start making the first castings for testing in the summer. I would say that by early August, we will be pouring metal on the casting line. And that is also -- when we installed -- or when we decided to make this investment, we already have contracts for that line, too. As the time went by, we can say that, that line is going to be full pretty soon. And for that reason, we are already considering that with the nearshoring, we will need to add more capacity in the near future. So the near-shoring trend and the U.S. MCA is really bringing some benefits to the automotive industry in the auto parts industry in Mexico.

We are seeing it, and we are definitely prepared to take advantage of that trend. So this is for the first question.

For the second question, in which regions we are getting new businesses, this is the question, right?

[Carlos Alcaraz Pineda, analyst]

Yes.

[Jorge Garza, executive]

We are getting new businesses definitely in North America. And for that, we are adding capacity that is very clear. I already have addressed that in the first question. But in Europe, we are also getting new businesses. We are adding more and more machining operations, many more customers are interested in giving more volumes to Draxton. And not only in the automotive and the light vehicle, let's say, light vehicle industry, I will say that 30% to 35% of the products that we will be making in Europe are coming from the, let's say, truck industry. It's not -- a heavy truck industry, is not only the light vehicle industry. We are adding more and more machining capacity. And I will not discard that in the future, we will end up doing something else, like assembly of some components, probably coating of components so we can add more value to the customers, and we can make the core customers more satisfied and more loyal to us.

In China, we are not adding capacity at this moment. However, we are gaining more and more business. So by -- in the next 2 years, we will have to decide if we need to add additional capacity so we can produce more because we have a cap in terms of melting, is only one process, melting of the scrap. That limits, I mean so far, the capacity that we can have in castings. But if we have a slight or a small investment in the melting, we can make more castings. So in the next 18 months, we will have to face that decision. But if it is necessary, we definitely would like to continue growing in China because it's the biggest market in the world. So this is also, let's say, a demonstration that, in China, we are also growing.

So in the 3 regions where we have operations, we are getting new contracts, and that is a very good and positive trend for Draxton.

And in terms of capacity utilization, what I can tell you is that in North America, we are operating at 90% utilization, and that is why we are adding capacity. In Europe, we are now between -- I mean, higher than 80%. And pretty soon, we will reach the 90% capacity across all the plants. Some plants have the highest occupation or utilization, some plants less, but we are now over 80% of capacity utilization. And in China, we are now around 80% capacity utilization. And in the next 2 years, we will get to the 90%. So it's a pretty good trend for all the regions in which we operate. Carlos, did I answer your question? Sorry, you have any additional thoughts.

[Carlos Alcaraz Pineda, analyst]

No, that's all here. Congratulations again.

[Jorge Garza, executive]

Thank you.

[Operator]

Our next question comes from Alejandro Azar.

[Alejandro Azar Wabi, analyst]

Jorge, Saul, Arturo, can you hear me? I'm sorry, I'm having trouble with my voice.

[Jorge Garza, executive]

We can hear you.

[Alejandro Azar Wabi, analyst]

I just have one question. You have a great quarter on volumes in the casting side, 57% growth on machining, which is higher value, more margins. But we don't see that expansion in margins from operating leverage plus higher value-add process. So my question is, from the impacts you mentioned, FX scrap or higher raw materials and launching, is it possible for you to separate those costs and tell us which ones do you believe are one-timers and -- because the FX, if it stays at 18, that's going to be there. But could you elaborate more on those, please?

[SaúlCastañeda de Hoyos, executive]

Probably, if I may, Jorge. Thank you, Alex, for your questions. Sure, probably we were not able to go as deep as we would like to, but I can give you some color. For example, on the FX side, I will say the impact was around $2.5 million. It was a huge impact. And as you mentioned, it will stay there if the exchange rate persist or keep it in that -- in the same level. On the other hand, I will say, definitely, you highlight an important aspect, one shot or onetime effects. And I would say those related to expansion, new capacity added and new product launch, there are definitely one timer effect, onetime effect and that we can probably reduce on the following quarters, and probably we will end with a normalized operation at the end of the year.

I would like to emphasize that this is a normal situation in the industry. As you may know, every expansion or new capacity added has these ramp-up effects. So it was expected from our side. And we think that we can manage the situation and be in a better way on the following quarters. And probably, in my side, to end my comment, I will say that we believe Draxton EBITDA without these effects would have been a double-digit growth, just to give you more color on that side.

[Alejandro Azar Wabi, analyst]

Okay. And one more, if I may, on the industry. What are you seeing in terms of how the OEMs are reacting because I think we are reaching a pretty interesting time where they make -- they made a lot of money by having lower inventories and higher prices. Now we've been having more than 1.5 years of increasing volumes on the production side. Are you guys seeing more production increases in the coming quarters, so inventory levels could be replenished? Or do you think that OEMs will maintain that pricing power with the consumers due to lower inventories on dealerships. What are you seeing on that front?

[Jorge Garza, executive]

Well, we think that the OEMs will try not to come back to the original or the traditional inventory levels in the industry, especially in North America because they already learned how to make more money and less investment in, let's say, working capital with the inventories. However, once all the OEMs reach a certain level of inventory, they will start fighting for market share. So they were -- they increased prices, prices are really high. Interest rates are relatively high, but they are coming down. okay? So we think really that there is pent-up demand and the OEMs will try to fight against each other for market share. So we really expect production volumes to continue high. And maybe this year is going to be about 5%, 6% higher than last year, and we expect another 5%, 6% next year. So we definitely need to be prepared for that because OEM will start to give incentives for selling, maybe to give some, let's say, lower interest rate financial schemes, things like that. So we definitely need to be prepared for this higher-than-expected production volumes. Does that make sense?

[Alejandro Azar Wabi, analyst]

Yes. Thank you, Jorge. And one more, if I may. Regarding nearshoring and all these investments that we've been hearing, Tesla, there's Chinese company that wants to invest in Mexico. You were previously discussing about your capacity utilization near 90% in the next 2 years. That -- I think that incorporates your 60,000 tons expansion or....

[Jorge Garza, executive]

No, no. This is current. If we consider the 60,000 tons additional capacity, then we relieve the -- let's say, the 90%, it will go down, so we can continue capturing more business. So at the moment, we are -- we really needed this capacity. That's why we are installing it, and we are -- one of the lines is already up and running. But this is based on the current volumes with the existing capacity. The new capacity will give us additional volumes, and we will expect not to be higher than 90%, which is normal. We don't want to sell more than 90% of the capacity because that -- it's also dangerous on the other side.

[Alejandro Azar Wabi, analyst]

Okay. So thinking on all these new OEMs coming to the region or suppliers, should we think that GIS' CapEx for the next, I don't know, '23, '24 would be closer to $100 million because you're going to need new capacity ramping up in '25 and '26? If your growth continues, I know that you don't have the contracts yet, but I'm just trying to figure out what the -- the CapEx of the company that is growing and with these trends should be in the next 2, 3 years?

[Jorge Garza, executive]

It depends, Alex, because it's -- if it is casting capacity or machining capacity or something else, we definitely think that, in Mexico, for example, one more line is going to be needed. And one line is going to be less than $40 million for sure, is going to be between $30 million and $40 million depends on where we install it. So $100 million looks a little bit high every year. However, it depends if we are going to do something in Europe, it's going to be machining, casting, et cetera. But definitely, we are prepared to grow. We want to grow. We think the trends in the industry are very positive. There is another trend that we don't normally talk about, which is the outsourcing. OEMs are focusing a lot on the e-mobility.

The same thing is happening with the Tier 1s in the e-mobility, and they need additional suppliers who can do things that they used to produce in the past. And so they are outsourcing more and more, and this is something that we want to take advantage, right? The outsourcing trend. So we are adding capacity in processes that we didn't have before, but our customers used to have, okay? And that's why we are adding more value added to the castings we produce. Casting is one thing, but now Draxton is becoming, let's say, a full-fledged company producing. We are designing together with the customers. We are casting, we are machining, we are coating. And most probably, in the future, we will start to enter into the preassembly of components. So we will definitely add more value and level of investment is different in every process, but definitely, we see more investment for growth.

[SaúlCastañeda de Hoyos, executive]

And Jim, I would like to add that those $40 million that Jorge just mentioned will be for around 30,000 metric tons on a yearly basis capacity expansion.

[Operator]

[Operator Instructions] With no further questions in the queue, I would like to return the call to the management.

[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 further questions. Have a nice day.

[Operator]

Thank you. You may disconnect.