Grupo Industrial Saltillo SAB de CV

BMV:GISSAA

Earnings Call Transcript 2024-Q1

[Operator]

Good day, everyone, and welcome to GIS' First Quarter 2024 Earnings Conference Call. Joining us today, we have GIS' Chief Executive Officer, Mr. Jorge Rada; GIS' Chief Financial Officer, Saul Castaneda; and GIS' Investor Relations Manager, Mr. Arturo Morales.

Please be advised that this call is meant 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. [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 subject to change due to a variety of factors. For more details 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. As we have anticipated, the first quarter results are starting to better reflect the improving key performance metrics enhanced by our initiatives in operational discipline and cost control as well as the ramp-up of our expansion projects and additional value-added processes, resulting in higher profitability with the EBITDA margin returning to double-digit region.

In this context, our 2 additional casting lines in San Luis Potosi continue advancing to reach optimal capacity. Line 6 being the closest to this level, and Line 7 moving forward in this quarter to reach a similar level by the year-end. Additional efficiencies are anticipated to emerge organically as we aim for our operational goals and to hand with the ramp-up progress of both lines.

Furthermore, the capacity expansion of value-added processes notably contributes to the enhanced profitability, outstanding machining, even when its progress reaches 60% of the target of tripling the installed capacity of our JV Evercast. As you may recall, the installation of machining capacity strictly follows the timeline set by the customer's schedule.

On the plating side, the first line is operating at 100%, and we expect the second to start production by the third quarter of this year. The aforementioned factors, together with our strategic initiatives oriented to the addition of new programs and enhancement of our market positioning at the commercial vehicle component sector will enable us to further improve our profitability.

During the quarter, the whole Draxton system secured TISAX certification, which is Trusted Information Security Assessment Exchange. This certification is very, very important achievement in the automotive industry. In China, we advanced towards our goal of environmental stewardship, installing solar panels at our production facilities that will allow us to self-generate green energy and alongside our purchase agreements, ensure that 75% of our energy consumption comes from renewable sources, thus reducing our carbon footprint.

Shifting now to the automotive industry developments. In North America, vehicle production and sales continue showing sequential growth, driven by pent-up demand from a lower vehicle availability as of the end of 2023. Annually, vehicle production in sales increased by 1% and 2%, respectively, reflecting underlying demand supported by expanded production and higher inventory levels. In Europe, vehicle production and sales remained almost unchanged sequentially. However, annually, production decreased 3%, while vehicle sales increased 1%, as the increased imports of vehicles from China has impacted domestic production, but stimulated sales. Regarding China, on an annual basis, government incentives and increased exports continue to be the main catalyst for the region search in production and sales, which increased by 12% and 5%, respectively.

Moving on to Draxton's performance. Casting and machining volumes continued their upward trend with sequential improvements, increasing 2% and 31% on an annual basis, respectively, mainly driven by the further integration of the expansion projects launched last year, enabling us to meet the increased demand from OEMs as well as our product portfolio diversification strategy. By region, in North America, casting and machining volumes increased 1% and 51% year-over-year, driven by the automotive industry's recovery and integration of additional production and expansion projects. In Europe and Asia, we grew 2% in both casting and machining despite a softening market. For the rest of the year, product launches are expected to support increasing casting volumes.

Quarterly revenues totaled $246 million, recording a 3% annual growth rate, performance attributed to an incremental volume from expansions, launching of new programs, further value-added solutions, and price adjustments. It is important to note that this result was achieved even with a lower raw material and energy cost base index. EBITDA for the quarter reached $27 million, outperforming the last quarter of 2023, despite a $3 million impact due to the appreciation of the Mexican peso. We expect this paramount indicator to gain further traction from the ramp-up of the additional installed capacity in tandem with the commercial agreements reached to mitigate the effects of inflation and foreign exchange.

Throughout 2024, Draxton will remain committed to its ongoing operational improvement, focusing on the development of projects, consolidating its capacity expansions, and acquiring new contracts for EV and ICE applications. During the first quarter, the expansion of facilities at GISEderlan, our JV with FagorEderlan in Mexico continued as expected. We estimate its completion as soon as the next quarter. This expansion will enable GISEderlan to better meet the demands of our OEM customers. GISEderlan reported revenue of $18 million in the quarter, 14% higher than the first quarter of last year.

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

[SaúlCastañeda de Hoyos, executive]

Thank you, Jorge, and good morning to everyone. The company's first quarter results certainly reflect surging operational traction from the ramp up of Line 6 and 7 in San Luis Potosi, alongside the incremental contribution of value-added processes, enabling us to maintain record volumes, both in casting and machining while encouraging to a further recovery of profitability. In this context, GIS posted a quarterly revenue of $272 million, a 4% growth against the $260 million recorded in the same period last year, mainly driven by incremental volumes in casting and machining alongside the recovery of the North American automotive industry and successful commercial negotiations.

GIS delivered an EBITDA of $28 million, 40% higher than last quarter of 2023, marking the third consecutive quarter of sequential improvement at the back of higher sales and profitability at Draxton. We anticipate further strengthening of EBITDA in upcoming quarters given the reduction in costs from enhanced key performance metrics and strategic commercial agreements to mitigate inflation and foreign exchange impacts.

During the first quarter, we sustained a solid financial position with a net debt of $171 million. The net leverage ratio remained stable at 2.2x, partially reflecting the improved EBITDA generation. In this sense, we can anticipate further financial improvement as profitability increases. Along the most important developments of the reporting quarter, we are moving forward with our refinancing process to be executed through syndicated loans in Mexico and Europe. This process will raise our financial flexibility and significantly improve our maturity profile, bringing additional strength to our balance sheet to support working capital needs and CapEx related to capacity expansion and growth projects. Closing for these transactions are expected during second quarter 2024.

During the quarter, CapEx deployment was close to $20 million allocated to ongoing expansion projects and value-added processes. In this sense, we are quite on track to achieve our $100 million target of CapEx for 2024.

I will now hand the presentation back over to Jorge.

[Jorge Garza, executive]

Thank you, Saul. Before concluding, I want to highlight that in line with our commitment to promoting sustainable growth and delivering value to our shareholders, on April 9, we held the Annual General Meeting, where a cash dividend of up to $0.086 per share was approved, to be settled in 2 installments. The performance achieved at the beginning of this year constitutes the first step through the achievement of our 2024 prospects of growth and profitability.

2024 also emerges as a consolidation year in the step-up contribution of ongoing projects of expansion and value-added processes as we anticipate its full contribution towards 2025.

Lastly, we will continue striving to close both strategic agreements to offset macroeconomic impacts and refinancing transactions to unleash financial flexibility while we move forward in the ramp-up of capacity expansions, all of the benefits of the company's profitability and generation of value in the long haul.

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

[Operator]

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

[Carlos Alcaraz Pineda, analyst]

Congratulations on this first quarter results. If it's okay, I will take my questions one by one. So my first question is about the profitability. What is your expectation for the EBITDA margin for this 2024?

[SaúlCastañeda de Hoyos, executive]

Carlos, Nice talking to you. Thank you for your question. I would say, as you know, we do not provide a guidance specifically to give a reference of that level of EBITDA. Nevertheless, we are pretty confident that we will be improving both the total amount of EBITDA level and also the EBITDA margins. Probably, I would say, as we already mentioned, to strengthen this double-digit EBITDA margins. It will be harder to establish a specific level, but I will definitely say that we are very confident that we will improve our margins during the year, Carlos.

[Carlos Alcaraz Pineda, analyst]

I understand. Great, great. And my second question is about the financing process. Could you give us more color on that about the maybe amount of this loan? Could you give us your target for this process?

[SaúlCastañeda de Hoyos, executive]

Sure. Absolutely, Carlos. As we mentioned, we were analyzing and assessing the different kinds of ways to improve our balance sheet and to strengthen our financial position. So we decided to launch these both syndicating processes in Mexico or North America and also in Europe. I will say that with both loans, we will reach up to $250 million. Probably, we will see around $225 million or something like that. But I will say the process will go up to $250 million. As we already mentioned, our main purpose of this transaction or refinancing is to prepay and consolidate that, giving a higher flexibility to the company, improving our debt maturity profiles, and also keeping the best interest rate for our P&L during the year and following years also.

We are moving forward very good in both processes. As we mentioned, we will finish or conclude these transactions during the second quarter 2024. But we believe that we will be ready probably in late April or early May, I will say, Carlos.

[Carlos Alcaraz Pineda, analyst]

Okay. And finally, I would like to ask you if the increase in tariffs of steel and aluminum from Asia is approved, what will be the implications for Draxton?

[SaúlCastañeda de Hoyos, executive]

I don't know if Jorge would have a better reference than myself, but probably we will need to take a deeper look on that issue. Carlos, we are not foreseeing an immediate impact. But I will say it will be better for us if we can take a deeper look of that aspect and revisit this issue in a later moment. I don't know, Jorge...

[Jorge Garza, executive]

I would like to mention that we are not in the aluminum business in North America. And we are basically on the iron business in North America. The main raw material that we use is not steel, but is steel scrap and the steel scrap is very regional. So most of the scrap that we buy is basically from Mexico. That is why we don't think it's going to affect prices that we use to buy and to sell in the raw material, because it is indexed in the selling price of our products.

This is based on indices that are published and they are available for everyone. So if these indices go up, we will have to apply these both on the purchasing side and on the sales side. This is a standard formula used in these kind of commodities in the automotive industry. So if this situation creates a higher, let's say, price trend in the market in Mexico, which I don't think so this will just have the increase of the price, but the margin eventually will stabilize the same. So in the long run, I don't think this is going to have an impact on our business.

[Carlos Alcaraz Pineda, analyst]

Okay. I understand. Thank you very much, Jorge, Saul, and again, congratulations for the results.

[Operator]

Our next question comes from Emilio Fuentes from GBM.

[Emilio Fuentes, analyst]

Hello. First of all, congratulations on the results. I would like to know if you have any insight on potential risk from the entry of spare part manufacturers from China and Asia into the Mexican market looking to capitalize on the new sharing trend? We've recently heard plenty of news of different companies that want to relocate to Mexico. Any insight on this?

[Jorge Garza, executive]

Yes. We always hear similar news in different, let's say, commodities, different parts, components of the automotive industry, different companies are announcing investments. And the trend is so strong that we are adding additional capacity because the customers demanded this and the customers continue to demand additional volumes. We announced several years ago that we started with an expansion process that will finish at the end of this year. It means that we will finish paying all the expansions or all the CapEx, and we are going to be, in the next 12, 18 months, consolidating these investments, because we need to stabilize the production and everything.

So if the demand continues to grow, we are analyzing the possibility to continue adding capacity in Mexico, because the nearshoring trend has not finished. So if other companies decide to join in Mexico and start opening capacity, number one, it will take them about 2 years. And number two, this is basically because the demand is there. So we are not afraid of this. We are the leaders in the market. We know this market. We have the people, the technology, the know-how, so we believe that we will still continue to be leading this industry.

[Operator]

Our next question comes from Alejandro Azar from GBM.

[Alejandro Azar Wabi, analyst]

I have several ones. So if I may, I can take them 1 at a time. The first 1 is, how should we think about FX losses? If I'm not mistaken, you have like close to $30 million accrued since January 2023 until today. How should we think about those. Let's think if the FX moves back to MXN 19, MXN 20 per share, because I understand that you guys are trying to do agreements with your clients. So how should we think about the figures if you do those agreements and the FX moves forward?

[SaúlCastañeda de Hoyos, executive]

Alejandro, nice talking to you. I will say that for a quick reference, during 2023, and if I'm wrong, please, Arturo, correct me, the FX impact was around $20 million -- $10 million. I have that number in my head, $10 million. I don't know if you are talking about $30 million for a different reason, Alex, but it's quite less than that. It was $10 million. And for this quarter, it was less than $1 million. And as you know, GIS, it's moving forward to establish different hedge instruments to protect our company from that scenario. As you already know, commercial negotiations were made more to recover the inflation effects more than FX, but in this process, we were benefited also to cover that impact. I don't know, Jorge, if you would like to add something else?

[Jorge Garza, executive]

Sure. Definitely, I mean, the prices in this industry, all the automotive, let's say, component suppliers price their products in U.S. dollars, the ones that are producing in Mexico, right? And this is not going to change, let's say, in the near future. So that is why all the companies that are in the position that we are had to go and negotiate with the customers' price increases. We have been very successful. And you will see that is why about the question of the margin for the next quarters, we still consider that the price negotiations that we are achieving with the customers are going to help us to go back to the original margin that we had before the disruptions of the industry last year and before the exchange rate started to pressure our margins.

In addition to that, to what Saul said about the hedging instruments, we are working very, very hard on productivity, quality improvements that will allow us to compensate and offset the price of the U.S. dollar that is becoming, let's say, lower, or the Mexican peso is becoming stronger. We don't have a crystal ball that we can say if the number is going to go down to MXN 15, but we are doing our best efforts and all we can to continue improving productivity.

Volume is helping us also, because we are getting economies of scale. The more volume we have in the plants, then the fixed costs represent a lower percentage of our total cost. And volume and scale is helping us also to compensate the exchange rate pressures. Okay?

So as I said, commercial negotiations, hedging mechanisms, and productivity improvement programs that we are applying, because we have plants in Draxton that are operating in, let's say, much higher cost environments. And those plants are already operating with these kind of costs. So what we have to do is to try to bring to the plants in Mexico the operating methods that we have in those plants with more automation, with more, let's say, automation is the word, better quality, better productivity, and we have a know-how in Draxton. So it's a matter of just implementing those in Mexico, and then we will offset this pressure from the exchange rate.

[SaúlCastañeda de Hoyos, executive]

Thank you, Jorge. Very clear. And also, Alex, let me correct myself. The impact of 2023 compared with the previous year, 2022, was $10 million, as I already mentioned. And during this quarter, compared with the first quarter of 2023 was $3 million, the impact.

[Alejandro Azar Wabi, analyst]

Okay. My second question would be on the industry. I wanted to hear your thoughts on the slower electrification path that OEMs are targeting right now, or that dramatic shift, I would say, that we've been hearing in the past 7 months, something like that. How do you see your crankshaft business? Are you seeing changes in the orders that you receive? Are you at full capacity now? How do you think of that business?

And the other 1 related to the industry is on nearshoring. This would be the third year that you guys spend close to $100 million in CapEx. And you are saying that you are close to reaching peak utilization capacities again. Should we expect that CapEx for GISSA, let's say, '24, '25, I don't know if even in '26, it should stay closer to $100 million, as also your EBITDA grows as these new programs are coming online?

[Jorge Garza, executive]

Well, let me start by the crankshaft, and let's say, the reduction of the base of increase in sales of the electric vehicles right -- the battery electric vehicles. This is something that we have seen all of us in the media, and we are talking to all our customers to try to understand their view on the programs that they have given us or they have nominated Draxton, okay?

We have an advantage. We have, in many cases, the version for the electric vehicle of 1 platform, and we also have the production -- I'm talking about brakes and other components, we have also the component that is going on the internal combustion engine version of the same platform. Okay? And we use the same production line. So if the electric vehicle doesn't sell as well as expected, and the ICE sells, let's say, better, the total volume of the same platform tends to be the same. And we have the capacity for that, and we are using the same production line.

In our case, the technology is the same, the component doesn't change very much, and we can use the same assets to produce the components for electric vehicles or for internal combustion vehicles. Okay? So that's a big advantage in our process.

Regarding the crankshaft specifically, for example, we were making the crankshaft for 1 OEM in the U.S. And that engine is disappearing, but that's for a different strategy. It doesn't have to do with electrification. The customer decided to change that engine for another one, and that engine is going to stop producing. The other crankshafts probably are not increasing the volumes, but they are going to remain pretty much the same. So the order book is very solid. We don't see that we will have an over demand on the crankshafts in North America. We also produce crankshafts in Europe, okay? But again, we don't think this is going to, let's say, increase a lot. And on the other side, let's say, reduction of the ramp-up of the electrification is not going to affect us because of this. The fact that I mentioned that we have the 2 versions, and we are using the same production line to produce both versions. I don't know if I answered that question.

[Alejandro Azar Wabi, analyst]

Yes, that's very clear, Jorge. And the second one, my question on the nearshoring and the investments. It's also regarding free cash flow, because your EBITDA, let's say, close to $100 million, $120 million, CapEx is almost hitting the entirety of the EBITDA. So my question is that you're seeing a lot of investments, and it seems that you are thinking of adding a new capacity in the next 18 months as you are seeing the volume come.

[Jorge Garza, executive]

Yes, it's a very good question. And I think it's a fair question. We don't think at this moment that we will add additional production lines in casting. However, we are concentrating our capacity in the highest value-added products, and we are reconfiguring the portfolio of products, so that we can focus on products that are, let's say, of more value-added and more profitable for us, which we can do.

I mean, we are already talking to some customers to try to get, I mean, finished contracts of some products that are not our core business, and we are opening capacity with the same facilities or more of the high value-added product that we like and that we want to concentrate on, okay? And that is why the investment in the additional increase in, let's say, core business products is going to be marginal. It is not going to be substantial. This is in casting. In the machining, we already see some additional projects in the way. We don't have any confirmation, but those expansions are more gradual. You will not see $150 million investment in machining in 1 year, okay? So we will do it gradually. And you haven't seen either the additional EBITDA that we are bringing from the investments we are making right now, and this EBITDA is going to go up, and then you will see that the free cash flow is going to start to be positive.

[SaúlCastañeda de Hoyos, executive]

Absolutely. Yes. And just to add to Jorge's comments, Alex, as you already mentioned, 2023 and 2024 are extraordinary years of around $100 million of CapEx, that we are not expecting to keep that level of CapEx for the following years, as Jorge just mentioned, but we are expecting a very important improvement on EBITDA levels.

[Jorge Garza, executive]

Just to clarify, because I think it's important that you don't get the wrong idea, we are not at 100% capacity in San Luis Potosi, for example. The Line #6 is already running, let's say, in 3 shifts. However, it is very important to mention that these lines, you can run at 3 shifts, but you are not at the top productivity level that you want to achieve. So during the year, the outline is going to improve productivity and the volume will grow. Line #7 is just starting. So at the end of the year is when we will see that the line is going to be running full at 3 shifts. And in 2025, we expect to continue running at better productivity levels and improve the volumes. And also, as I mentioned, we are trying to reconvert the portfolio and concentrating some lines in products that are more value-added, that are more related to the business that we like and we want to make.

[Alejandro Azar Wabi, analyst]

Thank you, Jorge. Just to give us some context, if you exclude strategic investments, how much would the CapEx be?

[SaúlCastañeda de Hoyos, executive]

I will say, more around $40 million.

[Alejandro Azar Wabi, analyst]

So that would be the CapEx to run your business without expansion, without adding new lines, just replacement CapEx, maintenance CapEx?

[SaúlCastañeda de Hoyos, executive]

Exactly, replacement, maintenance, around $40 million, I would say, top $50 million. But that will be half of what we are deploying during this year. And the EBITDA is going to grow, right? I mean, we are not staying at this level, because we come from a relatively, let's say, bad year. We are adding capacity. We fix prices, and fixed prices means we have negotiated with the customers, we have new levels of prices, okay? And also, we are improving productivity. So we are very optimistic about the future.

[Alejandro Azar Wabi, analyst]

I mean, 1 more, if I may, on GISEderlan. You are adding capacity. So that business is generating $18 million per quarter that probably -- can you share with us the EBITDA? Is EBITDA closer to 30%, 35% on that machining business? With the expansion, how big would -- do you have contracts there? How should we think about GISEderlan in the next 18 months?

[Jorge Garza, executive]

Well, we can tell you the number. I think it's not a big problem. We don't consolidate that, but you can see it if you go deeper into our numbers. You can find it there. So EBITDA is around $10 million.

[Alejandro Azar Wabi, analyst]

Per quarter?

[SaúlCastañeda de Hoyos, executive]

Annual basis.

[Jorge Garza, executive]

Remember that this is a machining company. The sales include the value of the casting and the value of the machine, okay? So this $18 million of sales include part of the -- I mean, intercompany sales.

[Alejandro Azar Wabi, analyst]

Okay. So that $10 million in EBITDA annually, would that be your stake or 100% of GISEderlan?

[Jorge Garza, executive]

100% GISEderlan.

[Alejandro Azar Wabi, analyst]

Okay. Okay. And with the expansion, Jorge, how big are you seeing this business?

[Jorge Garza, executive]

Well, depending if we fill up the business, the expansion that we are making at the moment, it could go all the way up to double that. However, we don't have the business to do that at the moment. We don't have the order book for that. You have to remember some products go out, some products get in. You need to have the available capacity there. So I can see that more in the next 4, 5 years in the range of $30 million. This is our order book approximately.

[Operator]

[Operator Instructions] With no further questions in the queue, I would like to turn the call to the management for the close of this conference.

[SaúlCastañeda de Hoyos, executive]

Thank you, and thank you, everyone, once again for your interest in GIS. Please do not hesitate to touch base if you have further questions. Have a nice day.

[Operator]

With this, we conclude our conference. You may disconnect.