Grupo Industrial Saltillo SAB de CV

BMV:GISSAA

Earnings Call Transcript 2018-Q2

[Operator]

Good day. My name is Leo, 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] Thank you.

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 Second 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. Jorge Mercado, Chief Financial Officer; and Mr. Saúl Castañeda, Investor Relations Director. They will be presenting the company's performance as per the earnings release issued Friday after the close. If you did not receive the release and would like a copy, please contact i-advize in New York at [phone], and we will email 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 stated otherwise.

It is now my pleasure to turn the call over to Mr. José Manuel Arana, CEO of GISSA, to begin with the main highlights and a strategic overview. José Manuel, please go ahead.

[José Manuel Arana Escobar, executive]

Thank you, Patty, and to everyone for joining us today. I will give you a quick update on the evolution of our globalization strategy, and then allow Jorge, our CFO, to dive into our results.

We continue focusing on operational efficiencies, organic growth, organizational agility and financial flexibility. We have made significant progress since we first decided to increase our geographic presence and product diversification.

Second quarter results are proof of that. Despite having a highly volatile and uncertain scenario during the period, specifically Mexico, we are reporting double-digit year-on-year growth of 11% and 10% in revenue and EBITDA, respectively.

On a year-to-date basis, sales show a steady behavior with a 5% increase versus previous year. Draxton is again the main driver of this growth as the segment of Europe and Asia reported double-digit growth in revenues. The EBITDA performance of Draxton, Calorex and Cinsa offset challenges in Vitromex.

The globalization strategy we implemented in the past years has delivered a stronger financial position. The business exposure to NAFTA has been reduced considerably. This also lead us to improve our currency hedging. Today, we have 62% of the revenues in U.S. dollars or euros and up to 82% of the EBITDA in these foreign currencies. This has been a key factor to foster the growth trend we are experiencing geographically and in currency diversification.

Investments in Mexico construction industry continue steady despite uncertainty over the country's relationship with the U.S. Senior U.S. and Mexico officials have agreed to step up negotiations to overhaul the North American Free Trade Agreement with the aim of reaching a preliminary deal by late August.

Ildefonso Guajardo, Mexico's chief trade negotiator, said the agreement is feasible from a technical perspective. Politically, there is a need of flexibility from all parties. Regarding this, Mr. Guajardo plans to meet with U.S. Trade Representative, Robert Lighthizer, in Washington on July 26 to address NAFTA sticking points such as content rules for the automotive sector and mechanisms to solve the disputes. Canada will join in negotiations, Mr. Guajardo said.

Draxton's strategy is accelerating team integration and customer demand generation globally, providing many new commercial operating and marketing advantages. We are engaging with former customers in new regions and new customers in existing regions, expanding our presence in global platform programs.

Due to these, volumes grew overall as strength Europe and Asia outweighed weakness in North America. We are developing a strong order book for the future, and we feel very strong on volume growth for the next 5 years.

Our focus at Draxton for the second half of 2018 will be to maintain our leadership in the Mexican market, strengthen our position in Europe and accelerate growth in China.

During the quarter, our efforts in Vitromex focused on recovering profitability in Mexico by aligning production and inventories to products with higher turnover and investing CapEx in productivity improvements. While in the U.S., we relaunched an innovation process that will be deployed in the next 2 quarters.

Vitromex is in the process of a turnaround. Progress will be slow but steady. Vitromex's strategy to enhance profitability has 4 main focal points. The first one is to strengthen revenue management; second, improve sales and operations process; third, optimize working capital to focus on cash generation; and the last one, to continue to improve cost productivity.

We are aware that many of the setbacks in the past were completely related to internal factors. Therefore, to drive the success of the strategy, we have created a committee to oversee the execution of the following 3 goals: cultural change in terms of work, routines and employee safety; an operating change to ceramic engineering and key performance managing systems that focus on a few vital indicators to help the business increase value; and finally, resource optimization related to manufacturing design, project management improvement and a cost efficiency program to improve competitiveness.

Vitromex trend for third quarter of 2018 will be similar to the ones reported so far as the transition requires time, but we expect to start seeing an EBITDA trend turnaround by first quarter of '19.

Now the Construction segment has reincorporated Calorex into its results. Last month, we announced the termination of the sales agreement of our Water Heater business. This decision highlights the fact that we own a true truly strong, dominant player in the Water Heater business that is well regarded by our customers.

The significance of the Calorex brand, our manufacturing capabilities and premium quality products and service, will continue driving us to maximize profitability and seek growth in this dynamic market.

GISSA's mandate is to constantly seek opportunities that add value to our shareholders. Therefore, we will continue those efforts in order to strengthen innovation and identification of energy consumption efficiencies and, at the same time, increase practicality for the users of Calorex.

And last but not least, the houseware sector. GISSA had a very active and dynamic quarter. Strong EBITDA growth came from double-digit top line growth. Looking ahead, we plan to expand our U.S. presence and take advantage of the positive trends for enamel-on-steel products.

Our main challenge for the second half of 2018 is Vitromex turnaround process, where GISSA is committed to globalization strategy and to deliver shareholder value.

I now give the floor to Jorge for the discussion of GIS' financial performance.

[Jorge Armando Perez, executive]

Thank you, José Manuel, and good morning, everybody. Turning now to our financials.

I'm pleased to say that GIS had solid second quarter performance vis-à-vis the challenging Vitromex results. On a consolidated basis, we reported double-digit growth, both in revenues as well as EBITDA, 11% and 10%, respectively. And excluding Vitromex, EBITDA growth was 34%. The Draxton business added MXN 500 million of additional revenues and MXN 123 million of additional EBIT for the quarter. Expense control in Vitromex in G&A provided additional [indiscernible] to our profitability.

Net income for second quarter '18 include some items that influenced comparability to the second quarter '17. One is higher depreciation and amortization expense affecting this quarter related to the previous quarter last year because of the price paid for acquisitions of Infun, now Draxton Powertrain Europe. This process is known as the Purchase Price Allocation, or PPA, which we will lap for most of the year. And the second, in the Comprehensive Financial Result line in 2017, there was a benefit of MXN 14 million related to exchange rate fluctuation, while in the second quarter '18, this represented a charge of MXN 138 million.

The geographical diversification has helped GIS create a stronger cash flow base not only in [indiscernible] but also in a shift in the currency mix [indiscernible] currency. Today, as José Manuel explained, 62% of our revenues and 82% of our EBITDA are generated mainly in euros or dollar. Not many public companies in the Mexican Stock Exchange can deliver in this situation.

On a pro forma basis, including joint ventures, GIS has an even stronger performance. JVs had double-digit increases in revenues supported by higher iron casting and machined volumes having MXN 12 billion or 13% EBITDA growth year-on-year for this quarter. The JV strategy has been validated by these results. We have achieved the integration of value-added profits, additional customer relationships and more focused [indiscernible].

Now let me take you through the key business drivers of these results in EBITDA and sales, starting with Draxton.

In dollar terms, EBITDA -- sales grew by 12% year-on-year and EBITDA up 19%, once again exceeding our expectations for this quarter. In the North American geography, revenues were up 6%. The business in this region delivered an important margin expansion, driven by a profitable volume mix, favorable exchange rates and operating efficiencies and expense control, particularly in the [indiscernible], who delivered a solid 24% EBITDA growth for the quarter.

Europe and Asia revenue growth was 17% supported by a 5% volume growth, improved product mix, the surcharge adjustments, delivering 10% EBITDA growth. Some operating [indiscernible] lost [indiscernible] in terms of volume in our [indiscernible] plant, and [ I mentioned ] quality [indiscernible] this year and adverse exchange rates in China. Year-to-date June in NAFTA and [indiscernible] contributed to the increased [indiscernible].

Now let me turn to the Construction segment. It has been a tough year for Vitromex and Calorex. During the first half of the year, [indiscernible] experienced some slowdown as [indiscernible] came closer and led to an cost increase in raw -- of some raw material prices and [indiscernible] in the exchange rate.

All these factors [indiscernible]. In the case of Vitromex, our [indiscernible] indicated that for the first half, the volumes [indiscernible] fell around 5% versus last year. In addition, sales [indiscernible] 1x than [indiscernible]. As José Manuel mentioned, we are committed to delivering improved operating performance and achieve [indiscernible].

Let me turn to the financials in more detail.

The business has continued to face some challenges, both in the U.S. and Mexican markets. In the U.S. market, we suffered a sharp drop in volumes due to delays in the [indiscernible] profit and a [indiscernible] in some key customers, which accounted for a large [indiscernible] in 2017.

In [indiscernible], volume and price/mix gap drives a significant part of the loss of revenue and profitability for the business as a whole as the margin contribution of in the U.S. was much higher than in Mexico. We are well executing and we are completely [indiscernible]. In addition, we are strengthening our innovation [ pipeline ] in the [indiscernible] where we operate. This market is crucial for the growth of the company.

In Mexico, the industry slowdown has pressured prices and slowed inventory turns. We are responding by maintaining market share in all segments. We are starting to [indiscernible]. We understand the [indiscernible] of part of our turnaround strategy. Our [indiscernible] is in Mexico [indiscernible] in efficiency and creates revenues and profitability.

As such, revenues in the second quarter of '18 for Vitromex were down 10% to MXN 878 million. EBITDA was negative MXN 41 million, half of it driven by onetime [indiscernible]. Our savings in fixed costs and other [indiscernible] in the gross margin.

We are 100% [indiscernible] in the initiatives to help turn around the business in the coming quarters.

On a positive note, Calorex posted double-digit growth of 11% in revenues in the second quarter.

EBITDA decreased 26% to MXN 13 million due to raw material and energy cost increases, onetime [indiscernible] charges and higher marketing and advertising expenses [indiscernible]. Most of the [indiscernible].

Given that the business was [indiscernible], excluding some [indiscernible], allow me to expand a little bit on what happened in some of the key factors [indiscernible] performance.

We [indiscernible] 2 challenges primarily on the instant water heater category [indiscernible] strategy to focus on vertical housing and [indiscernible] products. In addition, the market [indiscernible] exceeded our expectations, thanks to the [indiscernible] in the [indiscernible] housing and residential market estimates there.

[indiscernible] positive [indiscernible] and [indiscernible] in the low double-digit numbers. It's a very good sign of Calorex [indiscernible] opportunity besides Mexico.

Finally, let me comment on Housewares. Fees have increased revenue by 12% to MXN 400 million on the back of the food processing product line added to the [indiscernible] last quarter as well as the pretty strong performance of [indiscernible] and savings.

The segment's EBIT and EBITDA margin for -- in second quarter '18 both significantly increased, one by 64% to MXN 31 million and then the EBIT margins [indiscernible] at 3% -- 3 percentage points to 8%, respectively, due to the federal price effect year-on-year on steel and ceramics and [indiscernible]. But as said, significant raw material increases for the quarter.

For the first half of the year, GIS revenues have increased 5% while EBITDA [indiscernible] performance relative to challenging [indiscernible] of the first quarter and challenging economic performance.

As previously mentioned by José Manuel, we achieved successful refinancing of our corporate debt. We have signed a syndicated loan to bolster our liquidity as part of the financial strategy with the aim to meet our [indiscernible] globalization strategy. The loan will be used to pay off the existing balances of the previous syndicated loans contracted for the acquisition for the acquisition of the Infun Group [indiscernible] in Asia.

In dollar terms, at the end of this quarter, we were able to lower overall debt balance in dollars [indiscernible] and increase the duration of the loan to 4.6 years and have now lower financing costs and good financial covenant.

We are certain that this transaction strengthens our financial situation by enhancing our liquidity and providing the flexibility to [indiscernible]. [indiscernible] the market's trough, we are confident in [indiscernible] supply.

Finally, let me share with you at a high level what we [indiscernible] outlook for GIS.

The different business sectors and geographies in which we operate allows to participate in dynamic markets and industries in which we will continue to find ways to grow and create shareholder value. To be a little bit more specific, for Draxton in the short term, we expect top line positive trends across all regions. Theirs financials should continue in the same trend as well in North America as we see no NAFTA renegotiations impact in the short term.

In the mid- to long term, we are most confident that [indiscernible] the trends that we see right now allow us to think that we will have a significant top line growth. Programs have been awarded, about 35,000 tons per year of incremental business level. We are committed to understand the Chinese market better and to create a profitable business there.

Vitromex' turnaround is [indiscernible] and will remain a key priority. Given the current [indiscernible] and the seasonality of sales, we see limited recovery in the short term, although mid- to long term, we foresee a turnaround in revenues and EBITDA trends due to the recovery in the U.S. volume, efficiency in operation and strong revenue management.

Calorex, we are very profit driven. And we continue the top line trend in the short term, while in the midterm, we expect expansion driven by exports continuing to improve profitability and margin.

In Cinsa, we'll see a stable top line and profitable growth versus last year and continue in the short term and midterm. Higher -- the high-growth businesses lead to higher margins and higher market penetration in the U.S.

Regarding CapEx, on a consolidated basis, we estimate that for the year 2018, we will reach about MXN 1.3 million to MXN 1.5 million.

This concludes my presentation today. I'll now ask the operator to please open the floor for the Q&A. Thank you all.

[Operator]

[Operator Instructions] We'll take a question from Alejandro Chavelas of Actinver.

[Alejandro Chavelas, analyst]

Just a couple of quick questions. Yes, the first one is regarding the financial gains that you posted as classified by the gains from financial instruments. I'm guessing that this is related to hedging instruments. Would you like to understand this and how to think about these effects going forward? And if you want, we can answer this one, and then I will go to the next question?

[José Manuel Arana Escobar, executive]

Jorge, you want to try that?

[Jorge Armando Perez, executive]

I could not hear the question, I'm sorry.

[Alejandro Chavelas, analyst]

No. Regarding the financial gains, you reported MXN 160 million related to financial instruments. Just to understand where that came from.

[Jorge Armando Perez, executive]

I would tell you, I cannot hear the question. I apologize, I'm in a different phone.

[José Manuel Arana Escobar, executive]

Yes, let me take that if you can hear me.

[Alejandro Chavelas, analyst]

Yes, I can hear you, José Manuel.

[José Manuel Arana Escobar, executive]

The gain is the combination of risk or exposure that were negative impacts on exposure and a positive impact on the gain. When we were selling Calorex, we hedged the income related to the sale of Calorex. When COFECE notified us that they denied the operation, we downturned or unwinded the coverage. And that gain, I think, is -- MXN 120 million comes from the unwinding of that hedging.

[SaúlCastañeda de Hoyos, executive]

That's right, José Manuel.

[Alejandro Chavelas, analyst]

Excellent. The second one, regarding Vitromex, you mentioned that you were trying to relaunch an innovation process for Vitromex. I did not understand what that referred to. What was that about also?

[José Manuel Arana Escobar, executive]

In the U.S., the market is also changing in terms of design, not only in formats, but within the formats, there is -- innovation is referring to product design. So we hired additional people in the marketing area, and we appointed people in Mexico in the design area to support the U.S. business in developing at least 12 new series of products to launch in the U.S. so that we can increase sales.

[Alejandro Chavelas, analyst]

Okay, perfect. Yes, and the third one. Regarding Cinsa, you mentioned that you plan to reach for higher penetration in that market. I'm guessing it is related to the U.S.-China tariffs that are being applied. Or what's the driver behind this effort?

[José Manuel Arana Escobar, executive]

No. There are no China tariffs related to our finished products. The driver is because the mix of U.S. sales have a much higher margin, and we are identifying retail stores that we are already showing our products and sales are in a very good increase. Primarily in enamel steel, that's where we are focusing the U.S. sales.

[Operator]

We'll take our next question from Jose Vazquez of GBM.

[Jose Vazquez, analyst]

I was seeing the numbers in Draxton's page, saying that JVs had a record 45% increase in revenues -- in volumes, sorry, and 47% in revenues. But I managed to see that the EBITDA margin had declined. Well, it came below like 2 percentage points. Could you explain why -- the reason for this?

[José Manuel Arana Escobar, executive]

You want to take that, Saúl?

[SaúlCastañeda de Hoyos, executive]

Sure. Thank you, José Manuel. Thank you very much, Jose. Sure, let me give you an explanation. As you know, energy costs had been an issue in the Auto Parts segment. We had been working on that issue and making some progress, but we have struggled with some kind of additional costs. But as you see, we are reporting an important growth in the Auto Parts segment as a whole segment. And mainly, I will say that's the impact on the EBITDA margin.

[Jose Vazquez, analyst]

Okay. Well, going into Cinsa, how much of the growth is from -- if you can explain to us, from the new line that you've been -- that you incorporated this quarter? And how much of it was from the legacy business in Cinsa?

[SaúlCastañeda de Hoyos, executive]

Sure. Do you want to take this, anyone of you? Or should I...

[José Manuel Arana Escobar, executive]

Go ahead, Saúl.

[Jorge Armando Perez, executive]

Go ahead, Saúl.

[José Manuel Arana Escobar, executive]

Thank you.

[SaúlCastañeda de Hoyos, executive]

Okay, sure. Let me give you some reference, Jose. I will say for revenue, it's an important addition, the new line. I will say probably 15% to 20% of the revenue. But in the EBITDA level, I will say the efficiencies and the performance of the enamel steel, ceramic and also aluminum lines are the main contributors or drivers. Not -- I will say the EBITDA growth is not related to the new lines, more with the traditional lines that we have.

[José Manuel Arana Escobar, executive]

With the -- I think the Houseware business, we are working with the flows of the plant and increasing the output of the plant so that we can reduce our cost, our processing cost, to offset the incrementals of our products that are mainly used in each one of the business.

[Operator]

Our next question is from Alejandro Azar of GBM.

[Alejandro Azar Wabi, analyst]

First, on Draxton, could you give us more color on the margins per region? For example, we are seeing that NAFTA, despite a decline in volumes, you have increase in margins by around 3 percentage points. Would you say this is only a product mix in terms of pricing? And in Europe, where you see growth in volumes, we are seeing a decline in margins. Would you comment that the impact here is the FX? Or...

[José Manuel Arana Escobar, executive]

Go ahead, Saúl.

[SaúlCastañeda de Hoyos, executive]

Sure, José Manuel. Thank you, Alejandro. Yes, let me give you the first reference. For NAFTA, we are increasing in an important way the margins. We have a margin expansion. And I will say, as you mentioned, some effects will be related with volume and then with FX, but the most important one is the surcharge. We're having an important surcharge positive effect in this quarter. And as you know, we have quarterly cut our transition processing between the surcharge, and we are having a benefit in this quarter. And in the other hand, in Europe and Asia, it's where we have the main aspects of energy and some other ramp-up costs of the new lines in Europe due to the capacity that we recently launched, the new capacity launch on the last quarter. I will say that's the more important issues there.

[Jorge Armando Perez, executive]

Let me add to that. There are some actually timing because of delays on some volumes that we've been carrying either in the customer side to -- for those project to start, so there are some dealers in which we lost some operating leverage there.

[Alejandro Azar Wabi, analyst]

I'm sorry, Jorge, I'm having a hard time hearing you.

[Jorge Armando Perez, executive]

Can you hear me better?

[Alejandro Azar Wabi, analyst]

A bit.

[Jorge Armando Perez, executive]

Hello? Sorry. Yes, I think just to Saúl's response, there were a couple of projects which was delayed in Teruel plant in the powertrain division, which now also contributed to the margin or operating leverage loss for the quarter. But these are only timing issues.

[Alejandro Azar Wabi, analyst]

Okay. Another one in Draxton. In the outlook, you mentioned that you're -- in the mid- to long term, you have been awarded around 24,500 tons (sic) [ 34,500 tons ] per year. When are we seeing these volumes ramp up towards 2019? Or are we seeing some of these volumes in this year?

[José Manuel Arana Escobar, executive]

We're going to see a steady growth year-over-year to the extent that in the next 24 months, we will be reaching our NAFTA capacity. And we have the need to expand our manufacturing capacity. We see that despite NAFTA making a lot of noise, we continue capturing volume in the next 5 years in what we see is a steady growth that will definitely not only pressure us to build capacity in 24 months, but we see that in the third and fifth year in the next 5 years.

[Alejandro Azar Wabi, analyst]

Is this the same -- not problem, but is this the same case as for Europe in terms of capacity -- in terms of reaching capacity in the next 24 months?

[José Manuel Arana Escobar, executive]

No. Europe is different. Europe, we have capacity in Teruel. We expanded or doubled our capacity in Czech Republic. So by 2019, we will be reaching our 80% capacity with the -- a slower trend, and we also see synergies that we will implement in Europe. We'll expand our current capacity through efficiencies, so we can cope the next 3 years in Europe. In China, China is different. We do have additional volumes in China. We are currently investing in capacity in China to grow 50% our China capacity. And that should be ready by the beginning of Q1 of '19.

[Alejandro Azar Wabi, analyst]

And one more if I may, José Manuel. You mentioned on your remarks that one of your key objectives is to achieve breakeven levels in the JVs, and I would think that you referred to GISEderlan and InfunEderlan. Would you comment in which part of the breakeven phase are those subsidiaries?

[José Manuel Arana Escobar, executive]

Yes, yes. That is the case only for GISEderlan and InfunEderlan because Evercast is truly one of our examples on our growth, profitability also and cash flow. For GISEderlan, we should be getting to that level early next year when we start launching the bigger volumes of that plant. InfunEderlan has many, many plants to expand that will be reached probably late '19, early '20. It's a much, much smaller operation in China in InfunEderlan.

[Operator]

[Operator Instructions] We'll move next to Alan Hernandez of Signum Research.

[Alan Hernandez, analyst]

Yes, a quick question. Can you tell us a little bit more about your construction investment. Especially what percent of your total cost were represented by aluminum, scrap metal and steel?

[José Manuel Arana Escobar, executive]

Jorge, you want to take that?

[Jorge Armando Perez, executive]

Can someone just repeat the question? I'm sorry, but this -- the line is really bad on my side.

[José Manuel Arana Escobar, executive]

Okay. Saúl, can you supplement...

[SaúlCastañeda de Hoyos, executive]

Sure, I can take that one. Don't worry, Jorge. Sure, thank you for the question, and let me give you an important reference. On June 7, we released a report in which we announced that we have on the Draxton sector, we are dedicated to casting and machining auto parts in gray and ductile iron and -- for brake, engine and suspension systems. And an important note here is that we are comprised on this kind of products of non-steel or aluminum materials. We don't have aluminums and material for our processes in NAFTA, that's important to highlight. We have aluminum auto parts just in Europe. So here, we have just gray and ductile iron auto parts.

[Operator]

[Operator Instructions] We'll move next to [ Luis Vega ] of GBM.

[Unknown Analyst]

I would like to ask if you had any impact from the tariffs imposing in Europe mainly on metals during this year.

[SaúlCastañeda de Hoyos, executive]

Sure. And we are not foreseeing any important impact there because -- just to give you a reference, we have around 550,000 metric tons of iron capacity and just -- and it's like 20,000 tons of aluminum. So probably, we will have an impact there but not as relevant as for the whole capacity production of our Auto Parts segment.

[Operator]

[Operator Instructions] And it appears that we have no further questions at this time. I'd be happy to return the call over to our host for any concluding remarks.

[José Manuel Arana Escobar, executive]

Thank you, thank you very much. In closing, I would like to highlight that we are generally focusing volume growth to help increase operating leverage and, as we're improving profitability through better revenue management, improve cost efficiency. Meanwhile, our business and geographic diversification has helped to improve our results, and the turnaround of Vitromex continues.

Thank you guys once again for your continued interest in GIS. Please don't hesitate to contact us if you have any further questions. Have a great day, and thank you so much for your questions.

[Jorge Armando Perez, executive]

Thank you.

[Operator]

Thank you. This does conclude today's Grupo Industrial Saltillo's earnings conference call. You may now disconnect your lines, and everyone, have a great day.