Grupo Industrial Saltillo SAB de CV

BMV:GISSAA

Earnings Call Analysis

Earnings Call Transcript 2024-Q2

[Operator]

Good day everyone, and welcome to GIS Second Quarter 2024 Earnings Conference Call. Joining us today we have 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 meant for investors and analysts only. During this call, the 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 GIS management team. Mr. Jorge Rada will lead the call.

[Jorge Garza, executive]

Good morning, everyone, and thank you for joining us today. To start my presentation, I want to share that our profitability recovery strategy continues to yield positive results, with this quarter's EBITDA growing at a significant rate in an annual basis against a low base of comparison, while maintaining stability in a sequential base despite a lower vehicle production environment in Europe.

This result certainly highlights our ongoing operational enhancements and strategic capacity expansions at Draxton facilities, which have been instrumental in gradually improving profitability metrics.

During the first half of 2024, Draxton has won contracts equivalent to over $75 million for iron casting volumes focused on electrification agnostic parts. In this sense, our San Luis Potosi facilities additional casting lines 6 and 7 continue to progress as planned, with line 6 currently operating close to peak utilization and anticipating that line 7 finishes its ramp-up towards year end, having both lines filled by the beginning of 2025.

And regarding our plating capacity, the first line is fully operational, while the second line is going over the testing phase and expected to start production towards the third quarter of the year with gradual contribution to revenue.

On the sustainability front, outstands our solar energy self-generation capacity expansion program across our Draxton plants in Europe and China. It is important to mention that this initiative requires no upfront CapEx. Thanks to our partnership with strategic providers and will help us reduce our environmental footprint while optimizing our energy costs.

In North America, vehicle production and sales increased 1% and 3% year-over-year respectively, still showing signs of growth, but also reflecting stronger industry-wide inventory levels, especially for Pickup and SUV platforms.

In Europe, vehicle production declined 5% in an annual basis, while vehicle sales increased 3%, as influx of vehicle imported from China has taken a toll on domestic production, thus contributing to the deceleration in the European automotive sector.

In contrast, on China, production experienced an 8% annual increase, primarily driven by exports, which accounted for 20% of the units manufactured in the first half of the year. However, sales decreased by 3%, despite government subsidies and tax incentives aimed at boosting electric vehicle sales and from a general decrease in price due to intense competition.

Moving on to Draxton performance. Casting volume decreased by 4% compared to the same period of last year, which experienced an extraordinary demand, while machining volume increased by 26% due to the investments made last year. In this regard, year-to-date casting volume decreased by 1%, while machining volume increased by 28%.

By region, in North America, casting volume decreased by 2%, reflecting the high production in 2023 ahead of the anticipated strike at the Detroit Big Three effect, partially mitigated by the capacity ramp-up of our investments in San Luis Potosi. Machining volume surged 40% on an annual basis, boosted by investments made in recent quarters to expand machining capacity. In this context, we remain advancing towards our transition strategy to focus on electrification agnostic parts and components with higher value added.

In Europe and Asia, casting volume experienced a contraction of 6%, driven by a slowdown in the industry's vehicle production. Meanwhile, machining volume increased by 2% year-over-year. To minimize margin impacts in Europe, we are enhancing key operational metrics and implementing costs and expense mitigation strategies.

For the second quarter, Draxton reported revenues of $235 million, reflecting a 5% annual decrease, mostly due to volume fluctuations in the lower raw material and energy price base, which are indexed to selling prices despite incremental volumes from high value-added processes and commercial negotiations.

EBITDA for the period was $27 million, matching last quarter's performance, boosted by the achievements of ongoing improvements at profitability metrics of our production facilities. This figure doubles that recorded in the same period last year, given a low base of comparison that reflects the operational impacts of extraordinary volumes recorded at the second quarter 2022.

GISEderlan, our JV with FagorEderlan, reported a 15% annual growth in revenues supported by an incremental volume. The current capacity expansion project will enable this operation to continue increasing its volume in the future.

I will now hand over the presentation to Saul Castaneda, our CFO, to discuss our financial results in more detail. Go ahead Saul.

[SaúlCastañeda de Hoyos, executive]

Thank you, Jorge. Good morning, everyone, and thank you for joining us today. Moving on to my remarks. GIS consolidated performance has kept a resilient trend, with EBITDA reaching $28 million, doubling the figure recorded at the same period last year with a low base of comparison, but remaining consistent when compared to the previous quarter.

This performance was partially due to the achievement of operational efficiencies and execution of strategic initiatives, especially at Draxton, which has maintained a resilient EBITDA, despite a slight decrease in casting volumes that reflects broader industry trends as previously discussed.

In this sense, GIS consolidated revenues declined 4% year-over-year to $260 million, mainly driven by decreased casting volumes in the North American and European business units and a lower base price for raw materials and energy.

In contrast, the pace of commercial negotiations and the increased contribution from value-added processes contributed to partially offset the impact of reduced volumes.

Down into the P&L, profitability continues to benefit from ongoing improvements in key performance metrics at our North American facilities particularly with line 6 and line 7 production ramp-ups, alongside with the unscheduled installation of a new plating line that will further enhance our manufacturing capabilities and product diversification, thus helping us to maintain and secure new contracts.

In this context, we are confident in effectiveness of operational enhancements, diversification efforts, and cost and expense mitigation strategies, as these are crucial in minimizing impacts on margins and meeting market demand.

We successfully closed our refinancing endeavors through syndicated loans in Mexico and Europe, enhancing our financial flexibility and significantly improving our maturity profile. These transactions not only boost our liquidity and strengthen our balance sheet, but also secure favorable financing terms, which are better aligned to our cash flows across different currencies.

Our net debt stands at approximately $228 million, having a net leverage ratio of 2.5x. Following the closing of 2 syndicated loans which are primarily aimed at debt [ refinancing ]. It is important to know that with this refinancing process our maturity profile improved having an average loan maturity extended to 4 years.

As of the end of the second quarter 2024, our CapEx deployment was approximately $38 million aligned to our ongoing strategic investments and technology integration processes. These expenditures are part of our committed investment plan of $100 million for 2024, which remains on track and financed through a mix of internal cash flows and strategic use of debt.

I would also like to give an update on GIS dividend approved by the Annual General Meeting. The payment of the first installment was carried out in June, totaling $0.056 per share, or approximately $17 million.

I will now hand the presentation back over to Jorge.

[Jorge Garza, executive]

Thank you, Saul. Before concluding, I would like to give a warm welcome to Cesar Cardenas as CEO of Cinsa and Juan Antonio Villarreal as Chief Human Resources Officer of GIS. These 2 executives joined our team with a wealth of experience that will help us adapt to market dynamics and position our company for sustainable growth while navigating through the current economic landscape.

It is important to know that as we move into the second half of 2024, our focus remains on leveraging our operational strengths and capacity expansions to face market fluctuations and seize avenues of growth.

And finally, we are confident in our strategy roadmap and its thorough execution to position us well for sustainable profitability and value creation.

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

[Operator]

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

[Carlos Alcaraz Pineda, analyst]

And congratulations for the results. I have 2 questions. The first one is about the EBITDA margin. What is your estimate for the end of the year?

And the second one is about the additional casting capacity that you are evaluating in North America. You can give us more color on the amount of this investment and the capacity of this increase.

[SaúlCastañeda de Hoyos, executive]

If I may, Jorge, I can answer the first part of the question. Carlos, thank you for being with us. As you know, we do not give a specific guidance on our projections, but what can we tell you is that we're very confident that we can maintain our, I will say, low double digit EBITDA margins. We are still growing. We are at the ramp-up of our CapEx expansions in foundry in line 6 and line 7, that will boost our revenue in the following months and will contribute to, I will say, to boost our margins. But it is important to highlight that we will keep our track and we will grow in a significant way against 2023.

Jorge, I don't know if you would like to add something.

[Jorge Garza, executive]

No, yes. Actually, you are saying it very well. We are in a growth, let's say, trend. So in North America, for example, volumes are growing both or in casting, in machining and in plating. We finally -- we finalized negotiations with customers regarding prices. So you will see now starting the second semester that our numbers will continue to be better because now we will have practically all the products with updated prices recovering inflation effects. So this will bring us additional benefits. So you will see better results quarter-by-quarter.

And regarding the second question, additional capacity that we are considering is because we see customers still wanting to relocate production to Mexico. And we are still quoting products and we see that some of the products might need additional capacity.

One of the things that we are doing at this moment is that we are converting existing equipment to produce products with higher value-added or higher margins. It means we are trying to, let's say, cherry pick products that are the highest margin product. And before adding any capacity, this is what we want to do. For example, if some products are not, let's say profitable, we are going to negotiate with customers the end of these products and to try to incorporate to our portfolio products that are with higher margin that don't need additional capacity. While we finish that, then we will consider definitely to add more capacity because we see still that the reshoring and relocation of additional production to Mexico continues. And if -- I mean if the need is there, then somebody will have to put the capacity. And we are the leaders in the market, and we want to continue to be the leaders.

[Operator]

Our next question comes from Alex Azar from GBM.

[Alejandro Azar Wabi, analyst]

I have a couple of questions. The first one is a follow-up on Carlos, just to understand it completely. There is no more commercial negotiations with your clients, is that correct? You already finished with those, at least for this year?

[Jorge Garza, executive]

Yes, for this year, correct, because it's very difficult to get to that point. The industry changed a lot in the last couple of years. Inflation is very persistent. We don't see that inflation is, let's say, facing out. I mean, we continue to see interest rates that are high and we continue to see inflation that is still high. So we cannot say that we will stay with the prices I mean, long-term as they are today, there is always a market limitation. The moment that you want to have a higher price than your competitors and it means that you will not get it definitely. But if everybody is suffering with the same cost pressures, definitely we will have to go and negotiate additional price increases. But at the moment, basically, we can say that we are practically done.

[Alejandro Azar Wabi, analyst]

We've heard not only in the auto industry, but in other industries, industrial manufacturers, that labor is being one of the, let's say, worst pains that you're having on the cost side in terms of inflation. Is there any way that you could share with us the increases that you guys are seeing, are those increases in labor double digits year-over-year? Or are we thinking high-single digit, mid-single digit? I'm just trying to understand how -- what [ GISSA ] is seeing on their regions.

[Jorge Garza, executive]

You mean, in -- for example...

[Alejandro Azar Wabi, analyst]

In terms of labor.

[Jorge Garza, executive]

Labor in different regions or in a specific region in regions you mean?

[Alejandro Azar Wabi, analyst]

No, no. I mean, yes, yes, yes on your consolidated regions, Mexico or North America, Europe, China.

[Jorge Garza, executive]

Look, we have to consider that, for example, in North America, labor has been increasing, let's say, 7%, 8%, okay? That is the contract with the unions. However, when you had a MXN 20 per $1 exchange rate a couple of years ago, and then you went down to [ MXN 17 ], it is not only 8%, it is more than that, okay? Because prices are in dollars. So of course, in the future, we see that maybe contractual negotiations will go a little bit down below the 8%. There are several pressures from labor reforms that will add additional cost to our, let's say, cost structure.

What we are doing to offset that is that we are applying a lot of, let's say, productivity improvement, let's say, projects which we will automate processes. We will try to increase the speed of our lines. And what we are going to do is to try to reduce the labor content of our products. Still maintaining quality and then compensate all these additional cost increases on the labor.

In Europe, inflation is still high, but what we are seeing is increases of 3%, 4%. Okay? That is what we are seeing. In China it's more or less the same. So we don't see double digit in the near future. We don't see that. However, we need to see what is the development because things change a lot depending on surprises that we can see, I mean, geopolitical surprises. We don't expect double digit, but we need to see.

I don't know if you want to add something, Saul.

[SaúlCastañeda de Hoyos, executive]

Yes, in that regard, Jorge, I would like to add, just as Jorge just mentioned, Alex and I believe that in the past years and even looking forward, I will say that we will see increases of around probably high single-digit increases. I will say, as Jorge just mentioned, we will -- hardly we will see double-digit increases. But we are working, as just Jorge mentioned, to improve efficiency, productivity, automation to mitigate those increases.

[Alejandro Azar Wabi, analyst]

And on that front, and I think also Carlos asked about margins. My question would be a bit different. With the change -- with the accounting changes that you made in terms of allocating the other expenses or the eliminations to the subsidiaries, how should we think about EBITDA per unit margin in Draxton now? Because before this, if I'm not mistaken, you guys were targeting above $300 or around $300 per unit. So how should we think about that figure now?

[SaúlCastañeda de Hoyos, executive]

Alex, it's a good question. I would say that we should expect something very similar that what we accounted for the first half of the year. So, because we have like, this kind of corporate expenses on some allocations that are -- that they are very stable during the year. So we are not expecting an important change on the allocation, or in other words, the EBITDA margins that you're looking at this moment, probably they will see -- for this reason they will keep in the same line. We're not foreseeing any important change in that matter, Alex.

[Jorge Garza, executive]

But I think what Alex is asking is if we were targeting $300, when we have the central expenses not allocated in Draxton, for example, is the $300 stay in $300, it will be $270, for example, or something. This is your question, right, Alex?

[Alejandro Azar Wabi, analyst]

Yes, yes, yes.

[SaúlCastañeda de Hoyos, executive]

In that regard, and probably Jorge can explain better this than myself, but we are -- at that moment, we had this target of $300 before those allocation. But I don't know, with this increase in volume, the value-added from machining and plating, and even with the improvements in all of our operations, probably we can see a figure or our target should be probably around that same $300. Jorge, I don't know...

[Jorge Garza, executive]

It's around, but basically the cost of the central functions that are already -- you can see them in Draxton already. It's about $30 per ton more or less [ looks like ], so. But we have to go back to the $300. I mean, we will not stay comfortable. As I said before, we are implementing productivity measures, a lot of projects for automation, trying to reduce the labor content in our operations. And also, we want to reduce the central costs also. Because remember, we were a conglomerate in the past, and now we are almost a single pure player in Draxton. So we definitely need to make sure that the central functions are at the minimum size needed for Draxton to operate.

[SaúlCastañeda de Hoyos, executive]

Absolutely. I will add something in that regard. Alex, we already executed some saving strategies regarding corporate or headquarter expenses. So we have a bigger figure or a bigger impact than these $30 that Jorge just mentioned. So we are foreseeing that this can be also improved for the following months and years.

[Alejandro Azar Wabi, analyst]

And 2 more questions on my side, if I may, guys. And it's regarding industry. The first one would be, how do you see your competitive position across your markets regarding Chinese investments, I mean, especially in Mexico, but also in Europe. I mean, in Mexico, for example, would it make sense to Chinese Tier 1s to come to Mexico? Or given the scale of GIS, it would be really hard to compete with you. That would be the first one in terms of your competitive position.

And the other one would be, if you can talk a little bit about where you guys are seeing in terms of how Chinese OMs or Chinese competitions are actually competing in Europe and in Mexico on your markets.

[Jorge Garza, executive]

The Chinese Tier 1s?

[Alejandro Azar Wabi, analyst]

Yes.

[Jorge Garza, executive]

You mean customers? I mean the customers that we have in China, for example.

[Alejandro Azar Wabi, analyst]

No, I mean your direct competition.

[Jorge Garza, executive]

Look, I'm going to answer the question in 2 parts. First, definitely the market is growing. And as you see, North America is a [ bloc ] and they are imposing some, let's say, measures to try to protect the market. So some competitors from China will definitely consider coming to Mexico and produce from Mexico. And that that might happen. We cannot say it is or is not happening. Definitely a plant like, the plans that we have requires a lot of know-how, a lot of experience, and it's not going to be easy, but it's not impossible for a Chinese company to install capacity in Mexico. And it is also why we are saying that maybe we need to add more capacity because we see still additional products being relocated to Mexico. Okay? So definitely we can all discard competition from other countries in Mexico.

In Europe there is a lot of capacity, but we are seeing or hearing that some Asian companies would like also to add capacity in Europe. But definitely, when they go there and when they go to Mexico, they need to compete with the same cost structure. They will hire the same kind of people. They will -- I mean, equipment is more or less the same because we all buy from the same suppliers of equipment. Electricity is going to be the same. So we will compete under the same basis. So I think since we are here and we are producing for many, many years, we definitely must have an advantage. Right?

[Alejandro Azar Wabi, analyst]

Jorge, out of your, let's say, if you were to produce a caliper in Mexico, in China and in Europe, in which place would be, let's say, cheaper to produce? Is that in Mexico?

[Jorge Garza, executive]

Well, let me tell you, the raw material, for example, in China is cheaper. So raw material is a big portion of the cost of the total products. So that makes a big advantage. When you try to bring the caliper all the way to Mexico, then you have transportation and import duties and things like that that make it not as competitive. But if you consider the total production costs for an iron casting, it will be cheaper in China. I mean, X works, right?

[Alejandro Azar Wabi, analyst]

Yes. And the other one, what are you seeing in terms of the -- I mean, not only Tier 1, but OEMs, what are you hearing from your clients in terms of the Chinese competition? And also, regarding electric vehicles, powertrain, you guys have a strong position in powertrain components. So what can you tell us about those, let's say, factors in the industry?

[Jorge Garza, executive]

Well, in North America, we are very strong with -- not only with the Big Three, but we are also selling to Japanese companies and Korean companies and their Chinese companies are not here yet, so. But we have contact with Chinese companies in China because we produce already in China. So if some of those definitely decide to come to Mexico, I don't see why we cannot be a supplier to them in Mexico. Okay?

In Europe, again, also, they are not producing from Europe. They are having plans to produce in Europe. So I don't see why we wouldn't be able to provide them with caliper brackets and other components. Okay. So electrification, definitely there is no crankshaft on an electric vehicle, but in the hybrids there is crankshaft, and the brake components and chassis components, the ones that are designed in iron, are the same and they don't care if it is electric or hybrid or ICE. So I think we are well positioned in the 3 regions to continue supplying to whoever the customer is. Yes, we don't necessarily think if it is a German company or an American, Korean, Japanese, American Chinese, we should be able to supply to them.

[SaúlCastañeda de Hoyos, executive]

And I will add that, Alex, that even considering a lower pace in the electrification trend, Draxton is a strong player there in the powertrain, I mean, but we, as you know, are stronger even in auto parts for brake systems. So we are growing. In our last CapEx, it had been directed to increase our capacity for brackets, mainly. So we are a strong player. Draxton is a strong player in powertrain, but our bigger part of our portfolio is not powertrain, as you know, it's brakes and other components.

[Operator]

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

[Jorge Garza, 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.