Grupo Industrial Saltillo SAB de CV

BMV:GISSAA

Earnings Call Transcript 2020-Q3

[Melanie Carpenter]

So good day, everyone, and welcome to GIS' Third Quarter 2020 Earnings Conference Call and Zoom webinar. Joining us today is GIS' Chief Operating Officer, Mr. Jorge Rada; GIS' Chief Financial Officer, Mr. Jorge Mercado; and GIS Investor Relations Manager, Mr. David Sandoval. Please be advised this event is for investors and analysts only.

During this call, we'll be discussing the company's performance as per the earnings release that we issued on Tuesday. If you didn't receive it, it's now available on the company website at www.gis.com.mx in the Investor Relations section, and we encourage you to follow along with this on screen presentation through Zoom.

All the lines are now placed on mute so that the speakers won't have any background noise. We're going to do a question-and-answer session after the speakers' remarks. We're going to take your mute off when you've raised your hand to ask a question. There may be a slight delay from our speakers. So the company is really doing a great job in innovating and being one of the first in Mexico to use the Zoom platform for an earnings call. So we ask you to just bear with us, and we really hope that this enhances your experience this quarter.

So turning now to some housekeeping items. Just remember that some forward-looking statements will be made during the call, and they're based on information currently available. So these might change due to a variety of factors. So for more information, there's a disclaimer in the earnings release. And all the figures are going to be in U.S. dollars unless otherwise indicated.

So it's now my pleasure to introduce the GIS team, and we're going to start with a presentation from Mr. Jorge Mercado to begin the event. Please go ahead, Jorge.

[Jorge Armando Perez, executive]

Thank you very much, Melanie, and thank you all for joining us today. I sincerely hope that you and your families are in good health in the midst of this pandemic. In the past months, we have seen an important recovery in the main economies in which GIS operates. Thanks to the different strategies, they have been making to contain in the spread of the virus and the stimulus packages that have been implemented. It should be noted that more than 70% of GIS revenues come directly or indirectly from economies that have been benefited by these stimulus packages.

Although new cases have been registered in China. And thanks to strict sanitary measures implemented in the country has effectively controlled the pandemic, and it now is expected to grow around 2% this year. Our new wave of infections is hitting the Europe and the U.S., but its mortality rate seems to be lower. Even though in Spain, cases are rapidly increasing, other countries where [indiscernible] and outbreaks have shown a large spread.

Despite the containment measures, the manufacturing sector is not affected. Meanwhile, in the U.S., after the pandemic induced crisis in the second quarter of 2020, the economy now begins to recover, and we can appreciate a significant rebound. Regarding this quarter's results and its highlights. We saw a significant recovery in all our businesses. On a consolidated level, GIS EBITDA was the best it has been in the last 8 quarters, which is the result of the big efforts we have made in our rightsizing program as well as our global economic reactivation.

Our EBITDA margin was 360 basis points higher than the first quarter of 2020, with important cost reductions in different business units. Regarding our financial position, GIS has managed to assure a solid position with a net debt-to-EBITDA of 2.7x and 1.4x if we use the annualized EBITDA for the last quarter.

We have maintained a healthy cash level of $76 million. Regarding sales, we had a positive performance during the third quarter. Vitromex grew 16% in pesos over the third quarter of 2019. Our volumes improved following the reopening of the economy, also due to channel replenishment and increased remodeling activities in Mexico.

CINSA got its highest sales level of the last 6 quarters and increased its revenues in pesos by 27% due to a significant increase in exports and attaining an EBITDA margin of 11%. GIS has continued to have a very disciplined and responsible approach regarding that policy. As I mentioned in the highlights, GIS has managed to assure a solid position with net debt-to-EBITDA of 2.7x. And 1.7 -- I'm sorry, 1.4x if annualized EBITDA for the last quarter.

It is important to mention that due to the positive financial results of the company, we have paid down the committed credit lines of $50 million that we announced during the second quarter report. We will continue having these credit lines available, if necessary.

As you know, and thanks to the refinancing carryout last year, we don't have significant payments for the next couple of years, which allows GIS to have a financial position with a lot of flexibility. Now, I will pass the presentation to Jorge Rada. Thank you.

[Jorge Garza, executive]

Thank you, Jorge, and good morning, everyone. I hope you and your families are staying safe and healthy. As we have mentioned before, our priority at GIS has been to protect and support our employees' health, sparing no resources to achieve this end. We have developed a COVID-19 4-pillar strategy at GIS.

First, we designed our protocols to exceed government regulations and recommendations in all our operations worldwide. Second, we developed an information system to track the health of our workers to protect them and guarantee the continuity of our operations. The third pillar consists of the attention to COVID-19 cases when necessary via telemedicine and the fourth pillar is culture and communication, for which we have held different campaigns, surveys, town halls, and other activities to raise awareness and commitment among all our personnel. We will continue to monitor the pandemic and take all necessary actions to keep our employees safe.

Now, let me turn to Draxton. Regarding the automotive industry, I will share some trends in the market where we sell and operate. In North America, light vehicle sales are trending upward, supported by government stimulus packages, low interest rates, and extended loan payoff periods. Solid production levels are expected for the rest of the year as demand is recovering and inventory replenishment is needed.

In Europe, vehicle sales are showing improvements derived from incentive programs in the main markets. Compared to the last year's third quarter, sales dropped just 2%, which is a sign of market recovery. In China, some OEMs even decided not to have their typical summer shutdowns, repairing inventories prior to the October's festivities. Sales during the quarter continued to improve due to incentives and subsidies supporting the acquisition of new vehicles.

Regarding Draxton's performance. During the third quarter, our global foundry volume decreased 5% year-over-year. However, this was significantly higher than in the second quarter of 2020 due to the reopening of the main markets where we operate. Our North American sales contracted 14% year-over-year, while in Draxton, Europe, and Asia sales decreased by just 2%, showing sustained improvement.

The change in EBITDA versus the third quarter of last year behaved similarly to sales, closing at $32 million. However, although sales were lower than the third quarter of last year, our rightsizing and efficiency programs allowed us to reach a 23% EBITDA margin, which is higher than margins in the first quarter of this year.

We are proud to announce that over the last 3 months, Draxton was awarded with new projects in the brake component sector that will be launched over the next 2 years for several end customers, as well as new business for brakes from our customer [indiscernible] in the trucks market. We also secured our first contract with Tenneco for machine chassis supports for Daimler.

All of this will assure us medium and long-term growth. Looking forward to growing and diversifying our business in China, we already began our first program for machine differential housings for Volkswagen. While in Europe, we expanded our portfolio of materials and technologies by launching new components in vermicular graphite iron for ZF and silicon molybdenum for Renault Nissan. This is for Draxton.

Now, moving on to Vitromex. Revenues grew 16% with respect to the third quarter of last year, where a strong recovery was seen in the market, following negative effects called by the pandemic. In Mexico, we observed a high level of activity associated with home remodeling. This was thanks to the recovery plan, which includes cost reductions, renewal of the product portfolio, management of working capital and service level improvements.

Vitromex has had strong cash flow generation of nearly MXN 200 million in the quarter. The heavy focus on improving manufacturing processes enable Vitromex to set records in several productivity and quality indicators in the quarter. And thus, the manufacturing unit cost dropped 16% versus the average of last year, meaning this was our best unit cost in the last 15 quarters.

The dynamism of revenues in Mexico and the strong cost reduction led to the third quarter of this year EBITDA of MXN 97 million, which is the best result since September 2016. Without extraordinary costs of the restructuring program and inventory reduction, EBITDA would have been MXN 130 million. There are still many opportunities of efficiency and improvements in operations, which we will capitalize on the following quarters as we continue to implement our strategies.

Now regarding CINSA, the business obtained its highest sales of the last 6 quarters, driven mainly by exports and our Granite Wear brand in the U.S.A. In addition to higher sales volume, our operating efficiencies allowed us to significantly reduce our costs, resulting in an 11% EBITDA margin for this quarter. Now, I will pass the presentation back to Jorge Mercado.

[Jorge Armando Perez, executive]

Thank you. And just to close, GIS outlook. Basically in Draxton. As you can see, we'll maintain the rightsizing strategy, which has provided us with a lot of benefits. We will continue to take advantage of relocation trends driven by the U.S. MCA and continue to grow machine parts across all geographies, while leveraging our engineering in these same capabilities.

In Vitromex, as Jorge mentioned, we continue to focus on building cost competitiveness. Regional growth in the U.S. will be a high priority to focus in areas in which we are cost competitive. And in Mexico, we'll continue to grow profitably by managing mix according to our market segments.

Finally, in CINSA, we'll continue to expand our footprint in the U.S., leverage the brand portfolio that we have in the U.S. and also continue to innovate in products to revitalize our traditional channels in Mexico.

This concludes my remarks for today, and thank you for your attention. Operator, please begin the Q&A.

At this time, we're going to open the floor for questions.

[Melanie Carpenter]

At this time, we're going to open the floor for questions. So first, we're going to take them from the conference call, and then we'll take them from the chat section in the Zoom platform. [Operator Instructions] So we have our first question from Alejandro Azar.

[Alejandro Azar Wabi, analyst]

I have a few questions. First, on Draxton. And Jorge, with your experience in the auto industry, I would just want to ask if you could give us some context on how are you seeing the recovery of the industry this time versus the 2008 crisis? Are you seeing any particular differences you would like to point?

[Jorge Garza, executive]

Well, thank you, Alejandro, and nice talking to you. Well, this is definitely the difference, the reasons for the, let's say, reduction of the economies is totally different. It comes from a pandemic that fortunately, the different countries are learning to live with it.

Unfortunately, we don't know what is going to be the next step because there is like a second wave coming, and we see that the markets -- sorry, the countries in Europe are suffering now a second wave and it is striking strongly. However, there is a big sense of the need of the countries not to close down the economies and not to slow down again. So they are trying to keep the economies open. Of course, they are going to try to keep people safe, and there are going to be lockdowns and some recommendations to try to avoid the spread of the virus and to make sure that the health systems are not collapsed, okay?

But from the point of view of economics, it doesn't look like it's going to be -- it's not the same as what happened in -- sorry, 2008, 2009. We see that in the U.S., with the stimulus packages that have been implemented, the market is practically back to normal. Only the fleet sales of cars are not back to normal, but the retail is very, very close to the normal pre-COVID-19 levels. So we are cautiously optimistic that the market is going to come back to normal.

For example, China, I'm going to tell you, the sales of our plant in China were -- or set a record high historically. The market has now come back to normal, and many OEMs didn't even take the shutdowns in summer. So they could really replenish the inventories that were depleted, and were preparing for the end of the year sales.

So if this continues like this and the countries learn to live with the pandemic and the vaccines are released next year. We hope that next year we would see a steady recovery. We don't see the volumes back to normal until maybe a couple of years. But if the countries really to learn to live with it, we will see a steady recovery.

[Alejandro Azar Wabi, analyst]

And now that you mentioned that volumes are not going to recover, but I think you also comment on your press release and during the past quarters that given your rightsizing, you are going to be able to recover the EBITDA, the absolute EBITDA. Do you think that these efficiencies or Draxton margins, are we seeing this due to the rightsizing and efficiencies? Or is there a portion of those benefits that come from a better product mix, given more profitable components?

[Jorge Garza, executive]

Well, definitely, we are adding more and more machining and the machining is like a downstream process that will add more value to the product. And when you add more value, then you have more possibility to have a higher margin, okay? And that's one. The second one, volumes are coming back, and volumes are very important to give you a better EBITDA margin. But most importantly, we are really working very strongly on efficiencies.

Remember that we have many plants around the world, and we are sharing best practices among all of them. And in Europe, we continue with the integration of the 2 business units that we used to have. Remember, we acquired 2 companies. Now we have everything integrated in one. And with this, we are accelerating all the efficiencies, transferring the best practices from one plant to the other. And of course, integrating the administration organization from the 2 previous business units in one, we are finding a lot of efficiencies. So definitely, we see that if the volumes come back, we will be able to increase our margins.

And of course, to come back to the absolute numbers and even not only that but surprisingly because we are working very strongly also in commercial, diversifying customers and products, and we see that in the future, we have a very good potential for growth.

[Jorge Armando Perez, executive]

Alejandro, if I may add, I think it's important to remember that even though the overall trends for the car sales, as Jorge mentioned, will take some time to recover. Beneath that, the growth for the suppliers in the different tiers is a bit different. Given the -- as we mentioned in the highlights, the process of the free trade agreement between Mexico, U.S., and Canada, there is a trend that will push platforms from other geographies into Mexico to make sure that they comply with the regional requirements.

Thus, even though you might have a mature industry in NAFTA, for instance, which might grow at 0.5% to 1%, we might -- we believe that we can achieve higher growth rates in Draxton in NAFTA because of these trends. Our objective is to remain leaders in the platforms in which we have focused. And there's trends that will push more volume from geographies, mainly from Asia, that will allow us to grow above those rates.

In the case of Europe, as also Jorge mentioned, we have started to make inroads into commercial vehicles. As you well know, our mix of commercial vehicles is very, very limited right now. So that progressed with a growth path for Draxton Europe, which is very interesting. In the pandemic we saw that the volumes of commercial vehicles were much more stable than the light vehicles. And in China, one of our best plants, which is in full recovery. The strategy that factory has followed there, mainly selling to local OEMS, which are the ones that are recovering more rapidly, can allow us to grow very significantly.

We just have one line there. If we're able to fill that line and then have another one, that's 100% growth potential. So there's beneath those numbers of the overall industry, there's dynamics that will allow Draxton to have higher growth rates in the medium and long-term for sure. I don't know, Jorge, if you want to.

[Jorge Garza, executive]

No, no. I think it's okay.

[Alejandro Azar Wabi, analyst]

Just one comment if I may. You had a very good quarter. Actually, the industry, the ceramic tiles industry had a very nice quarter. But I would just want to ask if there are any extraordinary benefits on figures regarding a possible inventory replenishment or should we account for this quarter and the second one? Or how should we do it?

[Jorge Armando Perez, executive]

If I may, Jorge. Thank you. The trends that you're seeing, Alejandro, I think now are in line with the trends that we saw in the first quarter in terms of where the improvement was going. They were actually sort of interrupted by the pandemic.

We do realize that in this quarter, as you just mentioned, there's an overall benefit for the whole industry, which is the -- basically 2 things: replenishment of the inventories for most of our customers. And also, there's an effect of people you know that there are spending a bit more money redoing their homes, and that's a benefit for us. So we do realize that.

And we think that that's going to probably slow down in the next quarters. Having said that, there is no other sort of onetime effect that we have in Vitromex. But I mean, what I'm saying is we realize that there's one quarter maybe of positive effect due to the market conditions, but not to the operating performance of the company. The company has continued to improve in its strategy in terms of cost competitiveness.

Our operating metrics are going in the right direction in most plants. We have a full team in terms of the capabilities we require in the technical part. The team has been doing a great job for a few quarters now, which is now materializing. And as volume comes, our cost structure will allow us to continue to have a very competitive profitability. And that's where the company is right now.

If volume levels can be maintained, then we should have a positive performance from Vitromex as you've seen in this quarter.

[Jorge Garza, executive]

Yes, Alejandro. We don't know exactly how long this wave of remodeling and this -- and the dynamics of the Mexican market will take. I don't know if this is going to be lasting for the whole next year or it will last for half a year next year. But one thing is for sure. Our operations team is doing an excellent job by improving KPIs in the production efficiencies and costs. So as I mentioned in my presentation, we have the best unit cost in many quarters. And this is going to be reflected in the next quarters for sure.

And now with the strategy of regional growth in the U.S., we will complement the Mexican volumes with the U.S. volumes, and that will give us an edge. I mean if we continue operating at these levels and continue with our efficiency programs that we implemented since several quarters ago, we are sure that the margins will continue to grow because we are also applying a strategy of portfolio in which we will, for sure, dedicate to the best value as a main market, but also we are applying strategies to improve portfolio with products with higher margins, and that will be reflected in the next quarters for sure.

[Melanie Carpenter]

[Operator Instructions] So we're actually going to turn to one that's coming from the webcast, and that is from [ Jorge Lagunas ]. And he asked, do you think CapEx is going to maintain a similar pace in 2021 as your expected full year 2020 CapEx?

[Jorge Armando Perez, executive]

We are being very cautious about CapEx this year, for sure. We had to postpone several projects for -- because we didn't know about how long the pandemic was going to take and how deep it was going to affect the operations not only for GIS, but for the world. So now that we see that the volumes are coming back, we are going to be very selective in the way we are going to approve CapEx.

Of course, there are some projects that are going to bring us benefits in terms of productivity, efficiency, and other projects that are going to be for growth. Remember that in Draxton, one of our strategies is to continue growing in additional added value to the products. That means mainly machining.

And on the machining, we are very active, and we have been awarded several important projects from several customers that will require additional investments in CapEx for machining exactly because we have the capacity installed for foundry, but these products, new products are going to be machine. And we are going to invest in China. We are going to invest in Spain, and we are going to invest also in Mexico for the machining. So that is a very good news because it means that we are going to be able to add more value without necessarily increasing the tons that we will sell.

So this will be reflected, as I mentioned before, in the margins. When you produce products that are machined, you are giving additional value to the customer, and that will require -- that will result in higher margins. It is very important also to mention that when you add machine into the products, customers will be more loyal because it will be much more difficult to change supplier. So you will marry them for longer times, and that is a very good news also for -- when you acquire business from the market that is machined.

In Vitromex, we see also some -- definitely some CapEx that will be dedicated mainly to efficiency improvement. So the trend is to be very cautious about CapEx, very selective. And when it's necessary CapEx to grow, we will do it because the growth is very important, and we are going to be very, very active trying to get additional business for Draxton, as I said, on the machining side.

So Jorge, I don't know if you want to add something?

[Jorge Garza, executive]

No, I think you hit on all the themes that are pretty--

[Jorge Armando Perez, executive]

Did I answer the question? I don’t know if this is…Jorge. Many Jorges here.

[Melanie Carpenter]

We're not seeing any other cued up questions at this time. We will pause a moment if maybe somebody has one last minute item. And you know what, Alejandro Azar wants a follow-up. So we're going to open his line again. Is that okay?

[Jorge Garza, executive]

Yes, sure.

[Alejandro Azar Wabi, analyst]

Jorge, you mentioned machining on all your regions. Do you have a percentage of machine pieces, of machine parts that you do right now and a target in the next 2, 3 years?

[Jorge Garza, executive]

Well, the target is very difficult, Alejandro, because it depends on how much the customers are willing to outsource, okay? But our internal, let's say, strategy is to try to machine as much as we can because there are several benefits of that, okay, as I mentioned before. More loyalty from the customer, longer-term assignment of the project, better margin because you are having additional processes, et cetera, okay?

So -- but at the moment, we are around -- I don't know, 15% of the products are machined worldwide. And that is a very good news again. Why? Because we have a lot of offside, okay? So if we are at that level right now, it means that we can go to 20%, 30%, 40% in the next years. And that is, for us, one of the main avenues for growth.

We don't necessarily have to add more tons. If we are machining, you will see our top line grow because we are adding more value and also the bottom line will grow.

[Alejandro Azar Wabi, analyst]

So if I understood well, Jorge, most of the machining, the [indiscernible] products, they all went [indiscernible], right? You don't outsource to other Tier 1, Tier 1 players.

[Jorge Garza, executive]

Well, we sell several products and some of them go to an OEM, some of them go to Tier 1, okay? Depending on the product, they have different strategies. For example, if we make a crankshaft, it goes to an OEM, for example, to General Motors, okay?

And normally, the crankshafts are machine by them. Okay? But if we go to engine support, more and more, customers are asking the suppliers of castings to add a machining because they want to focus on other, let's say, downstream processes. They are investing a lot in R&D for autonomous vehicles for electrification, all that, okay? So they are trying to concentrate their CapEx on those kind of additional value that the automotive industry needs to provide to the customers.

So there is a great opportunity for us as suppliers to try to take advantage of that outsourcing trend from the OEMs. Because the OEMs will transfer to Tier 1s and Tier 1s are going to transfer that to us in some cases. For example, we are machining -- we are going to machine in GIS Ederlan, our JV, some products for a Tier 1. And these products are for brakes.

So the Tier 1 is a brake supplier, and we are going to do the casting and the machining of brakes components for a Tier 1. And like this, I can tell you a list of many other products. Okay? I don't know if I was clear, Alejandro.

[Alejandro Azar Wabi, analyst]

Yes, that's a great color, Jorge. And one more, if I may. And I really thank you for your time. On Vitromex, could you explain a bit more about your strategy in the U.S. Right now, the U.S. -- your margins from this quarter are great, and we see very low contribution from the U.S. operations. And as you probably know, we are a little bit skeptical about the U.S. market. Could you give us more color on the strategy over there? What are you doing this time?

[Jorge Garza, executive]

Well, first of all, we started by bringing a person with a lot of experience in the U.S. This is our sales director of Vitromex U.S.A., and this is Brandon Dahlbo. He's an American. He worked for us in the past, and he knows the market very, very well. And he is helping us to design a very aggressive strategy, which is going to be regional, okay?

We cannot attack or to try to sell ceramic or porcelanic products in the whole U.S.A. We have to target the places where we can be competitive, okay? So we are going to try to do it from different channels and not to focus on only one channel. And we are going to try also to sell more porcelain products. The market in the U.S. is more oriented to porcelain than ceramic. And we have production in San Luis Potosi, which is very competitive and that is going to be the target.

So we can give you more details as we go because we are still working on that. But we are very optimistic that with this new strategy, we are going to be able to see a change in the trend in the U.S., where we used to have pretty good volume. And now, the percentage of volume that we have in our portfolio in the U.S. is very, very small. There is a very high upside from our side.

[Jorge Armando Perez, executive]

I agree. If I may add, Alejandro, the way you're looking at Vitromex is the right way in which you say Mexico is making up most of the number with a very low contribution from the U.S. And if you may recall, we mentioned that we would actually manage Vitromex, making sure that it was profitable with Mexico and the U.S. would be something that would allow us to expand margins. And -- but it would not necessarily, as it was in the past, be a business that would have an impact -- very big impact in whether or not Vitromex could be profitable.

Said that, as Jorge mentioned, the U.S. can provide significant upside. It will take time because we are not going to be going, as our main strategy for the home center. We will have home centers, but it will not be the main driver because it's in the case of Vitromex USA, it might be a risky strategy.

As Brandon has put in front of us a very exciting plan that will allow us to regain from the highest levels that we had a few years back, which was about 9 million meters. Probably 50% to 60% of that in the next couple of years. So of course, we have to be able to deliver the service and the quality that the market does. So that's the reason we have focused so much on building the business from the bottom-up from the manufacturing, from then the supply chain, making sure it works.

And currently, the operation in the U.S. has had service levels, which we haven't seen in a long, long time. We are doing a great job in the service part. So we feel confident that, that strategy is going to work because of those processes are going -- are doing the right way for the customers and for the company.

[Alejandro Azar Wabi, analyst]

Thank you both. Thank you again for your time and great call via phone.

[Jorge Garza, executive]

Give us your comments later, if you like it. We wanted to innovate here. And I think it's working really, very well.

[Alejandro Azar Wabi, analyst]

Yes. I think the other companies should copycat you on this.

[Melanie Carpenter]

Well, ladies and gentlemen, we're just going to pause a few seconds. If anyone else has a question, this is your opportunity here for Jorge Rada, Jorge Mercado. David Sandoval is on the line as well. So we'll just take one other second to see if anyone else asks a question.

It looks like we have no more questions. So I'll turn it back to you gentlemen for your closing remarks.

[Jorge Garza, executive]

Okay, you want to close it?

[Jorge Armando Perez, executive]

Well, I want to thank everybody for joining us today, and we will be working very strongly in the next quarter. And I hope to see you again, healthy next -- in the next quarter. Thank you for your interest in GIS. Don't hesitate to contact us if you have further questions, and see you next time. Have a nice weekend, and stay safe, please.

[Jorge Garza, executive]

Thank you very much. I think that closes the call for today.