Grupo Industrial Saltillo SAB de CV

BMV:GISSAA

Earnings Call Transcript 2021-Q3

[Melanie Carpenter]

Okay. Ladies and gentlemen, we're going to begin. Good day, everyone, and welcome to GIS' Third Quarter 2021 Earnings Conference Call. Joining us today is GIS' Chief Operating Officer, Mr. Jorge Rada; GIS' Financial Officer, Mr. Saúl Castañeda; and GIS' Investor Relations Manager, Mr. Arturo Morales.

During this call, they're going to be discussing GIS' performance as per the earnings release that was issued yesterday. If you didn't receive the report, it's now available on gis.com.mx in the Investor Relations section, and we encourage you to follow along with the on-screen presentation. [Operator Instructions]

Let me just remind you that forward-looking statements may be made during this call, and we just ask -- that's based on information that's currently available, and they're subject to change due to a variety of factors. For a more detailed and complete disclaimer, we ask that you please refer to the earnings release.

Also, all the figures discussed today are going to be in U.S. dollars, unless otherwise stated.

So it's now my pleasure to introduce the GIS team, and I'm going to turn it over to Saúl Castañeda to begin the call. So please go ahead, Saúl.

[Jorge Garza, executive]

Well, good morning, everyone. This is a Jorge Rada. Thank you, Melanie, for introducing the presentation, and thank you all for joining us today. On behalf of GIS, we hope that you and your families are in good health.

We would like to start this call by talking about the situation of the auto industry. During this third quarter and throughout 2021, the industry has been affected by 3 external and temporary challenges. First is the global shortage of semiconductors. The low supply of these components allocated to the auto industry has limited the production capacity of the OEMs, and of course, the whole industry. We believe the impact of the semiconductor shortage has reached its peak, and production of vehicles will begin to grow starting in the fourth quarter of this year and will largely recover during the first semester of 2022 as the supply of semiconductors normalizes.

Second, raw materials price increase. During 2021, the prices of scrap iron and ferro alloys have risen to unprecedented levels with more than 100% increases. As you know, the indexation formula takes about 3 months to reflect these increases into our prices, so this metal lag misaligns our price cost structure, resulting in temporary lower margins. Scrap iron prices are starting to stabilize, and this will significantly reduce the impacts on our margins going forward.

And third, the high energy costs in Europe. Prices of electricity in this region have reached to new highs in the last weeks. A combination of higher carbon-based energy generation and lower natural gas inventories, as well as the deferral of the Nord Stream 2 pipeline, have caused prices to peak. However, forward energy prices show a stabilization by the second quarter of 2022 which will significantly reduce the impact of the energy prices.

As I mentioned before, these effects are temporary and external. Draxton will continue to implement rightsizing measures to mitigate the impact of these effects. The new programs we have been assigned during the year for 115,000 annual tons confirm our solid fundamentals and the competitiveness of our business.

We will be prepared for the pent-up demand as the industry normalizes. The investment announced for our San Luis Potosi plant is taking its course and will be ready by the end of next year. Based on our commercial performance and the industry growth expectations in North America, we are considering an additional expansion in Mexico.

I will now hand the presentation over to Saúl Castañeda. Saúl?

[SaúlCastañeda de Hoyos, executive]

Thank you, Jorge, and good morning, everyone. I hope you and your families are staying healthy and safe.

Our top line growth trend continues with this quarter $248 million revenue and all sales growing towards a new high. During this quarter, revenue grew 21% year-over-year driven by higher volume in Draxton North America, mainly related to new product launches and the consolidation of Evercast third line, which was launched last year; Draxton indexation formula that reflects the increase of raw materials into prices partially offsets the impact of lower volume in Europe; and finally, strong dynamism in local consumption as well as higher exports in Vitromex and Cinsa.

A challenging shirt-term scenario in the auto industry caused by semiconductor shortage, historical iron scrap and other raw material prices, as well as higher energy costs, has temporarily affect our EBITDA, which, during the third quarter, stood at $23 million or 9% margin. Stabilization of these external factors in the next quarters should bring an important recovery in our margins. Last 12-month EBITDA figure amounts to $138 million.

Our debt strategic actions deployed last quarter and consistent financial performance provides a solid financial position with a net leverage ratio of 1.4x, emphasizing no debt service payments required during 2021 and 2022. A strong financial position allows GIS to continue supporting capacity expansion within its different businesses and also explore strategic opportunities for growth and value creation for our shareholders.

I will now hand the presentation back over to Jorge Rada.

[Jorge Garza, executive]

Thank you, Saúl. Well, pressure in supply chains continue to push for higher commodity inflation. Steel prices have risen almost 3x during the year. Although scrap prices are starting to stabilize, during the year, they have increased more than 100%. These higher costs are indexed in our selling prices with an average lag of 3 months.

In addition, energy costs in Europe has increased almost 3x throughout the year to unprecedented levels. Analysts believe that normalization will begin in the second quarter of next year. We have started to see a change of trend in the last weeks, and we expect input prices to normalize gradually during 2022. We have rebooted rightsizing plans similar to those of 2020 to provide our operations with flexibilities and partially offset these impacts.

I will now shift to the automotive industry. In North America, vehicle demand continues strong. In accumulated figures, auto sales grew 40% in spite of this quarter's 9% decrease, which is explained by the global shortage of semiconductors that is still limiting the production of vehicles. Third quarter vehicle production was down 23% year-over-year, which has pushed vehicle inventories to less than 25 days at the dealers.

Sales in Europe increased by 11% year-over-year in the first 9 months. The vehicle production in this quarter decreased 21.3% because of the same supply chain limitations. Analysts expect a recovery in production levels starting in the fourth quarter this year and be extended throughout 2022.

In China, vehicle sales showed a 6% increase year-over-year by September. However, this quarter, vehicle production and sales decreased 17% and 16% year-over-year. Government incentives and subsidy programs for electric vehicles have been extended to 2022, seeking to benefit the local market.

Moving on to Draxton's performance. During the third quarter, our global casting volume increased 2% year-over-year in spite of the vehicle production limitation. In North America, the volumes of new programs and the launching of Evercast third line have mitigated these external challenges. In Europe and Asia, our volumes decreased 6%. Volumes for commercial vehicles are growing, bringing a better mix of products for Europe, while China remains in a very strong position based on its solid order book.

In the quarter, Draxton recorded sales of $169 million, which is a 19% increase year-over-year, mainly due to indexation of scrap prices in the prices of our products. Accumulated EBITDA close to $83 million, 42% higher than 2020 figures. In the quarter, Draxton's EBITDA was impacted by lower volumes related to the global semiconductor shortage, higher prices of scrap iron and energy. These temporary effects are expected to normalize in the next quarters as some of these prices have already started to show a change in tendency.

During the third quarter of 2021, Draxton won new contracts for 35,000 tons per year, which, in addition to the contracts awarded during the first half of the year, amounts to 115,000 tons per year to be launched in the coming 2 years. I believe important to highlight that most of these new contracts include components for brake systems which are 100% compatible with electric vehicle platforms.

Based on our successful business acquisition performance and the industry's volume expectations, in addition to the investment in a new foundry line announced last quarter and which will be ready by the end of next year, we are considering an additional capacity expansion in Draxton North America.

Moving on to Vitromex. Vitromex's revenues grew by 8% year-over-year. The growth trend continues, reaching record sales in the domestic market and with a greater export contribution. This quarter's EBITDA margin stands at 12%, confirming the solid results of the sustainable profitability strategy. The efficiencies in operations that are still being implemented, as well as the investments to increase installed capacity, will continue to boost profitability and margin expansion. EBITDA in the last 12-month basis amounts to MXN 442 million. Higher volumes and a better product mix help sustain our positive trend in revenues, supported also by the dynamism of demand in the market. Exports to the U.S. and South America continue growing quarter-by-quarter as the commercial strategies aimed to these regions take place. We will continue seeking for opportunities to increase our participation in the U.S. through different programs and customer relations.

In September, we approved an investment of $11 million to increase Vitromex's installed capacity by 2 million square meters of annual production. This investment added to the efficiencies implemented last quarter will increase our total production capacity by 15% to support our growth strategy. EBITDA performance continues to confirm the success of the turnaround process reaching MXN 123 million or 12% margin for the third quarter of 2021.

Regarding Cinsa, top line growth trend is confirmed in this quarter, posting a 31% increase year-over-year. Higher exports to the U.S. and Canada support this growth. The business achieved better volumes, product mix and operational efficiencies that partially mitigated the impacts of the quarter related to the increased cost of raw materials, like cold rolled steel, which was tripled in the year.

Well, this concludes my remarks for today. Thank you for your attention, and Melanie, please begin the Q&A session.

[Melanie Carpenter]

Thank you, Jorge. Ladies and gentlemen, at this time we're going to open the floor for questions. So first, we're going to take questions from the conference call participants, and then we will follow with questions from the chat. [Operator Instructions]

We're going to take our first question from Carlos Alcaraz. Go ahead, Carlos.

[Carlos Alcaraz Pineda, analyst]

This is Carlos from Apalache Análisis. I have a couple of questions. The first one is the -- with the increase in energy prices, can we expect an investment plan for electric energy in the future? And the second one is, given the current situation, can we expect new contracts for Draxton in the last quarter of the year?

[Jorge Garza, executive]

Yes, Carlos. Thank you for your questions. Well, with the energy prices, we are not, at this moment, considering investing in energy ourselves. But what we are trying to do is to try to follow them -- the futures or the forward market prices and to try to protect the futures. So we have done this in the past. We haven't found the right moment at this time to fix the prices and to make contracts for the future. But what -- the good news is that we see a very good trend of recovery of the prices starting in the second quarter of next year, so we are already considering making contracts in which we will not have an obligation to buy energy, but we will have fixed prices. So we can do that in layers. We will not make only one contract. We will consider different contracts, so we can protect the prices for next year. So this is the -- for the first question.

And the second question, if we are considering or expecting additional contracts for the next quarters, I would like to -- I'll be very happy to tell you that, yes, we are moving very strongly commercially with different customers. We are taking advantage of several geopolitical and geographical situations in which companies are trying to nearshore and to try to buy more locally. And for example, in Europe, what we are doing at this moment is considering companies that are relocating production from other regions to Europe, for example. And we see very good perspectives in terms of volume, acquisition in the next quarters. And all -- everything that we gain, for example, we win a contract in the fourth quarter this year will be launched in the next 18 to 24 months.

So fundamentally, the industry is good. Unfortunately, there is a scarcity of semiconductors. And once the situation comes back to normal, we think that we will be totally prepared to deliver all the volume that is needed for the pent-up demand. And with the new programs, we see our future volumes continue to grow, and we are very optimistic about not exactly the short term because the short term has a great problem. But once the situation normalizes, we are cautiously optimistic that we will get new businesses, and our plans will be running at full capacity in some of -- in all of the regions. And in Mexico, we are actually considering already an additional investment to the one that we announced in the last quarter.

[SaúlCastañeda de Hoyos, executive]

And if I may, I would like to ask Carlos. Thank you for your questions. That -- as you know, most of this volume awarded are fully compatible with hybrid and electric vehicles. So it's another important aspect for us.

[Carlos Alcaraz Pineda, analyst]

Okay. That's so clear. Congratulations for the results.

[Melanie Carpenter]

Thank you, Carlos. [Operator Instructions] Now we have a question from Alejandro Azar. Please go ahead, Alejandro. You can unmute yourself.

[Alejandro Azar Wabi, analyst]

Do you hear me well?

[Jorge Garza, executive]

We hear you very -- with a very low volume. I don't know if you are far away from the microphone.

[Alejandro Azar Wabi, analyst]

I will disconnect and connect again because I think I'm having trouble.

[Jorge Garza, executive]

We can hear you, Alejandro. So maybe in the interest of time, you can ask a question.

[Alejandro Azar Wabi, analyst]

Okay. I have 3 questions. The first one is on Draxton. I'm a bit worried about OEM inventories that are only awaiting to be installed chips and already have your products. How do we think about this? Do you think these semi series are large and a problem to Tier 1, Tier 2 players ramping production next year? That's the first one.

And if you want to answer that, and then I'll follow up with the second one.

[Jorge Garza, executive]

Well, if I understand your question, you are worried that the OEMs have inventory of cars or vehicles that are not completed, right, because they are missing some components because of the chip.

[Alejandro Azar Wabi, analyst]

Yes, yes. Definitely. And that those cars already have your products but are only awaiting to have the chips.

[Jorge Garza, executive]

And then your concern is that maybe the recovery will not be so fast.

[Alejandro Azar Wabi, analyst]

Yes.

[Jorge Garza, executive]

Okay. Well, remember that the inventories, especially in the U.S., are extremely, extremely low at the dealers, okay? So even though they have some inventories, which is very difficult to estimate for us, we expect the -- I mean, they have to build up inventories, okay? And they haven't been able to sell enough cars because they haven't [ passed ] to the dealers. So our expectations and all the -- what the analysts, the best analysts in the industry are forecasting is that definitely the production volumes will recover next year, okay?

Of course, the highest volume will come maybe in the 2023. But in 2022, they are forecasting higher production volumes. We are not -- at the moment, we are focusing a lot on production of cars more than in sales because of that reason, exactly the reason you are mentioning. We are -- in the supply chain, we are linked to production, okay? So we have to be very close to our customers, so we can be prepared to catch up in the moment that they start ramping up because it will be -- everybody is saying that it's going to -- or maybe very, very fast recovery.

[Alejandro Azar Wabi, analyst]

Regard that very fast recovery, Jorge, and with the current price of your commodities of steel, do you think that the pent-up demand could tighten more demand for your raw materials when that big production comes across all the industry?

[Jorge Garza, executive]

Well, the thing is that there is a bottleneck at the moment because prices are so high that everybody is trying to adjust to this situation, but all the industry is negotiating with the customers across the supply chain to try to agree on contracts or, I mean, relief, temporary relief on prices, so everybody can continue producing. Some of the producers or some -- let's say, for example, raw materials, they say that the energy cost is so high that they -- it is not -- let's say it doesn't make sense to produce at those costs. But if the prices are adjusted, then they will continue producing.

So definitely, the supply chains will continue to be tight, but OEMs are able to transfer this higher cost to the market. And if they are, let's say, willing to pass this to the suppliers, to the supply chain, I -- or we believe that the suppliers will continue producing. At this moment, there is a turbulence, definitely, in the market because some companies are being harmed very strongly because of these high prices.

[Alejandro Azar Wabi, analyst]

Great, Jorge. And then I'll follow on, if I may, on 2 other questions. On Vitromex, do you still see margin improvements ahead despite the increasing natural gas prices? And if you could take us through how you would achieve this.

And the third one would be, when you say strategic opportunities, could you share with us a bit more on where are you looking at, perhaps Draxton, Vitromex, organic, inorganic growth. Those would be my last question.

[SaúlCastañeda de Hoyos, executive]

The first one...

[Jorge Garza, executive]

Yes. Because I was writing, and I lost track. The first question, Alejandro. We definitely are in a very good track in improving our costs because of productivity improvements, efficiencies and everything in the plants in Mexico, the 4 plants we have. However, we are still in the way. I mean we are not there where we want to be. So definitely, we continue working on cost reductions and efficiencies. And with these additional programs that we are implementing, we believe that we have still some margin for improvement and to compensate, at least partially, the increases of energy, okay?

We don't believe that energy will continue growing forever. Actually, there are some news in the U.S. that -- because of the autumn, the weather is going to be a little bit milder than -- or hotter, warmer than expected. So probably inventories are going to be higher, and the prices are not going to be as high as expected. I'm talking about natural gas, okay? But based on our productivity improvement programs, we have very high goals for cost reduction, so we definitely expect that the margins will continue to grow in Vitromex, okay?

Regarding strategic movements. For example, we are announcing that we are increasing capacity in Vitromex. We are going to install a new furnace -- hotel, sorry, in San José, in Guanajuato. And we will continue to add more capacity as the demand continues to be high. And we want to continue growing, and we are actually attacking or target in the U.S. market and export markets in Latin America. And so adding capacity in Mexico is going to help us to continue growing together with the market. We continue to see a very strong demand, especially for remodeling in Mexico. And with our new U.S. strategy, we will definitely continue growing with capacity.

So the first initial move is in Guanajuato with an additional

[Audio Gap]

we believe, maybe in the future, we will have to continue making additional investments to continue capacity of production.

In the case of Draxton, definitely, we see, as we have mentioned in the past, a trend in the industry in which we could participate in the consolidation. At the moment, we don't have any news or anything that we can share. But definitely, we are very keen to see how the development of the industry continues. And definitely, we consider Draxton to be in a very good position to participate in the consolidation of the industry. So yes, that is the way we are managing Draxton for the growth.

We have very good news in terms of organic growth. For example, we are adding capacity in San Luis Potosi. Based on the programs that we have won recently, we have already in our plans to consider an additional expansion, even in Mexico. In China, we have a very good order book, and we definitely want to continue growing in China. So we are analyzing different paths of how we can grow, and we see a very good perspective for the future.

[Melanie Carpenter]

Thank you, Alejandro. Our next question comes from Laisha Carrillo. [Operator Instructions] So go ahead, Laisha.

[Laisha Zaack Carrillo, analyst]

This is Laisha from GBM. Do you think you can share the magnitude of the metal lag impact during the quarter? That's my first question.

And then with that question, we would like to know, given the impact and how it's going to amount up to last quarter's impacts, I think it would be roughly -- how -- what's the figure for the metal lag impact during the quarter? First -- that will be my first question, sorry.

[SaúlCastañeda de Hoyos, executive]

Sure. Thank you, Laisha. If you like, we can answer the first one. As you remind, our first half impact of metal lag was around $10 million, $5 million in each quarter. So in the third quarter, it was a pretty similar amount for the quarter. It was around $5 million again, just for the metal lag.

[Laisha Zaack Carrillo, analyst]

Great. And then if we have this impact to the past quarters, so it will be amounting up to roughly USD 15 million, right?

[SaúlCastañeda de Hoyos, executive]

$15 million for 9 months. That's right.

[Laisha Zaack Carrillo, analyst]

Yes, yes. Okay. And then considering scrap prices remain flat, as you said, or like they stabilize next year, do you think we should add this figure to next year's EBITDA?

[SaúlCastañeda de Hoyos, executive]

Yes. It's an important question. And please, Jorge, complement me, if you would like to. But at least for the end of the year, Laisha, for the fourth quarter, we are expecting that impact to go probably to 0. So yes, it's a good conclusion that you made and in fact just for a normalized scenario for metal and scrap iron prices. And we are not considering or we are not talking about decreasing prices. We are just imagining a stabilization in prices. As you mentioned, it will be fair to analyze in that way to add that amount for projection of next year's EBITDA.

[Jorge Garza, executive]

Yes. For example, we are normally selling at the prices of the previous quarter, okay? So we have an average of 3 months lag in -- I mean, across all the products, and what we are seeing at this moment is that the scrap prices are not growing anymore. This is what we see at the moment. Actually, we see a slight decrease in scrap prices. So we don't expect the metal lags to be there in the results of the fourth quarter or maybe it's going to be very, very low. And then if the prices continue to be stable, it doesn't matter if the prices continue to be high. As long as the prices don't move, then the metal lag would be close to 0.

See if the scrap prices start to go down, then, temporarily, we will have the opposite effect in which we will have temporarily maybe better margins because we will be, again, selling at prices of the previous quarter, okay, about buying scrap at the prices of the current month, okay? So this is the effect. Unfortunately, the prices of the scrap grew so fast this year that the impact of the metal lag was very, very strong.

[Melanie Carpenter]

Thank you, Laisha. [Operator Instructions] We're not seeing anyone queued up anymore for questions, so I will turn it back to Jorge and Saúl for some closing remarks.

[Jorge Garza, executive]

Well, thank you very much, Melanie.

Well, just a summary, we are going through a situation at the moment in the industry that is not particular to GIS or Draxton. That is a little bit difficult because the prices are going up, and the volumes are going down. But we are cautiously optimistic that this quarter, the fourth quarter, we started to see a change in tendency. So during the next year, volumes are going to go up. Prices of scrap will stabilize. And energy prices, we see the light at the end of the tunnel because we see forward prices of -- maybe half of the prices that we see today, starting in the second quarter of next year. So based on those factors, we see a much better 2022. And what is more important is that the fundamentals of the business are good. And we have won, let's say, this year, 115,000 tons for volumes or program that we will launch in the next 24 months globally. So that's very good news. And based on that, we are continuing with our investment programs. And so we are very optimistic for the medium and long term about Draxton and Vitromex and Cinsa.

Saúl?

[SaúlCastañeda de Hoyos, executive]

Thank you, Jorge. Thank you for those closing remarks, and thank you once again for your interest in GIS. Please don't hesitate to contact us if you have further questions, and we hope you stay healthy and safe. Have a nice day.

[Melanie Carpenter]

Thank you, everybody. You may now disconnect. Have a good day.

[Jorge Garza, executive]

Thank you.

[SaúlCastañeda de Hoyos, executive]

Thank you.