Grupo Industrial Saltillo SAB de CV

BMV:GISSAA

Earnings Call Transcript 2022-Q3

[Operator]

Good day, everyone, and welcome to GIS Third Quarter 2020 Earnings Conference Call. Joining us today is GIS President, 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 for investors and analysts only.

During this call, they 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 detail and a complete disclaimer, please refer to the earnings release. Also, all figures discussed are in U.S. dollars, unless otherwise stated.

It is now my pleasure to introduce the GIS team. Mr. Jorge Rada will lead off the call.

[Jorge Garza, executive]

Hi, good morning, and thank you all for joining us today. It is a pleasure to talk to you once again. At the face of a challenging environment that has began to show signs of gradual normalization on certain fronts, we were able to maintain a trend of EBITDA growth and made further progress in margin recovery, thanks in large part due to contracts secured by Draxton in previous years and the benefit of indexation of raw materials and energy prices.

Supply chain disruptions, primarily in semiconductors and escalating energy prices in Europe, continue to constrain vehicle production and sales on a global scale to such an extent that inventory still remain at historic lows and pent-up demand remains high. On the other hand, we have started to see an easing in terms of raw material procurement and pricing.

Over the coming quarters, we expect the pent-up demand, vehicle demand and gradual normalization of the supply chain to be major drivers for the automobile industry recovery, which in turn will benefit Draxton's volumes. In this sense, we are preparing for this scenario by making well-planned investments to expand our casting and machining capacity at all the regions where we operate.

Our outlook for future growth, particularly in EBITDA, is further strengthened by the startup of the ongoing investments that we have announced in recent months and the new contracts won by Draxton, which are worth approximately $153 million in annual revenues so far in 2022.

Regarding the sale of Vitromex, the process is still under review by the antitrust authorities. This transaction will allow us to gear efforts on strengthening the GIS Auto Parts business unit. This quarter's results show we are well on track to achieve our long-term goals and that our overall strategy, including the commercial and financial fronts, has been adequate to face the headwinds of the global environment.

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

[SaúlCastañeda de Hoyos, executive]

Thank you, Jorge, and good morning, everyone. GIS financial performance was greatly supported by the growth recorded in casting and machining volumes following the programs captured in previous years by Draxton and the effect of raw material and energy price indexation, which more than offset global supply chain constraints and higher power prices.

Revenues for the third quarter increased 23% year-over-year to $305 million, driven primarily by higher volumes at Draxton and the indexation strategies deployed in every region.

EBITDA reached $38 million at the quarter, a 69% increase year-over-year, driven by the same factors that boost consolidated revenue. This led to an EBITDA margin of 13% compared to a 9% post in the third quarter of the previous year. It is important to note that the result marked the third quarter of consecutive sequential EBITDA growth and a continuation of the margin expansion that started at the first quarter 2022, thus addressing the success of our strategic approach to address the backdrop's challenges.

Earlier this month, GIS made the payment of the second installment of the dividend approved by the Annual General Meeting. With this payment, a dividend equal to MXN 1.41 per share was distributed in total during 2022, reaching 4.8% of annual dividend yield.

As of the end of September, the consolidated net leverage ratio continued to improve on a sequential basis, standing at 1.8x on the back of a stronger EBITDA generation year-to-date and a solid cash balance that remains at suitable levels. The company's leverage metrics will rapidly improve as soon the potential divestment of Vitromex is consummated, from which we expect to receive around $260 million of net proceeds.

Regarding the investments announced in previous quarters, the different projects are running as planned with the first phase of Draxton capacity expansion starting with validation process in the next quarter. This phase will increase casting and machining capacity in North America with a volume ramp up. Those investments are geared towards to meet up the surging vehicle production, as Jorge just mentioned, and to wind up the new business won so far this year. which are mostly programs compatible with hybrid and electric vehicles platforms.

As was mentioned in our earnings release, the competition of these investments will result in an additional casting capacity of 60,000 tons, incorporating a new high value-added process to our portfolio, triple our machining capacity in North America and significantly increase our machining capacity in Europe.

I will now hand the presentation back over to Jorge.

[Jorge Garza, executive]

Thank you, Saul. Well, moving on to the automotive industry developments. Starting with North America, vehicle production was up 25% year-over-year despite the supply chain constraints, particularly in semiconductors. Vehicle sales posted a slight annual increase, standing at the same levels of last quarter as inventories still remain at minimal levels with -- even with the increased pace of production. Within the next few months, semiconductor supply pressures are expected to ease so that vehicle production and sales in North America will continue their trend of gradual recovery.

In Europe, vehicle production climbed 22% year-over-year even as the Russia-Ukrainian war continues to exacerbate the energy and supply chain situation in the region, which in turn has caused energy and raw material prices to rise to record highs.

Following the same dynamics, vehicle sales declined 4%, but remaining at the same levels recorded in the past quarter. As for China, vehicle production and sales increased 25% and 23% year-over-year, respectively. On a sequential basis, vehicle production and sales climbed 41% and 31%, and this trend is expected to continue with the support of fiscal stimulus for the purchase of new units.

Now Draxton's performance. Draxton's casting and machining volumes grew 17% and 41% versus the third quarter last year, respectively, mostly driven by the incorporation of new programs, which allowed us to more than offset the effects of semiconductor shortages and other supply chain disruptions. Year-to-date, performance was also positive with annual growth of 8% in casting volumes and 19% in machine parts.

In North America, we were able to keep up with the positive trends of this market, particularly with an important increase in machining volume. Meanwhile, in Europe and Asia, sales volumes received a significant boost from the new commercial vehicle programs. As mentioned, Draxton's volumes are expected to rise as the industry gradually recovers and new production programs and capacity expansions come into operation in the next quarter. And as Saul has already mentioned, our investment plan is aligned with these expectations.

Draxton's revenue closed the quarter at $225 million, an increase of 33% year-over-year, thanks to the combined effect of higher volumes and raw material and energy price indexation. Year-to-date, revenue increased 26% versus the same period of last year.

EBITDA increased 18% year-over-year and 17% versus the previous quarter, totaling $34 million as a result of the efforts towards the indexation strategy and the higher volumes already discussed. EBITDA per ton also showing positive trends throughout the year.

Summing up, the third quarter of 2022 performance marks a step forward on our path to improve our profitability amidst a complex scenario for the automotive industry. So far this year, Draxton has won new business worth approximately $153 million in annual revenue. Nearly 90% of these programs are compatible with hybrid and all-electric platforms.

Now moving on to Vitromex. Revenue for the quarter was up 12% year-over-year, supported by the improved product mix resulting from the ongoing launch of large size items and a favorable yet softer consumption environment, which more than offset the volume effects linked to the scheduled plant shutdowns to carry out capacity reconfigurations and expansions.

EBITDA fell 7% to MXN 116 million due to the volume effects already mentioned, an increase in natural gas prices and costs related to plant updates and capacity expansions. Our strategic approach for this business will continue focusing on cost reductions, introduce higher value-added items to improve product mix and tap into the capacity expansion already completed.

Regarding Cinsa, revenue decreased 18% to $428 million, following softer consumption dynamics in the domestic market. EBITDA totaled MXN 16 million. As the price adjustments to match market conditions, the introduction of new products and improved customer service were not enough to offset the effects of the downturn in the consumption environment and higher raw material costs.

Going forward, we will pursue the consolidation of our e-commerce channel, boost sales to other countries, with a larger focus on the United States and develop initiatives to achieve greater operational efficiencies and improve productivity.

With this, I conclude my remarks for today. Thank you all for your attention. And now we can start with the Q&A session. Thank you very much.

[Operator]

[Operator Instructions] Our first question comes from Laisha Zaack.

[Laisha Zaack Carrillo, analyst]

Can you hear me?

[SaúlCastañeda de Hoyos, executive]

Yes.

[Jorge Garza, executive]

Yes.

[Laisha Zaack Carrillo, analyst]

I would just like to ask 2 different ones. The first one would be in the line that if you see any short-term benefit from the drop in prices of raw materials. Scrap has been falling quarter-over-quarter. So I would want to know if there is a benefit that you see from that.

And the second one is that if it's possible that you could share with us the schedule of Draxton's investments and when will production ramp up for each one of them?

[Jorge Garza, executive]

Sure. Thank you, Laisha, for the question. I think it's a very interesting question because during several quarters, we were disposing the metal lag impact in a negative way because prices were going up, and we were suffering from the lag that we adjust prices one quarter after the prices have moved. So the results of this quarter actually are showing around $2 million of positive impact of metal lag in this case because raw material prices are going down not so fast as they were going up in the past, but we could see this in this quarter a benefit of about $2 million.

We don't see the price of scrap going down in the next quarters. We think that there is going to be a price stabilization. So if this happens, then we will not see big positives or negatives in the next quarter. But this quarter, definitely, you can see, in that result, $2 million approximately of benefit.

Regarding the investments of Draxton, what I can tell you at the moment in terms of operational, let's say, launching, I will ask Saul to give you the scheduling of the investments. But regarding launching, what I can tell you is that the first line that we are adding at San Luis Potosi will start making validation parts from tests by the end of this year. So in December, end of December or early January, we will start sending parts to our customers so they can validate the product. And that will take approximately 3 months more, so they can make the tests and homologate the product. And after they complete this validation process, we will be ready for start of production. So in the second quarter, we see the line #6 at San Luis Potosi already running.

The second line, which is second line we announced as investment, is going to be in production in the second part of the year. So next year, you will see an additional capacity during the year of 2 additional lines, which is about 60,000 tons of capacity in addition to what we have today.

In Irapuato, we already announced an investment of tripling the capacity for machining and adding a new process, which is called plating, which is kind of coating for the parts that protect the parts from corrosion. These 2 processes will start production next year.

By the end of this year, we will start making some tests in the machining. We will start already making production parts in the first quarter of next year, and the planning will be starting on the third quarter -- second, third quarter of next year. So next year is a year full of activity of increasing capacity. So we are very, very happy and enthusiastic about this additional capacity, which not all the companies can be saying the same that they are growing in Mexico. We are -- we believe in Mexico. We believe in the growth of the automotive industry, and we are very happy about that.

Now I will pass the microphone to Saul so that he can share with you the scheduling of the investments.

[SaúlCastañeda de Hoyos, executive]

Sure. Thank you, Jorge, and thank you, Laisha for your question. As just Jorge mentioned, it's a very important one. As you know, this CapEx will be around $140 million for Draxton. Just for Draxton, North America and Europe, but most of this investment in North America.

It is important to mention that during this year, particularly during the second semester of 2022, we already are having the CapEx cash flows, probably up for around $45 million to $50 million. And we will be -- also with cash flow during probably the third -- 3 quarters of 2023. As just Jorge mentioned, the first 30,000 additional capacity that we call the sixth in line will be available for -- or will start operations at the last quarter of this year. And basically, 1 year later, at the end of 2023, we will have the other 30,000 additional metric tons for this expansion.

And it is important to mention, as you probably recall that we do not take any loans or credit lines for this, and we are facing this with our own funds, but for ever cash expansion, we do have a credit line. So we are going to use this credit line during the fourth quarter, starting to use this line.

[Operator]

Our next question comes from Carlos Alcaraz.

[Carlos Alcaraz Pineda, analyst]

Congratulations for the results. I have 2 questions. The first one is about Draxton volume. What volume of casting and machining do you use to make to finish the year?

And the second one is about the resources from the sale of Vitromex? Will they be used essentially to pay off debt? Or will you keep a part of these resources in your balance sheet?

[Jorge Garza, executive]

Okay. Let's start with the Vitromex resources. You go ahead with the Vitromex, Saul?

[SaúlCastañeda de Hoyos, executive]

Sure, absolutely. Thank you, Carlos. As we just mentioned before, our primary purpose will be to deleverage the company. That definitely will be our first use of resources.

[Technical Difficulty]

[Carlos Alcaraz Pineda, analyst]

I'm sorry but I can't hear you.

[SaúlCastañeda de Hoyos, executive]

I'm going to move to the speaker. Do you hear me, Carlos?

[Carlos Alcaraz Pineda, analyst]

Yes, yes.

[SaúlCastañeda de Hoyos, executive]

Okay. Sorry for that. I'm going to repeat. It is a very important question, Carlos. Thank you for asking that. As you know, primarily, we are going to use these funds to deleverage the company that will be definitely our primary purpose. We would like to analyze in which proportion that we would like to use these funds in each of our credits. But definitely, that will be our first approach.

Then we would like to support our organic growth, as you know, and as I just mentioned. So far, we are dealing or facing these CapEx investments with own resources. So we would like to have also these net resources or proceeds available for organic growth. But also, we would like to have a solid balance as well with the remaining resources of this divestment and also with the balance to pursue any inorganic possible transaction. We are not specifically pursuing anything at this moment, but we would like to have the opportunity and the balance to analyze these kind of opportunities in the near future.

[Jorge Garza, executive]

Well, Carlos, regardless the volume, if I -- I want to make sure that I understood the question. You would like to know what is the, let's say, run rate of Draxton at this moment, right, globally, in terms of volume?

[Carlos Alcaraz Pineda, analyst]

Yes.

[Jorge Garza, executive]

Okay. We are running at around 400,000 tons of volume per year. This is our run rate at the moment, okay? And 420,000 something like that. This is up and down a little bit. So with the additional 2 lines that we are installing in San Luis Potosi, we will go in the next couple of years to 60,000 tons more, okay?

So in Mexico, we are growing because of the near shoring, and this is where we are adding additional casting capacity. In Europe, we don't have to add capacity. What we are doing is adding more machining capacity. And in China, we are also growing. Our order book is very solid. And probably in the future, we will have to do some bottleneck opening capacity, not additional -- sorry, casting capacity, but more on something to be able to produce a little bit more because of our solid book is really -- order book is really solid. So answering your question, run rate of around 420,000 metric tons per year, and this is growing.

If you have any additional questions regarding this, very happy to answer.

[Operator]

Our next question comes from Alejandro Wabi.

[Alejandro Azar Wabi, analyst]

I just have 3 questions, and I'll separate them. The first one is a follow-up on your last question about your run rate capacity. If my numbers are correct, your -- let's say, your practical capacity or real capacity should be around 550,000, 570,000. That's -- I think that's including the new expansions. So would that number be correct? You are operating at 70% capacity utilization with the 420,000 figure?

[Jorge Garza, executive]

Yes, more or less. Actually, it's going to be actually more than 600,000 after the investment in San Luis Potosi. And definitely, we have several plants that are running at 90% capacity utilization. Some of our plants are running around 60% to 70%, especially in Europe. But we expect that the utilization will increase as we'll start launching new programs that we have won in the past years, okay? So we see the Draxton volume going, as I mentioned, from 420,000 to probably 500,000 pretty soon.

[Alejandro Azar Wabi, analyst]

Okay. That's good to know, Jorge. And my other question is I just wanted to pick on your brain guys regarding the industry cycle. What can you tell us about the environment in the short term as we enter a possible recession in the upcoming quarters? It is interesting to see how automotive inventories are depleted, even at below past recessions -- at levels below past recessions. And production is still growing despite lower sales. So what are your thoughts on how the industry enters this part of the cycle?

[Jorge Garza, executive]

Well, it's a very interesting question because there are many versions. Many people are -- have different opinions, but we -- what we have seen with different analysts is that the industry is running at, I would say, recession-like volumes for already 3 years. You haven't seen these volumes for 3 years in the past history, in the modern history, I would say.

So even if there is an official recession in the economy in the U.S., there is a lot of pent-up demand. There is no inventory in the dealers. So the OEMs will take advantage of potential recession and try to fill up the pipeline, okay? So when the recession phases out, they will have the service level inventory ready for the customers to buy their brands because, remember, if you don't have the car in the U.S. in your dealer, the people will go and buy the car that is available maybe next door or across the street in another dealer. So this is why we are optimistic that even if there is a recession, the recession should be relatively short, and this will be taken advantage of by the OEMs to try to fill up the inventory levels.

In addition to that, we have been awarded a lot of business -- new business that -- for that reason, we are making these additional investments in Mexico. And with these new programs, which are, in general, relocation of programs from other regions to Mexico, we are very optimistic that we will be able to fulfill or to fill up the capacity of these additional 2 lines pretty soon.

[Alejandro Azar Wabi, analyst]

And the last one would be on the longer term. I'm thinking that you already -- that the proceeds from the Vitromex are already in your belly, if I can say that. How do you see Draxton moving forward? I mean do you guys see Draxton moving to a larger role in the brake system segment? Do you -- would you like to increase your footprint in some regions, maybe having a plant in the U.S. to strengthen your footprint in North America? How do you see the company going forward?

[Jorge Garza, executive]

Well, good question. In the future, what we see is a continuation of the growth in Mexico for the North American market based on the near-shoring trend that we all know. And we see that a lot of our customers are growing in Mexico and drive from here from Mexico. They are going to deliver products for the whole North American market, okay? We want to take advantage of that in terms of additional tons of castings. But also, we see Draxton investing and growing more on value added. It means machining and potentially other processes like plating, coating and even preassembly of additional components in some of our castings, okay?

When you add more value, you are increasing also the loyalty from the customers. You can deliver products further away to different regions and be able to attack markets that in the past you were not able to attack based on the relatively low value added that you are giving to the product, okay? If you are more value-added, then you can travel more, your products can travel more.

That has taken over some of the operations that our customers at the moment are considering to be core business for them. But to jump from a casting company to a brake company, it's a big jump. And so what we are doing is to follow in the trend of outsourcing. The OEMs are trying to dedicate more resources for the electrification. The Tier 1s are taking over some activities in the past, where exclusively made by the OEMs.

And to do that, they are outsourcing more to the Tier 2s. And in some cases, we are Tier 2. Remember that we make a brake component. We sell it to a Tier 1. And these Tier 1s are outsourcing more and more value added. We see taking over those activities and making Draxton grow, but not necessarily to go and make the brakes, complete brakes because that's not our core business, and that will be, let's say, our contract with our customers. But we are cooperating with them to try to help them with this kind of outsourcing trend.

[Operator]

[Operator Instructions] We have a follow-up question from Alejandro Wabi.

[Alejandro Azar Wabi, analyst]

Just jump on a new one for Saul. In terms of liability management, Saul, with the rates at current levels, wouldn't it be possible for you guys to actually buy the bonds at a discount? Or given your strong balance sheet, I don't know, I haven't seen where the bond is trading, but if you could share with us a little bit on the analysis that perhaps it would be better to have that cash and invest it at a current rate, I don't know. What can you tell us about that, Saul?

[SaúlCastañeda de Hoyos, executive]

Thank you, Alejandro. Very good question. Let me ask that in 2 different ways. The first, I would like to emphasize, at this moment, the healthy leverage ratio that we have because we are below 2x net debt to EBITDA. So we have basically a good balance and a great maturity profile. But even though, as I just mentioned, the first purpose of the potential divestiture will be deleverage.

Regarding your question, we are definitely looking -- taking a deeper look on this. As you just mentioned, at this moment, the bonds are trading basically at our level. So we could be able to prepay those at basically handle or par level. So we would like to be ready to have the ability to move forward in different ways to take an advantage there.

I would like to add also that, at this moment, our mark-to-market of the several financial instruments -- derivative financial instruments are an important asset for us. I will say around $20 million. Those are reflecting basically our -- the value of those instruments regarding swaps, rate swaps and currency swaps. So we would like to take the time to analyze the exact or the appropriate moment to prepay or to unwind those in any case. But definitely, that benefit that we have at this moment as a mark-to-market will compensate or more than offset if we will move to a new credit line. I don't know if I made my point here, but even if we move forward with a different credit line in the future at a higher rate, we can be compensating that or more than offsetting that with the unwind of this mark-to-market of this financial instrument -- derivative financial instruments.

But all of those must be analyzed in a comprehensive way regarding just the things that I just mentioned, the appropriate time and the options doing before or after, we have these net proceeds for the divestiture. But you made an excellent point, we are pretty aware of that, and it's something that we would like to keep in the tables for a deeper analysis.

[Alejandro Azar Wabi, analyst]

Very clear, Saul. And one more, if I may, and I'm sorry. What can you tell us about dividend policy? In the past 5 years or 7 years, Grupo Industrial Saltillo has been giving shareholders a little bit more. Is there any way that we can estimate a dividend policy going forward, I don't know, a percentage of your cash generation, a percentage of EBITDA, a percentage of the net income? What can you tell us about that?

[SaúlCastañeda de Hoyos, executive]

Sure, sure. Thank you, Alejandro. Good question also. As you just mentioned, GIS has been very specifically paying dividend in almost every year since probably 2016, and I will say -- or even before that date. I will say, at this moment, our policy is more linked to a specific amount that it is defined as pesos per share, and it's going to be at -- each year, it's adjusted mainly by inflation.

But it is important -- an important point because, basically, a couple of weeks ago, we just made an analysis. And we realized that as we already know that we confirmed in that study that GIS, it has a great dividend yield. It's around 4% to 5% as an average on the last 4 or 5 years. And we made different kind of analysis regarding, as you just mentioned, like a percent of our cash or a percentage of EBIT or EBITDA or even the net profit. But so far, I will say, we will keep this policy regarding a fixed amount that is going to be adjusted annually by inflation, but this can be revised in the future, definitely. But I will say, at this moment, we believe it can be in the same way that we are just having in the past.

But I would like to emphasize, we are on the top, probably top 5 of the Mexican Stock Exchange companies regarding dividend yield. And as you mentioned or probably you saw in our earnings release, we just made the second payment of the dividend for MXN 1.41. It's around a 5% of dividend yield. And I will say for the next year, an option of -- to estimate that will be to take that amount or figure and to get an inflation adjustment.

[Operator]

With no further questions, I would like to return the call to the management for the call -- for the closing of the call.

[SaúlCastañeda de Hoyos, executive]

Thank you, and thank you, everyone, again, for your interest in GIS. Please don't hesitate to contact us if you have further questions. Have a nice day.

[Jorge Garza, executive]

Thank you.