Rumo SA

BOVESPA:RAIL3

Earnings Call Transcript 2019-Q2

[Operator]

Good afternoon, ladies and gentlemen. At this time, we would like to welcome everyone to Rumo's First (sic) [ Second ] Quarter 2019 Results Conference Call, which will be led by Mr. Ricardo Lewin, Chief Financial and Investor Relations Officer. We would like to inform you that this event is recorded. [Operator Instructions] The audio and slide show of this presentation are available through live webcast at ir.rumolog.com (sic) [ ri.rumolog.com ]. The slides can also be downloaded from the webcast platform. Before proceeding, let me mention that forward-looking statements will be made under the safe harbor of the Securities Litigation Reform Act of 1996. Forward-looking statements are based on the beliefs and assumptions of Rumo's management and on information currently available to the company. They involve risks, uncertainties and assumptions because they relate to future events and therefore depend on circumstances that may or may not occur in the future. Investors should understand that general economic conditions, industry conditions and other operating factors could also affect the future results of Rumo and could cause results to differ materially from those expressed in such forward-looking statements. Now I will turn the conference over to Mr. Ricardo Lewin. Mr. Lewin, you may begin.

[Ricardo Lewin, executive]

Good afternoon and thank you for joining us. I would like to take this opportunity to thank you for the recent recognition of Rumo on Institutional Investor ranking among the best companies in the transportation in Latin America mid-cap's categories.

Another important milestone was Rumo being included on FTSE4Good Index Series for companies with strong ESG practices measured by global recognized standards.

Before starting the presentation, it's important to highlight that 2018 results presented in our earnings release refer to the pro forma figures, reflecting the impact of IFRS 16 to guarantee a fair comparison.

On Page 2 of the release, the impact on each line item of our income statement is summarized. Let's begin our presentation on Slide 2. I start our presentation analyzing the market scenario this quarter, which was unusual. On one hand, soybean forecasts predicted high supply due to large inventories in the United States and strong crops in Brazil and Argentina, important exporting countries. On the other hand, it may show a contraction in China soybean import demand due to African swine fever. This scenario led to a decrease in international soybean price, and producers preferred to stock unsold volumes instead of closing new sales at market price.

As a result, for the second quarter, Brazilian exports were hampered and Rumo soybean volumes were essentially limited to those previously contracted.

The corn scenario should be the opposite. Forecast points to record-high domestic production this year, which combined with an equally favorable pricing scenario, a potential American crop [ resurrection ] and domestic higher soybean inventories should boost Brazilian corn exports. This favorable combination could rarely be seen in the North Operation in June.

On the next few slides, let's see the transported volumes. Volumes grew 7.1% in the second quarter '19. As mentioned in the previous slide, most of this growth happened in June, mainly on the back of corn inflows in the North Operation. Segment highlights include more than 3x fertilizer volume transported in the North Operation. Pulp volume grew by 28.6% due to the annualization of last year's second half volumes.

Container transport, that grew by 20%, having successfully diversified cargoes, which now reaches over 70 different types, strengthening its business model and continued to spread its network in the Southeast and Midwest regions of Brazil.

Please let's move to the next slide. Rumo's EBITDA rose 1.9% this quarter compared to the same period last year. And the consolidated margin stood at 53.4%. The 7% volume increase was satisfactory, considering the unfavorable soybean market. We highlight North Operation that grew 14% on volumes this quarter. Tariffs dropped almost 4%, impacted by North Operation, mainly due to the single effect of higher volumes in June when prices tend to be lower; early entrance of corn in the grain mix as corn has a lower tariff; exposure to lower spot prices in June when volume exceeded contractual levels; and finally, fertilizer volumes, which has a lower tariff when compared to the rates.

Regarding cost, variable cost has positively contributed to the results as it grew less than volumes. Fixed cost rose 6.6% due to high maintenance expenses on April and May when capacity was idle and the end of payroll exemption at Malha Oeste and Malha Sul. Therefore, even with a lower margin due to lower yields, North Operation reported EBITDA growth. South Operation reduced its EBITDA and margin due to weaker soybean volumes. Container operations stood at the same level as the previous year as the second quarter '18 results were impacted by the revenue from the selling of a business unit.

We will now take a look at the financial results and net income. The financial results decreased by 48.2% compared to the second quarter '18, mainly due to a lower yield curve, lower gross debt and the drop of average cost of debt. Consequently, we had yet another quarter of net income, reversing the loss posted in the same quarter last year.

On the next slide, we will take a look at our debt. Rumo's indebtedness decreased to 2x net debt-to-EBITDA compared to 2.1x in the first quarter '19. We emphasize our commitment with capital discipline, always trying to keep leverage at acceptable levels for the company.

On the next slide, we have more information about the Norte-Sul Railway. On July 31, we finally did some concession agreement for North-South Railway, and we are now officially responsible for the new concession. It is still too early to set volume, price, EBITDA and CapEx commitments, and they are contingent on the conclusion of the operating work and the start of negotiations for commercial agreements. However, I would like to share more in the figures on the market dynamics.

North-South Railway brings to Rumo access to various potential markets. In addition to grains, we have great opportunities to transport fertilizers, [indiscernible], biofuels, byproducts and containers. We have already started to reach out clients, and we pursue commercial agreements for the volumes as soon as the railway is ready.

In the grains segment, we will enter 2 new markets: the state of Goais and Tocantins. In the case of other cargoes, it is still too early to talk about future market share levels, but we can access the market's potential based on [ extra ] export data from 2018 and estimates from the Ministry of Agriculture.

In 2018, the 2 states exported approximately 13 million tons, which could reach up to 25 million tons in the next 10 years. This is a promising market for grains and other cargoes but currently has no access to an efficient railway. [indiscernible], we will do for Goais and Tocantins what we did for Mato Grosso and other states.

We are now focused on making the network ready to run. Therefore, the required investments will be deployed without any change in our already released guidance of BRL 13 billion to BRL 15 billion. We reinforce that we will remain committed with capital discipline and a constant seeking for efficiency. I conclude my presentation emphasizing our commitment to the company's business plan, increase capacity and improve efficiency while putting safety first. We plan to ramp up our business by connecting more producing regions in Brazil to foreign markets, significantly contributing to domestic transportation with backhauling capacity while reducing greenhouse gas emissions through energy efficiency and market share gains, all this coupled with the highest governance and capability standards committed to profitability and value generation to our shareholders. I will remain at your disposal for the Q&A session.

[Operator]

[Operator Instructions] Our first question comes from Thiago Cassebi (sic) [ Thiago Casseb ], Crédit Suisse.

[Thiago Casseb, analyst]

My question is regarding the inventories of grains stocked [indiscernible]. We see that due to prices, a great part of the soy crop was not exported yet. So how do you compare the current inventories of soy with last year? Any changes we could see part of this volume being transported by Rumo in the end of this year already?

[Ricardo Lewin, executive]

Good to have you in the call. Thank you for the question. Well, last year, we did have a small inventory during -- from December to January, okay, due to the high prices. Okay? This year, it's a bit difficult to foresee what will happen. Okay? You know that what happened with the market this year. This is well explained in our material here that the prices of soybean went down, so the inventories went up. Okay? What we are seeing right now is a complete different scenario for the second half of the year due to several reasons, among them, what's happening in the U.S., okay? USDA announced recently disruption -- the crop disruption in the U.S. So the soybean production will drop from 124 million tons to 100 million tons. That can -- as a consequence of that, we already see prices starting to improve. So what we see the inventories at the end of the year depends on the prices and the willingness of the farmers to trade their inventories. Okay? So it is difficult to foresee. What we foresee right now is that we may have a good -- if the prices continue to be in this level, we foresee a good trading in the last quarter, what can we do with inventory. So it's difficult to foresee right now. We will see more to the end of the year.

[Operator]

Our next question comes from Josh Milberg, Morgan Stanley.

[Joshua Milberg, analyst]

My first question is if you could give us some perspective on the third quarter volume outlook. We know that grain exports were strong in July and -- but just wanted to see if you could talk a little bit about the outlook for the remaining months of the third quarter. And also just wanted to understand if we need fear at all that with the anticipation of corn volumes in June and what looks like it's going to be a very strong July, if we could then see a shortfall later in the year? That's my first question.

[Ricardo Lewin, executive]

Thank you for the question. The scenario as it stands for corn is very positive. Okay? We -- as you saw the volumes in our website, we had anticipated an all-time high corn crop. So this year, crop is expected to be 102 million tons of production, okay, all-time high. As you said, this already brought a strong growth in June. We -- for example, the North Operation delivered already 27% growth as we published the volumes. Okay? Also, high inventories of soybean coupled with a good trading due to the international prices for corn, okay, and as I said, the crop disruption in the U.S. I said before about the soybean, but that will happen also with the corn. There's a drop from 366 million tons in 2018 to 353 million tons in 2019. So in our opinion, for this third quarter, we'll have a very huge additional corn transportation pressure and that will bring the strong volumes throughout all the second half of the year.

[Joshua Milberg, analyst]

Okay, Lewin. That's good color. And I presume that those strong volumes will translate into a better yield performance in the third quarter as well. Actually, if you wouldn't mind just touching on the yields outlook as well, that would be good. And then I have a second question.

[Ricardo Lewin, executive]

Yes. Good. Well, let me give you some idea of what's happened in the North Operation. It's well explained, but it's good to reinforce here. The yield was lower than expected, but that happened because no recurring issues that affected the tariff. So the first one is the seasonality among the months in the quarter. So volumes were lower than expected in April and in May when the price are higher, while we had good volume of corn in June when the prices are lower. Okay? In the second quarter '19, also, we had a significant amount of corn being transported.

And remember that the corn yield is lower than the soy yield. So that helped also to bring yields down. Also, we have the RTK volumes went up something around 27% in June, and that was higher than clients expected. And therefore, they started to pursue spot volumes on top of the commercial agreements in a moment where the spot prices were very low. Okay? And finally, something that is happening recurrently, that's the volumes of fertilizers that are growing fast as expected, this is good news for us. And although it will bring up the margins, the yields start to be reduced while the backhaul freight is something around 40% lower than the average. Okay? Now that what happened in this quarter. Now analyzing these factors, okay, that implies yields for the future, for next half. Regarding the seasonality, among months, it's not expected to have any huge influence in the second half of the year compared to the previous year. Okay? Regarding the spot logistics, we'll have a strategic position to spot prices, okay, in the second half and our expectations of high volumes. However, we already see better yields in July and August that show the improvement of spot prices. They're getting better in the market. Okay? But we cannot guarantee that these higher spot prices will remain until the end of the year. And regarding fertilizers, it will continue to grow at yields that are lower than the rest of our products. Okay? Regarding next year, it is still difficult to determine that, okay because we need to start negotiations for commercial agreements that will happen later in this year.

[Operator]

Next question comes from Rogério Araújo, UBS.

[Rogério Araújo, analyst]

I have a couple of questions. So first, a follow-up on Josh questions on the tariffs. So is there a way that you can provide an estimate of how tariff variation would look like in North Operations if we exclude the nonrecurring items, which is the corn mix and the lower volumes in April and May and also the lower spot price in June? So in other words, if you get our contracts on average, excluding those impacts, how much did the yield vary in this period?

[Ricardo Lewin, executive]

Rogério, a very brief answer, there's no reason for orders not considering these nonrecurring issues. There is no reason for the difference from last year unless the volumes of fertilizers that are going up. Okay? So there's no reason for being different.

[Rogério Araújo, analyst]

Okay. But was it -- so I just referred those impacts. Was it above inflation and even fertilizers? Or you are not passing through inflation in your contracts this year?

[Ricardo Lewin, executive]

Yes -- no, they do have inflation, okay, in our contracts. So there is increase of inflation and of the fuel. Okay? However, when you consider the average yield, then don't forget to consider the fertilizer volume that, as we said, improve our margins but reduce our tariffs.

[Rogério Araújo, analyst]

Okay, yes, it's a good color. So my second question is on Sorriso expansion. Is there any recent development in this project? And if you could provide a little bit more detail on how the company expect to see this happening? It's through a contract arrangement? It's through a project law that enables authorization for rail in Brazil? Or any other way you can do that? So if you could provide the recent developments on that project, it would be great.

[Ricardo Lewin, executive]

Regarding the expansion of Sorriso, remember that we split the project in different phases, okay, in different pieces, stages. So the first stage will be the road terminal, okay -- so sorry, the truck terminal in somewhere between -- in between Rondonopolis and Sorriso. This project, we are already deploying some CapEx for studies, okay, and we are also looking for the best place to buy land to do this terminal. Okay?

Regarding the Sorriso project, actually to do the first stage, we need to -- the first phase of the project, we need to know where the railway will go through. So we are deploying also some CapEx to make the analysis of the network, okay? But this -- compared to the size of the entire project, this is still irrelevant. In a while, we will start to hear about the first stage that -- the truck terminal. Okay? So once we buy the land and we have the beginning of the construction of the project, we will let the market know.

[Rogério Araújo, analyst]

Okay. What about government approvals? They're already asking for any? Or when do you plan to do that, and how are you going to do that?

[Ricardo Lewin, executive]

For the first stage, it's not necessary to have ANTT approval, okay because this is a truck terminal, okay? Regarding the second stage, that's the extension for Sorriso, the railway, we are waiting for the approval for Paulista renewal to restart the process.

[Rogério Araújo, analyst]

If I may, you mentioned about Malha Paulista. So any news or expectations for timing on the conclusion of that?

[Ricardo Lewin, executive]

Yes -- no. Regarding timing, Rogério, importantly, this is impossible to guess how much time it will take, okay, to the renewal. The last news that we have is their recommendation of TCU prosecutor, Júlio Marcelo, for the nonrenewal of Malha Paulista that goes public in the beginning of July. Okay? This is far from being bad news for us because having this decision, at least we can move to the next stage of the process. That means the process will go to TCU Minister Augusto Nardes. That's the rapporteur of the process. He will present his recommendation and we also believe to TCU [indiscernible]. And also bad news for us that the recommendation for nonrenewal from Júlio Marcelo because there are some cases, previous cases which the rapporteur of the process did not agree with the public TCU prosecutor. A very good example is that Júlio Marcelo was aghast that our South Railway and Minister of TCU didn't agree. Okay? So we know what are the next steps. For us, the TCU Minister in charge of the case has no deadline for approving it. But in our opinion, the process is very mature. The TCU Minister in charge of the case is familiar with the process because he has been following it since the beginning, many years ago. And in our opinion, the decision is not supposed to take that long.

[Operator]

Next question comes from Stephen Trent, Citi.

[Stephen Trent, analyst]

I was curious, I know you've had this plan to start running 120 train cars per local versus 80 on some of your network. And I'm wondering if you've made any adjustments to that plan, given what's happened with soy, if it's still intact? And if so, approximately what portion of your network would be impacted?

[Ricardo Lewin, executive]

Good question. You know that this is a very strategic project for us. We are investing since the merge between Rumo and ALL in the improvement of the capacity. And as you've seen, we have done up to now is to support the 120 railcars train. That means we will have a longer train, much more efficient and with an increased capacity. So this is not a project that will change due to very punctual changes in crops as happened in this year for soybean. This is a very strategic project that is foreseen to be running between 2021, '22. So we had no changes in the plan. We keep doing our yards -- the crossing yards that will allow to handle 120 trains crossing. Okay? So we are very disciplined in this investment. That's very important for the company. And as I said, the soybean crop -- reduction of [indiscernible] this year doesn't mean that we will have this for next year. So we continue to see a very huge potential for soybean in the next year as well as increase of crop of corn and other products such as cotton, for example. Okay?

[Stephen Trent, analyst]

Great. And just one very quick question aside from that. I mean kind of a follow-up on Josh and Rogerio's question. When you look at the 2Q freight tariffs, how much of that -- the delta was related to lower sugar volumes?

[Ricardo Lewin, executive]

Just coming back to your previous question, Stephen, sorry, I was so excited to answer that, I forgot to finish it. That -- after the increase in capacity is something around 70%, okay, that we foresee in the North Operations (sic) [ North Operation ] once we have the 120 railcar train. Regarding sugar, the trade of sugar has been very bad this year and last year, but that doesn't affect us at all because actually, we are using our capacity to transport much more profitable cargo, that's sugar and -- sorry, that's soybean and corn. So the reduction of trading has not affected us at all.

[Operator]

Next question comes from Victor Mizusaki, Bradesco BBI.

[Victor Mizusaki, analyst]

I have 2 questions. The first one is a follow-up on Stephen's question. When you mentioned about capacity and given all this positive outlook for grain volumes in the second half, can you comment a bit about your capacity utilization in the second half, especially in Q3? And if -- I mean if we compare Q3 with the second quarter, if you think about volume in the second quarter, the volume was concentrated in the North Operation. So if we can expect that maybe in Q3, that this volume growth will be spread or split between the North Operation and the South Operation?

[Ricardo Lewin, executive]

Good to have you in the call. Let's start with the last one, the answer is yes. The volumes in the South were worst in the second quarter because we didn't have anticipation of corn, okay? So we'll have increase of corn in the South, so the volumes will go up and will be more spread, the results, between North and South.

Regarding the third question -- oh, regarding the capacity in the third quarter, we will be very close to the full capacity. Okay? We can't say that in the second quarter, for example, in June, that was a very intense month. If we had more capacity, we could transport more. That means that we were full. So we expect to be in the next months with this size -- the good size of corn crop, that we'll be at full every single month. Okay?

[Victor Mizusaki, analyst]

Okay. And my second question, I think about new investments, how do you start to invest in the North-South Rail?

[Ricardo Lewin, executive]

In the North-South, we have a very, very small, I would say, relevant investment in this year. That's basically on a study that we have to do and some consultancy that we have to do this year. And next year, we will start to have the big investment in the Norte-Sul. Okay? The focus in the first year will be to prepare the network to operate. Okay? So the required importance -- [ state ] that the required investments to do the network operator to be deployed without any change in the already released guidance of BRL 13 billion to BRL 15 billion from 2019 through 2023.

[Victor Mizusaki, analyst]

Okay. So if you think about 2020, it makes sense [indiscernible] that your CapEx will go up versus 2019.

[Ricardo Lewin, executive]

100%, it will increase.

[Operator]

[Operator Instructions] That concludes the question-and-answer session for investors and analysts. Now I'd like to turn the floor over to Mr. Ricardo Lewin for his final considerations.

[Ricardo Lewin, executive]

I'd like to thank our investors and sell-side's participants in the call and talk to you in the next quarter. Thank you.

[Operator]

That concludes Rumo's first quarter results conference call. Thank you.