WEG SA

BOVESPA:WEGE3

Earnings Call Transcript 2019-Q1

[Operator]

Good morning, and welcome to the WEG conference call to release results for the first quarter 2019. We would like to inform you that we are broadcasting this conference call accompanied by the slides at our Investor Relations site at the address, ri.weg.net (sic) [ ir.weg.net ]. After the conclusion, the audio will be available at our IR website. [Operator Instructions]

Any forecast contained in this document are forward-looking statements made during the conference call regarding future events, business outlooks, operational and financial projections and goals and the future growth of WEG are based on beliefs and expectations of the management at WEG and based on information currently available.

These forward-looking statements involve risks and uncertainties, and, therefore, depend on circumstances that may or may not occur. Investors should understand that general economic conditions, industry conditions and other operating factors could affect the future performance of WEG and lead to results that differ materially from those expressed in these statements.

This conference will be made in Portuguese with translation into English. With us today from Jaraguá do Sul, we have André Luís Rodrigues, the Financial and Administrative Director Superintendent; Paulo Polezi, Chief Financial Officer and IR Officer; Wilson Watzko, Controller; and André Salgueiro, the IR Manager at WEG.

You may proceed, Mr. André Rodrigues.

[André Rodrigues, executive]

Good morning to all of you, and it's a pleasure to be with you, once again, for the results of the first quarter 2019. To begin with the highlights, net operating revenues grew 15% vis-a-vis the first quarter '18, reaching BRL 2.9 million. We also presented a growth of 22% in EBITDA that reached BRL 462 million with a margin improvement that grew 0.8 percentage points reaching 15.7%.

Return on invested capital reached 18%, showing one more quarter of evolution and returning to the levels observed before the global crisis in 2009. We will have more details on the ROIC that presented a growth of 1.5 percentage points vis-a-vis the first quarter '18, reaching 18%.

Operational profit after taxes, explained by a growth of revenues and an improvement in operational margin, more than offset the increase in capital invested. This is a reflex of the combination of our strategy of development of new businesses with a return on invested capital, along with discipline in the use of capital, shown through the management of working capital and the optimization of our investment program.

I would now like to give the floor to Paulo Polezi.

[Paulo Polezi, executive]

A good morning to all of you. We go on to Slide #5 to present the evolution of the different business units. We begin with Electro-Electronic Industrial Equipments in Brazil, where the short cycle equipment continues to show growth. We also have an increase in the share of revenues in long cycle equipment, especially electro centers and automation panels. The search for equipment for capacity expansion projects, both brownfield and new investment greenfield, was better than expected at the beginning of the year.

The GTD area had a growth of revenue in Brazil, although there was a lower share in wind generation projects, which is something we have anticipated. The positive highlight is the solar generation business, especially distributed generation. The GDT (sic) [ GTD ] business also contributed positively this quarter with an improvement in the business dynamics and distribution transformers and renewable energy products.

In domestic use motors, we also had a growth of revenue. Because they are short cycle in characteristics, this business depends on the economic performance and especially on consumption. And we now observe signs of recovery and economic resumption. The paint business had a significant improvement in some areas, such as mining, metal structures and the white line. Abroad, the sales of Electro-Electronic Equipments continued to focus on the short cycle products where we have made strides through our expansion of our product line and gaining share in the market.

We have built new plants, and we see a good demand for long cycle products with good outlook, especially in the industries working in oil, gas, pulp and paper, infrastructure and mining. In the field of GTD, the greatest contribution was in the field of transformers where the growth at all the operations abroad were the highlight for the consolidation of the new transformer company in the United States.

In motors for domestic use, the revenue continues to show the impact already observed in the last quarter with a lower order intake in the local market in China, the weak development of the operations in Argentina because of the local problem. Now in paint, once again, there was a drop in revenues in the foreign market because of the difficulties in Argentina.

We see the evolution of EBITDA in the first quarter '19 where the great highlight when we compare this to the previous quarter, we had a significant growth of 2.16%. The EBITDA margin ended the quarter at 15.7% with an evolution of 0.8 percentage points vis-a-vis the first quarter '18. This is a reflection of an improvement in profitability of operations abroad, margin gains and a more favorable mix in Brazil because of lower revenues in wind generation and lower operational margins.

On Slide #7, we show you the investments of the last quarter. In the first quarter of 2019, investments reached BRL 91.8 million, 31% destined to Brazil, 69% to our production units abroad with a growth vis-a-vis the first quarter '18 due to the advent of investments in the first foundry of WEG outside of Brazil, which is in the final phase of construction in Mexico.

With this, I would like to conclude and return the floor to André.

[André Rodrigues, executive]

Thank you very much, Paulo. And before we go on to question and answers, I would like to reinforce our outlooks for the rest of the year.

At the beginning of March, we stated that WEG was, once again, considered among the main companies in clean energy throughout the world. We're a part of the Clean 200 ranking made up of 200 companies, and there are other Brazilian companies that are part of this. This shows our commitment with the best sustainability practices.

Now even though we have the expectation of lower revenue growth in 2019 because of that drop in our project portfolio and wind generation, we do expect to have an improvement in the operational margins of EBITDA. This because we expect a better performance of mature businesses in WEG in Brazil and better profitability in the operations abroad. And we will also have an improvement in the value of return on invested capital during the year.

We will now go on to the question-and-answer session.

[Operator]

[Operator Instructions] Our first question comes from Thiago Casseb.

[Thiago Casseb, analyst]

I have 2 questions. The first referring to the market abroad where we see good outlooks and during this quarter. I would like to hear about your outlook, if there is more space during the year to increase your share to obtain new customers or to increase the volumes with the present day customers. And which was the impact on your EBITDA margin in this first quarter of 2019?

[André Rodrigues, executive]

Thiago, this is André speaking to you. Thank you for the questions, and I would like to refer to your expectations on the market abroad, and Paulo will refer to the impact in 2016. Now we're thinking of a slowdown in economy abroad, and this has been disclosed broadly, but we do not feel this. We continue to show significant growth in the main regions, and we have carried out work to increase our market share through the mature businesses of WEG and by launching new products in a diversity of markets. And that is why we deem that our performance will continue to remain above that of the market.

In the foreign market, we should also reinforce that we're predominantly stronger with the short cycle products that has a portfolio of 3 to 4 months. Now with this portfolio that we have in hand at present, we're still not feeling this reflex abroad. But despite this, WEG is working with a winning strategy when it comes to the launch of new products, and we're exploring markets where we have strong participation in Brazil and abroad. Of course, we have a very good reputation. All of this has shown good results.

[Paulo Polezi, executive]

Thiago, good morning. This is Paulo. The series 16, the new standard, was adopted in Brazil beginning in January, and we have a new explanation on our side. All of the details are there. This represents a value of BRL 2 million approximately in our calculation, and you can calculate this yourself. It represents 0.3 percentage points for the company, an increase of 0.3 percentage points. Once again, you have all of the details in our explanation #3 on the slide -- side.

[Operator]

The next question is from Alexandre Falcao from HSBC.

[Alexandre Falcao, analyst]

I have 2 questions. The first, if you could speak about the situation abroad. When you think of this in the dollar denomination, perhaps, the situation is not as robust as it was. I would like to gain a better understanding of what you're doing with this in terms of your outlook, the local currency, the denomination in dollars. The second question refers to Brazil. When it comes to the short cycle, especially in terms of investments, your results show that there has been a drop in GDP and a drop in demand. Are you beginning to feel this contraction in demand?

[Unknown Executive]

Falcao, thank you very much for your question. Let's continue on then. We have to pay attention to the short-term analysis because WEG is exposed to a series of currencies, not only the American dollar, and that is why we always present the growth of local currency. And the local currency is a basket of currencies, and the countries in which we operate had a growth of 8.1% during the quarter. This is positive.

When it comes to the question in terms of operations in China and Mexico, let's begin with China. China is following the same trend that we observed in the last 5 years for industrial motors with a low voltage. There has been a growth of 2 digits in the last 5 years. For our performance, things were not different in the first quarter. And because of this, we increased the capacity of the [ Burgau ] plant to be able to continue on with the growth that WEG has there. We have found other opportunities of entering the market through a unit to act in the Chinese market. We have had some difficulties that we have reported because of some local issues of the market and the commercial war with the United States, but the general balance continues to be very positive, and WEG continues to invest in China.

Now Mexico tends to follow the same trend with lower growth rates compared to China. Now the first point, we continue on with our verticalization strategy in Mexico. And in the second quarter, we will conclude our investments in the foundry. Mexico will be ever more verticalized. We'll be more competitive in terms of prices, and the business of transformers did not show a good performance. It was somewhat below the previous year because of electro uncertainties in Mexico. And because of the issue of the United States, the trade barriers and the ongoing discussion, what we are reinforcing for this first semester is an improvement in the sales area in transformers coming out of Mexico for the domestic market as well as for export. Therefore, these 2 countries that are strategic countries outside of Brazil, where we concentrate our industrial production, are having a very positive evolution.

In terms of the short cycle, we like to always be very cautious about developments in Brazil because this gradual resumption of economy will depend on the economy. But this also holds true for the short cycle. When we speak about short cycle, we're referring to motors and automation as -- these are projects that have a shorter period, 3 or 4 months. But as I mentioned, those that we have in hand have shown a positive performance during the first quarter.

[Operator]

The next question is from Lucas Marquiori from Safra Bank.

[Lucas Marquiori, analyst]

I also have 2 questions. We see the revenue in energy growing year-after-year in the domestic market, perhaps more than was expected. There has been, of course, a drop in wind energy, but there has been a growth. Now I would like to understand where this improvement or enhancement in revenues is coming from. Why this is more than you had expected? And this is my first question. The second question. Well, you mentioned the improvement in the competitive environment in Mexico. Is this going in accordance to what you had planned when you acquired the company?

[Unknown Executive]

Lucas, thank you very much. And let's begin speaking about GTD and the results for this quarter. We had a very great expectation once again due to the fall of the wind portfolio that have already begun. During this quarter, we were able to report a growth of 13.3% higher than that of the first quarter in '18. Now what happened? The first positive aspect is solar generation that became ever more relevant for the company in 2018 and continues to grow. It is adding orders to our portfolio. And the outlook for this business is still positive, especially in distributed energy that has been showing continual growth in the last few months. So this has fully offset the fall in wind energy.

And even more so I would like to remind you that, in 2019, the GTD part has made a positive contribution. The outlook is for this contribution to continue. We do have an improvement in the dynamic of substations, and our deliveries will begin to take place in 2019 and 2020. And of course, we will be able to recognize these results. We should recall that, in 2018, we had a first quarter that was somewhat weaker in terms of transformers, and we had a smaller solar energy and distributed energy base. And in 2018, we only had 1 month of TGM that was consolidated only in March. So this explains the good performance we had in the first quarter.

Now when we speak about WEG Transformers USA, things are very positive from the viewpoint of sales. The transformer unit of WEG abroad has a better performance, all of the units. But in the United States, we have a very good order portfolio. WEG and NPS, once again, this is a highly renowned company in terms of transformers. And the good news is that, in this first quarter, the results have already become positive. The expectation was that this would happen throughout 2018. We also mentioned that the internal inflation in the United States and commercial issues were very strong and would not allow this to be possible. But we had announced that we had an initiative to increase prices because of inflation, and we have seen the good results already in the first quarter. Now the EBITDA is positive, and the operational results of this company are positive as of this first quarter.

[Operator]

The next question is from Bradesco BBI.

[Unknown Analyst]

Congratulations for your results. I have 2 questions. One is a follow-up on the question made by Lucas about GTD. If you could give us some more color in terms of backlog for solar energy. And if based on backlog we can say that GTD could become a reason of concern and on top of revenue, we see that this will not be the case. And the second question, you mentioned that some clients are beginning to quote prices for new projects. Could you give us some more color in terms of the potential revenue that could arise from these contracts?

[Paulo Polezi, executive]

This is Polezi. Let's begin speaking about GTD and solar energy. Now the backlog -- it's very difficult to speak about details but I can comment about some points. Well, we can advance in terms of solar plants and distributed energy in the first quarter. We have results similar to those we had last year. And for the time being, our deliveries will concentrate during this first semester. And I would like to remind you that since 2016, WEG has already delivered 4 solar plants, once again, Malta and Paraiba as well as 3 other projects. Until mid-2019, the forecast that we have is to deliver another 3, [ Geraldo ], Pernambuco, Sobrado and Bahia and another one in Paraiba.

To conclude, our vision is that this business has become ever more relevant in the GTD field, and the expectations are positive for the rest of the year. We still have projects that are open due to the auctions, and this will enable us to capture something. But this is still part of our outlook in terms of distributed energy, GTD. We had a stronger growth. And where does this growth come? From a very sound network of integrators with national coverage. And this has led to a great number of orders. And finally, this doesn't exactly pertain to backlog, but distributed energy is the segment where we are able to obtain better margins, and this helps us to recover our margins when it comes to distributed generation. Now if you could repeat your second question, please?

[Unknown Analyst]

The question is that there will be improvement in the long cycle in Brazil.

[Paulo Polezi, executive]

We already perceive that we're receiving quotes for long cycle equipment. In the same period last year, we did not have these requests for quotes. Some at present have interesting amounts. They are linked to the pulp and paper segment and especially mining. And this is favorable. We will begin the year with a better outlook. André at the beginning mentioned that we have to be very cautious. For the time being, there are few projects, but last year, we had an absence of projects. So we do have a better outlook for long cycle equipment if compared with 2018.

[Operator]

The next question is from Rogério Araújo from UBS.

[Rogério Araújo, analyst]

I have only 1 question in terms of your ROIC. We have seen an increase in the last quarter. But in the last quarter, there has been an appreciation of the real, and we continue to see an increase. You spoke about the transformers that have had positive results in the first quarter. And I would like you to give some more color in terms of what explains this improvement of return on invested capital and how far we can go. I recall that during the crisis, you didn't imagine that you would return to a level where you are but the investments in long cycle equipment are still missing. And I would like to know what will happen with these investments in long cycle equipment and when this will materialize? And which will be the levels that it can attain if we imagine a return of the long cycle projects?

[André Salgueiro, executive]

Rogério, this is André Salgueiro. To speak a bit about ROIC, we do have several impacts, and it's very difficult to explain the reasons. You mentioned them very clearly. There is an improvement in the margins in our operations abroad. This, of course, can be helpful. And additionally, we begin to see a resumption of the long cycle equipment in Brazil in industrial projects in specific segments like pulp and paper and mining. And we also see an improvement in GTD of what we deem to be long cycle. We believe that when the market is in a better situation, we will be able to recover those margins. And this will enable us to continue to grow the ROIC in the long term. It's difficult to give you a metric. What we can state is that this year, we should return to levels very similar to those of last year. This is our expectation at present for 2019.

[Operator]

[Operator Instructions] The next question comes from Joao Noronha from Santander Bank.

[Joao Noronha, analyst]

There have been several questions in terms of backlog and GTD. Now if you could refer to the orders that have come out from the transmission auctions at the end of 2016 and 2017. If you could give us some more qualitative answers, the results are above or below what you had expected in terms of the auctions.

[Unknown Executive]

Yes, we can give you more color. When it comes to the auctions, we would like to remind you that we had some contracts. Our clients were awarded for lots in 2017, 2018. There are several open contracts in the market, and WEG would have the opportunity of working with other players. It's also possible to work on other fronts, for example, by selling equipment directly in terms of other orders and other opportunities. And with all of this, we have a very clear vision of our order portfolio that has been improving quarter-after-quarter. We don't think that we will have great leaps from one quarter to the other, but instead a gradual improvement year-after-year. Year-after-year, we have observed a significant improvement semester-after-semester.

Evidently, we have to be somewhat cautious. Some of those who were awarded the auctions offered very low prices. This could have an impact on supply. And once again, we will have to be very selective to guarantee the best returns possible. We don't necessarily want to have a higher number of orders. We're working very well in this, and our expectations in this field are quite positive, not only for this year, but for coming years as well.

[Operator]

The next question is from Guilherme Mendes from JPMorgan.

[Guilherme Mendes, analyst]

Another question. Going forward, well, we're speaking about a better growth and improvement in EBITDA margin and much more. How do you consider WEG going forward thinking of the 2020/2021 horizon? Are we going to have a slower growth because we see that the improvement in margin is taking place at a faster pace since 2018? So what is your outlook for the medium term?

[Unknown Executive]

Guilherme, let's speak a bit about expectations in the long term, but, once again, we need to be very cautious when it comes to these expectations. In 2019, what we expect is the following. That the EBITDA margin will be better than in the previous years. We were at 15% -- 15.2% in the last 2 years because of the crisis that had an impact on the EBITDA margin. Now this year, we have everything to have a better performance. And we have 2 quarters, the last quarter of 2018 and this first quarter, with better results.

Now the expectation for the resumption of economy in Brazil means that we should have an improvement in margin in the more mature businesses of WEG Brazil. As Paulo mentioned, we will have a more consistent delivery of equipment this year and an improvement of profitability in businesses abroad. We have to speak about the U.S. as well as Mexico, where we're concluding an important part of verticalization in Mexico that, of course, will lead to improvement. And once we gain capacity, we're better able to dilute our costs, and we can improve our margin. The expectation to improve the margin of the mature operations in Brazil evidently depend on the market, as I mentioned. And our portfolio of wind projects will be delivered this year, and we do hope to have a better return on capital.

Now this is what we are expecting for this year. The margins of WEG can continue to improve during the coming years, yes. The response to this is positive, as Rogério stated in his question. The long cycle in the right economic conditions could further improve. Now those who were at WEG Day know that we have a new program for the improvement of cost presented in Brazil, and we're implementing the same program outside of Brazil as well. So there is an expectation that improvements will continue but we cannot state which will be the levels of our margins. We do have years where we have a better performance, other years when we continue our process of investments or acquisitions with a small drop perhaps. But I believe that the company will always present attractive figures, which is the main indicator for the company. Now we can't state if we will have an improvement quarter-after-quarter. Perhaps the figures will be somewhat lower than 2018. It is possible but we want to remain at attractive levels, once again.

[Operator]

[Operator Instructions] We continue with Lucas Barbosa from Morgan Stanley.

[Lucas Barbosa, analyst]

My question is a follow up on the discussion on distributed generation. Could you give us more color in terms of what you are expecting this year? And if you could speak about the competitors that are involved in this distribution network?

[Paulo Polezi, executive]

Lucas, this is Paulo. What we can advance is that we have a highly positive outlook in GDT (sic) [ GTD ]. This is something that has gained relevance. And insofar as solar energies have volatility, one quarter may be stronger. Another may be weaker. But we tend to have a more stable and constant base for distributed generation, and we will get to the point where distributed generation will become more important than the solar plants. The outlook nevertheless is positive.

WEG carried out very good work in terms of training the network installation. We have focused a great deal on this, and the financial results continue to be attractive. The payback for distributed generation is highly favorable, and, therefore, several companies are working in terms of cost reduction because of the present day situation of the country. Cost reduction has good results. So we're increasing our ability to assemble our export contracts for the long term, getting ready for a more prolonged improvement in distributed generation. As you can see, the company is ready to grow more in this sector, not only this year, but going forward as well.

[Lucas Barbosa, analyst]

So when it comes to competition, have you observed any differences, any new players in the market or not?

[André Salgueiro, executive]

Lucas, this is André Salgueiro. Yes, we do have other players in the distributed generation market. WEG is not the only player. But as we have been in Brazil for some time, as we are an acknowledged company, we do have a competitive edge. But of course, we have to think about the size of the market, and yes, we are competing with other players in the market.

[Operator]

At this point, we would like to close the question-and-answer session. I would like to return the floor to our speaker for the closing remarks.

[Unknown Executive]

Well, thank you very much once again to all of you for your participation. And what can I say at the end of this quarter? We ended this quarter based on confirmation of our expectation, and we have had a very good return on invested capital. Now even though we will have less growth during the year in wind generation, for example, we do want to reach better operational margins compared to previous years and deliver an attractive return on invested capital. Once again, thank you for your participation, and have a good day.

[Operator]

The conference call for WEG ends here. We would like to thank all of you for your participation. Have a nice day.

[Statements in English on this transcript were spoken by an interpreter present on the live call.]