Eregli Demir ve Celik Fabrikalari TAS

IST:EREGL.E

Earnings Call Transcript 2019-Q2

[Operator]

Ladies and gentlemen, welcome to Erdemir Group 2019 Quarter 2 Financial Results Conference Call.

Erdemir may, when necessary, make written or verbal announcements about forward-looking information, expectations, estimates, targets, assessments and opinion. Erdemir has made the necessary arrangements about the amounts and results of such information through its disclosure policy and has shared such policy with the public through the Erdemir website in accordance with the Capital Markets Board regulations. As stated in related policy, information contained in forward-looking statements, whether verbal or written, should not include unrealistic assumptions or forecasts. It should be noted that actual results could materially differ from estimates, taking into account the fact that they are not based on historical facts, but are driven from expectations, beliefs, plans, targets and other factors which are beyond the control of our company. As a result, forward-looking statements should not be fully trusted or taken as granted. Forward-looking statements should be considered valid only considering the conditions prevailing at the time of the announcement. In cases where it's understood that forward-looking statements are no longer achievable, such matter will be announced to the public and the statements will be revised. However, the decision to make a revision is a result of subjective evaluation. Therefore, it should be noted that when a party is coming to a judgment based on estimates and forward-looking statements, our company may not have made a revision at that particular time.

Our company makes no commitment to make regular revisions which would fully cover changes in every parameter. These factors may arise in the future, which may not be possible to foresee at this moment in time.

I will now hand you over to Mr. Avni Sönmezyildiz, Financial Control and Reporting Director, who will take you through the presentation. Dear Mr. Avni Sönmezyildiz, please go ahead.

[Avni Sönmezyildiz, executive]

Thank you, Alex. Ladies and gentlemen, welcome to the investor presentation of Erdemir for this period ended 30 June 2019. Our CFO, Mr. Emrah Silav; and our Investor Relations Managers, Idil and [indiscernible], are also joining the webcast with me. As usual, our investor call will start with the -- [indiscernible] our investor presentation that we have uploaded on our website yesterday. You can also follow through the webcast. Then, there's going to be a Q&A session after this presentation. So let's start the presentation.

First of all, let's take a look at the global and local steel markets. In Page 5, you will find the crude steel production figures in Eurozone, CIS region and China.During the first 6 months of 2019, where crude steel production were 925 million tonnes, up by 4.9% compared to the same period of 2018. Asia produced 660 million tonnes of crude steel, an increase of 7.4% over the first half of 2018. And European Union produced 85 million tonnes of crude steel, which was down by 2.5%.

North America's crude steel production in the first 6 months was 60 million tonnes, an increase of around 1.5%. And CIS produced 51 million tonnes of crude steel in the same period, almost the same as previous period of 2018.

When [indiscernible] that Europe's production is lower than the same period of 2018, and there is only 1.4% increase in the production of North America, you can conclude that around 5% increase increasing [indiscernible] our output is mainly produced by China. And in the first half of 2019, China steel production increased around 10%, and this increase also included iron ore prices, which I will explain in the next chart.

For the rest of the year, we will be closing the following China GDP growth and it's -- there's a government stimulus for the infrastructure project. And we'll cease -- we'll continue to support steel demand in China. This is one of the most critical things for the global steel industry.

So in Page 6, you'll see the price of iron steel and its commodities, which are iron ore, coking coal and scrap. And let's take a look at coking coal and scrap prices, first of all.

Coking coal prices are on a downward trend due to weak global demand. We closed first quarter with higher than $200 per tonne on benchmark coal index. However, now, we see less than $170 per tonne figures. Demand for coking coals still seems rich in global markets, and we don't expect significantly covering the prices in the short term.

Scrap price also has been below $300 levels, and it was around $320 at the end of first quarter. And especially the low demand with silica steel market is pushing the scrap prices down. As you'll recall if you follow, iron ore rally continues until the last couple of days, and we have seen high -- $130 per tonne figures last week, and we get that to below $100 level in the last couple of days because of the contract for trade and currency war between China and United States.

The [ boost brand ] in iron ore market was mainly because of 2 reasons: First one is the trade sample as that mining complex in January 2019; and then, one is required to take actions to close various other mining results, and estimated production cut around 50 million to 75 million tonnes in its iron ore production. [indiscernible] concerns in the iron ore markets were also further heightened when the HP lowered its iron ore production guidance to between 265 million to 270 million tonnes for the fiscal year ended June 30, and we also cut production forecast between 320 million to 330 million tonnes. While rate CapEx in Australia has ramped up during this period, it's not positioned enough to fulfill this gap.

Also, iron ore production in China has been declining in recent years, reflecting China's environmental policy restrictions and steel mills preference for higher grade iron ores to improve their efficiency in China. And the second reason for the increase in iron ore pricing is the increase in China steel output, as I mentioned in the previous slide. There was a 10% increase in China steel output in the first half of 2019. And that both -- because of both of the assets, the iron ore prices increased significantly.

During this period, a large portion of supply shortage has been covered to existing inventories at the Chinese ports. And cost of credit has increased, leading into new Chinese new break. However, we have seen 4 inventories for [indiscernible] since April, and inventories are now at the lowest level since 2016. Due to supply shortage and China's steel throughput production, it seems that iron ore oil prices will remain elevated during 2019 and maybe in 2020.

In Page 7, you will find the production and consumption figures in Turkish steel markets. In the first half of 2019, steel production in Turkey has declined around 20%, while consumption declined more than 32%. These figures indicate huge slowdown in Turkish steel market. When we combine these 2 -- these figures with the export and import data in the next slide, we can see that the planned scrap consumption, which is around 1.8 million tonnes, was compensated by increase in scrap export around 1.1 million tonnes by domestic steel producers. Decline in the consumption also lowered scrap steel imports around 700,000 tonnes in the first half of 2019.

In long steel segment, the consumption declined 4.9 million tons, and it indicates around 45% decrease in the long steel consumption in Turkish domestic market. At the same period, long steel exports increased only 300,000 tons, and total production declined around 3.5 million tons. As you can see from the production and consumption figures, it's -- there is some decline in [indiscernible], and we don't expect significant recovery for steel consumption in the second half, and performance of domestic producers depends on the export performance, as long as they -- where sanctions allows it.

Let's take a look at the financial and operational metrics, starting from Slide 10.In Page 10, you will see the brief summary of this first half results.

In the first half, we were able to produce just about 4.5 million tons of liquid steel, which indicates approximately 4% decline compared with the same period of previous year. However, [ running ], we were able to sell 4.3 million tons of finished product, which is around 3% higher than previous year's first half. The difference between liquid steel production and the finished product sales is just the inventory effect.

Our revenue in the first half has declined to USD 2.6 billion. Although sales growth is higher than previous years, average flat sales price declined to $599 from $659, and average long steel prices declined to $400 -- $500 from $575 when we compare the same period of 2019 and 2020 average prices of 2018.

In addition to decline in revenue, our costs have also increased, mainly because of the iron ore prices. And as a result of decrease in the sales price and increase in raw material costs, our [indiscernible] is approximately $300 million lower than EBITDA in the first half of 2018. However, the net profit for the period is only $290 million lower, thanks to lower tax expenses, realizing low enforcement tax and deferred taxation.

So I'll skip Slide 11 and continue with the next slide, as I already mentioned the liquid steel production.

In Page 12, you'll find our capacity steel utilization ratios. And our capacity utilization was lower than last year's average as the liquid production is low -- first half lower than previous years. So we end up with just below 95% capacity utilization. Its right to mention that global utilization is not announcing the global data for that because of constant scrap concerns, and we won't be, no problem. They won't be able to compare with our capacity utilization with the global capacity utilization.

So let's take a look at the next slide. And if you look at the finished goods production and sales volume in Slide 13 and 14, you'll see that the decline in production of hot and cold products have been compensated by the rental effect. Although we produced 77,000 tons less finished product, on the sales in cold products has declined due to low domestic demand and export opportunity in the cold products due to the [indiscernible] value of the union. However, we are still able to increase our sales volume around 3%, thanks to strong exports in hot and long product segments.

In Page 15, you can find a breakdown of revenue for domestic and export sales. As the export composition has changed in favor of long and hot products, the average export and domestic prices are not good indicators for the comparing domestic and export prices because of the composition change. However, we can say that the domestic prices are not in favorable than compared with the export prices in the first half.

So that -- let's take a look at the segmental breakdown of domestic sales in Page 16. We've seen a significant change in domestic sales, flat sales, for the first time. You have to remember that there is only small changes in the follow -- in those charts. But this time, there's a significant change. Although we were able to maintain sales -- our sales to the pipe profile and rolling and auto products or producers, our sales to distribution chains and general manufacturing industry around 330,000 tons lower than previous year's first half due to a slow demand in domestic market. As we were able to divert this domestic sales to the export market, we have reached higher total sales volume, although those segments had lower results on previous periods. And there is no significant change in our long sales in domestic markets.

So let's take a look at the export figures. And in this steel, in addition to flat exports, we were also able to increase our long exports -- long steel exports. In the first half, our flat product exports were 866,000 tons, while long product exports were 156,000 tons. And total export volume increased more than 55%. And now export sales are more than 20% of our total sales.

Due to slow demand in domestic markets, we assume that our export volume will stay higher than 20% for the rest of the year. And if there is no additional quota to be applied by European Union in the future phase or increasing sanctions of the trade wars.

So in the next slide, Page 18, you will see the historical figures for EBITDA and net profit. I'm not going to mention about this slide, and I'll stick to the next one, Page 19.

In Page 19, you will see the EBITDA to net profit bridge. Two things to mention in this bridge: One of them is the financial income, and the other one is [indiscernible] expenses. In this quarter, on the one-off income, we have realized a fixed income around $98 million from the difference of accrued and payment opportunities. As we see for our boost in U.S. dollars and paid dividends in Turkish Lira, foreign exchange difference occurred between accrued and payments of dividends, which is $98 million.

Second thing is the foreign exchange difference on deferred tax as we said on [indiscernible] period because of the currency fluctuation, and we have recognized around $50 million deferred tax -- foreign exchange on deferred taxes in the first half of 2019.

In the next slide, in Slide 20, you can see the EBITDA to net-- EBITDA to change in net cash bridge. Release around the working capital, around $200 million, is mainly coming from changes due to the decline in steel prices and increase in sales tables. We were able to achieve -- to extend our maturities for some of the [ soft buyers ], and it helped us to release significant amounts of working capital to the cash.

Cash flow and financial investments amounting to $48 million, as you can see on the chart, is mainly -- contains transfers from bank deposits to more than 3 months' maturity. Although we have to report these deposits as a financial investment, you can also post it as another cash balance. This is just the IFRS regulation.

As a result of $622 million EBITDA and $201 million coming from working capital injection, our cash balance have only declined $384 million even after reduced dividend payments of $794 million.

Slide 21 represents the quarterly trend of EBITDA per ton. Q2 EBITDA per ton was slightly higher than Q1 as the steel prices recovered more than negative effect of raw material costs over the cost of sales. Decline in Turkish Lira conversion cost, because of the depreciation of Turkish Lira, also helped slight increase in EBITDA, 8% in the second quarter. Because of increasing cost of iron ore prices, we expect squeezing EBITDA per ton in the following days.

In the next slide, you will see the financial figures, but we have explained the working capital change and the cash. And there is no significant change in other balance accounts, so I'll skip to Slide 22.I'll skip 22 and I'll continue with Slide 20 and 24. So in this Slide 23 and 24, you see disbursement plans of financial borrowings and net cash. Although we have seen significant amounts of dividends in the second half, we were still able to maintain net cash position of-- positive net cash position of $161 million, thanks to cash inflow coming from this working capital.

Slide 25 represents the maturity profile of the borrowings. There is no significant change in the maturity profile, as we keep more than $500 million in the short-term straight financing liabilities.

Slide 26 represents the cost of sales breakdown. Our Turkish Lira costs have declined in the first half as Turkish Lira depreciates, and also, iron ore costs have increased during this quarter.

Last 2 slides represents the historical CapEx spending and employee numbers. It's worth to mention that we haven't started spending for a new project yet, and spending for CapEx will be accelerating in the following period. And in the first half, new galvanizing line has also been completed and started in production, a ramp-up of the production. And as the last thing, there is no significant change in our number of employees, and the number of employees are constantly reducing because of the retirements, et cetera.

Now we may continue with the Q&A session, and we'll be happy to answer your questions with Mr. Silav and Mr. [indiscernible]. We can get questions.

[Operator]

[Operator Instructions] Our first question comes from Koray Pamir, Ünlü Securities.

[Koray Pamir, analyst]

Can you at least hone any of the details of the upcoming investment plan size-wise, timing-wise? Any details would be appreciated. And secondly, based on your order book for the third quarter, is $100 to $110 of EBITDA per ton a fair estimate at this point?

[Avni Sönmezyildiz, executive]

$100 to?

[Koray Pamir, analyst]

$100 to $110 range-wise.

[Avni Sönmezyildiz, executive]

Okay. I'll answer the second question about the order book and the prices. Then Emrah will answer your question for the investment plan. Actually, it's -- I mean it's always been on the margin [indiscernible]because of the recent volatility in the iron ore prices, it's not certain fact now because it changes everything. We have since [indiscernible] but now, it is lower than $100. So we definitely have [indiscernible] to this contract regarding our spot price. And the average, of course, every end of the quarter, we cannot comment for a certain number. But as the plan says, that is going to be executed on the margin. So I cannot -- we cannot comment on where it indicate on the margin.[indiscernible] for your second question?

[Emrah Silav, executive]

Mr. Pamir, we are still working on the new project. It's obvious to take time for negotiations. We are getting costs from all over the world, including European and other international vendors. We are working on it, but we are kind of close to actually closing some of those deals, including the blast furnaces and coking coal. The center will be coming afterwards. But whenever we are done and come up with a solid number, we are planning to share it with you, share that information with you as soon as possible.

[Operator]

Our next question comes from Andy Jones, Wood & Co.

[Andrew Jones, analyst]

Just a follow-up to that previous question about the guidance on the third quarter. You've talked in the past about having a 4- to 5-month lag in your iron ore and coal purchases. So you should already really have paid those prices for the third quarter, I would have thought. Did you do anything -- I mean, can you give us any guidance there? And did you do anything to kind of delay purchases of iron ore because of the high prices? I know in the past, you've talked about decent inventory management, which prevented you from seeing the sort of hit of the rising coal price a couple of years ago. Have you taken any measures in terms of your inventory management with regard to the recent spike in iron ore prices? Or should we succeed modeling game the prices we see in the market on a 4.5 month lag? That's my first question.

[Avni Sönmezyildiz, executive]

Okay. Andy, actually, the inventory management in the iron ore is not like the coking coal. Coking coal is a spot price. You see -- there will you see on the screen play, okay? But for coking coal, the pricing mechanism is different. So even if you deferred some procurement of iron ore, at the end of the day, you have to be to place the average of the core to the index. So it doesn't change so much. So in iron ore, the investor management doesn't work like coking coal. And so you buy and you wait for the next price for the quarter. So which means that, to be honest, we don't go a lot over the quarterly average of the iron ore prices because of the volatility in the prices right now. So that's why we cannot comment on the EBITDA per ton. We have to wait and see up to still the end of August.

[Operator]

Our next question comes from Can Alagöz, QNB.

[Can Alagöz, analyst]

You explained well the effect of higher exports on your pricing prospect. But I'm wondering the reason behind the decline in the share of export for second quarter-specific relative to first quarter. Is this related with the economic outlook in EU or any other one-off impact, maybe? And also, I'm also wondering if you put additional quarter limits on the steel imports in the coming quarters, do you have such a flexibility to direct your export volume to other regions such as Africa or Middle East maybe?

[Avni Sönmezyildiz, executive]

Okay. Let's start with the second one. Now we are exporting in more than 50 countries. As you already know, most of it goes to European Union, but our export union is expertized to direct those exports to the other regions. If something happens in, like, the quarter increase in the European Union. Of course, it's challenging times because of trade war fears, et cetera. But because of the diversity of our export sales, all those damages are minimal for some reason. We will push to the other markets if such things happen.

And yes, in the second quarter, the export war was different because of 2 reasons. One, after the winter time, our customers were -- have had to increase their [ demand ] for the levels. There is no [indiscernible] pileup in the domestic market. And you are right, there's also a slowdown in the European market. As you can see from these BMI figures and the Germany's GDP growth, et cetera. So both of the reasons because of the board of reasons, the export volume has declined in the second quarter.

[Operator]

Our next question comes from Koray Pamir, Ünlü Securities.

[Koray Pamir, analyst]

Just as a follow-up. I know you have already denied this several times, but we will also get some unusual, for example, currently, there's a headline that the [indiscernible] steel. I understand that it's a holding issue and it's not connected to you. But is there any chance that are you maybe more in the steel like service wise or given your expertise?

[Avni Sönmezyildiz, executive]

Actually, as you mentioned, this is kind of a holding process right now that we are obviously not aware of. We are not even sure that the process is going on. After everything is finalized, as is mentioned in the news, we have to check. But you have to keep in mind that these are 2 different entities and act accordingly. But we are not sure what's going to happen right now, so it's not very right to give personal opinions. But whenever the deal is done or not, people know. We'll come up with a sounder answer, I would say. But keep in mind, these are different company, different holdings, and we see these types of cases in the world, larger entities like this. So we will act accordingly. Thank you.

[Operator]

[Operator Instructions] We have no further questions. Dear Mr. Avni Sönmezyildiz, back to you for the conclusion.

[Avni Sönmezyildiz, executive]

Ladies and gentlemen, thanks for attending our earnings conference for the announcement of second quarter results of Erdemir. And we hope to see in the -- at the announcement of third quarter results, which will be held in October. And for our followers in Turkey, [Foreign Language]. And for the rest of the followers, have a nice weekend. Thank you.

[Operator]

This concludes today's conference call. Thank you for your participation. You may now disconnect.