Eregli Demir ve Celik Fabrikalari TAS

IST:EREGL.E

Earnings Call Transcript 2021-Q2

[Operator]

Ladies and gentlemen, thank you for standing by. I am Gelli, your Chorus Call operator. Welcome, and thank you for joining the Erdemir conference call and live webcast to present and discuss the second quarter 2021 financial results. [Operator Instructions] Please note, Eregli Demir Çelik Fabrikalari, T.A.S, Erdemir, may, when necessary, make written or verbal announcements about forward-looking information, expectation, estimates, targets, assessments and opinions.

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

At this time, I would like to turn the conference over to Ms. Idil Onay Ergin, Investor Relations Manager. Ms. Ergin, you may now proceed.

[Idil Onay, executive]

Thank you very much, Gelli. Good afternoon, everyone. Welcome to our conference call and webcast of Erdemir and its subsidiaries for the second quarter of 2021.

Today, our CFO, Mr. Serdar Basoglu, and our Financial Control and Reporting Director, Ulas Yirmibes, are also joining the webcast. First of all, I will go through our investor presentation, which you can find on our website, and you can also follow it through the webcast. Then at the end of this presentation, there is going to be a Q&A session as usual.

Before starting the presentation, I will hand over to our CFO, Mr. Serdar Basoglu. The line is yours.

[Mustafa Basoglu, executive]

Thank you, Idil. Good afternoon, everyone. Welcome to our second quarter conference call. And again, thank you for joining us today. Before starting, as you all know, our IR manager, Idil will take you through the details of second quarter performance of our company. But before starting our presentation, I would like to go through the market expectations for next quarters.

As you remember in the last quarter conference call, we were delighted to announce that EBITDA margin of the first quarter was the highest margin in the company's history. Today, I can say, we are very proud to publish another successful quarter and set a new record in the company's sales with 39.3% EBITDA margin.

Certainly, our successful results are not enough to say the margin only. Sales revenue increased by 60% and net profit was almost 4.5x compared to the same period of the previous year. Furthermore sector indicators shows us that an even better quarter will be experienced in Q3. This year, we understate that each quarter will be the most successful quarters in the company's history when evaluated individually. We estimate that we will achieve better results in the third quarter and the second quarter -- than the second quarter. And also, we expect that fourth quarter results will be in satisfactory levels as previous quarters.

As a result of these positive expectations, we are delighted to be the most valuable company based in Istanbul since April. As you all know, HRC Turkey domestic price was around USD 1,180 per tonne at the end of May 2021. As we mentioned earlier, our order book expanded from 2 months to 3, 3.5 months driven by the strong demand.

Consequently, the reflection of the increase in sales prices on the financial statements were visible in Q2. Currently, while steel prices are normalized compared to end of May, iron ore prices are also decreasing with the same trend. We expect that both raw materials and steel prices will normalize even today. On the other hand, we do not foresee a decrease in steel demand, both locally and globally.

As you all know, we always considered the margin between raw materials and product prices that we think that premium between raw materials and steel prices will be in our favor for next periods. I will be with you at the end of the presentation. So now I would like to hand over the mic to our IR manager, Idil.

[Idil Onay, executive]

Thank you, Mr. Basoglu. Our presentation consists of 2 sections, as you already know. The first one is the market overview and then the financial results.

So let's start with the market overview. In Page 5, you will find crude steel production figures in Eurozone, China and CIS regions.

So world crude steel production was around 1 billion tonnes in the first half. It means that it's up by 14% compared to the same period of 2020. The European Union produced 40 million tonnes of crude steel in the second quarter of 2021, up by 37% compared to the same quarter of 2020. China's crude steel production, as you may see on the upper right-hand side, reached to 291 million tonnes, up by 8% when compared to the second quarter of 2020. Finally, CIS region produced 27 million tonnes of crude steel during this period and it indicates around 14% increase.

I will explain the latest figure in Turkish steel market in the following slides. So let's continue with the raw material markets. In Page 6, you will see the prices of steel-related commodities. Let's take a look at coking coal, iron ore and scrap prices.

Current price level of coking coal is around $220 per tonne. In our first quarter conference call, 3 months ago, it was around $110 per tonne. So it's almost doubled. Coking coal prices are not expected to decrease significantly by market experts in the short term as the global supply-demand balance continues to tighten. Iron ore has fallen more than 20% since July and remains below the $200 per tonne level. The current price level of iron ore is around $170 per tonne, although there is an uncertainty in the market regarding the iron ore price future, it is highly likely to see $160 per tonne level. I also would like to remind that Erdemir is around 15% self sufficient in terms of iron ore.

The latest scrap price level was around $460 per tonne, and has not seen the $400 level since February 2021. As we always emphasize, high scrap price is a kind of disadvantage for the electric arc furnaces.

On Page 7, you will see the production and consumption figures of Turkish steel market for the first half of 2021. As you can see, there is an imbalance between production and consumption of long and flat steel in Turkey. Since the end of second quarter of 2020, with the reduction of negative effects of COVID-19, both production and consumption have increased. While steel production increased around 23%, steel consumption increased around 30%.

On Page 8, exports and imports data are presented. Turkish steel industry completed the first 6 months of 2021 with a significant increase in production and exports. However, the increase in exports lacks behind the increase in imports. Turkish Steel Producers Association foresees that production, consumption and foreign trade balances will gradually settle in the second half.

So let's take a look at the financial results and the operational metrics. On Page 10, you will see the brief summary of our first half results. In the first 6 months of 2021, we produced 4.6 million tonnes of liquid steel, 8% higher than the last quarter. And during this period, long production declined around 45,000 tonnes, while flat production increased around 200,000 tonnes. We sold around 4 million tonnes in the first half, which indicates an increase of 2% compared to the first half of 2020.

Our revenue is just about $3.2 billion, which is around 48% higher than the first 9 months of 2020. Also, we generated $1.3 billion EBITDA and $738 million net profit after tax, which are historical high levels. I will explain the details of P&L later in the following slides.

On Page 11, you will see the liquid steel production volumes, and I will skip this slide quickly and continue to next slide, which is about capacity utilization ratio of our group.

Our capacity utilization ratio was realized at 94% in the first half. This ratio was 97% in the first quarter and the reason of that decline was plant maintenance holds in our plants. As you all know, this ratio is far better than the world's average, and this is one of the key strengths of Erdemir.

On next page, you can see our finished goods production volumes. There is 109,000 tonnes increase in Q2 year-over-year, which comes mainly from the flat steel. As you know, depending on demand, we can easily shift our production between flat and long steel.

On Pages 14 and 15, you will see the comparison of sales volumes and revenue. Our sales volume was around 3.9 million tonnes in the first half of 2020. And this year, sales volume has increased around 2%. It goes flat by quarter. On Page 15, you can find a breakdown of revenue for domestic and export sales. 83% of revenue comes from domestic sales, in line with the domestic volume, which we'll discuss in the next page. Our sales revenue increased by 60% year-over-year in Q2 2021, driven by the high sales prices.

So let's take a look at the segmental breakdown of domestic sales in Page 16 and export volume in Page 17. As you can see from the pie charts, our domestic sales were almost 200,000 tonnes higher than the first half of 2020. While sales through distribution chains and general manufacturing increased compared to last year, sales to pipe and profile industry and automotive industry declined. Total export volume in Q2 was higher than first quarter exports, as you can see in Page 17. This is mainly because of the effect of prices in the foreign market.

On Page 18, you will see the historical figures for EBITDA and net profit. We generated $1.2 billion EBITDA in the first half of 2021. And our EBITDA margin of 38.3% is far better than the steel sector's average. Also, we announced $738 million net profit and 23.4% net profit margin in the first half of the year. Our second quarter EBITDA margin is the highest margin in the company's history as Mr. Basoglu mentioned earlier.

On Page 19, you can see how we reached net profit from EBITDA. The largest item was tax expenses, which was $382 million in the first half. Due to the Turkish lira depreciation, we have recognized additional foreign exchange loss on the deferred taxation, which is $112 million in the first half. The other major item in this chart was finance income of $57 million and depreciation of $112 million. After other expenses and noncontrolling interests, we reached to $738 million net profit.

On Page 20, you can see EBITDA to change in cash bridge. Change in working capital is a result of higher inventory, which is around $488 million. The reason for the increase in inventory is the rising commodity prices. Also, we spent around $242 million capital expenditures in 6 months of 2021. This amount also includes advances paid for the capital expenditures as well that you will see the difference between the CapEx page in Page 27 and this one. After the dividend payment of $827 million and acquisition of $294 million, the first quarter's change in cash level was $656 million.

On Page 21, you can see the EBITDA per tonne trend. We have achieved $336 per tonne in this Q2. This is one of the best quarters in terms of EBITDA per tonne. We are expected to see even better EBITDA per tonne in the third quarter.

So let's take a look at the balance sheet on Slide 20 -- 22, sorry. We explained the change in working capital and cash before. As I mentioned earlier, after the dividend payment of $827 million and the acquisition of $294 million, cash amount decreased by 36%. There is around 7% increase in fixed assets due to the Kümas acquisition. Also, there is an increased growth in inventories and trade receivables and payables due to the price increases in steel and raw materials. Other than these items, there is no significant change in our balance sheet position.

On Pages 23 and 24, you will see the historical trend of financial borrowings and net cash. Our net cash position will increase again at the end of the year due to the increase in profitability in the steel industry. So the next page just shows how we reached to this net cash level since December 2020. Our net cash position was $984 million at the end of 2020. After the dividend payment of $827 million and the acquisition of $294 million, the first half net cash level was $146 million due to the EBITDA generation.

Slide 25 represents the maturity profile of borrowings. As you can see, most of our short-term loans are revolving trade financing facilities mainly related to the export and import activity.

Slide 26 represents our cost of sales breakdown. There is no significant change in our cost breakdown. However, the contribution of iron ore and coking coal in raw material costs has changed, and the percentage of iron ore costs increased in the raw material basket, while coking coal has decreased, which is in line with the trend in raw material markets.

Page 27 represents the historical CapEx standing. The total CapEx spending excluding advanced payments,is $177 million in the first half of 2021. Our ongoing projects such as new blast furnaces are on progress, and there is no cancellation from the announced investments. Our capital expenditures will accelerate in the coming quarters. As the last thing, there is an increase in the number of employees due to the addition of our new subsidiary, Kümas employees.

Now we can continue the Q&A session. We will be delighted to answer your questions with Mr. Serdar Basoglu. Thank you for listening.

[Operator]

[Operator Instructions] The first question is from the line of Dan Shaw with Morgan Stanley.

[Dan Shaw, analyst]

It's Dan Shaw from Morgan Stanley. Just a couple of questions. The first one, just on working capital, I think you've touched on it in your presentation already. It's quite a big outflow in Q2. But given that we've seen iron ore prices start to come down, does that mean that we'll start to see a reversal of some of that buildup in the third quarter? That's the first question.

[Idil Onay, executive]

Dan, actually, if you look, considering the price trend in the first quarter, we expect to see increase. As we mentioned that there is some kind of delay of high sales price effect due to the expanded order book. So in the first quarter, actually we expect to see an increase in net working capital.

[Dan Shaw, analyst]

Okay. Fine. So your inventories -- the inventory values will fall because of the iron ore price, but your receivables will increase because of the steel price. Is that roughly how we should think about it?

[Idil Onay, executive]

Yes, that's right.

[Dan Shaw, analyst]

Okay. And then the second one, just with regards to the European carbon border adjustment mechanism, how do you see that impacting you? And perhaps, can you outline any longer-term plans that you have around reducing the carbon intensity of your operations?

[Idil Onay, executive]

Well, following the EU announcement, Turkey also put forward a follow green plan as a road map to cut emissions, which could help its industries limit the burden of competing with EU industry sectors under the carbon border adjustment mechanism. In view of these circumstances, how our company will be affected by carbon pricing has been calculated on the basis of scenarios. The additional costs of carbon border adjustment mechanism, which will start in 2026, has been calculated also.

In addition, the costs that will occur when the Turkey emissions trading system come into force whose signals are given by the Turkish government also have been calculated. The emissions effect is also taken into account in our adjustment mechanism studies. Our actual emissions are being reduced through activities such as energy efficiency and resource efficiency. And the actions can be taken to transition to carbon-free production are closely followed by the activities of other sector players. Well, obviously, a transition to breakthrough technologies is required for carbon-free production.

[Dan Shaw, analyst]

Understood. So the ambition going forward is to continue to reduce the carbon intensity of your steel and ultimately to travel towards carbon-free steel at some point. Do you have sort of long-term goals in terms of what dates you might achieve certain levels of reduction by and when you might get to that carbon-free point in time, whether it's 10 or 20 years from now? Do you have any long-term goals that you can talk about?

[Idil Onay, executive]

Well, we haven't announced any target and goal on that issue. But obviously, our management takes those seriously, and they are working very hard on that. So I assume you will hear from us soon.

[Operator]

The next question is from the line of Bulent Yurdagul from HSBC. Please go ahead.

[Bulent Yurdagul, analyst]

This is Bulent from HSBC. I have several questions. The first one is, looking at the sales volume, you registered around 2 million tonnes in the quarter, which is roughly the same in the second quarter of 2020, the peak of the lockdown in COVID. And also looking at the inventory levels as of end of second quarter, we see a substantial increase in the levels, also due to price impact, obviously. Is it fair to assume some sort of delay in some delivery in the quarters, which were pushed forward to third quarter? Because 2 million tonnes, I mean looking at the production, production is very strong, but that's not what we expected of sales volume. So some sort of carryover to third quarter seems likely in my opinion. And could you please comment on that? That would be my first question.

[Idil Onay, executive]

Well, yes, you have seen that production has increased, but not sales that much. As you know, there is Ramadan effect in the second quarter, but this is one of the reasons. But also there were and there will be some plant maintenance holds in our plants. And so actually, yes, the inventory levels came up. And we will use that inventory during the second half maintenance holds. So you will see that's the effect in the second half.

[Bulent Yurdagul, analyst]

Okay. And my second question would be actually listening to what Serdar said, you expect every quarter in 2021 to be record high -- to post record high margins in terms of EBITDA. So if I'm not wrong, third quarter all-time high EBITDA margin was in 2008 at 44%. So do you expect to beat that as well? And assuming and looking at prices, everyone is talking prices and costs, so the EBITDA per tonne applicable to third quarter should theoretically be at least $70 or $80 higher compared to third quarter. So that would actually bring the margin to above 44%, and that means a record high quarter. So is it fair to assume?

And thirdly, what sort of ease in margins can we expect for the fourth quarter? You're probably close to selling everything for November or if not December. So you probably have quite good visibility until the end of the quarter. Can you comment on this, please?

[Mustafa Basoglu, executive]

Actually, there is a misunderstanding. I'd say, yes, we think we will achieve better results in third quarter, you will see that. But for the fourth quarter, I can't say. We expect that fourth quarter results will be in satisfactory. It doesn't be higher than third quarter or nearly high, historical highs, but it will be satisfactory.

[Bulent Yurdagul, analyst]

Okay. Is my assumption about the third quarter's EBITDA per tonne calculation, is it reasonable? Do you find my assumptions reasonable?

[Idil Onay, executive]

Well, Bulent, we don't give any numerical guidance right now. But obviously, third quarter will be a record high. That's obvious, and everyone is expecting that way, which we are actually...

[Bulent Yurdagul, analyst]

Record high means above 44%, okay, historically it's not...

[Idil Onay, executive]

Well, it will be better than the second quarter. And actually Mr. Basoglu also mentioned that in his speech. So we are expecting better quarter when compared with the second quarter.

[Operator]

The next question is from the line of Anton Fedotov with Bank of America.

[Anton Fedotov, analyst]

I had a question regarding the Turkish domestic steel market. Right now, there is a deficit of HRC. And you show in the slide the HRC import volumes, which are quite significant. What can be the impact from the restart of the Iskenderun plant owned by the Russian company, MMK, which is started happening right now, as I understand, and gradually just want to ramp up, up to 2 million tonnes of HRC production per year. What can be the impact on the price and overall on the market from this?

[Idil Onay, executive]

Well, there will always be new capacity coming to the market. But actually, Turkish market follows exactly the global market. So on the pricing mechanism, Turkish domestic market follows, which is the global trend. So actually, there is always new additional factories. So MMK will be additionally producing HRC, but I don't think it will have some kind of effect on the overall pricing mechanism.

[Anton Fedotov, analyst]

Thank you. And then I have as a second question regarding your CapEx projections, you said that CapEx should accelerate in the coming quarters. Can you please remind us about your CapEx guidance for this year and for the next year?

[Idil Onay, executive]

Sure, Anton. Actually, we are expecting between $550 million to $600 million with maintenance and other ongoing investments as a CapEx, let's say, guidance expectations. And the maintenance will be around $50 million to $80 million per year as we go. And for the next year, actually, the total amount is $1.4 billion for the new investment plan. And out capital -- as I mentioned, our capital expenditures will accelerate in coming quarters as long as there is no global uptime again. And CapEx will be spent between 2021 and first half of 2024. And each year between 2021 and 2023, we are planning to spend approximately $400 million. But as I mentioned, this is $400 million just for the new investment. And we may -- actually, the figure will reach up to $550 million to $600 million with maintenance and other ongoing investments.

[Anton Fedotov, analyst]

Thank you. So the development CapEx is $400 million per year and maintenance is about $150 million, $180 million approximately, right?

[Idil Onay, executive]

With maintenance and other ongoing investments, yes.

[Operator]

Our next question is from the line of Boris Sinitsyn with VTB Capital.

[Boris Sinitsyn, analyst]

Congratulations with good results. I wish the posted performance continues. I have 3, probably 4 questions from my side. Firstly, could you please remind the timing of commissioning of your 2 new blast furnaces at Eregli and Isdemir. This is the first one?

[Idil Onay, executive]

Boris, well, let me give you the date, the revised dates actually because after we announced, there were obviously pandemic commission. So the new dates are for the Eregli, it's first quarter of 2022. And for Isdemir, it's going to be also the first quarter of 2022.

[Boris Sinitsyn, analyst]

Okay. And just a follow-up on this. Is it correct that you would expect incremental addition in your crude steel output of around 1 million tonnes for these 2 projects?

[Idil Onay, executive]

Actually, no. There won't be any effect on the final product capacity. Yes, the capacity of the facilities are increasing with this investment. But there's a concern that will we make enough. So there won't be any effect on end product, final product capacity.

[Boris Sinitsyn, analyst]

So you're substituting like old capacities with the new ones, right?

[Idil Onay, executive]

Well, actually, efficiency will be higher and also at the beginning of this CapEx, we said that these blast furnaces needed relining, but reline makes us losing around 3 to 4 months production. So instead of relining, we preferred -- management preferred building new blast furnaces. So the economical time of the new ones will be higher and the efficiency will be higher.

[Boris Sinitsyn, analyst]

Understood. The second question is just a follow-up on your sales -- on previous questions on sales. Could you please provide guidance for your production volume and sales volumes for 2021, if you may?

[Idil Onay, executive]

Actually, for sales volumes, we expect to see figures nearly close to 2020 figures. I mean this is not an official guidance, this is what we expect.

[Boris Sinitsyn, analyst]

Another question is on your -- on the fact that actually you are seeing that your net debt is declining, cash flow generation is quite weak. And the question is, what are your preferred ways of capital allocation for this additional cash, whether it's -- these are some new investment projects, which you are yet to decide and announce?

[Idil Onay, executive]

Boris, we don't have any plans for additional dividends. And also, we do not have any board-approved M&A plan. But we are always looking for opportunities. So for now, we don't have any approved new plans for cash spending.

[Boris Sinitsyn, analyst]

So you basically imply that your cash balance would just increase so far depending...

[Idil Onay, executive]

Well, actually, I know that you are asking with regard our dividend policy. So most probably, there is no change in our dividend policy. So most probably, most of the cash will go as dividends in next year.

[Boris Sinitsyn, analyst]

Okay. That's clear. And my final question is, do you see any effects on effect from Russian export duties introduced from August to December on either Turkish prices or domestic prices?

[Idil Onay, executive]

Sorry, could you repeat your question? I couldn't catch that.

[Boris Sinitsyn, analyst]

Sure. Do you see any effect from Russian export duties introduced from August to December on Turkish steel pricing? Do you see the duty's effect on some part of Turkish market?

[Idil Onay, executive]

Well, we are -- I don't know. We haven't seen any effect, maybe in the future, but until now, no, we haven't seen any effect.

[Operator]

Ladies and gentlemen, in the interest of time, I will now turn the conference over to Mr. Basoglu and Ms. Ergin for any closing comments. Thank you.

[Mustafa Basoglu, executive]

Hello, everyone, again. Thank you for joining us today. I hope we will be at the third quarter conference call together, also with better results. Thank you for joining us today.

[Idil Onay, executive]

Thank you very much.

[Operator]

Ladies and gentlemen, the conference has now concluded, and you may disconnect your telephone. Thank you for calling, and have a nice evening.