Eregli Demir ve Celik Fabrikalari TAS

IST:EREGL.E

Earnings Call Transcript 2022-Q2

[Operator]

Ladies and gentlemen, thank you for standing by. I'm Popi, your Chorus Call operator. Welcome, and thank you for joining the Erdemir conference call and live webcast to present and discuss the second quarter 2022 financial results. [Operator Instructions]

Please note Eregli Demir ve Çelik Fabrikalari T.A.S. may, when necessary, make written or verbal announcements about forward-looking information, expectations, estimates, targets, assessments and opinions. Erdemir has made the necessary arrangements about the amounts and results of such information through its disclosure policy and as such shared such policy with the public through the Erdemir website in accordance with the Capital Markets Board regulation. 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 case 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 a 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. 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 Önay Ergin, Investor Relations Director. Ms. Ergin, you may now proceed.

[Idil Onay, executive]

Thank you very much, Popi. Good afternoon, everyone. Welcome to our conference call and webcast of Erdemir for the second quarter of 2022. Today, our CFO, Mr. Serdar Basoglu; and our Financial Control and Reporting Director, Mr. 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 also thank you for joining us today. As usual, before starting our presentation, I would like to go through the development and the market expectations. As you remember in the last quarter's conference call, we were delighted to announce strong financial and operational results and also high dividend payment.

Today, we've published another successful quarter and first half. Although, as you know, 2021 was an exceptional year for the steel sector, we increased our sales revenue by 36.5% in the first half, thanks to high sales prices. We also achieved USD 1.4 billion EBITDA and $827 million net profit in the first 6 months of 2022, which are higher than the same period of the previous year. When we look at the development in commodity prices, as I mentioned in our last quarter call, high coal prices and increasing energy prices affected our 2022 costs, but I can say we balance these cost increases with the decreasing iron ore prices and increasing sales prices in the second quarter.

Although the first half results are above the sector average, due to the global recession and the decreasing demand in the world, we foresee that contraction in margins will start from the second half of the year for all steel producers. Therefore, we have more cautious projections for second half of 2022.

I will be with you at the end of the presentation. So now I would like to hand over the mic to Idil.

[Idil Onay, executive]

Thank you, Mr. Basoglu. Our presentation consists 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 4, you will find the crude steel production figures in Eurozone, China and CIS region. World's steel production for the 64 countries reporting to the World Steel Association was 158 million tonnes in June 2022, a 6% decrease compared to June 2021.

The European Union produced 74 million tonnes of crude steel in the first half of 2022, down by 6% compared to the same period of 2021. China's crude steel production, as you may see on the upper hand -- right-hand side, reached to 526 million tonnes, down by 6% when compared to the first half of 2021. Finally, CIS region produced around 44 million tonnes of crude steel during this period and in the case around 18% decrease.

I will explain the latest figures in Turkish steel market in the following slides. So let's continue with the raw material markets. In Page 5, you will see the prices of steel-related commodities. Let's take a look at coking coal, iron ore and scrap prices. Price level of coking coal was around $350 per tonne at the beginning of the year. After a roller coaster in Q1 in which Russia's invasion of Ukraine further compounded global supply tightness, coking coal has nearly doubled $670 per tonne in the mid-March. The coking coal, which is currently around $204 per tonne is not expected to decline in the short term.

Iron ore price was around $120 per tonne at the beginning of the year, although it's reached to a level of $160 at the beginning of April. The current price has dropped to $110. China buys about 70% of global seaborne iron ore volumes. So any steel demand concerns will flow through to the price of iron ore. The outlook for spot iron ore prices for the rest of the year largely rests on how successful China is at containing COVID-19 and how quickly the stimulus measures start to boost steel intensive activities such as housing and infrastructure construction and vehicle manufacturing.

Scrap reached its highest level in 12 years since 2010 with $665 per tonne in March. The current scrap price has dropped to $380. We always mention that increasing scrap prices is a kind of disadvantage for electric arc furnaces when we compare to the integrated steel producers in Turkey.

On Page 6, you will see the production and consumption figures of Turkish steel market for the 6 months of 2022. While steel production decreased around 5%, steel consumption decreased around 3% compared to the same period of the last year. Turkish steel production, which entered a downward trend in the first quarter of 2022, remains at modest levels compared to the decline in the world average. In the second quarter, the contraction in production accelerated. And as of the first half of the year, the gap between world steel production and Turkey's production narrowed significantly.

On Page 7, exports and imports data are presented. In the first half of the year due to the both protectionist approaches and the shrinking trend in foreign demand, an 8% decline was observed in the exports of steel products. Imports decreased by 6% in terms of quantity and increased by 28% in terms of value in the first half of 2022 compared to the same period of the last year.

So let's take a look at the financial results and the operational metrics. On Page 9, you will see the brief summary of our 6 months results. In the first 6 months of the year, we produced 4.2 million tonnes of liquid steel. During this period, long production increased by 19%, while flat production remained almost the same.

We sold slightly less than 4 million tonnes. Our revenue was $4.3 billion, which is around 38% higher than last year. Also we generated $1.4 billion EBITDA and $827 million net profit after tax, which is -- which are higher than the same period of last year. I will explain the details of P&L later in the following slides.

On Page 10, you will see the liquid steel production volumes, which I already mentioned. So I will skip this slide quickly and continue with the next slide, which is about capacity utilization ratio of our group. Our capacity utilization ratio was realized at 86% by the reason of early timing of planned maintenance holds in Q1. Although there is a decrease in crude steel capacity utilization ratio, this ratio is still far better than the world's average and this is one of the key strengths of Erdemir.

On the next page, you can see our finished goods production volumes. Production increased by 5% in Q2, which comes mainly from HRC. As you know, depending on demand, we can easily shift our production between flat and long steel.

On Pages 13 and 14, you will see the comparison of sales volumes and revenue. Our sales volume was around 2 million tonnes in Q2 2022. So basically, it goes flat by quarters. On Page 14, you can find breakdown of revenue for the domestic and export sales. 84% of revenue comes from domestic sales, in line with the domestic volume, which we will discuss in the next page. Our sales revenues increased by almost 37% year-over-year in 6 months, driven by the high sales prices.

So let's take a look at the segmental breakdown of domestic sales in Page 15 and export volumes in Page 16. As you can see from the pie chart, there has been a change between sectors due to the effects of market and demand conditions when we compare it to the last year's breakdown. There has been a transition from the pipe and profile and rolling industry, which mainly uses HRC to the industries that use value-added products and have higher profitability margins. There is no significant change in the long steel sector breakdown in terms of tonnage.

Our total exports volume gradually decreased by quarter, as you can see in Page 16. It was mainly because of the high demand in Turkish domestic market in the first half of the year.

On Page 17, you will see the historical figures for EBITDA and net profits. We generated $1.4 billion EBITDA in the first quarter -- I'm sorry, in the first half and EBITDA margin, our EBITDA margin of 32.2% is far better than the steel sector's average. Also we announced $827 million net profit and 19.2% net profit margin in the first half of the year. Both EBITDA and net profits in the first 6 months are higher than the same period of the previous year.

On Page 18, you can see how we reached to net profit from EBITDA. The largest item was tax expenses, which was $397 million in 6 months. $393 million of this value is cash payment and the rest of it is accrual. The other major item in this chart was depreciation of $110 million. After other expenses and non-controlling interest, we reached to $827 million net profit.

On Page 19, you can see EBITDA to change in cash bridge. Working capital increased, while tax payment also increased due to the higher net profit. Also we spent around $283 million to capital expenditures in 6 months. This amount also includes advances paid for the capital expenditures as well, and that you will see the difference between the CapEx paid in Page 26 and this one. $263 million credit was used for dividend payment and net working capital. After the dividend payment of $1 billion, 6 months change in cash level was $1 billion.

On Page 20, you can see the EBITDA per tonne trend. Although volatile market conditions, we have achieved $329 per tonne in Q2, similar to the first quarter.

Let's take a look at the balance sheet on Slide 21. We explained the change in working capital and cash before. As I mentioned earlier, after the dividend payment of $1 billion, cash amount decreased by 57%. The increase in financial liabilities is due to the credit usage. Also there is an increase both in inventories and trade payables due to the price and tonnage increase in steel and raw materials. Other than these items, there is no significant change in our balance sheet position.

On Pages 22 and 23, you will see historical trend of financial borrowings and net cash. After the high dividend payment in Q1 and increase in net working capital, net cash position turned to net debt as expected. So the next page just shows how we reached to this net cash level, net debt level, let's say, since December 2021. Our net cash position was $518 million at the end of 2021. Free cash flow turned negative due to the higher net working capital, CapEx and tax payments. After the dividend payment of $1 billion, net debt level of 6 months was $733 million.

So Slide 24 represents the maturity profile of borrowings. As you can see, some of our short-term loans are revolving trade financing facilities mainly related to the exports and import activities.

And Slide 25 represents our cost of sales breakdown. There is no significant change in our cost breakdown since Q1. Compared to the last year, the increase in energy costs was realized as expected. In addition, the composition of iron ore and coking coal in raw material costs have changed and the percentage of coking coal costs increased in the raw material basket, which is in line with the trends in raw material markets.

Page 26 represents the historical CapEx spending. Total CapEx spending, excluding advance payments is $218 million in 6 months. Our ongoing projects such as new blast furnaces are on progress. #3 Coke Battery Modernization, one of the investments of isdemir, was completed and commissioned in May 2022. Our capital expenditures will accelerate in the coming quarters.

As the last thing, there is no significant change in the number of employees. And also in this quarter, we added sustainability to our presentation to share our approach. We execute our strategy, which stands on the pillars of sustainable growth, responsible production and an approach which puts people at the heart of what we do by careful and risk sensitive execution.

So now we may continue with Q&A session. We will be delighted to answer your questions with Mr. Basoglu. Thank you for listening.

[Operator]

[Operator Instructions] The first question comes from the line of Nefedov Alexander with Renaissance Capital.

[Alexander Nefedov, analyst]

I have several questions. First is about CapEx. Could you please shed the light on capital expenditures to be incurred in 2022?

[Idil Onay, executive]

Shall we go question-by-question, one-by-one or you can just ask all of your questions? As you wish.

[Alexander Nefedov, analyst]

Okay. Okay. Then the next question is about production. Do you expect recovery in the steel output and sales in the next quarter? And the third question is about raw material prices. You mentioned that raw material prices have declined significantly in the second quarter and do you expect this decline to have a positive impact on financial performance of the company in the third quarter? That's all.

[Idil Onay, executive]

All right. Let's start with the CapEx. Actually, we have shared the number for the year for 2022 as a CapEx, $550 million to $600 million, with altogether maintenance and -- I mean, new investments, maintenance and other ongoing investments. So we keep that number at the same level. So we assume that CapEx figure will reach up to $550 million to $600 million level.

So you mentioned production and sales. Well, most probably, we're going to keep almost the same level, both production and sales, although there is a contraction in demand, global contraction in demand, steel demand.

[Mustafa Basoglu, executive]

And actually also there was a Ramadan effect in the second quarter and also there were and there will be some planned maintenance held in our plants. So also in Q3, there will be effects of another religious holiday. Currently, we know that actually we will see some recovery, but notable effect of some planned maintenance holds and also holidays.

[Idil Onay, executive]

And the last question about the raw material prices decrease, so yes, in Q2, we have seen -- we have witnessed a decrease in raw material prices. And there will be, of course, decrease -- I mean, cost decrease in our financials -- in our Q3 financials. So -- but let me remind you that there is a lag between 3 to 4 months. So when you look at the spot prices, you need to assume that these prices will have effect after 3 or 4 months to our financials.

[Alexander Nefedov, analyst]

Okay. Understand. To be clear, did I get it right that you expect production almost the same level as in the second quarter and sales, too?

[Idil Onay, executive]

Well, most probably yes, because obviously, there were Ramadan in Q2, but let me remind you that there is also another religious holiday in Q3. So therefore, I mean, the same level will be seen in Q3. That's our assumption.

[Operator]

[Operator Instructions] The next question comes from the line of Jones Andrew with UBS.

[Andrew Jones, analyst]

Just to clarify what you're just saying on the steel price lag. I think historically, you were talking about 2 months lag, and you were saying last year that given the large order books and high demand, that extended out to 3 or 4 months. I would have assumed it would have normalized down to more like 2 months given the reduced order book lead time scenario, but we're also seeing elsewhere. Can you confirm that we should still be modeling 3 or 4 months lag on the steel prices? Or should it be more like 2 now? And then just as an extension to that, you've said flat volumes into 3Q.

Clearly, price will be coming down. There's some ongoing inflationary effects. Could you just talk a little bit more about some of those cost drivers into 3Q and what's going on with some of the [Technical Difficulty] and how it works with potential wage increases for employees. What are the major moving parts on the cost side that you're seeing into 3Q? And can you give us some sort of steer on the potential scale of margin decline?

[Idil Onay, executive]

Andy, let me start with the first question. You've mentioned the order book. So yes, we were sharing that our order book was 2 months. And right now, [Technical Difficulty] for raw materials. So we still keep that lag, 3 to 4 months. That's for the raw material and for the sales.

[Operator]

Apologies, Ms. Ergin, but your -- there was a small cut in your line. So could you please repeat your answer because we couldn't hear you? Sorry.

[Idil Onay, executive]

Yes, no problem. No problem. I can just repeat it. Let me start from the beginning. Which part you haven't heard? I mean, I was mentioning the…

[Andrew Jones, analyst]

I heard all of it, by the way. I don't know…

[Idil Onay, executive]

Okay. Perfect. Perfect. So our order book is full for 1.5 to 2 months. Let me just confirm it again. So you also mentioned the prices. So of course, there will be both decrease in sales prices and raw material prices for Q3. So obviously, you will see both a decrease in costs but also in revenue. This is what all the markets expect for all the steel producers. And the cost part, of course, there is a wage increase, but it's TL increase.

And as you know, we keep our books in U.S. dollar, our functional currency is U.S. dollar. So the -- when you look at the percentage in cost of goods, it's almost the same, even -- sometimes it's even less as a percentage in our cost of goods. I'm just talking about wages. So yes, our wages increased, but it's Turkish lira and when you consider the devaluation in Turkish lira in U.S. dollar term, it's almost the same as a percentage.

[Andrew Jones, analyst]

Right. But so I think the operator interrupted when you were just talking about lag, just to clarify, you were saying that the -- you were talking about a 3- or 4-month lag on the raw materials, but it's still valid to have a 2 months' lag on the steel prices, right?

[Idil Onay, executive]

Actually, 1.5 to 2 months. I mean, it's between 1.5 and 2 months, our order book for this time, yes.

[Operator]

[Operator Instructions] We have a follow-up question from Jones Andrew with UBS.

[Andrew Jones, analyst]

I guess it's me, some more then. You -- as no one else is asking questions about, so I just follow up. Just one more on the scale of working capital build was obviously pretty significant. Could you talk us through that dynamic? Like how much of that is down to the impact of rising prices? And how much of it is a function of potentially stockpiling more material, more inventory because of some of the ongoing supply chain issues?

And could you give us an idea for how you see that working capital unwinding over the next sort of 6 months or into 2023 because it looks like you've built up, I think if I added up about $1.8 billion of working capital over the last 6 quarters. When will that reverse? And will it reverse entirely in your view?

[Idil Onay, executive]

Hello, again, Andy. So yes, when we look at the second quarter, our working capital increased because of the increase in inventories, as you mentioned, and also trade payables due to the price and tonnage increases in steel and raw materials. So considering the price trend in the third quarter, we expect to see a release in net working capital. I mean it's really difficult to share all the details like tonnage or prices, but of course, is due to the price and tonnage increases.

[Andrew Jones, analyst]

Okay. You expect to release in the third quarter? Could it be comparable to the build we've just seen in the second quarter or a lot smaller?

[Idil Onay, executive]

Well, considering the price trends, obviously, prices are decreasing. So naturally, yes, we expect to see a release in net working capital.

[Andrew Jones, analyst]

But given -- I mean, given steel prices have basically halved from the peak, it's a pretty sharp selloff. Coking coal prices are down from $600 to $200. I mean the scale of the downdraft is probably faster than the increase even. So I mean, is the $600 million release possible in the third quarter? Or is that too optimistic?

[Idil Onay, executive]

Really difficult to give some kind of assumption as a number right now. I mean this is how we expect for Q3.

[Operator]

Ladies and gentlemen, there are no further questions at this 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. Thank you for joining us today. I wish you all of you healthy days, and I hope and be with you with next conference call. Thank you.

[Idil Onay, executive]

Thank you very much.

[Operator]

Ladies and gentlemen, the conference is now concluded, and you may disconnect your telephone. Thank you for calling, and have a good afternoon.