Eregli Demir ve Celik Fabrikalari TAS

IST:EREGL.E

Earnings Call Transcript 2023-Q2

[Operator]

Ladies and gentlemen, thank you for standing by. I'm Poppy, your Chorus Call operator. Welcome, and thank you for joining the Erdemir conference call and live webcast to present and discuss the second quarter 2023 financial results.

[Operator Instructions] The conference is being recorded. [Operator Instructions]

Please note Eregli Demir Çelik Fabrikalari - Erdemir 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 than -- 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 as 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 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, Poppy. Good afternoon, everyone. Welcome to our conference call and webcast of Erdemir for the second quarter of 2023.

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 to the webcast. Then at the end of this presentation, there is going to be a Q&A session as you knew.

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 thank you for joining us today.

So our last call was before the earthquake disaster and in the meantime, we experienced very rapid recovery with the extraordinary efforts of our Eastern team members. We were able to bring the vessel back to pre-earthquake levels in a short period of time. While the earthquake disaster in February caused a 2-month effect on our operational results in the first quarter. This effect was limited to 1 month in the second quarter with the facilities commissioning at the end of April.

From the third quarter, our production and sales figures will return to normal level totally. After the operational data, I would like to touch the financial statement. Due to the material change in our second quarter P&L was in the deferred cash item. While the exchange rate rise in the first quarter was only 2%, the rate increase in the second quarter was 25%. Since our functional currency is U.S. dollar, the depreciation of Turkish lira leads to an increase in deferred tax liability.

As you all know, deferred tax item that is a negative effect on net profit in the second quarter is the market item. We continue our [indiscernible] at full speed. The second lateral investment in Agri is planned to be launched in the second half of this year, hopefully the last quarter. We already started USD 434 million for CapEx in the first half, and our CapEx will accelerate in the coming quarters. I think our CapEx will reach up to USD 1 million in 2023 with maintenance and other ongoing investments.

As you all know, recently a change in tax regulation has also been made in Turkey. The corporate tax rate has been increased to 25% from -- to 20% for corporate earnings, actually, for all of the 2023 and subsequent taxation period. Seeing this regulation announced after 30 June, it was reported as a subsequent event in the financial statements. However, the corporate tax increase will be reflected from the third quarter financial results.

On the other hand, when we look at the Turkish steel market, Asian countries such as China, India, South Korea and Indonesia, whose competitiveness was increased due to falling energy costs and low inflation. Actually, they gradually increased their shares in Turkish export markets, especially in Europe. While this situation caused the decrease in Turkish steel exports, it also covered an increase in steel imports from Asia, went down slightly. The Turkish steel industry experienced a negative 2-way effect due to this changing. But I can say despite the speed in domestic steel market due to the Asian countries, we foresee a recovery in operational data in the second half of 2023 with the disciplines of the earthquake expense. We also expect an improvement in EBITDA in the coming quarters.

I hope to be with you at the end of the presentation. So now I would like to hand over the mic to our Investor Director, Idil. The line is yours.

[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 financial results.

So let us start with the commodity prices. In Page 3, you will see the prices of steel-related commodities and HRC. Let's take a look at coking coal, iron ore, scrap and HRC prices. Price level of coking coal was around 295%, $5 per tonne, at the beginning of the year, and it gradually decreased to $245 per tonne in spot markets as of today. Prices have fallen on weak Asian demand with customers delaying purchases in anticipation of further price decline, while supply has improved with shipments from Australia exceeding 2022 levels since March.

A sharp decline is not expected in the short term for coking coal prices. Iron ore price was around $117 per tonne at the beginning of the year, and the current price has dropped to $104 per tonne. We expect that iron ore prices will stay between $110 in the second half of the year as we anticipate the production to moderate in China in line with the government policy and iron ore supply rebound.

After reaching its highest level in 12 years since 2010 with $665 per tonne in March last year. The current scrap price has dropped to $350 per tonne. On the bottom line -- bottom right, we show HRC prices in Black Sea, China and South Europe. HRC prices, which peaked in March 2022 due to the Russia-Ukraine war, are already normalized. And again, we do not expect a sharp movement in the short term.

On Page 4, you will see the production, consumption, exports and imports figures of Turkish steel market for the 6 months of 2023. While steel production decreased around 8%, steel consumption increased around 16% compared to the same period of the last year. Despite the 1% decrease in world crude steel production, Turkish crude steel production decreased by 16% and negatively differentiated from the world steel industry. While exports decreased by 46% in the first half of this year, the increase in imports by 23% caused the export/import coverage ratio, which was 97% in the first half of last year to fall to 48% in the first half of this year.

So let's take a look at the financial results and the operational metrics. On Page 6, you will see the brief summary of our 6 months results. Despite the earthquake disaster, we achieved $2.9 billion revenue, and we generated $232 million EBITDA.

On Page 7, you will see the operational indicators of our company. As you all know, due to the earthquake that occurred on February 6, the production at the scanner plant was suspended until the end of April. So we lost approximately 3 months production and 600,000 tonnes of sales due to the earthquake. All the decreases you see on this page are related with the situation actually. From the third quarter -- starting from the third quarter, our production and sales figures will return to its normal levels.

So let's take a look at the segmental breakdown of domestic sales and export volumes on Page 8. As you can see from the pie chart, there has been a change between sectors due to the effect of market and demand conditions when we compare to last year's breakdown. There has been a transition from the pipeline profile and also industry to distribution chains. The similar situation applies to the loan product. There has been a transition to industries that use value-added products and have higher profitability margins. As I mentioned in the previous slides, the unusual decline in exports is mainly caused by the earthquake.

On Page 9, you can find breakdown of revenue for domestic and export sales. 88% of the revenue comes from domestic sales in line with the domestic volume. The decline in sales revenue is mainly caused by the earthquake, as I mentioned earlier. The decline in EBITDA per tonne due to the earthquake recovered very quickly, even exceeding the last 2 quarters of 2022, and we expect to see even better figures in the coming quarters.

The main items affecting the financial results of this quarter is mainly deferred tax liabilities. Since our functional currency is U.S. dollar, the depreciation of Turkish lira leads to an increase in deferred tax liabilities. And as Mr. Basoglu mentioned, deferred tax expenses and noncash items.

On Page 10, you can see how we reach to net profit from EBITDA. The largest item was tax expenses, which was $238 million in 6 months. And the other major item in this chart was financial expenses, which are high due to the operational foreign exchange loss. Depreciation was $103 million. Also within the expenses from investment activities, there are assets that will be out of use at [indiscernible].

After other expenses, net loss was $178 million. In the graph below, you can see EBITDA to change in cash bridge. There is a release of $88 million in working capital. Also, we spent around $566 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 page in Page 13 and this one. $413 million credit was mainly used for net working capital. Also, $27 million was spent for share buyback in April and May in 2023.

On Page 11, you will see the historical trend of financial borrowings and net debt. When we look at the first half of 2023, our net working capital remained almost stable compared to the end of last year, although there was a decrease in inventories and trade receivables due to the earthquake in the first quarter. Net working capital remained stable due to the increase in these items in the second quarter. Our net position was $1.3 billion at the end of June 2023 due to the nonoperational costs incurred in the first 6 months since the earthquake. Low EBITDA was realized and the net debt EBITDA ratio was 2.3 multipliers. We expect that the EBITDA will increase and net debt will remain stable for the rest of the year, and net debt to EBITDA ratio will decrease below 2 multipliers again.

Slide 12 represents our cost of sales breakdown due to the increase in production after the earthquake in the second quarter. Our raw material usage increased. Therefore, our ratio in cost of goods sold have changed on a percentage basis. The decrease in energy prices compared to the first quarter led to a decrease in the percentage.

Page 13 represents the total CapEx spending. Total CapEx spending, excluding advance payments, is $434 million in 6 months. Our ongoing projects, such as new blast furnaces, are on progress. Isdemir #3 coke battery modernization was commissioned last year in May. In addition, the second blast furnace investment in [indiscernible] is planned to be commissioned in the second half of this year. Our capital expenditures will accelerate in the coming quarters.

On Page 14, you can find our value generation approach, which stands on 3 pillars of sustainable growth, responsible production and putting people at the heart of what we do plays a major role in our operations.

Now we may continue with the Q&A session. We will -- would like to answer your questions with Mr. Serdar Basoglu. Thank you for listening.

[Operator]

[Operator Instructions] The first question comes from the line of Agarwal, Krishan with Citibank.

[Krishan Agarwal, analyst]

Can you hear me?

[Idil Onay, executive]

Yes, we can hear you, Krishan.

[Krishan Agarwal, analyst]

Can you please discuss your plans for the medium-term CapEx, especially when you guided for $1 billion CapEx this year. I'm curious to understand, I mean, when do you expect the [indiscernible] coking and furnace plants to get approved after this commissioning of the blast furnaces? And what sort of capacity we should expect you to operate in the next 2 to 3 years once the basic [indiscernible] furnace plants also come through.

[Idil Onay, executive]

Hello again. So yes, we already spent $434 million in 6 months. And you may assume that CapEx will reach up to $1 billion in 2023 with included maintenance and other ongoing investments. So we are planning to -- I mean the second blast furnace investment in Isdemir is planned to be commissioned in the second half of this year, most probably in the fourth quarter. But I think you remember -- you will remember that these investments are not for the capacity increase, actually. These are the efficiency and cost reduction investments. So at the end of these investments, we are not expecting to see any kind of capacity increase in the final product.

[Krishan Agarwal, analyst]

Yes, I understand. And then the follow-up on that is that is this $ billion expected to remain stable, for example, for 2024 or expecting to go down. And if go down to what levels?

[Idil Onay, executive]

Actually, we expect to see a similar level in 2024, Included, by the way, most probably, we will start palletizing with them at the end of this year. So you should also add $550 million come from palletizing plants. And just as a reminder, this plant will take 3 years to 3.5 years to finish. So we will spend $550 million in 3 years or 3.5 years.

[Krishan Agarwal, analyst]

Understand. And a very near-term question. What is your expectation for the raw material cost for third quarter? And also, do you expect the prices to remain stable or go down in the third quarter?

[Idil Onay, executive]

Well, actually, let me just give you some brief information for the Turkish market because at -- currently, our order book is full for 2 months, and we don't expect to see a lower level than this. And unless there is a sharp decrease in raw materials, HRC Turkey price is expected to remain between $600 to $700 levels. So of course, there is a lag difference. Raw material prices are reflected in the financial statements approximately after 4 months, but sales prices 2 months later.

As a summary, actually, we -- the raw material price is expected to stay stable or maybe just a slight decrease. Also, there would be, again, a slight decrease in sales prices, but we expect to see higher premium in the next quarters. So when we said we expect to see better EBITDA per tonne, it was because our sales and production figures will be back to normal levels after the earthquake. And the other indicator was we expect to see higher premium for the next quarters.

[Operator]

The next question comes from the line of Jones, Andrew with UBS.

[Andrew Jones, analyst]

I just got question on this CapEx because every -- in -- last year, we were talking about maybe $550 million to $600 million or something in that ballpark per year for this spending on the current ongoing sort of blast furnaces and so forth. I'm trying to understand how we've gone up to $1 billion this year. And also next year, I mean we're saying that this power charging plant comes in, perhaps $550 million spread over 3 years, so it shouldn't be that much. How is CapEx going to be $1 billion again next year? I don't understand what has changed. Maybe it's the fact that we haven't had calls in the last 2 quarters, but could you explain what has changed in the last 6 months because this is a huge increase compared to what we were talking about this time last year.

[Idil Onay, executive]

Okay. Andy, yes, you are right. Last year, we said that the CapEx spending will be $550 million to $600 million for next -- last year, sorry, for 2022. But there are some changes in the situation. For example, we spent some money on earthquake impact in Iskenderun plant, which was included in CapEx in 6 months. And also inflation, this is one of the reason that we have higher budgets when you compare with last year.

[Andrew Jones, analyst]

How much was the earthquake impact in the first half?

[Idil Onay, executive]

It's around $100 million in 6 months.

[Andrew Jones, analyst]

Okay. And the increase next year, what's -- I mean most of these blast furnaces, coke batteries, et cetera, should largely be done by [indiscernible] would be. What's the breakup of that $1 billion next year?

[Idil Onay, executive]

So it's such a long detail, but I can just give you the names of the CapEx. I'm sure you will remember. So 2 blast furnaces, one of them is planned to be finished this year. And so we will finish Iskenderun blast furnace, 1 center plant -- sorry, 2 center plants and 1 coke battery in [indiscernible].

Also back in degassing plant, and you need to add pelletizing plants, as I mentioned earlier. So these are the investments that we will finish. We plan to finish excess pelletizing plans until the end of 2024. So next year will be such a tight schedule for investments. That's why we keep the same budget for next year. So this year, as I mentioned, we are going to spend almost $1 billion for CapEx. And again, for next year, you can assume a similar number as a CapEx, but...

[Andrew Jones, analyst]

Okay. So that's -- I mean, that's incredible inflation compared to what -- you were guiding last year -- it wasn't just last year, you were guiding for $550 million to $600 million. You are saying that that would be the level for the next few years. And okay, if we added $100 million for earthquake issues, I still don't get here how you get to that sort of number. I mean, well, is there any other color you can add or give some examples as to what has inflated that much because it's -- I mean, that's insane.

[Idil Onay, executive]

Well, actually, everything -- when Turkish lira devaluate, it affects everything we stand on. So I mean most of the vendors are foreigners. And we also get some services from outside for our investments. So everything gets just higher with higher prices

[Andrew Jones, analyst]

So these are dollar figures, right? These are not Turkish lira numbers. These are hard dollar figures?

[Idil Onay, executive]

Yes, correct. But we pay both in Turkish lira and dollar for investments and everything gets more expensive.

[Andrew Jones, analyst]

But the Turkish lira stuff should have come down, should it not? You've given the -- it's -- yes, I mean you have labor and some things that go into some of these large projects should have decreased. I mean there must be something else in here than just inflation because it's a huge increase.

[Idil Onay, executive]

Well, inflation is getting higher, more than the devaluation in Turkish lira in Turkey. So that's the reason, actually, I can just give you the answer for your question.

[Andrew Jones, analyst]

Okay. I'll move it to someone else, but maybe we can follow up off the line.

[Operator]

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

[Andrew Jones, analyst]

Okay. Because there's no one else is asking, just to clarify on the second quarter. So you're expecting prices to be stable, raw material prices to go down, I guess, and volumes to increase. So overall, we're expecting an improvement in EBITDA in 3Q. Are you able to quantify any of that?

[Idil Onay, executive]

For a previous question, I said we are expecting to see stable or slightly lower prices both in raw materials and sales prices. And yes, higher number of production and sales figures. So yes, we are expecting to see better EBITDA total numbers for the next quarter.

[Andrew Jones, analyst]

Can you give us some guidance around the volume that you're expecting?

[Idil Onay, executive]

For a year, we expect to see higher than 7.5 million tonnes as a sales number.

[Andrew Jones, analyst]

Higher than 7.5 million tonnes, okay. That's a large step-up. And Okay. And just generally, any other one-offs we should consider? And what about working capital? I mean that's obviously built in this quarter. Can you just give us some steer on how working capital will evolve in the second half?

[Idil Onay, executive]

Actually, considering almost stable commodity prices, we expect to see a stable position in net working capital in Q3.

[Andrew Jones, analyst]

Stable in Q3, okay. Do you expect any release in 4Q?

[Idil Onay, executive]

No, and we do not.

[Andrew Jones, analyst]

Okay. Cool. Okay. And just on the market, maybe. I mean what are you seeing in terms of demand in the near term? Obviously, there's probably some earthquake related demand boost to come through at some stage. I mean are you seeing any impact yet? And what's your expectation for maybe Turkish steel demand over the next sort of several quarters or into next year and year after? What's your take on the demand situation there?

[Idil Onay, executive]

Well, for our company, we don't see any problem because as I mentioned, we already have 2 months full order book, and we don't expect to see any lower than this level until the end of this year. But yes, in Turkish steel market, of course, as Mr. Basoglu mentioned, there is some kind of pressure from the Asian countries, with China, India, South Korea, Indonesia, all of them. So they most go to the export markets that we already in these markets, for example, European countries. And also, they reduced the prices because they have some kind of advantage for the cost advantage, of course, falling NRG costs. So they don't surprises. Of course, there will be some kind of negative effects in Turkish steel market. But so far, we haven't seen any impact in our order books, and we do not expect to see any kind of decrease in our order book.

[Andrew Jones, analyst]

Okay. And on the situation with regard -- regarding what you said about Russian imports and so forth. I mean how much do you expect to see any sort of pricing pressure coming from that? It seems like that's been one big source of replacement tonnes for the lost production at the start of the year. Is that a short-term effect because of low domestic production? Or do you think that there's going to be continued pressure from the imports coming in from Russia?

[Idil Onay, executive]

Well, Russia and Asian countries, yes, they come, they sell. They're imports are getting higher. But we are very used to working in these kind of environments. So Turkey was always an open market. Our duty taxes are not very high. So I mean, as a 50 years -- more than 50 years working in Turkish steel market as a steel integrated steel producer, we are very used to working in this kind of environment. And I can easily say that we have a very strong communication with our customers, et cetera. So -- and also the quality of our production. There are many metrics that customers choose us. So not only price, but there are some other indicators that they choose before the prices. So again, we do not expect to see any decrease in our order book, although there is some kind of pressure from the import side.

[Operator]

The final question comes from the line of Demirtas, Cemal with Ata Invest..

[Cemal Demirtas, analyst]

My questions again about the investment side. You had just said a bit of [optimism in the] cycle. And I see that over the last 2.5 year you already spent $.5 billion. And in the previous questions, you had a partial answer, but we understand that the total investment amount for this year could reach around $ billion for the full year. And I also wonder your potential investment CapEx in 2024. What might be the -- in terms of timing, when do you think all these investments till be completed. The big investment I'm talking about, by, when, possibly 2024? Beginning or at the middle? I would like to understand the least a rough direction on that front?

And the other question is, as you mentioned, there's a pressure from the price pressure from global market, but many markets are protecting their markets and the big governments are protecting their market to some extent. I don't know if the Turkish steel producer association have any attempts to just go to the government and ask for some actions that this situation is highly having negative impact, maybe not on you, but the others. Just do you have any color on that front?

[Idil Onay, executive]

Cemal, let me start with your first question. Yes, you remember it right. So we -- our budget for CapEx for the full year is $1 billion. We already spent $434 million. And yes, the same number we expect to see next year as a CapEx. So until the end of 2024, we aim to finish all of the big, let's say -- let's call it big investments included 2 blast furnaces, 2 coke batteries, 2 center plants, 1 [indiscernible] degassing. So actually, one of the blast furnaces will be finished until the end of this year, and the rest of them will be finished next year.

So yes. And your second question, I mean I am not responsible with the dialogue with Turkish steel producer association. But I'm pretty sure they have ongoing dialogues with the government. I mean, so far, we haven't heard any change, any regulation change or taxation change for imports, but I'm sure there is some kind of dialogue between them.

[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]

Thank you, all of you, for joining us today. I hope to see you all at next quarter's call, and I wish you all a happy day. 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 good afternoon.