Eregli Demir ve Celik Fabrikalari TAS

IST:EREGL.E

Earnings Call Transcript 2018-Q3

[Operator]

Ladies and gentlemen, welcome to Erdemir Group 2018 Third Quarter Financial Results Conference Call. 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 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 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 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.

I will now hand you over to Mr. Avni Sönmezyildiz, Financial Controls and Reporting Director, who will take you through the presentation. Here, Mr. Avni Sönmezyildiz. Please go ahead.

[Avni Sönmezyildiz, executive]

Thanks, Suarez. Good afternoon, and good morning, dear participants, and welcome to the conference call for the consolidated results of Erdemir as of September 30, 2018.

I am with our group CFO Mr. Emrah Silav; and our Investor Relations Manager, Idil Önay Ergin. And I will go through the presentation first of all, then we will answer your questions, if any.

As you already know, our presentation has 2 parts. The first part is about the market overview, then in the second part, I will go through the financial results.

I also would like to indicate that the Iskenderun's investor presentation is in Iskenderun's website -- Isdemir's website. Right now, there is only Turkish version, but in the following week, we will provide the investor presentation of Isdemir in English as well. And start -- from now on, you will get both of the version of Isdemir's investor presentation also.

So let's start with market overview on Page 5. In Slide 5, you will see the change in crude steel production in major regions in the world. World crude steel production was 1,350,000,000 tonnes in the first 9 months of 2018, up by 5% compared to the same period of 2017.

Asia, including China produced approximately 900,050,000 tonnes of crude steel, which also indicates that increase of 5.5% when we compare it to the same period of 2017.

At the same period, the European Union produced 100,028,000 tonnes of crude steel, which is up by 1.3%. And North American's crude steel production in the first 9 months was 90 million tonnes, which also indicate an increase of around 3.5%.

And for the last thing about this page CIS produced 76 million tonnes of crude steel in the first 9 months, which is almost up by 2% comparing with the 9 months of 2017.

So in the next slide, Page #6. You can see the price trend of our major raw materials. So on the upper right side, you will see the iron ore prices. Although iron ore prices showed a stable trend and price fluctuates around USD 70 to USD 75 per tonne. Coking coal prices are on a rise since the beginning of third quarter. And premium hard coking coal is around $220 nowadays, while it was around $180 in the previous quarter.

And scrap prices are still above $320 levels, although crude prices are on a downtrend recently. And as you already know the high scrap prices supports our profitability as an only integrated flat steel producer in Turkey. It gives us a cost competitiveness when comparing with the other domestic producers.

So let's take a look at Slide 8. The production and consumption figures in Turkish market. And unfortunately, Turkey Steel Producers Association has not announced September production and consumption as of yet. However, according to World Steel Association, Turkey's crude steel production for September 2018, it was 2.8 million tonnes, which means decrease of around 6%, compared to the September 2017 crude steel production.

According to 8-month figures, total finished steel production is 1.2 million tonnes higher than same period of 2017. And it indicates approximately 5.5% increase in production in Turkey.

The increase in production mainly related to flat steel, as total steel production is increased 1.9 million tonnes, while long production declined around 700,000 tonnes.

So if you take a look at the export and its import figures in the next page, at Slide 8, you'll see 600,000-tonne increase in exports and 400,000 tonnes increase in imports. However, now we'll look at the details of import, we see that imports of [ slab ], which is a semi-finished steel product increased around 1.4 million tonnes, while the billet imports decreased around 800,000 tonnes. So we can say that the difference between production and consumption is mainly exports. You can also see the same kind of increase in our export sales in the following slide.

So this is the brief market overview, and I will move to the 9 months results starting from the Slide 10.

So let's take a look at the key operational metrics in that slide. In the first 9 months of 2018, our group produced almost the same amount of liquid steel as the -- as 2017. However, there is 5% decline in the shipment, only because of long steel sale, the difference between liquid steel production is the semi-finished goods inventory and finished products waiting for the delivery.

Although we lost 350,000 tonnes of shipment, revenue is 14% higher, and EBITDA is 31% higher than the same period of 2017. Thanks to higher sales prices and stable raw material cost, we are able to achieve higher revenue and EBITDA although sales volume is lower than previous year. However, the effect of EBITDA increase to the net profit is less, it's because of the foreign exchange losses arising from the deferred tax liabilities. We heard a lot of questions about it today after the announcement of the results.

Many of you know that it is because of the IFRS regulation. Due to IFRS, we have to recognize foreign exchange difference as the tax base of our companies are in Turkish lira, while we prepared -- announced financials in US dollars. There is the monetary difference -- the function of currency difference between the tax base and the IFRS financials. And unfortunately because of the IFRS regulations, we have to recognize the foreign exchange gains almost coming from the parity changes.

And in the third quarter because of the Turkish lira depreciation, we recognized USD 100 million foreign exchange difference coming from the deferred taxation. We expect that it will partially be recovered in the first -- fourth quarter if the U.S. disparity stays below TRY 6 level.

I will skip Slide 11, this is just the liquid steel production information, which I already mentioned. And -- so let's take a look at Slide 12 about the crude steel capacity utilization ratio.

As you can see from the slide, our crude steel capacity utilization is still above 95%. Unfortunately, starting from August 2018, World Steel Association has stopped publishing global capacity utilization ratios due to the antitrust concerns. So most probably we won't be able provide the comparison anymore between the world steel capacity utilization and our capacity utilization in the future periods.

So let's take a look at Slide 13. It's about the production levels. And as our [ crude steel ] production in last 9 months is very similar to 2017 figures, the difference between finished goods production levels is in our semi-finished goods inventory, actually and they are mainly flat. Because if you look at the figures, there is a difference between the production level, although our crude steel production is the same in the same period.

In Slide 14, you will find the breakdown of sales for long, hot and the higher [ flat ] segment, which is mainly cold product. And as you can see from the comparison, there is a shift between hot-rolled coil sales and cold product sales. The shift is mainly related with the market conditions and increase in our export activities because of a slowdown in domestic demand.

Also, the demand for long product is low, as the construction business slows down in Turkey.

As a result of it, we saw 350,000 tonnes less in long product. As the last thing for you, sales volume expectations, it is obvious that we will not be able to achieve 9 million tonne levels of 2017 this year. Even with our best shipment performance, we assume that we cannot sell more than 8.5 million tonnes in 2018, this is because of the loss in sales in the first 3 quarters.

In the next slide, you will find breakdown of revenue for domestic sales and exports. I'll also skip this slide quickly, continue with the breakdown of domestic sales in Page 16.

So in this slide, you will see the breakdown of domestic flat and long sales, and on the upper side, you will see the comparison of flat domestic sales.

And as you can see from the slide, our domestic sales slows down both in flat and long segments. Thanks to increased exports, we were able to cover it by selling our finished products to eurozone. And the main sectors affected from the slow down in domestic market are distribution chains and pipe producers.

Due to tariffs applied by United States, pipe sales slowed down in 2018 and it affected our domestic sales. In long product segment, the main industry affected is rebar producers, which are heavily dependent -- depend on the construction business.

On the next slide, you will see the sales exports breakdown. In Slide 17. Although, there is 200 days [ safeguard ] applied by the European Union, we were able to increase our exports to eurozone, this is very important for us, on the current market conditions in Turkey, and we are closely following the quota levels. And it seems that quota levels will not be fulfilled in the segment related with us in Europe -- applied by the European zone. If the slowdown in domestic market gets stronger in the domestic market, in 2019, we will be more aggressive for export activities especially for the eurozone in 2019.

In the next slide, Slide 18, they are just metrics about the EBITDA and net profit. I have already mentioned the effect of deferred tax -- foreign exchange difference on the deferred taxation around $100 million to the net profit, so I will skip this slide quickly.

In the next slide, Slide 19. You will see EBITDA to net profit margin -- bridge, sorry, and although our net finance income is $120 million, we recognized USD 94 million foreign exchange in the first 9 months of 2018 due to the depreciation of Turkish lira.

And Page 20 is the EBITDA to net cash bridge. The most important thing in this bridge is the increase in working capital around $418 million. And its -- and it affected our cash position negatively in 2018. This is actually due to the maturity mismatch between sales and procurement. When the sales price are on a rising trend, our working capital increases because of the trade receivables and inventories, that actually lock up until 2018. I would like to indicate that there's no significant change in sales and procurement terms. And increase in working capital is mainly because of the maturity mismatch and because of the rising steel prices. And we expect that working capital will come back to normal levels and will turn into cash in 2019.

In Slide 21, you will see the EBITDA per tonne trend, starting from 2015. And I would like to say that this EBITDA per tonne calculation is only for the finished products segment. When you compare your calculation with our calculation, most probably your calculation also includes the other sales, like the byproduct sales or other service income, and doesn't include our exclusion for the one-off items such as the provisions et cetera.

As you can see, third quarter is another profitable period for us. And we were still able to achieve higher than $200 EBITDA per tonne level in the third quarter. However, as the steel prices go down -- go lower because of the concerns of global economy, we expect to see lower EBITDA per tonne figures in the last quarter of 2018.

In the next slide, you will see the financial metrics about the balance sheet. I'll skip very quickly because there is no significant change in our balance sheet position expect trade receivables and inventory which I already mentioned in the working capital part. Also there is no change -- significant change in our borrowing maturity profile and you will see it on the presentation also.

So I'll move to the Slide 26, which is about the breakdown of cost of sales. And the major change in the costs of -- cost breakdown actually is decrease in employee costs because of Turkish lira depreciation, when you compare 2018 with the annual figures of 2017, as a breakdown percentage wise. And the other effect is the increase in percentage of raw material costs because of the slight increase in the raw material prices and Turkish lira depreciation, also because total conversion costs gets lower and it increased the percentage of raw material costs also.

In the next slide, Slide 27. You will see that there is no significant change in our capital expenditures when we look at the last several years. We assume that the capital expenditure will increase starting from the second half of 2019, and we expect to spend significant portion of CapEx on 2 blast furnace construction, which I already mentioned in the previous conference call. It will be in 2020.

And as the last thing, we will show you the number of employees. And there is a significant -- unsignificant (sic) [ insignificant ] decrease in the number of employees, which is mainly because of the retirement. And this is the end of my presentation. Thanks for listening. And now we are happy to answer your questions. Thank you.

[Operator]

[Operator Instructions] Our first question comes from Koray Pamir, Yapi Kredi.

[Koray Pamir, analyst]

Two questions. First of all, if I understand correctly, the Capex for the capacity investment will start in second half of 2019, you mentioned that it would be -- the total costs will be under $1 billion. Could you provide any further numerical details on that? And secondly, I know it's too early to tell, but on your budgeting numbers, do you see any downside to your flat steel capacity utilization rates in 2019? Or do you think you can sustain these, I would say, high levels for foreseeable future?

[Avni Sönmezyildiz, executive]

You're right, you heard this right. And the CapEx of 2 blast furnaces will start starting from this second half of 2019 and it will be mostly started in 2020. Unfortunately, in this conference, I won't be able to tell you exact figure, because we have to make a public announcement before we announce first thing, but I will tell you the same thing, it will be lower than $1 billion level. For your second question, budget. We are currently preparing the budget. And actually, we don't expect significant decline in our capacity utilization ratio in 2019. So we assume that the total production and the sales figures will come back to the same levels of 2017 in 2019. Once -- we don't know whether there's profitability because not yet -- as you already know, nobody knows what will happen for the steel prices all over the world.

[Operator]

Our next question comes from Andrew Jones, Wood & Co. (sic) [Wood & Company]

[Andrew Jones, analyst]

I got several questions. Firstly on 4Q, you said that you don't expect sales to be higher than 8.5 million tonnes this year, if you get to that level that will be a 10% increase, given the slowdown that's happening through the third quarter and you have a lag in your sales. You should have a pretty good idea now as to what sales volumes kind of look like in the fourth quarter. I mean, do you believe that you can keep sales flat or even increase them? Or do you think there is a significant risk of a decent decrease in sales volumes for a reason? That's the first question. Secondly, can you give us some [ full ] guidance on likely profitability trends, given you know a lot of the pricing so far as we're along a decent way through the quarter already, and there's a lag there, can you give us some guidance on how much lower that EBITDA per tonne potentially could be? And then just on the investment programs, could you -- can you give us a bit more detail on kind of some of the economic upside you expect from these things? We talked about it on the last call and you didn't have any details at that time, presumably you have more info now? It sounded like the Iskenderun blast furnace was the one which really would add net capacity overall, the other stuff was largely replacement. But you were not talking about investing and convert the capacity, just blast furnace capacity. So I mean, what is not likely to add in terms of volumes? Will you just go along pig iron and potentially try and sell pig iron on the market as a result of that? And could you give us some estimates for what capacity additions you're going to gain from these? And on the replacement capacity, could you give us some indication what's the costs savings or maybe quantify potentially premiums you might get for quality improvements? Can you just give us a bit more detail around those projects now that you've done a bit more work on it?

[Avni Sönmezyildiz, executive]

Thank you, Andrew. Let's start with the volume in Q4. Of course, we know our order book and we have a shipment plan. But it's very hard to estimate the exact figure because of the shipment problems, the customers requests et cetera. That's why I told you, we don't expect higher than 8.5 million tonnes for the whole year. There is nothing I can comment more than that. But I mean, all I can say is that, at least we will see the similar trend in the third -- second and third quarters. So we don't expect significant decline in the shipments actually.

And for the EBITDA per tonne, I already mentioned that it will go back from $220 level. Of course, you are right, there is a lag on the prices because of the order book that we carry. But I mean, I cannot comment on an exact figure. But you can -- if you look at the trend in the sales prices in last couple of -- last month and this month, you can easily assume the decrease in the EBITDA per tonne volume because we don't expect significant change in our cost structure. For the CapEx program, I told Pamir that we don't have any additional details at this moment. You are right, there is a capacity expansion in Iskenderun. And I cannot give you more detailed information about how are we going to utilize this liquid steel. Of course, there are several plans to do that, but I cannot comment on that at this moment before the public announcement of our group and before the board decision made -- final board decision. But I can tell you that costs, even if we don't see anything with the new blast furnaces, there is going to be slight cost saving. In addition to that, because it's a more effective blast furnace, now we are building a new one, it's going to be more effective of course. But the most important thing is, after the new blast furnaces, we could be able to use more sinters than the pellet, there is a huge gap between the pellet price -- pellet premium and the iron ore prices. So after the new blast furnaces, we should be able to utilize more sinters, which could [ bypass ] to lower our raw material costs -- raw material basket costs.

[Operator]

Our next question comes from Anton Fedotov with Bank of America Merrill Lynch.

[Anton Fedotov, analyst]

Can you please elaborate more on the quite high effective tax rate that you had in the third quarter this year? And based on your cash flow statement this tax was not paid in cash, as far as I understand?

[Avni Sönmezyildiz, executive]

Yes, actually I have already mentioned that due to IFRS regulation, foreign exchange difference is coming from the deferred tax base should be recognized in the P&L, as a tax rate cut or tax income if the Turkish lira appreciates. So we have recognized $100 million on the deferred tax expenses just because of the Turkish lira depreciation. And you're right, this is not a cash effect. I mean, if the Turkish lira stays around TRY 6 level, the cash effect will be utilized in 10 years. And it might go back to the -- it might go back again and we can recognize foreign exchange gain if Turkish lira appreciates. So you are right, it won't affect our cash payments in tax terms. The unique reason for the increase in the effective tax rate is just this $100 million foreign exchange loss recognized in deferred tax expense.

[Anton Fedotov, analyst]

When you will recommend your dividend early next year? Will you adjust your net income for dividend purposes for this noncash tax effect?

[Avni Sönmezyildiz, executive]

I mean, yes, because we distribute dividend from the IFRS results -- consolidated IFRS results. And it will affect our -- the distribution income. But if, I mean, at the end of the third quarter, Turkish lira-U.S. disparity was higher than current level. So if the parity stays below TRY 6, there will be partial recovery from that, and we will recognize foreign exchange gains on deferred tax side. Yes, I mean, so we will see, I mean, it depends on the year-end Turkish lira dollar parity.

[Operator]

Our next question comes from Rishad Ahmed, GoldenTree Asset Management.

[S. Rishad Ahmed, analyst]

I just wanted to see if you could talk about the demand environment currently. What you're seeing? And whether you're facing any issues from your customers in terms of payments or delayed receivables, credit that you're having to extend to your customers in that vein basically?

[Avni Sönmezyildiz, executive]

Thanks, Rishad. Actually, in -- at -- after the sudden depreciation of Turkish lira, the demand was almost half for a couple of weeks. But as the Turkish lira stabilizes around this levels, that demand started to recover and it gets back to normal levels. I mean, we carry the same levels of order books as in the previous quarters right now. So there is a recovery on demand side and...

[S. Rishad Ahmed, analyst]

.

In terms of -- and then for the receivables and whether you...

[Avni Sönmezyildiz, executive]

Okay. For receivables, you know all of our receivables are guaranteed by bank. And so far, we haven't heard any significant payment issue. I mean, [ bank calls the ] total receivables as $800 million, it's immaterial actually. We haven't heard significant payment problems from our customers. Of course, there are a couple of customers who have some serious problems, but for the most of the customers, they are in good shape. Even something happens to them, there is a bank guarantee in our off-balance sheet items.

[S. Rishad Ahmed, analyst]

.

And in terms of exports for Q4, what do you expect the mix to be between domestic sales and exports?

[Avni Sönmezyildiz, executive]

Actually, you will see higher export levels in the fourth quarter. And as I mentioned, if the GDP growth stays around 1% or 0 in 2019, you will see more exports in our financial statements in 2019.

[S. Rishad Ahmed, analyst]

.

Sorry but realistically, I mean, is there a percent that you could increase exports to? Would it be 25% or 50%? I mean, or is there a gap due to logistical reasons?

[Avni Sönmezyildiz, executive]

I mean -- we can go higher than 20%. It depends on the global conditions also, I mean. As long as there is a demand coming from -- especially from European Union, there is no problem increasing in export sales. We can go up to 25% or maybe higher depending on the market condition.

[Operator]

[Operator Instructions] We have a follow-up question from Anton Fedotov, Bank of America Merrill Lynch.

[Anton Fedotov, analyst]

How much is approximately the cost of transportation of your finished steel products from Turkey to the European export markets roughly in dollars per tonne?

[Avni Sönmezyildiz, executive]

Anton, actually I don't have the exact figure. But it changes if we use Eregli plant or Iskenderun plant. From Iskenderun plant it's much cheaper, because it's in Mediterranean Sea region. I can't comment on the exact figure right now, but there's around maybe $7, $9 difference between exporting from Eregli or Iskenderun because of the logistics, because of the geographical positions of Eregli and Iskenderun. Iskenderun is very cheap actually when you compare with Eregli exports.

[Operator]

[Operator Instructions] Comes from Cemal Demirtas, Ata Investment (sic) [Ata Invest Co.].

[Cemal Demirtas, analyst]

My question is regarding the competition from Russia and China. How do you see the pressure from those markets?

[Technical Difficulty]

[Avni Sönmezyildiz, executive]

Your line has been blocked. Sorry about that so we'll continue.

[Operator]

We have a question from Cemal Demirtas, Ata Invest.

[Cemal Demirtas, analyst]

.

My question is regarding the competition from China and Russia and India in third quarter. How was it? And how do you see it for the following 2 quarters?

[Avni Sönmezyildiz, executive]

Actually, Cemal, I mean there is no change in the competition environment in the flat markets. We haven't seen any trade from China in domestic -- in Turkish market for flat. And also the conditions are the same with the Russians, I mean, they're always aggressive in Turkey. To be honest, we don't expect significant change in the competition with the Russians or Chinese guys or from India in the near future.

[Operator]

We have a follow-up question from Rishad Ahmed, GoldenTree Asset Management.

[S. Rishad Ahmed, analyst]

Just in terms of the -- there was a coal asset that was -- that you guys acquired the license too, could you just talk a bit about that? And then on a pro forma basis, how much of your raw materials do you have in-house?

[Avni Sönmezyildiz, executive]

Actually, Rishad, it's a very small asset. And it's not a metallurgical coal asset and it's a negligible source, do not consider it in your calculations, in your cost assumption. Most probably you will not feel any effect of it in the financial statement.

[Operator]

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

[Avni Sönmezyildiz, executive]

Thanks for participating in our conference call for the third quarter results. We hope to meet with you again at the year-end for the announcement of annual results. We have -- we will give you more detailed information in January for the announcement time. Hopefully, we will be seeing you in February. Thank you. Have a nice weekend.

[Operator]

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