Eregli Demir ve Celik Fabrikalari TAS

IST:EREGL.E

Earnings Call Transcript 2022-Q3

[Operator]

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

Please note, Eregli Demir ve Çelik Fabrikalari T.A.S. Erdemir may, when necessary, make verbal or written announcements about forward-looking information, expectations, estimates, targets, assessments and opinions. Erdemir has made the necessary arrangements about the amounts and results of that information through its disclosure policy and has shared such policy with the public through the Erdemir website in accordance with the shared Capital Market 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, that 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.

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

[Idil Onay, executive]

Thank you very much, Mina. Good afternoon, everyone. Welcome to our conference call and webcast of Erdemir for quarter 3 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.

[Mustafa Basoglu, executive]

Thank you, Idil. Good afternoon, everyone. Welcome to our quarter 3 conference call, and thank you for joining us today. Before starting our presentation, I would like to go through the current developments and the market expectations for the rest of the year. In our last conference call, we were delighted to announce successful first half results.

As we approach the end of the year, we are witnessing challenging market conditions among economic uncertainty in the world. As you all know, a number of European steelmakers have decided to cut production by [ using blast furnaces ] due to soaring energy costs, weakening demand and falling steel prices. World Steel Association shows the magnitude of recent production cuts. According to World Steel's latest report, world crude steel production dropped 4% in the first 9 months of 2022, while EU 27 crude steel production was down nearly 9% in the same period of time. As the current price in the cost levels are not at the mark-to-market level.

In 2022, the global economy is being adversely affected by ongoing supply chain issues, high inflation, particularly in the energy sector. Energy prices have spiked to levels [ nothing ] indicates. European natural gas prices have reached all-time highs and remain substantially above their previous peak in 2008. High energy prices kept not only energy costs, but also coal prices high. Increasing energy demand created high coal demand and caused coal prices to rise to the historical high level of USD 650 in March, although it has reached the level of USD 300 today.

As you remember, I mentioned that we have more cautious projections for the second half of 2022 due to the recession and the demand contraction in the world. Despite a conservative market with low average selling prices and weak demand, we achieved USD 124 EBITDA per tonne in quarter 3, just in line with our previous year's average. It should also be noted that the main items affecting the results of this quarter are higher coal prices and energy costs.

As I said in the previous call, the effect of high coal and high energy prices are seen in quarter 3. Although the market outlook is uncertain in the world due to rising inflation, recession energy crisis and the war in Ukraine, raw material costs in quarter 4 are expected to be relatively stable compared to the quarter 3. In line with all these expectations, we foresee to obtain stable or slightly weaker results in quarter 4. So I will leave you to the end of the presentation.

Now I would like to hand over the mic to our Investor Relations Director Idil. The line is yours.

[Idil Onay, executive]

Thank you, Mr. Basoglu. Our presentation consists of sections, as you already know. The first one is the market overview and then the financial results. Although we have revised the presentation visually, the basic structure is the same. So let's start with the commodity prices.

On 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 $350 per ton at the beginning of the year after rising to the historical high level of $650 in March due to the global supply tightness, it dropped to $300 per ton in the spot market. Although it is still high, it is now expected to decline in the short term.

Iron ore price was around $120 per ton at the beginning of the year, although it reached the level of $160 at the beginning of April. The current price has dropped to [indiscernible]. In September, Fitch lowered its short-term forecast for iron ore prices for 2022. And this forecast reflects a decline in demand for steel, particularly in China, leading to reduced steel production, lower demand for steel resources. Scrap reached its highest level in 12 years since 2010, with $665 per ton in March. The current scrap price has dropped to $360.

On the bottom right, we show HRC prices in Black Sea China and South Europe. HRC prices, which peaked in March due to the Russia/Ukraine war are now normalizing, and we do not expect a sharp movement in the short term.

On Page 4, you will see the production, consumption, export and import figures of Turkish steel markets for the 8 months of 2022, while steel production decreased around 9%, fuel consumption decreased around 5% compared to the same period of the last year. The decrease observed in crude steel production since the beginning of 2022, continued by gaining momentum in the second half of the year.

In the first 8 months of the year due to both the protectionist approaches and the shrinking trend in foreign demand, a 13% decline was observed in the exports of steel products. Imports decreased by 6% in terms of quantity. The ratio of exports to import, which was 104% in the first 8 months of 2021 decreased to 94% in the same period 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 9 months results. We achieved $6.3 billion revenue, and we generated $1.6 billion EBITDA. As a result, our net profit was $936 million in the 9 months of 2022.

On Page 7, you will see the operational indicators of our company. The decline in both final products and liquid steel production and also in sales volumes is related to religious holidays in Q2 and Q3. Also plant maintenance, audit and seasonal effect in summer affected the results. Although there is a decrease in crude steel capacity utilization ratio, this ratio is far better than the world's average.

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 type and profile and the rolling industry, which mainly uses HRC to industries that use value-added products and have higher profitability margins. The similar situation applies to the [ load ] products. Although our first choice is always to focus on domestic sales, if there is an attractive demand, we prefer export.

On Page 9, you can find the breakdown of revenue for domestic and export sales. 83% of revenue comes from domestic sales, which is in line with the domestic volume. Our sales revenues increased by almost 19% year-over-year in 9 months, driven by the high sales prices. Despite conservative market with low average selling prices and weak demand, we achieved $124 EBITDA per ton in quarter 3, just in line with previous year's average. As we always say that 2021 was an exceptional year and if we exclude this year, 2021, we can say that the profitability has started to normalize. It should also be noted that the main items affecting the results of this quarter are higher coal prices and energy costs.

On Page 10, you can see how we reached net profit from EBITDA. The largest item was expenses, which was $468 million in 9 months. And the other major item in this chart was depreciation of $163 million. After other expenses and non-controlling interest, we reached $936 million net profit. In the graph bill, you can see [ a bit ] change in cash bridge. Working capital increased while tax payments also increased due to the higher net profit.

Also, we spent around $475 million to capital expenditures in 9 months. This amount also includes advances paid for the capital expenditures as well, and you will see the difference between the CapEx page in Page 13 and this one. $286 million credit was used for dividend payment and net working capital. After the dividend payment of $1 billion 9-month change in cash level was $1.1 billion.

On Page 11, you will see the historical trend of financial borrowings and net cash. After the high dividend payment of $1 billion in Q1 and increase in net working capital, net cash position turned to net debt as expected. Also, there is an increase both in inventories and trade payables due to the price and tonnage increases in steel and raw materials. Other than these items, there is no significant change in our balance sheet position. Our net debt-to-EBITDA ratio was 0.3 multiplier in 9 months of 2022.

Slide 12 represents our cost of sales breakdown. There is no significant change in our cost breakdown since Q2. Compared to 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 13 represents the historical CapEx spending. Total CapEx spending, excluding advances payments is $380 million in 9 months. Our ongoing projects such as new block furnaces are on progress. Number three, coke battery modernization once the investment of [ estimate ] was completed and commissioned in May. And our capital expenditures will accelerate in the coming quarters. The share of capital expenditures in EBITDA is 23%.

On Page 14, you can find our value generation approach, which stands on the 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 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 Gabriel, Alain with Morgan Stanley.

[Alain Gabriel, analyst]

I have 2 questions from my side. The first one is on your costs. Can I confirm that you just said on the call that you expect your coking coal and energy costs to be broadly flat into Q4? And as an extension to this question, can you remind us about the contract structure that you have in place for electricity and natural gas, just so that we can understand how your costs will progress beyond Q4? That's the first question...

[Idil Onay, executive]

Yes, for the first question, yes, you are right. We are expecting a stable position in raw materials and also for the steel prices. And your second question was, can you remind me?

[Alain Gabriel, analyst]

Yes, it's on the contract. It's part of the contract structure basically for electricity and natural gas, just to see how these costs will evolve beyond Q4?

[Idil Onay, executive]

Well, actually, I mean, let me just explain the mechanism, how we supply the energy. We get our supply from BOTAS, like everyone else. So in our contract, which includes certain tolerances in terms of quantity, but the prices are based on the general country tariffs prices announced by BOTAS. Electricity is like an open market and we buy from [ EPIAS ] into a day and day-ahead market. So it's like a system of electricity exchange. So it's like the...

[Alain Gabriel, analyst]

Okay. So it's daily prices but you do not do much hedging on electricity side?

[Idil Onay, executive]

No, no.

[Alain Gabriel, analyst]

Okay. And then the second question I have is on the working capital. How should we think about an unwind of working capital in light of all the raw material prices eventually coming down, steel prices coming down and shipments maybe being on the softer side. How long is it before we start seeing some meaningful release of working capital?

[Idil Onay, executive]

Okay. When we look at quarter 3, our working capital remains stable, considering the decrease in inventory levels and decreasing prices in quarter 4, we expect to see a release in net working capital.

[Operator]

The next question comes from the line of Agarwal, Krishan with Citi.

[Krishan Agarwal, analyst]

I have 2 questions, if I can. First question is on the production. I can see the production has gone down significantly into the Q3. So what is your outlook on the production in the Q4? Do we see quarter-on-quarter improvement or the production levels are going to be similar to quarter 3 in the year-end?

[Idil Onay, executive]

Actually, we are waiting -- we are expecting a very similar level to quarter 3 in quarter 4.

[Krishan Agarwal, analyst]

Understood. And then on the pricing, I mean, spot market pricing has come down while your [ ESPs ] in quarter 3 were broadly stable. So should we expect that the pricing for quarter 4 will come down based on the spot pricing and hence, there is a potential for the margin squeeze because you have guided for a stable cost profile in the fourth quarter?

[Idil Onay, executive]

Well, Kristen, actually, for the pricing side, we are expecting to see between stable to slightly lower. So as a whole picture, we are expecting stable or slightly weaker results in quarter 4.

[Operator]

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

[Andrew Jones, analyst]

Just a question about Q4. I mean you seem to be talking about stable prices, stable costs, stable volumes. I mean, so it's kind of implying Phase 3 flat or maybe slightly lower EBITDA. But I mean I must admit, I can't understand why the prices would be flat, when they dropped so much over the last 6 months. Clearly, there's a lag in your realizations, but the decline in Q2 on prices was nowhere near as much as the market price level. I would have assumed there would be quite a steep decline into Q4 and with stable costs on the raw material side, should that not lead to a over a sharp margin contraction. Why would your prices be stable given what we see in the market?

[Idil Onay, executive]

Okay. First of all, for the sales prices, currently, our order book is full for 1.5 months due to the recession and global demand contraction, so actually, we can see the sales prices for Q4 starting from now, so we know the prices actually. And for the raw materials, actually, there's an inventory effect. So we know partially our raw material costs as well. Of course, at the end of the quarter, there will be some kind of adjustment because of the procurement. But because of the third quarter inventory effects, again, we can foresee partially our raw material costs.

[Andrew Jones, analyst]

Yes. Okay. But I mean that still doesn't answer the question of why those, you're not saying you can see the prices for most of the rest of the year. So you're seeing that they're stable quarter-on-quarter. But my question is how when there's been such a large decline in the broader market?

[Idil Onay, executive]

Well, I follow the sales prices daily, and actually, it's been on the level of $690 per ton for a while. It was sometimes lower, like $620 for maybe more than a month. In Turkey, [ prices are talked about ], it was at the level of [ $690 ] per ton. So that's why we are saying we foresee stable conditions, both in sales and raw materials.

[Andrew Jones, analyst]

Sure. But given the drop in Q3 was so small because presumably, you weren't getting those 670 surprises you were getting prices in line with what we saw in June, July, saw a lot of that, or maybe given the lag was larger in the past, maybe some of it was still coming from before that, so yes, they have been stable recently, but surely, Q3 must have included a lot of those higher Q2 prices. So again, it just seems very strange to me.

[Operator]

The next question comes from the line of Sinitsyn, Boris with Renaissance Capital.

[Boris Sinitsyn, analyst]

I still have 2, please. You mentioned that you expect stable production in quarter 4, which means basically that crude steel output would be just over [ 8 million ] tonnes for 2022 whereas last year, it was above 9%. The question is, do you expect to reach like previous levels of 9 million tonnes next year, for crude still?

[Idil Onay, executive]

Actually, it's very difficult to share some kind of expectation for the next year. We can just give some expectations for the next quarter actually. So yes, as you mentioned, we are expecting a very similar production and sales for the next quarter, same as quarter 3. But it's really difficult to give some kind of guidance for the next year.

[Boris Sinitsyn, analyst]

Okay. Fair enough. Then my second question, given that the conditions in quarter 1 are right what is the breakeven HRC price for Erdemir if we look at adjusted EBITDA level?

[Idil Onay, executive]

Boris actually we don't share the breakeven prices, any numbers of cost or prices, unfortunately. So we don't declare actually.

[Operator]

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

[Cemal Demirtas, analyst]

My first question is about the capacity issue or the production issue. I think one of my colleagues asked already about the production for the -- our sales for the following years. But I would like to understand what would be the capacity capabilities? I know that the market conditions will be important, but what might be the capabilities regarding furnaces that you can produce, because you're already in the investment process, so I would like to understand if demand is there, what might be the capacity usage you can have? That's my first question. And the second question is about, again, the pricing side.

Recently, the prices are stabilizing at around $700 levels in the region in Turkey, but the Chinese futures are much lower -- on the other hand, we normally see differences, but now the widest range of difference we are seeing. How do you see that picture constrict imports from Russia already, I guess, they had some -- there's some dumping in the Turkish market over the last several quarters.

So how could you position the Chinese import and the Russian import impact on Turkish markets? And how do you explain the difference between the Turkey prices and the China prices. Now is it much less uncoordinated? I would like to understand the mechanism on that front. And in addition to the sector side, how do you compare yourself with electrical furnaces, which are mostly dependent on energy prices? So just when we put together, I'd like to ask about the competitive environment right now.

[Idil Onay, executive]

So the first question was about our capability, our capacity utilization ratio. So I'm assuming that we will produce and sell almost similar to quarter 3, we can assume that capacity utilization ratio will be very similar as well, due to the planned maintenance hold and also, of course, the contraction in demand. And for the Chinese imports, Russian imports, actually, when we check the numbers, the official numbers, import numbers in flat steel, we haven't seen any increasing tonnages from Russia site.

So the tonnages are very similar before the war. So actually, let me remind you that Turkey is not market, so there isn't any restriction or ban to Russian steel. And actually, we heard many dumping issues in the long steel side, but we haven't heard any aggressive movements or any increasing activities for that still, from Russian or Chinese So, so far, we haven't seen any effect on the pricing side because of the imports.

[Mustafa Basoglu, executive]

[ But as you might started talking. ] Also, you're right on the fourth part, I can say the Asia price is going to be lower in Turkey. We know that the Asia prices, Asia HRC prices affect Turkey price. But let me clarify something, we are saying we were in stable or slightly weaker prices in quarter 4 according to our inventory in product line, so we will effect some high prices inventory effect on the sale prices in quarter 4. Because of that, we are saying, we will see the relatively close price to, for example, August price. But you are right, Asia, especially China and India, giving aggressively lower prices, but not part of quarter 3, actually, we can say start-of, at the beginning of quarter 4.

[Cemal Demirtas, analyst]

And Serdar as a follow-up related to your procurement, I think we had a high price in coking coal side and the earlier higher prices lagging effect had some positive impact in quarter 3. So starting by quarter 4 or the following quarters, assuming that the prices are going to stabilize. Could we just have more predictable EBITDA per ton for the following quarters like the ending of the super cycle.

[Mustafa Basoglu, executive]

Actually, I can't share a guideline for next few years. The visibility of our sector is clearly uncertain. But I can say, we will see, the coking coal price actually comes down nearly USD 300. But we will see also high coal prices affect our cost in the forecast because of the inventory, as Idil explained before. But I think on the cost side, actually, it will be eventually normalized, maybe [ after one question ] later. But actually, the metrics on the price side, I can say the product price is not on the [ mark to market ] level because of the [ Asian ], their lower price policy.

[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 for your attention, and thank you for joining us today. Hope to see you in the next quarter conference call. Have a nice day.

[Idil Onay, executive]

Thank you.

[Operator]

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