Eregli Demir ve Celik Fabrikalari TAS

IST:EREGL.E

Earnings Call Transcript 2018-Q4

[Operator]

Ladies and gentlemen, welcome to Erdemir Group 2018 Financial Results Conference Call. Eregli Demir Çelik Fabrikalari may, when necessary, make written or verbal announcements about forward-looking information, expectation, estimates, targets, assessments and opinions. Erdemir has made the necessary arrangements about the amounts and results of such information through its disclosure policy and has shared such policy with the public through the Erdemir website in accordance with the Capital Markets Board regulations.

As stated 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'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 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 a -- have not 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 Control and Reporting Director, who will take you through the presentation.

Dear, Mr. Avni Sönmezyildiz, please go ahead.

[Avni Sönmezyildiz, executive]

Thanks, Valeed. Ladies and gentlemen, welcome to investor call of Erdemir and its subsidiaries. As usual, today's presentation covers market overview and details of our financial results for the year ended 2018. After going through the presentation, we will answer your questions with our group CFO, Mr. Emrah Silav; and our Investor Relations Manager, Idil Önay Ergin.

So let's start with Slide #5 about the crude steel production in the world. Global crude steel production reached 1.8 billion tonnes in 2018. It is up by 4.6% compared to previous year. Crude steel production increased in all regions in 2018, except European Union, which we saw a 0.3% contraction in the production. China's crude steel production in 2018 reached around 930 million tonnes, up by 6.6%, when compared with 2007 (sic) [ 2017 ] and which means that China's share on the global crude steel production increased to 51% from the 50%. Also CIS produced around 100 million tonnes in 2018, which indicates an increase of -- a small increase around 0.3%; Russia produced 52 -- 72 millions of it and Ukraine produced 21 million tonnes of it. Ukraine's production decreased around 1%.

In Slide 6, you will see the pricing trends for the commodities that we purchase, and let's start with coking coal. After a recent strong decline in the premium coking coal prices, it is again recovering because of the demand coming from Indian and Chinese producers. And this -- the prices are now stable around $200 this week because of the Chinese New Year. For iron ore market, the most important news about the dam accident in Vale's mine field, there has been a devastating accident in Vale's dam last week. And we are very sorry for the people who lost their lives. The mining facility has capacity of 7.8 million tonnes and it's immaterial when we consider the total iron ore production in the world. However, Vale had to temporarily shut down 10 other mines using the same technology at the dams, which have total annual capacity around 40 million tonnes. Although it's too early to assess the effect of the accident, as these fields are many producing pellet, it's expected that it could increase pellet premiums, again, which have recently declined around 10%. We will see the effect of the accident to the iron ore markets next week, after the Chinese New Year holiday.

In the next slide, you will see the figures for Turkish steel production and consumption, in Page 7. And although consumption declined around 5 million tonnes, Turkish steel producers are able to achieve 70% capacity utilization because of increased exports around 3.4 million tonnes, as you can see in the next slide. In the second half of 2018, the flat consumption in Turkey has shrinked around 40%. However, total export revenue of Turkish producers has reached around $15 billion level because of the increase in exports in the second half. Import consumption ratio in Turkey steel market is still around 50%, although there's a significant decline in consumption and it's not affected by the decline.

In Slide 8, you will find exports and imports comparison of Turkey steel market. As you see from the slide, flat export increased around 1.8 million tonnes, the import decreased around the same level.

So let's take a look at the financial results. Let's start with Page 10, which is the summary of the operational and financial highlights. For financial figures, we are above 2017 in revenue, EBITDA and net profit. It has been a very successful year for us. Thanks to increase in steel prices and decline in conversion costs, we are able to increase our EBITDA around 15% and USD 220 million, while the net profit increased only $130 million because of the increase in actual and deferred tax expenses. However, our sales volume declined more than 550,000 tonnes mainly because of decline in long product shipments, while total liquid steel production remains at the same level.

Around 350,000 tonnes of liquid steel production stays in the finished goods and slabs inventory, while the rest of the differences are semifinished coils. In Page 11 and 12, you will find our liquid steel production on a yearly and quarterly basis as well as our capacity utilization ratios. We have been running with above 95% capacity utilization in liquid steel since 2014. As I mentioned earlier, overall capacity utilization of Turkey steel producers in 2018 is around 70%, while the world average is above 75%. Our high capacity utilization is one of the main factors for our high profitability as it helps our -- it helps lower our costs.

Sorry, let's skip Slide 12 as the Worldsteel is not announcing the global capacity utilization ratios anymore because of the anti-trust concerns.

So let's take a look at Slide 13, which is about the production. In this slide, you will see the comparison of our finished goods production. Our HRC production increased around 150,000 tonnes, while the long goods production decreased around 350,000 tonnes in 2018. The difference in total annual finished goods production is mainly coils, which are not shipped to our customers yet, and they will be shipped to our customers in the first quarter of 2019. These unshipped coils will partially compensate the effect of the declining steel prices in the last quarter, which is supposed to hit first quarter of 2019 profitability for all steel companies.

In Slide 14 you will see the breakdown of sales volume on annual and quarterly basis. And we are able to increase our sales volume around 5% in the fourth quarter when we compare with the third quarter. And we are able to increase our sales in higher segments, although hot and rolled long sales remained almost the same when we compare fourth and third quarters.

And in Slide 15 you will see the net -- the trend of the net sales revenue. Maybe the most important thing in 2018 for us is the achieving -- achievement of exports, our exports, and we were able to increase our exports significantly under such a protection trade environment. In 2018, our export volume is almost 20% of our annual total sales volume. And it shows our group's ability to penetration to the other geographies when domestic demand declines. We sold our products -- we are selling our products to around 50 different countries. And it's very challenging work for our sales team under such protection sale environment, but we were able to achieve that, we have such flexibility even under the declining consumption trends in the domestic market. And we assume that our export sales will continue to increase in 2019.

So let's take a look at the distribution of sales, domestic sales in Page 16. Actually there is no significant change in the breakdown of domestic sales on a segmental basis as you can see from the slides, the pie charts. As the second galvanizing line will start production in 2019 and it will double our galvanizing capacity, we expect that we will be able to increase our sales to the auto and other general manufacturing segments starting from 2019.

In Slide 17, you will find EBITDA and net profit figures. We have reached historic high levels both on EBITDA and net profit in 2018. And we are able to increase EBITDA 15%, while net profit increased around 13%. Maybe it's worth to explain the reason for the higher EBITDA and lower net profit in the third quarter versus lower EBITDA higher net profit in the fourth quarter, actually this is mainly because of the noncash foreign exchange differences resulting from the deferred taxation I try to explain in each quarter. And we had recognized around $100 million tax losses coming from the foreign exchange losses in deferred tax. I already mentioned in the previous conference call. In the fourth quarter because of the appreciation of Turkish lira, this time we generated USD 50 million income in the deferred taxation. This is the main reason for the fluctuation between third and fourth quarters in the net profit, while the EBITDA goes in the reverse direction.

So in Slide 18, we present the EBITDA to net profit bridge. And we recognized USD 188 million depreciation and USD 534 million tax expense because of the high corporate taxation and deferred taxation expense coming from the Turkish lira depreciation.

In the next slide, you will find the EBITDA to cash bridge. And because of high commodity prices than previous quarter, our working capital increased around $480 million in 2018. As the steel prices decreased, starting from the last quarter of 2018, you may expect some recovery from the working capital in the following period. Also we have paid significant amount of tax in 2018 mainly because of high profitability in statutory books because of the Turkish lira depreciation. After the dividend payment of $661 million in 2018, our cash decreased around $210 million.

In Slide 20, we present the EBITDA per ton figures, which is one of the key performance indicator for us. After seeing the highest EBITDA per ton of $219 per tonne in the third quarter, it gets back to $170 level because of the decrease in steel prices in the fourth quarter. We expect that the decrease trend in EBITDA per ton will continue as the first quarter of 2019 because of the price trend in the steel markets.

In the next slide, let's take a look at the financial figures and you will see the summary of our balance sheet. We have pretty solid balance sheet and it's pretty simple, as you can see. I have already mentioned about the change in cash and working capital. And there is no significant change in financial liabilities as most of them are trade finance -- revolving trade financing loans. Our provisions and other balance sheet items, such as VAT, decreased in dollar terms because of mainly Turkish lira depreciation.

In Slide 22, the trend of financial borrowings and net cash is presented. Our balance sheet, as I mentioned, is pretty strong. We have net cash around $480 million at the end of 2018. And in the next slide -- actually, I will skip the Slide 23 and I will go to Slide 24. And in this slide, you will see the maturity profile of borrowings. Although short-term facility seems very high, it's worth to note that these are mainly revolving trade financing loans, which are presented as the green bar in the chart. And as our export activities increase, we are trying to increase our trade financing -- revolving trade financing facilities as well because of the cost of those loans.

Slide 25 presents the cost of sales breakdown. As you can imagine, as the Turkish lira depreciates, proportion of raw materials increased to 26% and labor cost are just 90 -- 9% of our total costs. And there is no significant change in the other cost items.

In the next slide, you will see the historical trend of capital expenditures. And as we always mentioned, we spend around $200 million every year for maintenance and other small CapEx projects. And last slide, before the Q&A session, is the number of employees. And our number of employees decreased to 11,600 from 12,000 level, mainly because of the retirements and the voluntary lease.

So thanks for listening our presentation. Now we can continue with the Q&A session. Valeed, may help us on that one.

[Operator]

[Operator Instructions] Our first question comes from Anton Fedotov, Bank of America Merrill Lynch.

[Anton Fedotov, analyst]

I have two questions. My first question relates to the increase in the export sales starting from the second half of the last year. What's the difference in the profitability of the sales in the export markets and in the domestic markets for you? And second question about the CapEx this, next year. What's your guidance?

[Avni Sönmezyildiz, executive]

Can you repeat the second question, Anton?

[Anton Fedotov, analyst]

What is your CapEx guidance for 2019?

[Avni Sönmezyildiz, executive]

Okay. Well, export sales, I mean, you know, when you export your product, you have to sacrifice, at least, the transportation cost. And before the presentation, we had a meeting with the Turkish analysts. And our CEO said that, if we didn't increase our exports and sold all of our products to the domestic market, like the previous year with the same ratio, our profitability would be $40 million higher. So it could explain the difference. I mean, it changes time to time, but it gives you a rough explanation what could be our profit level if we stayed at the 10% export level in 2018. I guess, it gives you some idea. And for CapEx, maybe Emrah, if you may explain maybe our recent announcements and the CapEx guidance.

[Emrah Silav, executive]

Yes. Thank you. And actually, yesterday we announced some investment schedules that we are planning to do. Obviously, it would take at least 2 to 3 years to complete any of these so far. If you're asking for 2019, I wouldn't expect a huge divergence from the slides that we provide you before. There wouldn't be a very drastic cash outflow for 2019. For the other parts, I would say we are dealing with the ECA export exempt credit lines right now for all these investment packages. So hopefully that we are going to find reasonable funding terms and costs that wouldn't be generating an extra cash outflow, so we are looking for 2 plus 5, 3 plus 7, those kind of longer maturity low-cost terms. And we are working on that right now.

[Anton Fedotov, analyst]

One more question from my side. Will this new investment projects that you announced yesterday and also the investment project that you announced in summer last year, will they have any negative input on your dividend policy and your dividend payout?

[Emrah Silav, executive]

Anton, right now what we shared with -- in our previous meetings and teleconferences that we can take the previous historical payment outflows as a guidance right now. So that's what I'm trying to say. We are looking for terms and maturities and cost that would not affect the dividend policy. So we are trying to keep up with the policy. So we didn't -- we wouldn't like to see a great divergence in that either.

[Operator]

Our next question comes from Andrew Jones, Wood & Co.

[Andrew Jones, analyst]

I've got several questions. First of all, on the CapEx for these new investments, combining the investments you announced yesterday with the ones you announced over the summer, the 2 blast furnaces and the rolling mill, what is that total CapEx supposed to be? You were saying that CapEx should be below $1 billion. And I think you were including potentially some of these investments. Is that still the feeling? And how will that CapEx be phased in your view over the next few years? Well, and you didn't given out a number to Anton, previously. What do you expect to spend this year? What do you expect to spend in 2020, 2021? What's your profile? Secondly, on capacities. How much is this going to add in terms of capacity for sintering, for coking into -- at each of the different plants? And thirdly, why are you building new sinter and coke plants at Eregli when -- as I understood from your previous plans with the blast furnace, you weren't going to be adding any net new capacity at Eregli. So why do you need those? Are they going to replace old, less efficient plants? And then just finally on the numbers from the fourth quarter. Your prices only dropped 2% versus over 5% of Russians, which is surprising given the slowdown of the domestic market. Well, how do you explain your prices being so stable, given the slump in demand? Do you have long-term contracts? Was it -- which markets did you pivot to in your exports? I mean, could you explain why that was?

[Avni Sönmezyildiz, executive]

Thank you, Andrew. Let's -- I mean, I'll try to explain the sinter capacity and the coke investment and then we can discuss the total CapEx plan with Mr. Silav. He'll give you more guidance because, I mean, sometimes it's hard to give even a rough figure because the investment plan could change based on the -- your strategy and the size and the vendor. I mean, if you go to one and you can get -- you pay more, but you have more quality. But if you go to other vendors, it changes. So it's -- it could change. That's why we are not trying to give you a total CapEx as we're still discussing with the vendors and haven't decided which -- what will be the final decision about the size of the CapEx, et cetera. But for sinter capacity and coke capacity, let's start with coke. Eregli requires coke. Sometimes it has to buy coke from the other -- from third parties. It's not coke self-sufficient at Eregli. And the current coke ovens are almost 50 years old. It requires renewal, it is obvious. And with the current coke investment in Eregli, we will be able to -- we will be self-sufficient, Eregli will be self-sufficient in coke requirements and also we will be able to add byproduct facilities, which gives us additional cost reduction for the energy. This is the main reason for the coke plants in Eregli. Also the same situation is also true for the sinter in Eregli. Eregli's sinter usage is lower than global sinter usages in the other facilities. That's -- and Eregli requires actually pellets. And as the premium for the pellet increases, Eregli has to increase its sinter capacity to lower its cost. That's the -- this is the main reason for the sinter investment in Eregli. For Iskenderun, we have already discussed about the capacity increase, and the liquid steel capacity increase requires additional coke and sinter capacity also in Iskenderun. This is the second reason -- this is the other reason for additional sinter capacity in Iskenderun. And you asked about the price trend in our -- in the fourth quarter and your comparison with the Russian producers, we don't have contracts actually. We -- our products are on spot like everybody else. It is just actually the trading management of our sales team, nothing else. Also the sales prices can vary from region to region, although we are in the black sea region, sometimes it varies. And that's the main reason. So it's not related with the long-term contracts, et cetera.

[Emrah Silav, executive]

Okay. I'll add a little bit more about the total spending schedule. So as we have discussed before, we shared the investment in 2 blast furnaces, but the negotiations are still going on. As Avni mentioned, this differs from one vendor to another and differs from one project to another. So briefly adding these new investment schedules with coking coal plus sinter, the total package is still under review. So we wouldn't like to share something that would give you a different idea or a wrong number. As we finish our negotiations, then we will be sharing those information, the capacities and et cetera, with our investors.

[Operator]

[Operator Instructions] Our next question comes from Adnan Bilgin, Metzler Asset Management.

[Adnan Bilgin, analyst]

Here is Adnan Bilgin from Metzler Asset Management. I just wonder the weakness in the steelmaking margin in the first -- in the last quarter of the year, is it going to sustain in the next quarters? I mean, you partially explained that it is due to increased export sales. What kind of other factors can we derive from that? And is it reasonable to expect that that's going to be sustained into the next quarters?

[Emrah Silav, executive]

Actually, it's not just -- of course, domestic factors. As you have seen already, we have a great increase in the exports. And this goes to many different countries. So other -- if you're asking other factors that we should be taking into consideration, I would love to say we are following China very closely, because last year, because of the deleveraging, Chinese infrastructure investments were very low and the contribution to GDP was very low. But this year, they announced new infrastructure investments and also they are also supporting the consumption by money market instruments and lowering reserve requirements and et cetera. So actually we would -- we think that we would see a stronger consumption plus infrastructure investment in China. So although we have some talks about global growth rate, but still it doesn't seem so bad. So we will see European and Far East demands, as we have explained before in India and et cetera. So that's -- those are the factors that we are following very closely, especially China. If the infrastructure investments keeps going, that's what they are saying, that would be helping both the prices of the end product. That would be a benefiting factor for us too.

[Adnan Bilgin, analyst]

And as for the input costs, I mean, iron ore was behaving last quarter, now it is up 20% on spot.

[Emrah Silav, executive]

Yes. Okay. Go ahead, please.

[Adnan Bilgin, analyst]

I think it's reasonable to assume that the EBITDA performance is even -- is going to be even more under pressure?

[Emrah Silav, executive]

But iron ore -- from the iron ore, it's like an exceptional case. It's because of the unfortunate accident in Vale dam. So actually we are still waiting on our site to see what's going on to see if it's going to affect the product because the place that the dam -- this accident happened is a very low part of Vale's production, it's a small part of Vale's production. But everybody is waiting what's going on with the other parts. If nothing happens, then it's not going to affect the market so badly. So if they come to the market rapidly -- so it's not like we're buying at that prices right now. So we work with inventory, that's going to help us go through this cycle. So we did not feel the pressure immediately. So we see this as a transitory period because others will be coming to the market if the prices stays like that, right? But we would hope to see that Vale is going to negotiate with their own government and they take -- they will take precautions about what's going on and then keep the production. But everybody is right now waiting for what's going to happen.

[Operator]

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

[Avni Sönmezyildiz, executive]

Thanks, Valeed. So thanks for joining our conference for the year-end results. And we hope to see -- talk to you again in the announcement of first quarter results in April or maybe at the end of April, most probably. Thank you. Have a nice weekend all of you.

[Emrah Silav, executive]

Thank you for your participation. Have a nice weekend.

[Operator]

Ladies and gentlemen, this concludes our conference call. You may now disconnect.