Vesuvius PLC

LSE:VSVS

Earnings Call Transcript 2018-Q1

[Operator]

Good day, and welcome to the Vesuvius plc AGM Quarter 1 Trading Update Analyst Conference Call. Today's conference is being recorded.At this time, I would like to turn the conference over to Mr. Patrick André, Chief Executive. Please go ahead, sir.

[Patrick Georges Felix André, CEO & Director]

Good morning, everyone. Thank you for joining this call to update you on our trading profit -- our trading during the first 4 months of this year. In terms of trading in Q1, the group benefited from good market conditions, both in Steel and in Foundry. In Steel, we saw continued growth in the steel production, which increased 2.8% year-on-year in the world, excluding China, and 4.1%, including China as reported by the World Steel Association.In Foundry, the market environment remains positive in all of -- end markets. In this favorable market environment, our performance volume-wise has been good with our volume growth continuing to outperform the underlying market growth. [indiscernible] prices, which was an important priority for us over the past few months, we've been successful in implementing a price increase initiative to compensate for raw material cost increase and the headwind, which we met last year in this regard, has now been addressed.Flow Control European production plants have also successfully ramped up production, enabling us to successfully meet the increased demand experience beginning of this year. So the temporary headwinds that we encountered also in this field last year have also been solved and have now disappeared.Regarding our restructuring programs, both the old programs and the new program announced at the same time of our full year results. We are completely on track in terms of implementation of both these programs. As a result of these, our trading performance has exceeded our expectation -- expectations in Q1. Today, the market conditions remain positive. And as we speak, we see no sign of weakening in any of our markets, be it Steel or Foundry.For these reasons, this performance and this favorable outlook of our market, this underpins the board confidence to revisit the expectations for trading performance for the full year, marginally above our scheduled guidance, and this, despite foreign exchange headwinds.As far as foreign exchange is concerned, a few decisions there. The net impact of the average Q1 exchange rates as compared to 2017 averages has been approximately GBP 1.6 million, the main driver being a 7.9% strengthening sterling against the U.S. dollar. All things being equal, if end of March 2018 rates were to persist for the remainder of the year, this will impact our trading profit by approximately 4.7%, but this has been taken into account when the board revised its expectations when it met yesterday.Regarding our financial position and working capital. We continue to make progress in our working capital management and registering incremental improvement as compared with last year. So globally, our cash flow generation remained strong, and we've been able to further reduce our net debt position at the end of Q1 '18 as compared with the end of 2017.So thank you for your attention. Now, Guy and I will be happy to take your questions.

[Operator]

[Operator Instructions] We'll take our first question from Glen Liddy.

[Glen Liddy, Analyst]

Just on raw materials. You've recovered all the price rises from the last year. Are prices for raw materials still rising?

[Patrick Georges Felix André, CEO & Director]

Most of the raw material prices, especially the one which had increased significantly last year around magnesite have either stabilized or even started to decline. The only raw material, which is still an upward trend is zirconia, and based on the success we've had in mitigating scoop price increase, the rise of the biggest fraction of raw material so far, we are not particularly worried about our ability to also continue to do that and mitigate also zirconia as we did with other raw materials. But most of the raw materials now, it seems that the peak is behind us. They have either stabilized or even started to decline.

[Glen Liddy, Analyst]

And on steel production going forward, President Trump is moving with his trade tariffs. Is that likely to be a modest benefit to you as domestic steel production in the U.S. rises?

[Patrick Georges Felix André, CEO & Director]

Yes, it is. We are, what I'll call, unvoluntary beneficiary of this Section 232 mergers because as you know, our beneficial rates in the U.S. is quite high, probably one of the highest in the world. So when steel production increased in the U.S., it's beneficial for us. So we have already seen some announcements being made regarding the restart of some idle capacity in the U.S. These are plants where we have quite high penetration rates so this will translate in -- this will be an upside for us in the coming few months. However, it's relatively limited. We are talking about a few million tons translating into a few million dollars or pounds incremental turnover and margin for us. So it's positive. It's a positive trend here.

[Operator]

We will take our next question from Andrew Douglas from Jefferies.

[Andrew Douglas, Equity Analyst]

A couple of questions please, if I may. The statement this morning, it's positive pretty much across the board, both in income statement and on the cash side. Can you give us an idea of what specifically has pleased you in the first quarter maybe from an operational perspective? That will be the first one, and the second one, I guess it almost links to that maybe, in terms of the kind of change in strategy or change in how you guys are going to be approaching your customers in the market, which you guys outlined at the 2017 results. How has that been taken on the ground? And are you okay with how that's been -- has started? I mean, if you can start with those 2 questions, that would be great.

[Patrick Georges Felix André, CEO & Director]

Thank you, Andy. The thing -- the biggest success we see for us over the past 2 months is really of pricing increase initiative. I think that's -- on one hand, you know that our strategy is not being -- not to be vertically integrated because we are visualizing high range of products with a good pricing power, but it's always good to check on the ground that it works. And we were happy to be able to do that over the past few months, being quite successful with our pricing initiative everywhere in the world across the board, and this is probably the biggest satisfaction for us over the past few weeks and months. Of course, our policy is not to abuse this because we have a long-term relationship with our customers, which we strongly care about. So our strategy in terms of pricing increase initiative is to fully compensate our cost increase. But we are also reasonable in the way we do that because we want to continue to grow our market share on volume and to maintain the relationship of trust between us and our long-term customers. Your second question?

[Andrew Douglas, Equity Analyst]

It was regarding the kind of the change to a more decentralized proactive entrepreneurial business organization with no matrix. I think it was Slide 8 in the full year results, and how do you think that's progressing?

[Patrick Georges Felix André, CEO & Director]

It's progressing very well. By the way, it syncs with the first point. I think that I've been very pleased with the way our managers on the ground have been taking matters into their own hands. This is not something we manage centrally, price increase initiative. This is done locally because the conditions locally are different from one country to the next, from one customer to the next, conditions for competitions are not the same. And even raw materials cost increase are not the same, depending on the countries or logistic costs or specific local reasons. So I've been very pleased with the way managers have been taking matters into their own hands, and this is progressing quite well. We have both existing managers now very happy to enter into this new cultures. In other places, new managers have been joining us from outside. The blending between the experienced managers and the new ones is going well, and all in all, the evolution of the group towards this new culture is progressing quite fine.

[Operator]

We will take our next question from David Larkam from Numis.

[David Alexander Larkam, Analyst]

A few questions. First, just on the materials. What tends to happen if we do start to see raw material price sort of come off the peak? Can you hold on to that excess margin? Or the steel mills presumably quite quick to claim that back? What's the historic experience?

[Patrick Georges Felix André, CEO & Director]

Yes. If raw materials -- if and when, because it's more than when than if, by the way, because I think that the raw materials will go down. The only question is how long will that take? When raw materials go down, our policy is, again, to maintain the long-term relationship with our customers is to adapt our prices. So obviously, then there is a question of speed and reason. And in the same way, that will suffer from the negative timing impact on the way up. Generally, we benefit from a positive timing impact on the way down between the moment the customer start to offer -- to ask for a price decrease, and the moment it's implemented, you always have a certain time line. But this time line has to be reasonable because, again, we totally value, meaning -- by reasonable, I mean, not too long. It's still a good strategy, in our opinion, to wait for too long because we care about the long-term relationship with our customers. For Flow Control, for example, we have customers that have been with us for the past 20 years and we very rarely lose a customer. We gain customers, we extremely rarely lose customers, and we are proud of that, and we sell ourself as a nonintegrated company. It's also the reason why customers accept our price increase when raw materials increase. They will not understand if we will not decrease our prices when raw materials go down. So we play the game, and we do what is necessary to maintain the relationship, of course, with our customers. So yes, we will decrease our prices the day progressively, the day raw materials will come down.

[David Alexander Larkam, Analyst]

Just moving elsewhere, I mean, the oil price has been quite strong this year. Guy, can you just talk about energies and importance to your cost base?

[Guy F. Young, CFO & Executive Director]

Energy is not a major component for us. It's a -- we consume a little bit of energy like anybody else, but energy for us is not a big component. I think, if I may, when energy prices go up, it has a positive for us for market reasons because oil and gas pipes, activity is increasing and the steel used to -- for this oil and gas pipes is a big consumer of our Flow Control products. So in terms of cost inputs, it's, I would say, relatively insignificant. In terms of market, it's quite good for us because it is quality steel which is required when drilling activity or oil transport activity increases. And we see that typically in the states, in North America, which is one of the most important regions for us in that respect. We see positive impact of this, market-wise.

[David Alexander Larkam, Analyst]

And just finally, a small one. I mean, Argentina seems to be having some troubles at the moment. How important is that for you? I'm assuming it's quite minor.

[Patrick Georges Felix André, CEO & Director]

It's -- again, Argentina is not a -- it's hardly positive because we sell in dollar. Ourselves, we sell in dollars in Argentina, we don't sell in peso. So we are not impacted by the fall in the peso, and all things being equal, the Argentinean steel producers, because of the fall of the peso are getting more -- rather more competitive. So for us, what is happening today in Argentina is, I will not go as far as saying that it has a positive, but it's not competing against you.

[Operator]

We will take our next question from Sandeep Gandhi from Exane BNP Paribas.

[Sandeep Gandhi, Analyst of Capital Goods]

Just a couple of questions from me. So first one on operating leverage. So can you just give us an update on how operating leverage has developed in Q1, given it was quite weak in H2 '17? And secondly, can you just give us a sense of the level of outperformance in the Steel Division, specifically in the EMEA region versus your production volumes? I mean, was the outperformance in Q1 as large as what you saw in H2 '17?

[Guy F. Young, CFO & Executive Director]

Sandeep, it's Guy. I'll start on the operating leverage and then, I think, Patrick will take care of your second question. The points you raised at our full year results was well made. The 2 headwinds that impacted our operating leverage were the Flow Control friction costs and the raw material lag. To both of those points, our trading update is reinforcing the fact that we have managed, as expected, to counteract both of those. So we see our operating leverage intact. We have spoken about incremental drop-through associated with our operating leverage of around 35% in a range between that, and more significant growth would mean a drop-through for anywhere between 25% and 35%. So our operating margin is intact, given the fact that we've managed to address the 2 headwinds that we were facing last year.

[Patrick Georges Felix André, CEO & Director]

On your second question, we are continuing to perform better than the market in the EMEA region, and especially in Middle East where we are continuing to make significant inroads and progress there. But it's true across the board. And so we are quite happy with the way we are continuing to make progress there.

[Operator]

We will take our next question from Andrew Caldwell from Barclays.

[Andrew Francis Caldwell, Research Analyst]

I think I've only got one left now, it's on the price increases you put through. Could you give us an idea what the scale of those price increases is?

[Patrick Georges Felix André, CEO & Director]

An idea of what? Sorry, I could not hear you.

[Andrew Francis Caldwell, Research Analyst]

Sorry, I hope this is better. In terms of the price increases you pushed through, could you give us an idea what scale of those are? If your volume growth is ahead of the mark, which is around 4%, what's the pricing growth on top of that?

[Patrick Georges Felix André, CEO & Director]

The pricing is very different from one product to the next because of the raw material content of each of our products is different. As you know, we are not a commodity producer. So we produce, I would say, kind of tailor-made products, which nearly each of them has its own raw material content. But I would say, for those products containing a high level of magnesia content, we are talking about double-digit type of price increase. For those products containing less of new magnesia and other types of raw material, whether the cost increase was significantly less. It's high single-digit, and for some of our products where the content of raw material is relatively low and you know that's, for example, in Flow Control, the raw material part of our costs -- of our costing is significantly lower for Flow Control than for Advanced Refractories. For Flow Control, these are single digits, mid-single-digit type of numbers, but which is quite significant for us, and they're more than enough to cover any raw material cost increase we are confronted with. So a wide range from mid-single digits to well above double digits.

[Andrew Francis Caldwell, Research Analyst]

Okay. So as a group, I imagine, given the weighting, you're probably mid- to high single-digit overall, is that a sensible way to look at it?

[Patrick Georges Felix André, CEO & Director]

It's -- I won't comment on too precise number at this stage. But yes, the reasoning -- you can make a reasoning based on kind of the weighted average things. An important thing also is that we are less magnesia-type-product oriented including in our Advanced Refractories division than other players on the market. So it's important to take that into account also when you make your weighted average type of reasoning.

[Andrew Francis Caldwell, Research Analyst]

Okay. And then just a quick follow-up. On raw materials price increases, it's sort of general cost inflation. Are you able to push through any of that? Or is your price increases purely focused on that raw material recovery at the moment?

[Patrick Georges Felix André, CEO & Director]

Our general policy is to push all cost increase. It's clear that as we speak of raw material, because of what happened in the market over the past 12 months, raw materials is, by far, the vast majority of our cost increase, but our policy has always been and remains to push all of cost increase through our pricing policy, not only the raw materials.

[Operator]

[Operator Instructions] We'll take our next question from Andrew Douglas from Jefferies.

[Andrew Douglas, Equity Analyst]

My follow-up questions have all been asked, but I've got one more quick one. On M&A, I recognize that it's not easy for you guys to do kind of large-scale M&A, particularly in Flow Control and in Foundry. But can you give me your thoughts on the outlook for M&A for the [indiscernible] going forward?

[Patrick Georges Felix André, CEO & Director]

Yes. This hasn't changed much. I think that we are clearly proactively looking at opportunities. However, we are not in a rush. We want to take the time to assess those opportunities. We will only implement in case we can identify such an attractive opportunity. I don't know today what will be the outcome. But again, we are not putting ourselves under time pressure to implement. It would be the surest way to do something stupid, which we don't want to do. So it's one thing to be proactively looking and we clearly are. Then, we'd see if it materializes or not and between -- in which time frame. It's clear that we are now continuing to deleverage, so we are in a favorable position to implement in case we would identify an attractive opportunities, but it's not because we are deleveraging that we are -- that we should force ourselves to do something stupid. So we are keeping a cool head, and looking professionally at potential opportunities and we'll see if it materializes or not.

[Operator]

That concludes today's question-and-answer session. So I'd like to hand the call back over to your host for any additional or closing remarks.

[Patrick Georges Felix André, CEO & Director]

Thank you very much for your attention. So if you have any questions furthermore, of course, we are still at your disposal, and I wish you a nice day. Bye-bye to all of you.

[Operator]

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.