Vesuvius PLC

LSE:VSVS

Earnings Call Transcript 2021-Q3

[Operator]

Good day, ladies and gentlemen, and welcome to the Vesuvius Trading Update Call. Before I introduce the speakers and start the call, we will now respect the 2-minute silence for Remembrance Day. Thank you, ladies and gentlemen. Today's call is hosted by Vesuvius CEO, Patrick André; and CFO, Guy Young. [Operator Instructions] I will now hand over to Mr. André to open the presentation. Please go ahead.

[Patrick Georges Felix André, CEO & Executive Director]

Thank you. Good morning, ladies and gentlemen. So my name is Patrick André, Chief Executive of Vesuvius. And with me is Guy Young, our Chief Financial Officer. I will start by giving you some -- a quick overview of our trading situation now and then open the floor for questions. Starting with the situation in our end markets. We still -- first, the situation is quite positive in the steel sector in the world, excluding China. In the world outside of China, the steel production has been growing a bit over 16% year-to-date. And even in September, it continues to grow close to 9% above last year in the world outside of China, and we see this positive trend continuing going forward. In China, however, the situation is a bit different with a marked slowdown in the second half of the year after a very good start beginning of the year. Year-to-date, the steel production in China is relatively similar to what it was last year, 2% year-to-date above last year, but the month of September is sharply down 21.2% as compared with last year. So it's really representative of the sharp slowdown that we see in the steel industry outside of China. However, I'd like to remind you that the vast majority of our activities is conducted outside of China. So we benefit from the good situation of the steel market outside of China mostly. In the foundry market, we also see a clear recovery of most end market after the pandemic with a positive situation in core market, with one important exception, which is the automotive market not because the end demand is bad. On the contrary, the end demand for automotive is quite good. But because of the situation, you all know of the semiconductor shortages, which creates bottleneck in the production chain of the OEMs and which, in turn, reduces the demand. The latest IHS forecast for light vehicle production in 2021 is 75.8 million, meaning more or less the same level as during the very difficult year 2020 last year. So it shows the extent of the difficulties the automotive sector is confronted with. And this, of course, has a negative impact on our Foundry activity. Because the automotive, like vehicle, they present on or around 22% of the end market. However, all the other markets, the remaining 78%, which is the vast majority, are going quite well. General engineering, which represents around 16% of our end market, will grow around 13%, 14% this year, and growth is currently expected to continue next year. Mining construction, which represents 19% of our overall sales, will grow around 20% this year. And again, growth is expected to continue next year. So globally, a two-side type of situation in Foundry. This is quite a good situation for 78%, 79% of our sales and a more difficult one in the important automotive sector. Another important point is the situation in terms of cost and prices. As you know, we have been confronted since many months to relatively unprecedented inflation situation on the cost of many of our production factors, raw materials, the price of which have been increasing and continue to increase, as we see, quite rapidly. And of course, the freight market. And now to a much lesser extent because we are not very energy-intensive, the energy market. The good news there is that we've been able to confirm over the past few months and weeks, the pricing power of our business model and also the speed of reaction of our decentralized business model. Of course, for the year 2021, we will suffer, we continue to suffer from a time lag impact between the speed at which we are able to pass our price increases and the speed at which these raw material costs or freight costs have been increasing. But we are now catching up. And with the price increase, which we have introduced and which now have been accepted in the market, we are in a situation where assuming no further cost increase, of course, based on today's cost of factors, production factors, we will have restored our margins as from the end of this year, so for the year 2022. So it's quite a good news, and it confirms the pricing power of our business model. And we are confident that in case the raw material or trade costs will continue to increase, we will be able to pass further price increase to also compensate for this volatility. All our growth projects, which we announced in media, are proceeding on track. I'm talking to you from India today where I had the opportunity to visit the work on many of our capacity increase investments, which we launched a few months ago. It's proceeding quite well on schedule, on budget. So we are very confident that this new investment will support our growth when they will become fully operational in H2 2022. From an R&D and innovation point of view, we also confirm our good performance. All our new product launches are on track. With the coming end of the pandemic, our customers are reopening. It's become now possible to visit again more and more of our customers, which is good for us because it means that it will facilitate the introduction of our new products on the market. So we are very positive in that respect. From a cash management point of view, we have decided some time ago to increase our raw material inventories considering the extreme volatility of the situation on the raw material side. So we have an increased level of inventory. However, despite this decision to guarantee the security of supply of our customers, we expect to lower again in 2021 our working capital-to-sales ratio as compared with the already good record level historically -- recorded low level historically, which we had achieved end of 2020. So we should make further progress in that aspect in '21 despite the fact that we made the strategic decision to increase our raw material inventory. This shows that in the strong cash discipline that the teams are showing all over the world. Thanks to this very good cash discipline and despite the payment of the interim dividend and this investment in raw material inventory, we expect our net debt leverage ratio to remain more or less at the same level of 1.1 at the end of the year, meaning the same level where it was midyear when we announced our half year results. We -- on the sustainability front, we are continuing to make quite good progress. We are progressively converting our site or plants worldwide to green electricity, which enable us to reduce and, at some point, completely eliminate our Scope 2 emissions. Already, 11 sites worldwide among the most energy-intensive has been -- electricity incentives have been equipped, and we have a plan to continue to convert more sites in Q4 this year and in 2022. After the improvement in the MSCI rating in June, where we are now rated A by MSCI, we were also upgraded in the rating of EcoVadis to gold level, which positions us in the top 5% of all companies being assessed by EcoVadis. In terms of outlook, our revenue so far remains in line with our expectations despite the weakness in the automotive market and in the steel sector in China, which means that two cons are being compensated by good performance in all the other geographies and sectors. The raw material and freight costs, as mentioned earlier, have been increasing more than what we thought at the time we published our half year results, but at the same time, we have also been able to increase our prices more than what we thought at the time of the half year results. And this is what will enable us to restore our margin as from year-end. However, for the year 2021, of course, the time lag impact has a negative impact on us between the price increase on one hand and the cost increase on the other hand. Taking into account all these effects, we expect our group EBITDA for the full year to be in line with the current consensus of GBP 137 million to GBP 147 million, albeit, however, towards the lower end of this range. Going forward, even -- we expect demand in our two end markets of steel and foundry to remain quite dynamic over the coming years. At some point, the semiconductor shortage will alleviate. It's difficult to predict at this stage where -- when in 2022 as of beginning, middle or a bit later, it's extremely difficult to predict. But at some point, it would elevate, and this will, we believe, support the dynamic of both our steel and foundry markets. We feel that we are extremely well positioned to benefit from this continuing strength in our two end markets, thanks in particular to the important capacity increase investments, which we decided midyear and which we believe will be operational right -- at the right time towards the second half 2022 to enable Vesuvius to be ideally positioned to benefit from the recovery in the market. Thank you very much for your attention, and I now propose to open the floor for questions.

[Operator]

[Operator Instructions] Your first question comes from the line of Andrew Douglas, Jefferies.

[Andrew Douglas, Equity Analyst]

I just wanted to ask two questions, please. Can you give us an update on how you see or how your customers see their current stocking levels? Are we still due a phase of restocking? I'm assuming that hasn't happened yet. And secondly is just regarding China power and how that is impacting your ability to deliver in China. We're hearing from some companies getting a little bit worse. We're hearing from some companies that's getting a little bit better. I'm just wondering how you guys are currently seeing that.

[Patrick Georges Felix André, CEO & Executive Director]

Thank you, Andy. On the first part, we have, today, no indication that stock level will be abnormally high. From all we see, inventory level remains at a relatively low level everywhere. We do not see any sign -- any obvious sign of restocking in the market, neither in steel nor on the refractory side or even on the foundry side. We do not see any sign of stocking -- abnormal stocking in the market. Regarding your second question, China power is a relatively unpredictable sector. So we will be very humble in my answer. What we see -- because we are -- we have many operations in China, the situation seems to be improving a bit. It's not back to normal. But as compared with the situation 2, 3 weeks ago, we have less power shortages than 2, 3 weeks ago. There seems to be a drive towards regulations of prices, so kind of a market regulation rather than regulations through restriction and quantities. And so we see an increase in the price of electricity in China over the past few weeks. And from everything we hear, this will continue in the months to come. But at the same time, physical availability of electricity for those willing to pay the price is getting better than what it used to be 2, 3 weeks ago. So I would not dare to say that we are representative of all activities in China. But I hear a similar story to many of the companies also active in China I'm talking to.

[Andrew Douglas, Equity Analyst]

And one quick follow-up, if I may. I think previously, we've talked about your focus on R&D and new products. Are your customers now opening up to a level where they will -- you can kind of push that harder? I sense that, previously, getting people onto customer sites, et cetera, was one of the restrictions that you have. Can you give us an update on that, please?

[Patrick Georges Felix André, CEO & Executive Director]

Yes. It's a very important point, Andy. We see a clear improvement with -- in many places in the world, customers reopening, reaccepting physical visit on the shop floor, which for us is very important because we have been suffering over the past nearly 18 months, 18 months from strong difficulties to visit physically customer to present our new products and pursue their introduction. Now it's clearly getting better. I will not say that it's back completely to normal. It depends on the region. Some regions, it is back to normal. There are some regions in the world, especially in Southeast Asia, a little bit in China also, where visiting customers remains more difficult than before the pandemic started. But slowly but surely, things are getting better.

[Operator]

Next question comes from the line of Dominic Convey, Numis Security.

[Dominic Convey, Research Analyst]

I've got three, if I may. I'm just intrigued really as to how we're seeing the second half develop, specifically the year-on-year growth in sales. Obviously, first half, you printed, I think, plus 18% on an organic constant currency basis. But I'm just mindful in terms of the comps. Really, you saw the acceleration in recovery in Q4 last year. So how you would expect that to play out? And maybe specifically the degree of sequential growth that you think you'll see in Q4 over Q3. So slightly long-winded there, apologies. But second question, just specifically on automotive, what your working assumption is for Q4 versus Q3. IHS, as you said, is still indicating quite a healthy increase in production in the fourth quarter, whereas a number of automotive suppliers are actually working on the basis that it's actually flat Q4 and Q3. And then final question from me. Can you just confirm what you think the net drag from raw material price inflation and the excess freight cost has been this year and the extent to which that will revert back next, if assuming raw material prices don't continue to rise as now?

[Patrick Georges Felix André, CEO & Executive Director]

I would defer to Guy to answer your first and third question. Regarding the second question on automotive, we are integrating in our own internal forecast a relatively weak Q4 on the automotive market. Certainly not better than Q3 and possibly a little bit worse than Q3. We are on the cautious side. If it's a bit better, we'd be very happy. But we believe that now we -- the semiconductor shortage is really hitting quite hard all OEMs worldwide, and we don't really see any significant improvement in Q4. We believe that improvement will only come somewhere in 2022 but clearly not in Q4. On the sales and raw material price question, maybe, Guy, you would like to comment?

[Guy F. Young, CFO & Executive Director]

Sure. Thanks, Patrick. Dom, I'd try and answer the questions as follows. The revenue expectations we've got for the second half are not that different in any material respect to that which we discussed when we put forward our first half results. So we should see something fairly similar in the second half from a revenue perspective than we saw in the first. What needs to be considered is that there is going to be some price increase in the second half, which was higher than we had expected. And that is essentially offsetting the slightly lower volumes that we've touched on, both in Advanced Refractories because we've led on price increases and in Foundry because of auto. So there are a couple of swings and roundabouts, but essentially, I'm expecting an H2 revenue fairly similar to in H1. If I turn to your other question, I think the shortest way to try and answer that is to say, in the first half, we suggested that the freight friction costs were around 10.3% for us as a group. We are now looking at a second half where if I take freight cost increases and raw material cost increases as far as they have been determined to date, so assuming nothing incremental in the fourth quarter, then our total selling price increase will offset that and mean that the H2 friction cost will be between GBP 1 million and GBP 2 million lower than the first half.

[Operator]

Next question comes from the line of Mark Davies Jones, Stifel.

[Mark Davies Jones, Associate]

Can I just follow up on that last question, actually? Looking forward, obviously, it's very difficult to know when somebody's moving parts of the cost base. But what is your current thinking? It looks as though some of those logistics costs appear to have stabilized, albeit at a very high level. Obviously, energy costs are still going up, but you said a smaller impact, and then there's the raw material piece. Could you just address those? And also just talk briefly whether you're seeing more inflationary pressures coming through also in your labor costs now?

[Patrick Georges Felix André, CEO & Executive Director]

You summarized it quite well. Trade costs looks like stabilizing. I am very cautious because a few months ago, we already said that, and it proved not to be true. So I don't think that the stabilization has been long enough to -- for us to be 100% sure. But there are some signs that freight costs may be in the process of stabilizing, actually not going down but stabilizing, so which is good news because it means that, on that part, we can catch up completely without worrying too much about what is forward. Raw materials are still increasing. So raw materials are not stabilized. These are not the same raw materials. By the way, that's the one which had increased a few months ago. A few months ago, the biggest increase was on the zirconia raw materials. Now we see very sharp increase in all magnesia-related products, which is imported mostly for Advanced Refractories, not that much Flow Control, and various type of aluminas and in various type of graphite. These three raw materials, which have not increased too much previously, are now increasing significantly since September. And we are still, as we speak, in an increasing phase, absolutely not in a stabilization phase. The last point is energy. It's -- so there, you know very well the prices. It has increased a lot. But for us, it's not -- it's relatively minor as compared with raw material and freight. So it's a point that we are watching carefully and that we intend to fully compensate with our price increases. But it's relatively minor as compared with raw material and freight.

[Mark Davies Jones, Associate]

Great. And anything on the labor side that is of concern at the moment?

[Patrick Georges Felix André, CEO & Executive Director]

Labor side is a point of concern, and we expect unlimited discussions in many parts of the world where we will negotiate labor cost increment for the year to come. This being said, we are -- we will make decisions. We have already started to make decisions to be -- to keep our labor cost under control. And we are confident that we will be able to keep labor cost under control going forward. There are some places where there are more tensions than others because labor cost is -- labor is relatively scarce. But the most important of our operations are in part of the world where there is, I would say, relatively speaking, less scarcity of workforce than in other parts. So we are confident that we would be able to keep our labor cost. We will have a more increment of labor cost this year than last year, obviously. But we are confident that we will be able to keep this in a reasonable range.

[Operator]

Next question comes from Robert Davies, Morgan Stanley.

[Robert John Davies, Equity Analyst]

First one I had was just on some of the difference in the divisional trends, whether you could give us a little bit more color on the outlook, I guess, through the second half Steel Control against Advanced Refractories. There's obviously quite a big difference in the first half just in terms of the growth profile. I just wondered if there's any catch-up. Advanced Refractories, I know you mentioned some of the raw material impacts there in Advanced Refractories specifically. But just to be kind of interested in the difference, I guess, in terms of outlook between Steel Flow Control and Advanced Refractories for the second half. And the second one I had was just on I guess the net impact of all these kind of cost-saving plans that you've had over the last few years, raw material prices. When you sort of put it all together, has that any impact over the sort of medium-term margin outlook for the business?

[Patrick Georges Felix André, CEO & Executive Director]

Regarding the first point, the second half is relatively similar in terms of story between Flow Control and Advanced Refractories through the first half. We continue to have a better performance volume-wise of Flow Control versus Advanced Refractories. Both business units are very disciplined in terms of price increases. And this is being done without loss of volumes in Flow Control, without loss of market share. We even continue to gain some market share in Flow Control. And in Advanced Refractories, we are continuing to lose some market share in the second half because we remain probably among the most dynamic in the industry to increase prices, which we think we have to do. So we are preserving prices -- margins in Advanced Refractories. And the -- our competitors in the Advanced Refractories field are, I would say, much more active in the second half in increasing prices than they have been in the first half. But -- so I would say the gap in their dynamism, if I could call it that way, between us and our colleagues still remains, but it's much less in the second half than it was in the first half. So progressively, I think we are now going progressive towards a normalized situation where there will not be any gap of dynamism in terms of price increase between Vesuvius and the rest of the industry. And this should translate into, I would say, a normalization towards in the course of 2022 of market share. So I believe we should gradually recover in '22 the market share that we lost in '21. But we continue to give absolute priority to price over volume in Advanced Refractories also.

[Robert John Davies, Equity Analyst]

And then on the midterm margins?

[Patrick Georges Felix André, CEO & Executive Director]

So could you repeat your -- the second part of your question?

[Robert John Davies, Equity Analyst]

Yes. Sorry, on the -- I guess it was two parts. One was just, I guess, the net effect of the sort of recovering volume, raw material prices that are sort of moving around, freight and logistics challenges, just how you're thinking about the medium-term margins. And I guess sort of an aside to that is just within the Foundry Division. Can you give us any sense of the different profitability levels between the different end markets? Are you -- which are better or worse between automotive versus general engineering versus the other bits and pieces you have in Foundry, just to get a sense of whether there's a sort of margin headwind or tailwind from the relative moving parts?

[Patrick Georges Felix André, CEO & Executive Director]

So we believe that when markets will have stabilized, raw materials and freight markets will have stabilized, there is absolutely no reason why we should not completely recover our margins and fully benefit from the -- all the restructuring programs that we have been launching over -- and implementing over the past few years. So for us, it's a question of timing. We need markets to stabilize for the price increase towards the time to catch up. But we remain completely confident in our margin objective when those raw material and freight market will have stabilized over the coming months and when all end market will come back to their normal growth pattern, including, of course, the automotive market. Second point, regarding Foundry, there is no significant difference in profitability between the markets. It's more by product line than there are differences. But the profitability of our sales in the automotive market is more or less average as compared with the rest of the Foundry activity.

[Operator]

Next question comes from the line of Sam Bland, JPMorgan.

[Samuel James Bland, Research Analyst]

I just really got one question. It's really on sort of when we think about 2022, there a lot of uncertainties here around China, autos, freight, raw materials, et cetera. Are those sort of -- all of those uncertainties sort of equally important and equally difficult to predict? Or is there sort of one or two that you think is particularly important how they turn out through the year?

[Patrick Georges Felix André, CEO & Executive Director]

It's a very good question. Thank you very much. I think there are two major uncertainties which, at this stage, we feel difficult to predict. The first one is when will the semiconductor shortage alleviate. Will it be Q1, Q2, Q3 or even Q4? We believe that it will be some time in 2022, but we don't feel we have not reliable information coming from the market to assess the timing in the course of '22. And this can have a significant impact, positive or negative, depending on if you are optimistic or pessimistic on that, on our end result next year. So for this, it is the first major uncertainty. It affects Foundry, of course. But indirectly, it also affects a little bit Flow Control because automotive consumes some of the most sophisticated flat steel of the steel industry, where the consumption of Flow Control product is above average. So there is also indirectly some -- also some impact, smaller than for Foundry on the Flow Control division. The second important uncertainty is what will happen with raw material costs going forward. Freight, we may have some reasonable hope that we are now at a stabilization point. But raw materials, it's very uncertain. And today, we could have very different sceneries for the raw materials, a scenario where material prices will decrease in the course of 2022 when after Chinese Olympics, some of the production bottleneck in China may disappear or at least reduce. But you also have scenery where some raw material costs could continue to increase, creating further time lag impact on our P&L. So raw material cost increase and timing of semiconductor shortage are the two major remaining uncertainty at this stage, which is the reason why we are refraining from giving you, at this stage, some 2022 guideline. We will feel more comfortable to do that beginning of next year when, hopefully, we'll have a little bit more clarity on the evolution of these two major uncertainty factors.

[Operator]

We have no further questions. I will now hand back to Mr. André for closing remarks.

[Patrick Georges Felix André, CEO & Executive Director]

Thank you very much, Mark. I would like to thank you all for your attendance today to this call. Thank you for your question. And of course, Guy and myself remain permanently at your disposal any time should you have any further questions. Thank you very much to all of you. Goodbye.

[Operator]

Thank you. That concludes your conference call for today. You may now disconnect. Thank you for joining. Please continue to stay safe and enjoy the rest of the day.