Aperam SA

MAD:APAM

Earnings Call Analysis

Recovery In Sight Despite Challenging Market

After encountering production issues in Belgium and facing challenging European market conditions, including soft demand and low pricing, the company is now operating normally, observing the only way is up. Brazil's solid demand outlook faces pricing headwinds due to global market links, with anti-circumvention measures underway against imports from Taiwan, Vietnam, and Turkey, aiming to preserve fair trade. The Leadership Journey self-help program continues, with Phase 4 achieving its target, and details on Phase 5 to be announced alongside Q4 results, including additional cost-cutting measures in Europe. The introduction of the 'infinite' brand underscores the company's commitment to low-carbon stainless steel and recycling leadership, aligning with Europe's carbon border adjustment mechanism. Adjusted EBITDA guidance for Q4 suggests EUR 50-60 million, with net debt expected to align year-on-year despite higher Q4 CapEx.

Navigating Through Unprecedented Challenges

The company faced a historically difficult quarter, marked by the lowest EBITDA in its history due to several adversities. These included the impairment of buffer stocks, designed to protect the footprint upgrade in Europe and Brazil, leading to negative EPS and operating cash flow. Despite no major financial items or exceptions, and a normal tax rate, these factors combined to deliver a blow to the company's financial performance.

Segment Performance: A Mixed Picture Amidst Economic Headwinds

From a segment viewpoint, Recycling & Renewables (R&R) along with the company's Brazil operations fared well, with R&R earnings aligning with normalized guidance, despite a quarterly decline. However, the European slowdown and one-time charges brought negativity to other segments. Notably, Stainless & Electrical Steel (S&E) grappled with production disruptions and inventory valuation charges, and Alloys & Specialties (A&S) dealt with the impact of declining precious metal prices on reported EBITDA. The latter is expected to have its best year by a wide margin on an underlying basis, showing the transitional nature of current challenges. For the upcoming quarter, the company has positive expectations for rebounding volumes and easing one-time effects.

Working Capital Dynamics and Capital Expenditure Outlook

The company's working capital increase is attributed to raw material price hikes, with nickel and ferrochrome prices jumping significantly, shaped partially by geopolitical events. The company's investments, a core part of the strategy for a EUR 300 million EBITDA improvement by 2025, and the incorporation of ELG, have structurally increased the net working capital. However, this is deemed a sound investment given ELG's substantial contributions and high returns on capital employed. Capital expenditures (CapEx) are projected to escalate in Q4 to align with annual guidance, yet net debt is expected to align year-on-year. Encouragingly, the adjustment in alloys EBITDA by doubling it by 2025 signals a commitment to growth and profitability, underlining the strategic pursuits in improving the business mix.

Financial Policy, Dividend, and Future Expectations

The company maintains a progressive dividend policy, evidencing a commitment to returning value to shareholders regardless of fluctuations in debt-to-EBITDA ratios. Looking ahead, the company is gearing up for a comeback, leveraging its roadmap dubbed the Leadership Journey Booster and eyeing a 25% improvement through high-value, non-volatile business opportunities. Emphasis will be placed on decarbonization, with likely insights coming from the upcoming Capital Market Day in Paris. Although the past quarter was challenging, the company appears poised for revival with promising strategies and initiatives on the horizon.

Guidance and Expectations for Upcoming Quarters

With Q3 hitting what is perceived as bottom, the guidance suggests a trajectory aimed upwards, with slightly higher shipments despite seasonal slowness in Q4. The expected adjusted EBITDA for the next quarter is EUR 50 million to EUR 60 million, with caution about the impact of raw material prices on valuation. The Q4 cash flow is expected to benefit from working capital releases, providing a springboard into 2024 with a solid balance sheet as the foundation.

Earnings Call Transcript 2023-Q3

[Timoteo Di Maulo, executive]

Welcome to Aperam Q3 broadcast. I am Tim Di Maulo, CEO of Aperam. Together with Sud Sivaji, Aperam's CFO, I will explain why Q3 was a tough quarter and how we'll surpass expectation again in the future. We will answer your questions at the webcast conference call today at 2:30 CET. The dial-in details are on our website and on the last slide of this presentation.

Please take note of the disclaimer on Page 2 and then move to the highlights on Slide 3. Reporting the worst quarter in Aperam history is painful, but we have a plan for the turnaround, and we also know that onetime effects play a major role here. We hit bottom to a very high inventory valuation charge and the footprint upgrade caused severe production issue in the upstream operation of our Belgium plants. The problems has been resolved and operations are running normally. The only way from here is up. Even though the market environment in Europe remains challenging, with very soft demand and still low pricing.

Brazil contributed to a solid result. Demand and the outlook are good, but pricing remains a headwind due to its link to the global situation. Imports have normalized after more effective dumping and then circumvention protection has been put in place by the European Commission. The commission is actively working on closing all loop holes.

They launched another anti-circumvention investigation against cold rolled material from Taiwan, Vietnam and Turkey. This is a significant initiative. The 3 together had a market share of 11.3% in the EU cold rolled market this year. Because of all the imports have on discount rate are registered, the retroactive duty seen in other cases is possible. If this initiative materialize, then we are convinced that the measure put in place since 2018 are effective in maintaining a fair global trade playing field. In Brazil, a circumvention investigation against some cold-rolled product in China was opened. This is the first of its kind in Brazil, which makes it very significant. Self-help measures within the Leadership Journey are the key pile to strengthen our flexible and resilient business model. Phase 4 is still running until the end of the year. We added another EUR 28 million gains during the quarter and with realized gains of EUR 178 million, we are now clearly meeting the target gains.

Major areas of improvement were raw material sourcing, efficiency gain scrap, efficiency gains in Brazil and the downstream integration of the alloy business.

We'll share the details of Phase 5 in February with Q4 results. However, it's clear that the current situation in Europe requires additional measure in the form of dedicated cost-cutting program, we will revert to this later.

On the ESG front, we launched our infinite brand this quarter.

Let's go to next page. infinite, it is our new brand for near-zero carbon stainless steel. Why this name? Because stainless steel has an extremely long useful life. It can also be infinitely recycled without any doubts on quality. infinite used the maximum possible amount of recycling material and is produced with the renewable energy. It yields an 85% reduction in CO2 emissions. It therefore, benefits our customers in the decarbonization efforts. infinite also differentiates Aperam's product offering for us. This is not a commodity that can be purchased from Asia. Let me remind you that the carbon product adjustment in making just started this October. This makes carbon optimized products like infinite, increasingly valuable to use of stainless steel in Europe. The infinite brand is also a showcase for our differentiated value chains come together. We are recycling champion via ELG, our distribution activities allow us to close recycling loops. In this way, the combination of ELG and SLS enable us to secure suitable clean feedstock in larger quantities. But there are more entities involved. Recyco process recycled nickel raw material like dust, ashes and residues. This entity will play a major role during the first 5 of the Leadership Journey. You are aware of the Energia, our FSC-certified forest operation in Brazil, this supplies more than 1/3 of the Aperam Group's energy on a sustainable and renewable basis.

And then there is Botanickel, our plant-based nickel source, harvesting nickel, sound like it's a dream, but you saw the picture on the previous page. Botanickel is real and makes good progress.

Let's go to next page. In Europe, the market environment has been difficult for some time, and changes is not apparent. Price has slightly recovered by remain at the level that we previously saw during the recessions. Volume remained depressed as the negative economic growth weighs on real demand and inventory cycle is still negative. The latter is actually quite interesting. Absolute tonnage and distribution chain is clearly below the seasonal normal level and more in line with previous recessionary stuff.

It is note worth that inventory days are close to a normal level despite a very low denominator. This is -- this will eventually turn into a restocking rush, but not yet in Q4. The nickel price continued to slide and distributors will polish their year-end balance sheet. The sectoral demand picture remains steady and very challenging. Construction is in the old homes together with white goods, where destocking has made some progress, but is not yet completed.

Automotive remains the bright spot, while food and beverage restaurants and catering remain below average. Industrial demand is unchanged with good business in energy and oil and gas. Everywhere else is quite poor.

In Brazil, we see solid volumes continuing into Q4. Distribution is stable, and real demand is supported by a very certifying capital goods and transport demand. White goods are recovering and construction is also seen some green shots. Pricing is the only headwind in Brazil as a spillover from international markets.

Just one add on to imports. We said for some time that imports will remain unsuspicious in the future. This quarter proves us right again. Furthermore, I am to repeat the potential positive impact of the new anti-circumvention investigation. It addressed 45% of all imports year-to-date. The additional action and vigilance of the European Commission should therefore keep imports at bay.

While the carbon border adjustment mechanism is technically not a dumping or subsidiary feature, it will further level the plain field with Asia on decarbonization cost. The program has now moved into implementation phase. And as previously reported, stainless steel imports are recorded on scope 1 and 3. This would hold value for the Europeans that is still investing in the future.

We go to the next page. The market environment is challenging and will most likely not provide tailwind for the foreseeable future. Self help is the name of the game to restore profitable operation and cash flow that covers maintenance improvement CapEx and shareholders' returns. Yes, one-time effect will fade at some point in time, but inflation has had a noticeable impact on our cost structure in Europe since the COVID recovery. We must and will reverse this to regain our leading competitive position in Europe. Energy and labor are the 2 major areas where we target the classical structure by cost reduction plan. Additionally, in Stainless & Electrical, we refocus CapEx from mix improvement and growth to productivity and efficiency -- and energy efficiency to combat these tailwinds. The scope has been defined and implementation for specific measure has commenced. The associated there's EUR 50 million gains will be realized during 2024 and 2025.

I want to stress 3 things. First, the EUR 300 million normalized EBITDA improvement target to 2025 remains valid. We are in a good way to reach this goal. This initiative takes into account a changed economic environment and contribute to securing it. The growth programs for renewable level cycle along in Specialty and Services & Solutions are well on track and continue.

Second, the cost-cutting program will be reported within the Leadership Journey Phase 5, that starts in January. But what we present today is a supplementary program, a program to restore competitiveness in Europe. This came in addition to the normal EUR 50 million gains per annum that you know from our Leadership Journey. We will share more detail regarding Phase 5 with you in February when we will report Q4 results, but you know that targets, the aim for 2024 and 2025 will be EUR 75 million in both years.

Third, the source of these measures. As you know, we have been investing CapEx for our improvement in mix and flexibility in different European locations to prepare for Leadership Journey 5. These investments bring in newer, more productive equipment and allow us to run our production lines at a lower operating point and efficiently utilize the capacity across the cycle. Aperam is known for a flexible and resilient business model. You can trust us that we have a plan that makes this company profitable and cash generative, irrespective of the shape of recovery, be it V, U or L shaped.

Sud will now comment on the financials.

[Sudhakar Sivaji, executive]

Thank you, Tim, and a warm welcome to all of you. Shipments declined by 6% during Q3. It is normal that Q3 forms a seasonal trough. But this time, it compares to an already extremely low Q2 base. To put this into perspective, Q3 steel shipments are comparable to the COVID crisis trough, the weak industrial chain in Europe and further destocking are 2 reasons. As expressed by Tim, production issues in our Belgium upstream operations came on top. Without these, Q3 shipments would have been comparable to Q2. Lower demand was further reflected in lower realized prices. We also recorded a near triple-digit inventory valuation charge because nickel declined by 9% during the quarter and ferrochrome by another 12%. Additionally, we had to impair the buffer stocks that we built to safeguard the footprint upgrade in Europe and Brazil. Altogether, this resulted in the lowest EBITDA in our history.

We had no exceptions, no major financial items and a normal tax rate. Summing all the factors up resulted in a negative EPS and a negative operating cash flow. Investing cash flow was also a bit higher because it contains our contribution to the joint venture on M&A for the forest expansion in Brazil.

Inventory increased during the quarter due to the buffer stocks with the upgrade in Genk, but has started going down towards the end of the quarter. What we see in Q3 is purely a technical effect where the reduction of net working capital starts with payables reduction. This materializes as a reduction in net working capital in Q4 as the effect translates into inventories when we focus on releasing all volume-related inventory buildup by end of Q4.

Net financial debt is, therefore, temporarily elevated this quarter. But by the end of 2023, it should be at a comparable level to 2022. Our commitment is to maintaining net financial debt below EBITDA, over the cycle, and is now a clear part of our financial policy.

Moving to the next slide to the segment perspective. Recycling & Renewables, together with Brazil performed solidly, while onetime items and the European economic headwind are clearly visible in the other entities. EBITDA in Recycling & Renewables declined from a very high level in Q2. However, annualizing the EUR 17 million shows that Q3 was fully in line with the guidance we gave for a normalized earnings for this segment. Scrap volumes declined due to the low stainless steel production in Europe as customers destock, but pricing was solid and Bioenergia delivered a stable result.

Looking into Q4, we expect an EBITDA increase due to higher scrap volumes and some year-end effects. Stainless & Electrical adjusted EBITDA turned negative due to the high inventory valuation charge and the production disruptions in Europe. Brazil volumes were solid, but a steady outlook, but prices softened. Like-for-like, we expect 2023 to surpass all years before 2021 for Brazil. Please bear in mind that the energy has now reported in R&R. On a fully underlying basis without onetime effects, S&E's Q3 EBITDA would have been in line with other recessionary phases. We expect a higher EBITDA for Q4 due to higher volumes and less negative onetime effects, but the price/cost spread will remain unfavorable this quarter.

S&S is back in black mainly due to reduced price cost squeeze as we reduce inventory and having slightly better volumes. This is despite Q3 still being highly burdened by inventory valuation charges. We expect to hire and historically more normal Q4 EBITDA as onetime effects fade. Alloys & Specialties results look unfortunately so much worse than they really are. As we have disclosed in our Capital Markets Day in 2021, alloys have 4x to 6x a nickel content of regular stainless steel. And the rest also consists of other precious metals such as molybdenum and CoBi. What you actually see is the price decline on all these matters that already had a high impact on reported EBITDA in Q1.

On an underlying basis, A&S will have its best year ever by a wide margin. However, this is merely the reversal of the inventory valuation gains we've had in the segment over 2021 and 2022, albeit faster in a 5-month frame. The volume contraction was seasonal and will reverse in Q4, together with a fading inventory valuation charge, we project an EBITDA increase in Q4.

Others & Elimination was once again positive at EUR 5 million EBITDA due to intercompany elimination when sales price moved down faster than raw material costs. Because of corporate costs and intersegment profit elimination, a negative number is normal here, and we expect that to show in Q4.

Going to the next slide. Let's take a closer look at working capital and what caused the increase. Most of you take the end of 2020 as a starting point and ask yourself when the accumulated EUR 784 million net working capital addition in the cash flow statement will flow out again. There are 3 factors at play: raw material prices, value chain differentiation and footprint upgrade.

Let's start with raw material prices. Nickel averaged close to $16,000 during Q4 '20 and was 28% higher during Q3 '23. That is an obvious and big driver. However, all our products contain 18% ferrochrome, and that is also up by a third over that period. Furthermore, you're aware of how electricity and natural gas prices have evolved since the Russian war and Ukraine started. This is also an important driver for net working capital. The working capital investment that happened in 2021 is a good proxy for the price effect driven working capital addition. These input prices cannot be influenced by us, but account for more than 60% of Aperam's net working capital increase. This will flow back only once raw material prices reverse again.

The second component is the footprint upgrade. These investments are a key building block for the EUR 300 million like-for-like EBITDA improvement to 2025. They enable us to produce a better product mix and less commodity grades. The new AOD in Genk and the hot rolling mill upgrade in Châtelet and Brazil are examples of this. These big investments are like open art surgery and require buffer stocks to safeguard operations.

We said in the past that these buffer stocks will reverse in Q4 and this year, which allows us to reduce net working capital by about EUR 200 million. The remaining block is due to the differentiation of our value chain. We consolidated ELG at year-end 2021. And we target to grow our alloys business significantly. Both are key building blocks for reaching our 2025 improvement target. Both also have a structural impact on net working capital. ELG due to its different business model, FX ratios like net working capital to sales or rotation base as it is a trading entity. In real terms, business working capital is a fast-rotating pure trading stock, of which 71% is already sold in the next 8 weeks.

But our returns benchmark on this invested capital remains high. ELG contributes through the cycle EBITDA of EUR 55 million and adds EUR 24 million synergies. That's operating at a 16% ROCE. So it is a sound investment.

For alloys, we target historical EBITDA to double by 2025 as we follow an organic path. In alloys, you don't see it at the moment, but the underlying EBITDA is up by more than 40% this year, and our multiyear order book mix is confident to double A&S EBITDA by 2025. The growth is based on our unique in margarines, but we are also ramping up substantial project business with very attractive margins.

Back to Tim for the outlook.

[Timoteo Di Maulo, executive]

Thank you, Sud. The guidance is easy this time after hitting the bottom the only way is up. Our order book indicates slightly higher shipments. Q4 is a seasonally softer quarter in Brazil and in Europe, the economic environment remains challenging. Normally distribute or destock towards the year and to voice the balance sheet, and we see no reason why this year should be decent.

Regarding EBITDA, we have a less negative inventory valuation charge, but realized price will still decrease, which is a drag on one. Based on today's spot raw material price, I would say, EUR 50 million to EUR 60 million adjusted EBITDA. However, because there is still a lot of quarter left where raw material prices can move and impact the inventory valuation, we cannot give guidance, but only after a few raw material price have known.

Sud have already explained that the working capital release will drive Q4 cash flow. Yes, CapEx will be higher in Q4 to match our 2023 CapEx guidance, EUR 93 million remain to be invested. Nevertheless, we project net debt at the end of the year to be a similar level year-on-year. A solid and an efficient balance sheet is then a good base to start 2024. Let me make one remark on the dividend. We do have a progressive dividend policy, full stock. We have, therefore, slightly adjusted the financial policy to make this as clear as possible. We delivered somewhat confusing link between the dividend and net debt-to-EBITDA to leave no doubt that we are committed to following a progressive dividend.

Historic low quarter naturally raises question about the implication for our road map and what levels we have to steer up on back on the road of success. Our road show schedule provides you many opportunities for dialogue in Europe and in the U.S.

If you can make these events, then please feel free to contact Aperam Investor Relations directly to accommodate request for corporate access and your feedback is valuable to us. Please also note that we will hold the next Capital Market Day in Paris on 27th of February with an emphasis on Brazil, the Energia and decarbonization.

In conclusion, times are very tough, but we are convinced to have the right strategy and the right tactics to set the company back on the road of success. We shared with you the Leadership Journey Booster. Next quarter, we will share with you the whole Phase 5 program. There are a lot of high value, non-volatile business opportunity in our differentiated value chain that will surprise you carbon monoxide, [indiscernible] are just 3 of them.

We will learn more at our Capital Market Day in February in Paris. Let me clearly say that we are actively steering this company towards the 25% improvement at executing all projects linked to the Leadership Journey and when accounted for the one-off time effect, there is a clear progress. We can and we will must up this crisis by leveraging our strength, by ingenuity and rightsizing the business. We ask for your trust and invite you to be part of the journey. Thank you for listening to Aperam's Q3 management podcast. We will host a conference call today at 2:30 Continental European Time to answer your questions. Wish you a pleasant day and hope to see you again at the Q&A.