Ence Energia y Celulosa SA

MAD:ENC

Earnings Call Transcript 2018-Q1

[Operator]

Good afternoon ladies and gentlemen. Welcome the Ence first quarter 2018 results presentation. I now hand over to Mr. Ignacio de Colmenares, CEO, and Alfredo Avello, CFO. Gentlemen, please go ahead.

[Ignacio de Colmenares y Brunet, Vice]

Good afternoon ladies and gentlemen. Thank you for attending our first quarter 2018 results conference call. I am here today with our CFO, Alfredo Avello, and our head of IR, Alberto Valdes. After the presentation, we will answer any questions you may have. Let me start this presentation as usual with the main highlights of this quarter. First of all, I would like to reiterate our positive view on pulp prices. Once again, we are seeing strong prices in all markets, with pulp demand at very high levels. Inventories are very low across the supply chain, and no major capacity increases have been announced. Consequently, we have seen new price increases during April, up to $1,050 per tonne. Our view is that pulp prices will remain high for the rest of 2018 and for the next three years as well. We will see more price increases in 2018. Now let me summarize our financial results. During the quarter, EBITDA was 54% higher than in the first quarter of 2017. Net income was 115% higher. In the pulp business, EBITDA grew by 80% despite a cash cost increase. In the energy business, EBITDA was EUR 9 million for the quarter. Our guidance of EUR 55 million EBITDA is maintained. Operationally, this first quarter was challenging. Our pulp mill closed for its annual maintenance in Pontevedra. We completed the works needed to increase capacity by 30,000 tonnes. We will see production and sales increasing steadily until the end of the year. Our Navia mill suffered from a very rainy quarter which has impacted on the operating performance, producing less pulp than expected. This problem should diminish as the weather improves. The next steps towards fulfilling our strategic plan are to increase our pulp capacity in Pontevedra by another 40,000 tonnes during 2019; to increase our pulp capacity in Navia by 80,000 tonnes by April 2019 we will start with some of the works during the annual shutdown in two weeks’ time; to continue the good progress with the construction of our new 40 megawatt biomass power plant in Huelva; to look for more opportunities in the biomass energy sector like the one announced this morning, the new 50 megawatt biomass power plant in Puertollano to start in second half of 2019 as well. Finally, we have reduced net debt by EUR 28 million in the quarter. In March, we issued a EUR 160 million convertible bond, which will save us EUR 11 million in annual interest payments, and we paid a EUR 16 million complementary dividend to our shareholders this month. In slide 5, you can see the RISI forecast of pulp prices in March and the same estimates three months ago. The real pulp price has consistently exceeded these forecasts. We believe pulp prices will again exceed these forecasts due to the strong demand for pulp, the low levels of eucalyptus pulp producers' inventories, the price gap between hardwood and softwood, which is now above EUR 120.00 per tonne. No large capacity increases are confirmed. As a result, we will announce new price increases very soon. Let's now move to slide 6, where we show our estimates of supply and demand in the pulp market. As I have said over several quarters in the past, new capacity will not compensate for the impressive demand we are seeing now. Demand growth is reinforced by increasing environmental protection in China. The consolidation of the industry via M&A and leverage may also delay new capacity increases. We continue to see ongoing conversions to dissolving pulp, and there is a limited supply from Indonesian pulp mills. The industry is operating above 90% of its capacity, so unplanned production outages may happen. Let me remind you that any new project needs a lead time of 3 years and more than 300,000 hectares planted at least 7 years before starting. If you go now to slide number 7, you can see our results in more detail. Our revenues are explained by an increase of 29% in net pulp prices, a 5% reduction in volume sold compared to the same period last year, stability in the energy business with more production but lower pool prices. If we look now at our EBITDA, you can see an impressive 80% growth in the pulp business despite an increase in cash cost due to the higher wood and caustic soda prices and slightly lower production in our Navia mill, a seasonally lower EBITDA in the energy business of EUR 1.8 million. Therefore, we have increased our EPS by 118%, partially as a result of last year's share buyback. In slide 8, I would like to elaborate a bit more on the evolution of our cash cost. It increased around EUR 25.00 per tonne compared with the same period last year. We need to consider three main factors; increases in wood costs deriving from the linkage to pulp prices, caustic soda has more than doubled, we are working on modifying processes to reduce the use of caustic soda and consequently reduce cash cost in the future; the lower fixed cost dilution. Ence is clearly focused on reducing cash costs, and we will continue to do so in the future. At current pulp prices and at current caustic soda prices, and taking into account the impact of the wood costs and our strategic plan target, we believe that our cash cost should be around EUR 360.00 by the end of the year and EUR 368.00 as an average for the year. Let us move to slide 9 where we review the performance of our energy business. EBITDA decreased by 18% or EUR 1.8 million compared to the same period last year due to the seasonal characteristics of this business and the optimization of the 6,500 hour limit for this technology. We believe we will achieve our target of EUR 55 million EBITDA in 2018. We will continue our cost reduction strategy with a target of 70% of agroforestry byproducts in our biomass fuel mix. And we also keep a lookout for acquisitions, always at conservative prices, in line with our strategy of consolidating the biomass energy sector in Spain. Turning now to slide number 10, let me explain our cash flow generation. During the first quarter of 2018, normalized free cash flow reached EUR 27 million, a 50% increase. Our net debt reduced by EUR 27 million to EUR 125 million. This includes a EUR 15 million positive effect of the new convertible bond issue, matched by the reduction of EUR 15 million in factoring. Our leverage ratio stands now at 0.5 times our last 12 months EBITDA, clearly below our peer average ratio of 2.9 times. With these figures, we will easily achieve the targets of our strategic plan while maintaining very prudent leverage ratios and an attractive shareholder remuneration. And now in slide 11, let me review the next steps of our strategic plan in the pulp and energy businesses. Firstly, we added 30,000 tonnes at our Pontevedra mill. 40,000 tonnes will follow in early 2019 at Pontevedra as well. Secondly, at Navia, we will add 80,000 tonnes in April 2019. We have already started. In our energy business, the construction of our new biomass power plant in Huelva and Puertollano will be completed in the second half of 2019 with EUR 24 million of expected new EBITDA. And we keep looking for new opportunities to buy biomass power plants at attractive prices in Spain although, after the new project announced today, by second half 2019 we will above our 2020 strategic plan EBITDA target. Moving to slide number 12, may I say that we will maintain our attractive dividend policy for our shareholders. Our policy includes three dividend payments during the year to achieve a 50% payout ratio. We paid a complementary dividend of EUR 16 million in April to fulfill this policy, which will continue throughout the year. I will now invite Alfredo to review these figures in more detail.

[Alfredo Avello De La Pena, Chief Financial & Corporate Development Officer]

Thank you, Ignacio. Moving on to slide 14, let me start with the operating performance of our pulp business. Net pulp price grew by 29% during the period, driving our revenues up to around EUR 40 million from the EUR 115 million accounted in the same period last year, even though the volume sold was some 5% lower, mainly due to lower sales from inventories, which are at the record lows with just 26,000 tonnes at the end of the quarter. Let me underline that this figure includes not only the pulp in our warehouses, but also all the tonnage currently traveling to our clients. 7% cash cost increase is mainly due to the indexation of wood prices to pulp prices, as our CEO has just explained, together with rising caustic soda prices and lower fixed cost dilution on the back of lower sales volume. All together, rising pulp margins boosted EBITDA by 18%, up to EUR 54 million in the quarter. In the next slide following the P&L, our EBITDA margin grew up to 33% from the previous 21%, while depreciation and financial expenses were basically maintained. Only the tax figure was higher than the EUR 3.4 million accounted last year, for obvious reasons. After all this, net profit for the pulp business almost tripled the one achieved last year, up to EUR 28 million.Following with our pulp business cash flow generation in slide 16, the current free cash flow after maintenance CapEx, working capital changes, interest and taxes doubled up to EUR 23 million compared to EUR 11 million in the same period last year. Our working capital increased by EUR 29 million, although only EUR 14 million are directly related to higher receivables due to price increases. The remaining EUR 15 million are fully explained through lower nonrecourse factoring levels on our receivables due to the calendar effect of the Easter season bank holidays coinciding with the end of the quarter. This difference should ultimately be compensated in the next quarters. Other non-cash expenses positive adjustment is due to commercial rappels and the energy regulatory collar. Remember that the company adjusts its cogeneration and generation operations to the regulatory tariffs on a monthly basis. The EUR 8 million shown under expansion CapEx are mainly connected to the Pontevedra 30,000 tonne capacity expansion successfully executed during the first quarter, which will be ramping up until autumn this year.Asset divestments of EUR 1 million are related to the last positive price adjustment on 2017 land sales, leading the pulp business to a free cash flow after CapEx of over EUR 19 million. In slide 17, let me update you on our hedging program. Ence maintains its FX hedging policy with the only aim of mitigating currency volatility. We continue maintaining a zero cost curve structure strategy with the objective of hedging at least 50% of our expected revenues for the next months. These hedging structures are weekly monitored and timely adjusted, taking into account expected price increases. We have already secured an average cap of 1.16 for 50% of our expected pulp revenues for this year and an average of 1.26 for the first half of 2019. Turning to slide 18 and continuing with the balance sheet, pulp business net debt ended the quarter at EUR 98 million, representing a leverage ratio of just 0.5 times LTM EBITDA, well below our self-imposed limit of 2.5 times. However, gross debt of EUR 460 million and a cash position of EUR 362 million at the end of the quarter are just temporary, as we intend to early and voluntarily redeem during the second quarter the EUR 250 million bond issued in October 2015.After the launch of our convertible bond, we are now in the process of refinancing the EUR 90 million RCF linked to the still outstanding high yield through a new EUR 70 million RCF, extending its maturity to 2023, also on a non-maintenance covenant basis and its use for general corporate purposes. The combination of the EUR 160 million convertible bond and the new RCF will target a more efficient capital structure, reducing our financial cost by EUR 11 million and ensuring appropriate financing on the long term. Let me now brief you on the main terms of our recently issued convertible bond in slide 19. As you know, this item was EUR 460 million with an annual coupon of 125 basis points. The funds will be used to partially finance the early redemption of the EUR 250 million high yield bond with an annual coupon of 5 3/8% with the aim of saving an annual interest payment of EUR 11 million from 2019 onward. The remaining amount needed after the EUR 250 million will come from current cash available in our balance sheet, reducing our gross debt down to approximately EUR 210 million and our liquidity to approximately EUR 112 million, still maintaining nearly EUR 70 million as yet fully undrawn.As said, the early redemption of the high yield bond is expected for the second quarter once the new RCF will be finally closed and will result in a one-off interest expense of EUR 7 million related to the 244 basis point call option over the EUR 250 million high yield; EUR 5 million related to the remaining 2015 issuance costs already paid but deferred during the life of the high yield bond. Therefore this is a non-cash item. And also remaining interest to be paid until the call in November 2018 will be now paid for an amount of EUR 11 million. Just for your information, the issuance costs of the new convert bond were only EUR 2 million. That will be now paid but deferred in the 5 years of the bond life. After all these impacts, the present value of the annual savings achieved with this financing amount to a positive EUR 30 million. Regarding its accounting, the conversion split of the bond has been valued at EUR 15 million, while the debt part of it at the remaining EUR 145 million. All these accounting processes have been reviewed by our auditors in order to fully comply with IAS 32. Let's now change the focus to our energy business operating performance in page 20. Average selling price in the quarter was EUR 103.00 per megawatt hour due to the lower pulp prices, which are explained through higher hydro and wind power generation compared to the same period last year. The energy volume sold was 8% higher due to the new Cordoba 27 megawatt plant, which has been partially offset by the optimization of the annual production limit of 6,500 hours and some lower output at our Huelva 41 megawatt plant. In response to lower energy prices and in light of the annual regulated cap of 6,500 hours of operation, we have saved operating hours at our Huelva 50 megawatt and Merida 20 megawatt plants for the third and fourth quarters, with expected higher prices. Regarding Huelva 41 megawatt plant, we have already solved the underperformance of its boiler economizer during its annual maintenance shutdown in April. Finally, first quarter results were affected by one-off expenses at our Jaen 16 megawatt plant caused by the heavy rains. Environmental protection is one of Ence's top strategic priorities. With this aim, we decided to empty its liquid ponds and move its olive pulp inventories in order to prevent any pollution risk. All together, first Q 2018 EBITDA was lower by EUR 1.8 million compared to the same period last year. This figure should be reversed during the year, alongside the optimization of the annual production limit of 6,500 hours and further cost savings arising from our ongoing biomass diversification strategy. Therefore, we stick to our EBITDA target of EUR 55 million for the year. Following with our energy business P&L in slide 21, note that our EBITDA includes a EUR 1.1 million provision for the regulatory collar. Below the EBITDA line, year-on-year higher depreciation charges are mostly explained by the asset base increase after our last acquisition in Cordoba. The remaining concepts are all in line with our expectations. Taking everything into account, our energy business reported a net attributable profit of EUR 1.4 million in the quarter. Regarding its cash flow generation in slide 22, normalized free cash flow after maintenance CapEx, working capital changes, interest and taxes amounted to EUR 4.4 million. Other non-cash expenses for another EUR 3.7 million are mainly related to the set regulatory collar and quarterly provisions of certain unpaid annual expenses. These EUR 8 million have been just enough to self-finance the EUR 8 million investment paid in the quarter for the construction of the new 40 megawatt plant in Huelva. Moving now to slide 23, net depreciation for the energy business decreased down to EUR 27 million at the end of March, which implies a very low leverage of 0.6 times LTM EBITDA. Our cash position at the end of the period amounts up to EUR 117 million, which together with the EUR 53 million still undrawn from our new financing will allow us to comfortably confront the remaining EUR 67 million spending investment for the construction of Huelva 40 megawatt plant and for the equity contribution of the new Puertollano 50 megawatt plant. On top of that, let me remind you that we continue analyzing different alternatives to exceed our strategic plan EBITDA target of EUR 78 million by 2020, since under the current parameter and the two new plants under construction, this target has already been over met. May I please now return the lead of this presentation back to our CEO for the closing remarks?

[Ignacio de Colmenares y Brunet, Vice]

Thank you, Alfredo. I wish to conclude this presentation by emphasizing our view that pulp prices will remain strong, with a tight supply and demand balance which will exceed analysts' expectations. At current market conditions, we believe our 2018 EBITDA will be above EUR 300 million. We will maintain an attractive shareholder remuneration and a strong balance sheet that will allow us to complete our strategic plan. With the 150,000 tonnes increased capacity at our pulp mills during 2018 and 2019 and with the two new biomass power plants at Huelva and Puertollano starting in second half 2019, we will have executed at 100% our strategic plan 2016-2020 one year before expected. We will present you a new strategic plan in the autumn. Thank you, ladies and gentlemen. Now we are glad to answer any questions you may have.

[Operator]

[Operator Instructions]. The first question comes from Jose Rito from CaixaBank BPI.

[José Manuel Rito, Analyst]

So I will have three questions, the first one related with discounts, pulp discounts in the quarter. We had a decline year-on-year of 30 basis points in discounts. Is this the reference for the full year, or could discounts fall further throughout the year? So do you expect this 30 basis point decline on discounts to be a reference, or eventually do you think that eventually discounts could actually fall further throughout the year?The second question regarding the cash cost evolution. We had in the quarter a EUR 25.00 per tonne increase when compared with Q1 last year. Is this also a good reference of the full year? If you could provide some outline, I think that your previous guidance was around EUR 15.00 per tonne. So how do you think this should evolve over the coming quarters?And finally a question in terms of M&A. We have been seeing M&A in the industry, in the pulp industry. Could Ence also be involved, or because you have been more focused on energy eventually we could rule out that eventually you could take part of this M&A? Thank you.

[Ignacio de Colmenares y Brunet, Vice]

Thank you very much, Jose Rito from BPI. The first question, discounts. All our contracts have an average discount of 26% for 2018. As you know, in the industry it's normal that you invoice with the pulp price of one month before. And in any context, you also have the exchange rate of the dollar of one month before, which means that when prices are going up, if you compare actual price with the end of the month ForEx price, you always have a higher discount. That's the reason why we are not at 26%, because prices, as you know, have been increasing during the first quarter.Answering to your question, if prices would remain stable, we will have 26% discount in the following months. But as we see prices to still continue going up, we may have a bit higher discount because of these effects that we are invoicing always for 80% with the ForEx price of one month ago. Regarding your cash cost question, due to these high pulp prices, and you know that our wood contracts are in some ways linked to the pulp price, and because this dramatic caustic soda price increase all the industry is suffering, we see for the average of the year, as I said before, a price of around EUR 368.00, although I see very clearly that by the end of the year we will be closer to EUR 360.00. Then we see a second quarter very similar or a bit worse than the first quarter because we are stopping Navia. And it's our best factory, and the effect on the average is important. And we see two good quarters, third quarter and fourth quarter. Let's go to the M&A. Well, we made a strong effort separating both businesses, not only from the balance sheet but also from management. Then we are making efforts to increase our energy business, but we are doing the same in pulp. In pulp, because of the size of our balance sheet, we cannot go to EUR 1 billion in ventures. That's why we are pushing for organic growth, and that's why we have been analyzing small and medium opportunities both in Asia and Latin America in the last three years. Regarding [Luacell], we are there. We think it's going to be competitive, but we are going to be very cold in our decisions.

[Operator]

[Operator instructions.] The next question comes from Alberto Sanchez from Fidentiis.

[Alberto Sanchez]

I've got a couple of questions. The first one is if you could give us more color on the business opportunity that brings the biomass project that you announced today, given that the financial terms look a bit less appealing than the last acquisition that you made or the greenfield project in Huelva.And the second question would be related to the previous one on cash costs. What is the average pulp price that you are assuming to make that EUR 368.00 per tonne average cash cost for the full year? Many thanks.

[Ignacio de Colmenares y Brunet, Vice]

Thank you very much, Alberto. Well, we think Puertollano biomass power plant is a fantastic project. The IRR for the equity matches our strategic plan, a bit more than 9%. It will increase our EBITDA by EUR 30 million year by year.We have been working very hard over the last months thinking that four competitors who also win some megawatts on the auctions two years ago weren't going to be able to build their biomass power plants by being realists. That is why in August last year we signed an option with Elcogas to buy their assets. That is why we've been modifying all the environmental permits during the last months with success. That's why we've been analyzing all the biomass supply in the area, where it's plenty of inexpensive and very competitive fuel at a very low range area of the biomass power mill. And that's why we've been working with SENER, with the same company doing the construction, the EPC construction of Huelva, in order to have a solid concept. And this morning we signed all the contracts. We acquire the megawatts. We signed the EPC contract with SENER. And we bought the assets of Elcogas, and we are very happy. It's going to be EUR 13 million EBITDA per year on an area we know very well. We bought two years ago a biomass power plant at 50 kilometers of the area. It's plenty of biomass, which is important in our business. And we have no risk nor any doubt regarding the EPC contract with SENER, because it's going to be a twin biomass power plant on the one that has already started in Huelva. And this a bit more than 9% IRR on the equity is what we want, and it's what we are going to get. And we don't see any risk. I don't know why you were thinking that it's poorer business than other business we have done. And regarding our pulp price expectations for the cash cost I said to you, well, we are working with a model with stable pulp prices, with current pulp prices for both the wood cost and this over EUR 300 million EBITDA. That's one thing. On the other hand, we will put prices on anything we can. And regarding the electricity, we are working with prices for the balance of the year of EUR 51.00 megawatt. And you know that forward today for third and fourth quarter is at EUR 57.00 megawatt. Thank you, Alberto. Is that clear?

[Alberto Sanchez]

Yes. Many thanks.

[Ignacio de Colmenares y Brunet, Vice]

Thank you, Alberto. Any other questions?

[Operator]

The next question comes from Nuno Estacio from Haitong Bank.

[Nuno Estácio, Equity Research Analyst]

Just one question from me regarding the CapEx. So just to clarify, you are going to invest EUR 100 million in the improvement of the mills, plus the maintenance CapEx, which should be another EUR 20 million. And with Huelva and Puertollano, it would be another EUR 100 million. So total CapEx for the year could be around EUR 220 million. Is this correct? Thank you.

[Alfredo Avello De La Pena, Chief Financial & Corporate Development Officer]

Yes it is, absolutely.

[Nuno Estácio, Equity Research Analyst]

Okay, perfect. Thank you.

[Ignacio de Colmenares y Brunet, Vice]

Thank you. More questions, ladies and gentlemen?

[Operator]

We have one more question coming from Alvaro Mata from Trea.

[Alvaro Mata]

Just one question my side. You published the average exchange rate for the quarter at 1.23. But given that you had some hedging at maybe 1.16, 1.17 for 50% of the revenues, I was a bit surprised to see this 1.23. You can please explain that a bit more?

[Ignacio de Colmenares y Brunet, Vice]

Yes. What we do regarding our hedging strategy and what we report is -- maybe could be a little difference in the sense that, when we report the average cap and the average floor, this is the average of many positions that are taken. Am I asking your…

[Alfredo Avello De La Pena, Chief Financial & Corporate Development Officer]

Yes, I think that you misunderstood his question. Yes, 1.23 is the average of the dollar before our hedgings. Then when we say the price, the average exchange rate is before any derivative, any financial hedging.

[Alvaro Mata]

You cannot hear me, I guess.

[Alfredo Avello De La Pena, Chief Financial & Corporate Development Officer]

Yes, we hear you, and we get what you are saying.

[Alvaro Mata]

Can you hear me now?

[Ignacio de Colmenares y Brunet, Vice]

Would you ask your question again?

[Alvaro Mata]

Can you hear me now?

[Ignacio de Colmenares y Brunet, Vice]

Yes, we do now. Yes.

[Alvaro Mata]

Okay. I'm saying there's got to be benefit somewhere in the P&L, right?

[Alfredo Avello De La Pena, Chief Financial & Corporate Development Officer]

Yes, EUR 3 million, and it is on the line other revenues.

[Alvaro Mata]

In other revenues, okay.

[Ignacio de Colmenares y Brunet, Vice]

Other revenues, EUR 3 million. In our presentation of the results in Spanish, on slide number 3 you have on the second block, commercial. You can see [spoken in Spanish].

[Alvaro Mata]

Okay, thank you. I have the English one in front of me, but I'll take a look later.

[Ignacio de Colmenares y Brunet, Vice]

How is that in English? Because it may be interesting for everybody. Yes, in page number 9, other earnings report, EUR 3 million. That's the profit of those hedgings.

[Alvaro Mata]

Page number 9?

[Ignacio de Colmenares y Brunet, Vice]

Page number 9, the penultimate paragraph.

[Alfredo Avello De La Pena, Chief Financial & Corporate Development Officer]

Second last.

[Alvaro Mata]

Of the report, not the presentation?

[Alfredo Avello De La Pena, Chief Financial & Corporate Development Officer]

No, in the report, on the quarterly report.

[Alvaro Mata]

Report, okay. Fine.

[Ignacio de Colmenares y Brunet, Vice]

Yes, page number 9, paragraph 2.6.

[Alvaro Mata]

Okay, great. Thank you.

[Ignacio de Colmenares y Brunet, Vice]

Thank you very much for your question. Any other questions?

[Operator]

Ladies and gentlemen, there are no further questions in the conference call. I'll now give back the floor to Mr. Ignacio de Colmenares and Mr. Alfredo Avello. Thank you.

[Ignacio de Colmenares y Brunet, Vice]

Yes. Thank you very much. We will meet again in three months’ time with very good results. Thank you.