Elkem ASA

OSE:ELK

Earnings Call Transcript 2019-Q2

[Odd-Geir Lyngstad]

Hello, and a very good morning to all of you, both in the audience and also participating on webcast. It's a pleasure welcoming you to Elkem's second quarter results presentation. My name is Odd-Geir Lyngstad, I'm responsible for Investor Relations in Elkem. With me today, I have CEO, Helge Aasen; and CFO, Morten Viga, who will take us through today's agenda, which is a business update, financials and outlook for the third quarter. We will take questions after the presentation. So for those who participate in the webcast, there is a function there where you can post your questions. And with that, I'll leave the word you, Helge Aasen.

[Helge Aasen, Chief Executive Officer]

Yes, thank you, Odd-Geir. Good morning, everyone. Welcome to the second quarter presentation. So the second quarter has definitely been a turbulent quarter, with market condition quite heavily impacting Elkem's financial results. In general, we have seen weaker conditions in automotive and construction, in particular. We also had the additional U.S. tariffs on a number of goods from China, which triggered a rapid decline in the Chinese silicone market. We had a delayed startup after maintenance stopped at our chemical upstream facility in France, which had a negative impact of approximately NOK 185 million. And consequently, we had to issue a profit warning, as you know, because of the significantly weaker result than expected before the quarter was started. So that gave us a total operating income of close to NOK 5.9 billion, down 17% from a very strong quarter last year and EBITDA ended up at NOK 647 million, which is significantly down from the very strong market we saw last year of approximately 67%. And earnings per share then at NOK 0.25 for the quarter and NOK 1.09 year-to-date. A few words on the environment, social responsibility and governance. We have a 0 harm philosophy, and second quarter has been quite normal in -- with regard to safety performance. We are, if you look at the total number of incidents, quite close to the year-to-date result last year, almost equal. We've had 18 recordable injuries year-to-date and 2 of those are in the category of high severity. We have a number of projects ongoing to reduce the environmental impact of Elkem's operations. The construction of new, and so until now the largest energy recovery facility at our plant in Salten, has started. The furnace upgrades that have been planned now for 2 big furnaces, one at Bremanger and one in Salten, will give substantial reduction in NOx emissions. And we are continuously increasing our share of biocarbon as a reductant, replacing fossil coal in silicon and ferrosilicon processes. So we are currently ahead of our target of 20% biocarbon by 2020. That level was reached already last year. On the strategic priorities, we announced the construction of a pilot plant for synthetic graphite for anodes in batteries. This will be gradually ramped up towards the end of the year and beginning of next year and is expected to run around 2 years, with commercial production then planned for end 2021, beginning of 2022. We are strengthening our position in the U.S., including basic silicones or intermediates, to meet the growing demand in that market. Our foundry plant in Paraguay has reached a new milestone in Elkem, now on 100% biocarbon or coal char sourced from local sustainable plantations. It's also on 100% hydropower, and as a consequence of this is the facility in Elkem with the lowest CO2 footprint. We are still working on bolt-on acquisitions, 2 particular projects are ongoing, getting closer to a completion. We have our accelerated cost improvement program, where we have delivered NOK 148 million year-to-date and expect to realize the full potential of NOK 500 million by year-end. And our specialization focus is continuing, where we are focusing on moving the product portfolio towards higher-end and more stable markets and margins. A few words on the Americas. We are well positioned in the U.S., with the -- as a fully integrated producer. We are -- we have, over the last few years, gained market share in specialties in the U.S. market. We are also now expanding our offering of what we call basic silicones or intermediates to meet the growing demand in that market, and those feedstock materials are supplied from our facility in France, St. Fons, and in -- from Xinghuo in China. This is a quite large market, $4 billion, and expected to grow above 4% in the coming years. When we talk about further specialization, we are particularly looking at battery insulation and cabling, high-quality rubber for electrical vehicles. All other important areas, key growth areas are health care, medical and drug delivery devices, so a lot of silicones is used in containers and tubes for medical applications. Specialty products also include haircare and paper and film coating. The expanding electronic market requires adhesives, so on all your iPhones, you have a plastic -- or many people have plastic covering. It needs a silicone adhesive in order to stick it to the screen. And this is a very interesting and fast-growing market for us and iPhone is one application. You find the same in many others. In buildings, we supply sealant as well, joining glass, metal and stone. This is particularly to ensure an improved tightness towards water and improve the performance in general. On EV batteries, Elkem have 3 entry points. I mentioned the investment of NOK 65 million in our R&D facility in Kristiansand for a new pilot plant. So carbon graphite is a market where Elkem has a very good and long experience in producing graphite materials, so we're leveraging our know-how within high-temperature processes and material know-how in general. In silicones is where we have made or where we are at the more mature stage, already supplying silicone solutions for battery packs, both in EVs and energy storage. And we are working also on silicon as a component in anodes, battery anodes, in order to improve energy storage capacity and charging time. The battery market is growing fast, as I mentioned. Last year, revenues generated from this market represented about EUR 30 million for Elkem, and is expected to grow to EUR 50 million this year. So China is obviously a very interesting market in this respect with -- where we have the fastest-growing conversion of -- into electrical transportation. I mentioned the achievement year-to-date on operational improvements, we have initiated a program early this year in order to accelerate the improvement initiatives. The target is to realize NOK 500 million on EBITDA level by the end of the year. This is moving forward according to plan. We have realized NOK 148 million by the end of this quarter. Given the continued weak market sentiment moving into third quarter, we are also now looking at further measures on how we can reduce costs and implement even additional actions. So we will come back to that in our next presentation in terms of details. The market conditions impacting Elkem more are in the automotive and construction segments. If you look at global car sales and how that has developed year-to-date, the sharpest decline have been -- has been in China. The automotive segment consumes many silicone products. I mean, we talked about EVs. But in conventional cars, silicones is an important material used in gaskets, in hosing, in electrical cabling insulation. It's also impacting silicon consumption towards in aluminum alloys consumed by the automotive sector and ferrosilicon going into steel. So somewhat as a counter-effect is the faster growth in EVs, which is consuming more silicones than a conventional car, 3 to 4x more. Moving to construction, the construction market in China has been weak following slowdown in GDP, although we do see now some pick up in real estate triggered by local incentives and domestic incentives. In construction, we supply a lot of silicones in formal sealants and adhesives and coatings. In consumer goods and luxury linked products and agrochemicals, we have -- see less of an impact of this market downturn. Consumer goods represents about 30% of our total sales within silicones. The escalation of the U.S.-China trade war had an immediate and quite dramatic effect on the China silicones market, in particular, and the market basically came to a halt following the introduction of these tariffs in May. As we moved into June, demand started picking up again, but at significantly lower prices. We see that now having leveled off and there is some signals of a pickup. In construction, there's also a seasonal weakness in June, July due to the wet season. In Specialty products, we have a much more stable price development, but there are certain segments that are also here negatively impacted by lower demand. Looking a little bit beyond the short-term picture. We still believe that silicones is a robust market with an underlying, I would say, healthy supply/demand structure. In silicon, market prices declined further in the second quarter from already low levels. We are now at 2009 financial crisis prices. There are some positive signals from solar and electronics and also the chemical segment has become quite stable, but we see also an impact here from the U.S.-China trade tensions. What is more challenging is within -- or silicon to aluminum as an alloying agent where we see quite weak markets due to the slowdown in automotive in general. Ferrosilicon is also a market where we saw a continued price decline in the second quarter primarily impacted by lower steel production in the EU, which is our main market. There are indications of now lower imports coming from Brazil and Malaysia, and tendencies or, I would say, quite clear signals that the markets now are leveling off. But we do not expect any significant change in the near future due to relatively, I would say, low growth expectations moving into the second half. In carbon, more stable, niche-oriented market for Elkem. Volumes and prices have been quite stable. So I think, with that, I'll give the word to Morten Viga, who will take us through the financials.

[Morten Viga, Chief Financial Officer]

Thank you, Helge, and good morning, everybody. I will take you through the financial numbers, and we'll start with the group numbers. So total operating income for the quarter was NOK 5.9 billion, which was down from NOK 7.1 billion in Q2 last year. This is mainly explained by a significant reduction for the Silicones division, lower prices and lower volume, but also a reduction in silicon materials and in foundry products. EBITDA ended up at NOK 647 million, which represents an EBITDA margin of 11%. Excluding the one-off effects from Silicones France, the underlying EBITDA margin was 14%, but still, of course, significantly low compared to the record high level in Q2 last year. Also here, the big reduction in EBITDA coming from silicones, more than NOK 1 billion but also a reduction in silicon materials and foundry due to weaker market conditions. A look at the overall P&L, I'm just going to comment on a few topics. Other items, plus NOK 25 million. The main item here was a positive value change on a power contract of NOK 39 million. No cash impact. The net financial items are minus NOK 108 million; net interest expenses, NOK 54 million, in line with our guiding; and then there is also a currency loss of NOK 49 million on group receivables versus China. Noncash impact. The tax for the quarter was -- tax cost were NOK 58 million, which represents a tax rate of 28%. That is higher than the guiding primarily due to low profitability in China, where we have a low corporate income tax, and particularly in France, where we have a 0 or where we are not in a tax position. And the tax losses that we have had have not been capitalized in accordance with our conservative accounting treatment. So if we look at the silicones numbers, the operating income was NOK 2.8 billion. That was 28% down from last year, lower volumes and particularly lower prices, and EBITDA ended up at NOK 333 million, which was significantly down, 75%, compared to the record high level last year. And as Helge said, main reason for this, the sharp decline in prices in China during the quarter and, of course, also the production problems and the maintenance stops that we saw in France. Silicon materials had operating income of NOK 1.6 billion, that was down 8% versus last year. EBITDA ended up at NOK 162 million, representing EBITDA margin of 10%, which of course was also significantly down versus last year. The reduction in EBITDA is mainly explained by lower sales prices, lower market reference prices but also somewhat lower sales volume. We have seen, so far, particularly at the beginning of the year, high raw material prices. We now see that also raw material prices are coming down but with limited impact in second quarter, but we expect that the impact from this will increase in the third and the fourth quarter. We have been -- we're now running with a reduced capacity utilization, taking out the Bremanger Silgrain plant, which produces specialized Silgrain, a powder silicon for polysilicon, to adjust to the market situation. Foundry products ended up with total operating income of almost NOK 1.2 billion. That is 8% down from last year. The EBITDA was very low, NOK 81 million, which represented an EBITDA margin for the quarter of 7%. And this was significantly down versus the EBITDA margin last year of 20%. We have seen particularly 2 factors. First of all, a sharp or a steady decline in ferrosilicon prices, so we're now back to financial crisis prices from 2009. Prices for foundry alloys have been holding up very well, but we see a significant volume reduction due to the weakness in automotive and also probably due to destocking before summer vacation in Europe. In order to adjust to the market situation, we have idled 1 furnace, 1 out of 3 furnaces in Iceland from mid-June. On raw material prices, we see the same pattern here, limited cost reductions so far, but expect to see more reductions in the quarters to come. Foundry, the smallest of the divisions plus the most stable in terms of earnings. Here, we have seen operating income of NOK 481 million. That is an increase of 8% compared to last year. And the EBITDA was NOK 86 million, which was 18% higher nominal value than last year, but the same stable EBITDA margin. And pretty stable sales volumes and also stable prices and stable margins. The earnings per share for the quarter was NOK 0.25 per share, and the earnings year-to-date is NOK 1.09 per share. We have a strong balance sheet. The equity amounts to NOK 12.6 billion, and we have an equity ratio of 44%. It's somewhat down from -- or the equity is somewhat down from the end of 2018, mainly due to the dividend of NOK 1.5 billion. We also have a low leverage despite lower EBITDA. Our net interest-bearing debt is NOK 5.1 billion as per end of June. That is an increase of NOK 1.8 billion from the beginning of the year, also mainly due to the dividend. And the leverage ratio was, at the end of Q2, 1.3. We still have a very good and solid debt financing with a robust maturity profile. The short-term maturities are mainly related to local Chinese loans, where we are in the middle of a refinancing process. We had a relatively good cash flow, a good cash conversion in Q2, so the cash flow from operations was NOK 645 million. This was supported by a further improvement in working capital. And here, we also now extended our nonrecourse factoring schemes and increased that by NOK 250 million. So now, we have approximately NOK 750 million in place of corporate factoring schemes. The investments for the quarter were according to plan, NOK 479 million; reinvestments, NOK 300 million, that corresponds to 87% of depreciation, that's in line with our financial targets; while strategic investments were NOK 179 million. It's primarily related to silicones specialization and primarily in China. But we're also doing some improvements in silicon materials and also expansion projects in carbon. So Helge, please take us through the outlook.

[Helge Aasen, Chief Executive Officer]

So we do not expect any significant change or improvement in market conditions. There's still quite a lot of uncertainty. Going forward, although prices on, let's say, commodity products have leveled off, and we see some signs of pick up on silicones, for instance, in China, silicon metal demand is expected to remain weak primarily as a result of lower demand in aluminum. Also here, signs of recovery, but with a modest impact going into the third quarter. Same with ferrosilicon, demand expected to remain on a weak level. Foundry alloy prices are stable, but also here, demand is impacted by the automotive sector, in particular. In carbon, we expect a more stable development going forward, although we see some weakening of demand for one of their products, electrode-based, which goes into ferroalloy production. The accelerated improvement program is expected to develop according to plan. And as I indicated, we are also now looking at further measures, which we will come back to, in order to mitigate and counter weak market conditions. So on this basis, we are a bit cautious around guiding in third quarter, and we expect the results to be in line with the second quarter. And keep in mind that with the quite turbulent changes in the second quarter, the average sales prices in Elkem are then, as a consequence, going to be on a lower level in Q3 than in Q2, but with a more stable situation. So I think that concludes the presentation. We are ready for questions.

[Odd-Geir Lyngstad]

Okay. Thank you, Helge and Morten. We will now open for questions. And first, we take the questions from the audience.

[Hans-Erik Jacobsen]

Hans-Erik Jacobsen, Nordea. We have seen prices for silicons starting to pick up somewhat in China. Is that mainly due to seasonal effects? Or have you seen the capacity utilization coming down? Is demand improving? Or what can we read from the increase?

[Helge Aasen, Chief Executive Officer]

We definitely saw a stock or inventory buildup in May, immediately following the new tariffs. That has not continued, so there are signs -- or there are some production adjustments taking place, which is supporting somewhat higher price. So I think that's the main -- and also demand because of, let's say, destocking and the immediate, let's -- I will almost call it a psychological effect following the implementation of tariffs is done over, and we see a pick up in demand. So -- but any significant price increase, I would be -- yes, I'm not expecting that to happen.

[Hans-Erik Jacobsen]

And within carbon, both the sales and margins continue to hold up very well compared to other 3 divisions and declines are broadly the same going into the melting industry. Why is it that this division is able to show -- so strong results when everything else is easing quite significantly?

[Helge Aasen, Chief Executive Officer]

There's a countercyclical impact in carbon because we supply quite a lot of lining materials. And typically, when the markets move into a downturn, you will see increased relining, so that goes both for aluminum and ferroalloy, so that's part of the explanation.

[Andreas Bertheussen, Equity Research Analyst]

Andreas Bertheussen, Kepler Cheuvreux. So first of all, on the cost program, just sort of a housekeeping question, is it fair to assume that the rest of the program will be sort of divided in 2 for the second half? Or will it be back-end loaded?

[Helge Aasen, Chief Executive Officer]

I didn't get the whole question.

[Andreas Bertheussen, Equity Research Analyst]

So the cost program, there's NOK 148 million, the remaining portion, can we expect this to be divided equally between the 2 remaining quarters? Or it will be back-end loaded of some sorts?

[Helge Aasen, Chief Executive Officer]

Morten?

[Morten Viga, Chief Financial Officer]

No. I think you can see a gradual increase, so a somewhat increase in Q3 versus Q2, and then a further increase in Q4. But the key thing is that we expect to reach the NOK 500 million total impact, and we're working on more actions.

[Andreas Bertheussen, Equity Research Analyst]

Great. Second question. On the cost position in China on silicones, we are seeing, of course, very weak prices recently with some recovery. But even at rough levels of prices this year, we didn't see too much capacity coming down from your competitors. Have this changed your view on Elkem's cost position in China versus competitors?

[Helge Aasen, Chief Executive Officer]

No, I wouldn't say so. I think underlying demand is still quite good. And as we commented upon earlier, the supply/demand situation in silicones is quite well balanced. But destocking combined with at least an immediate impact after a significant increase in tariffs had a big effect, but we see that now as a -- yes, the impact of that is now gradually disappearing.

[Andreas Bertheussen, Equity Research Analyst]

Can we expect it to run at 100% utilization into Q3 in silicones in China?

[Helge Aasen, Chief Executive Officer]

I think we will expect somewhat reduced capacity utilization going into now in third quarter. And then we'll see how things develop.

[Andreas Bertheussen, Equity Research Analyst]

And final question. You referred to the automotive sector as one of the key drivers on top of the trade war to the current weakness. And are you seeing any catalysts that might bring the automotive space back? Can you add some color on this?

[Helge Aasen, Chief Executive Officer]

I think consumer confidence is an important part of this, combined with the slowdown in GDP growth. So when that will turn, I'm not going to speculate for the moment. Any additional comments from you, Morten?

[Morten Viga, Chief Financial Officer]

No. I think we have seen a recovery in automotive in June. Whether it's going to last or not, I think it's too early to say.

[Morten Normann, Analyst of Materials]

Morten Normann, Carnegie. A follow-up on the NOK 148 million. You said that the effect was at the end of the second quarter. But what was the specific effect in Q2 alone? And the second question is the NOK 185 million in France. You mentioned that there was a negative result. Could You also give us how much the EBITDA was in France isolated in Q2?

[Morten Viga, Chief Financial Officer]

Let me start with the first question. We have reported NOK 148 million year-to-date in EBITDA improvement, and the major part of that was in Q2, approximately 2/3. The NOK 185 million is the calculated EBITDA impact in France. It covers, let's say, the maintenance stop as such, and it covers the delayed start-up and lost production and lost sales.

[Morten Normann, Analyst of Materials]

I think you mentioned that you had a negative result in France due to that. But how is the EBITDA in France?

[Morten Viga, Chief Financial Officer]

Yes. We have -- we need to stick to the reporting structure where we, let's say, report an EBITDA for the silicones division as such. So we cannot give specific numbers on the France EBITDA, but it goes without saying that it was very weak.

[Odd-Geir Lyngstad]

Then we continue with some questions that we have received on the Web -- from the webcast. First, let's start with some questions from Charlie Webb. First question, given the [indiscernible] that you see your headwind, although NOK 185 million in third quarter, doesn't the third quarter guidance for flat quarter-on-quarter seem a bit cautious?

[Helge Aasen, Chief Executive Officer]

I agree to that. It's a bit cautious, but it's also, I think, quite a lot of uncertainty on how things will develop. So the combination of that is the result of the -- gives the guiding.

[Morten Viga, Chief Financial Officer]

Yes. I think it really reflects 3 elements. Clearly a negative impact from lower sales prices, average sales prices, and we know that's going to happen because of the time lag. And then there is a positive impact, of course, that we will not repeat, the one-off impact from France. And then there will also be more positive impact from the improvement programs. And in total, we have then guided this to be neutral on an EBITDA basis.

[Odd-Geir Lyngstad]

Second question from Charlie Webb. What do you estimate the impact will be from the Bremanger furnace upgrade in third quarter?

[Morten Viga, Chief Financial Officer]

It's quite limited. We have, for a long time, planned with the idle of the furnace. As such, we are extending the maintenance stop for the downstream silicone implant. But the financial consequence of this is rather limited.

[Odd-Geir Lyngstad]

And we continue with the third question from Charlie. What portion of receivables are now affected? What is Elkem's cost of factoring?

[Morten Viga, Chief Financial Officer]

As I said, we have approximately NOK 750 million of receivables covered by factory. We're working on increasing that because it's a very attractive scheme. The cost of factoring is quite low, and of course compared to our alternative cost, our WACC is extremely low. So we would like to take more factory, but we need to find the right solutions.

[Odd-Geir Lyngstad]

Then a question from Thomas Wrigglesworth in Citibank. What is the update on the receivable return? What impact we can expect in third quarter from returning tons and profit?

[Morten Viga, Chief Financial Officer]

We are now ramping up the Roussillon plant, and we are, let's say, back to normal production. There was a reduced capacity utilization towards the -- or in the beginning of July. But for Q3 in total, the financial impact should be limited.

[Odd-Geir Lyngstad]

We have a question from [indiscernible]. Has Elkem looked at other ways to improve earnings if the trade war should escalate or drag out in time?

[Helge Aasen, Chief Executive Officer]

Yes. We have now taken an initiative to look at additional measures. It's a bit early to comment on that in detail, but the expected program will go on and then we're looking at other structural opportunities.

[Odd-Geir Lyngstad]

Then we have questions from Truls Engene in SEB and also Eivind Veddeng in DNB, more related to China and development in Chinese demand and supply. Truls Engene, SEB, could you please elaborate on curtailments, capacity utilization and inventory situation for commodity silicones in China following the recent price drop?

[Helge Aasen, Chief Executive Officer]

You want to go with that one?

[Morten Viga, Chief Financial Officer]

I can do that. We believe that the inventories for the time being are around 50,000 tons, still at a very moderate level. We believe that there is -- or we know that there is a reduced capacity utilization. Some of the producers clearly have a problem in covering their marginal cost while also other producers take responsibility and cut production in order to help restoring market balance.

[Odd-Geir Lyngstad]

And then we have a question from Eivind Veddeng in DNB asking for the more long-term part. What is the status of capacity expansions in the Chinese silicone industry?

[Helge Aasen, Chief Executive Officer]

What we know is that there are between 300,000 and 400,000 tons of capacity being planned. Nothing will come on stream until 2021. Clearly, we have seen higher announcements previously, so I think it's a clear indication that some of the players have put their plans on hold for the time being. I think, with this expansion, we should still -- I think we can still expect a balanced supply/demand situation given the underlying market growth.

[Odd-Geir Lyngstad]

And the second question from Eivind Veddeng. Where is pricing of silicon and ferrosilicon on the cost curve, that means how many percentage of production is losing money in Europe currently? Any curtailments happening?

[Morten Viga, Chief Financial Officer]

Yes. We clearly see that competitors are taking out capacity, and we believe that some producers clearly have a problem covering their costs. I would not be too specific in talking about competitors, but that is a natural behavior that you take out capacity when you're not able to cover the costs. So that as such should get support for at least a stabilization and, hopefully, a recovery in prices.

[Odd-Geir Lyngstad]

And then we have a question from [ Laura Pineda ] asking, you mentioned that you expect some volume weakness in the silicones specialties market. Where do you expect this to come from? And in what regions?

[Helge Aasen, Chief Executive Officer]

I think, again, where we see some drop in demand is mainly linked to automotive. And construction are typically around supply specialties, but in automotive, we do see that.

[Odd-Geir Lyngstad]

That is so far the last question also on the webcast. I don't know if there are any additional questions in the audience. If not, I think that concludes the second quarter presentation, and thank you very much, both to you and the audience and for those participating in the webcast. Thank you very much.

[Helge Aasen, Chief Executive Officer]

Thank you.