Elkem ASA

OSE:ELK

Earnings Call Transcript 2023-Q2

[Odd-Geir Lyngstad, executive]

Good morning. My name is Odd-Geir Lyngstad, I'm responsible for Investor Relations in Elkem. I have the pleasure welcoming you to Elkem's second quarter results presentation. With me today, I have, as usual, CEO, Helge Aasen; and CFO, Morten Viga. Helge Aasen will take us through the business update and the outlook for the third quarter and CFO, Morten Viga, will present the financials for the second quarter. We will open for questions after Helge and Morten presentations.

And with that, I hand over to CEO, Helge Aasen.

[Helge Aasen, executive]

Thank you, Odd-Geir, and -- good morning. Welcome -- it's a pleasure to present Elkem's results for the second quarter. We reported revenues of more than NOK 9 billion in the quarter with an EBITDA result of just above NOK 1 billion. As mentioned during the first quarter presentation in April, we decided to move forward planned maintenance work at 2 of the Norwegian plants. And we've also had a scheduled maintenance stop at the main silicones plant in China. These stops have impacted the financial results in the quarter.

And in addition, we've had to write down inventories in silicones due to declining market prices for finished goods and raw materials. So the combined impact of these maintenance stops and the write-down was approximately NOK 250 million. Silicon products and carbon continued to deliver strong results. And this is based on their superior cost and market positions.

So on this basis, combined with completed maintenance work and other growth investments, we believe that the company is in a very good position to take advantage of the markets when they recover. In the second quarter, we also completed an acquisition, a company named VUM. It's a slow back producer of carbon materials. This will further increase our capacity and market presence in the carbon area, where we have delivered excellent results over the past quarters.

Over to ESG, it is a key priority in Elkem. We have continuously stepped up our efforts in this area. And it's also being recognized by leading ESG rating agencies. Elkem as a gold rating from EcoVadis and we were awarded A- both on climate and forest by CDP in 2022. Safety is always on top of our agenda. And we are very happy to see that the injury rate is now gradually coming down to pre-COVID levels. We are in the process of rolling out the new EHS system to revitalize and strengthen this work, and we are very happy to see that this is now starting to yield improvements.

Green leadership is a key strategic goal for us. And for Elkem, it means to take a leading position on reducing CO2 emissions and also grow our sales of products into markets where our materials are vital for the green transition. In 2022, we reduced CO2 emissions by or product carbon footprint to be precise by 7%. We're also working on solutions for circular economy and recycling. And recently, as part of our open innovation initiatives together with researchers from CNRS University of Lyon. We have demonstrated the feasibility of an efficient chemical recycling of silicones. This has the potential to reduce carbon footprint with as much as 70%.

In the second quarter, we have also entered into a partnership for industrial climate solutions with Norway-based Environmental Foundation, zero. So we're very happy to continue the work with them.

Moving on to strategy. We have shown this slide before. We like to call it, dual-play growth and green leadership. The ambition is to improve and grow our positions to become a top 3 player globally in silicones and to take a #1 position in silicon-based materials and carbon in the Western world. To achieve these goals, we target a balanced growth in all divisions throughout the value chain, upstream and downstream and also geographically.

Dual Play comes from the fact that we operate fully independent, integrated value chains, both in the East and in the West. And we think this has proven to be a very robust business model in volatile markets and with increased geopolitical tensions. So we will continue to build on this dual structure, in order to limit our exposure to trade barriers and logistics challenges. The target is to grow by revenue by more than 5% per year and deliver an EBITDA margin of at least 15% per year.

As already mentioned, green leadership is an important part of the strategy. And we will now go into some more details on the strategic projects that Elkem is working on to deliver on this strategy. As mentioned, we have entered into an agreement to acquire VUM, a Slovak producer of carbon-based material. This company produces carbon materials to the metallurgical industry, including anode paste, electrode paste and a product called recarburizers for the foundry industry. The transaction will increase our capacity and competence in some very attractive specialty markets as well as increased flexibility in the carbon supply chain.

The acquisition is expected to increase annual sales by around NOK 360 million. And we expect to capture synergies within production, raw material supply and technology. So once this is fully integrated, we expect that the acquisition will deliver margins in line with the current performance in Carbon Solutions. So I think this is a very good example, spot on with regard to our dual play strategy with focus on diversified geographical growth across the value chain.

Another example is how we are working on cost improvements. The accelerated maintenance and improvement projects at the Thamshavn and Rana plants in Norway have now been successfully completed, and both plants have restarted production. As mentioned, we believe that these plans now are in a very good position for high capacity utilization when markets improve again. The picture is from a new state-of-the-art control room at our Bremanger facility in Norway. This was opened in the second quarter, and -- it illustrates our good position now for increased level of automation and utilizing digital solutions.

In silicones, we also have a number of digitalization initiatives under implementation, supported by artificial intelligence. In France, for example, we are working with 5 partners now to develop a complete digital chain from online process analysis, process control through prediction and optimization algorithms. The solution will be implemented in a specialty silicon manufacturing workshop in [indiscernible] just outside Leo as the first location.

Here is a summary of various ongoing growth and specialization projects. Several of these projects are addressing markets with higher entry barriers and high margin potential. We are focusing on building on already strong market positions. And in silicon and carbon materials, this is towards steel and ferro alloys, for instance. In silicones, targeting markets like health care, consumer goods, packaging, transportation and construction to mention some.

An important KPI in silicones is products developed during the last 5 years. And in 2022, 25% of sales were represented by this products. And that is a very important indicator, we think, to show our commitment and ability to develop and new and innovative products.

At the bottom of the page, you can see ongoing projects that will deliver top line growth, improve our cost position and enable upstream quality improvements, very much to support our specialization strategy. Our biggest project is the upstream expansion in silicones in China, which is expected to significantly improve both productivity and cost position.

In France, we are expanding silicones capacity with approximately 25%. Also, here to improve cost position and support further growth in specialty products in the European and U.S. markets. As announced earlier this year, we are also now expanding our production capacity of Pitch binder in Brazil. And here, we are targeting our existing customer base in primary aluminum.

And lastly, the Vum acquisition, as I've already talked about. So moving on to markets. The market for silicones is weak and also expected to be challenging going forward. This is mainly due to a slowdown in economic growth affecting key end markets combined with structural overcapacity in China. So we are trying to mitigate this as much as possible through systematic improvement work, and we're doing this along several dimensions.

We're focusing on fixed cost reductions, capacity optimization, which means running the production lines we are running at full capacity, increased waste recycling and also selected downstream initiatives. In addition, we are looking at cost improvements on CapEx projects and postponing projects that do not support immediate cost reductions. Weak results are mainly explained by challenging market condition as demand for silicones is closely correlated with GDP development.

But I think despite this challenging conditions, all these efforts are definitely going to ensure that Elkem is even better positioned longer term with our global market presence. And our diversified research and innovation capabilities. This slide is an illustration of the development in construction and automotive, 2 of the key markets actually for all of Elkem. The top graph is from China's National Bureau of Statistics and show new construction areas.

And as you can see, this has been on a declining trend since 2021. Also construction outside of China is weak. The numbers from Oxford Statistics show that Americas and Europe are in a decline. Light vehicle production is showing a modest growth, but with clear regional differences, and it shows a decline in China. It's coming from low levels. Automotive has still not recovered to pre-COVID levels, but we see some positive signs in some markets. As mentioned, silicones markets are weak, impacted by low demand and declining prices.

The demand for specialties in the EU and the U.S. is impacted by destocking and weak macroeconomic sentiment. This gives negative volume mix effects for us as high-margin segments partially are replaced by lower-margin commodities. The Chinese silicones industry is impacted by significant overcapacity combined with low demand from construction and other commodity markets. And the overall result of this is high inventory levels and continued price pressure, here illustrated by the DMC price, which has fallen to the lowest level since 2016. I would also like to add that commodity prices in China, although exports are reduced, are putting pressure on Western world markets.

Then over to silicon and ferrosilicon, also here, market demand is weak globally, impacted by the same lower economic activity and destocking resulting in downward price pressure. However, we do have reasons to believe that this is now bottoming out? Producers of silicon in China have now started reducing capacity. And one of the leading players in the industry have announced just last week that they are now reducing production by 1,000 tonnes of silicon per day, representing 25% to 30% of their available capacity.

So we think this is a clear signal that we could see an improvement, the question is when. The demand for carbon products varies by region and is driven primarily by steel, ferroalloys and aluminum. There are no reference market prices for carbon products and most producers are regionally based. Global steel production in the second quarter this year was estimated up 4% versus first quarter. And production was up 5% in both Europe and North America in the same period, while China increased by around 3%.

But weak demand of carbon products persisted during the second quarter despite this modest recovery in steel markets. Elkem's global position and diversified product portfolio is providing still good stability due to these regional market differences. Raw material costs are stable, but remain at relatively high levels.

So this sums up my update, and I'll -- with this, give the word to our CFO, Morten Viga, who will take us through the financials.

[Morten Viga, executive]

Thank you very much, Helge, and good morning, everybody. So it is a pleasure to present what we consider to be overall good results in what I would characterize as very challenging markets. Silicon products and Carbon Solutions, they do continue to deliver strong results, while silicones clearly had another weak quarter. The results for silicones was negatively impacted by maintenance stops in China and inventory write-down as mentioned by Helge.

Also, silicon products was impacted by maintenance stops, but still delivered strong results in the second quarter. Total operating income in the second quarter was above NOK 9.3 billion, which was down from Q2 '22 due to lower market prices and lower sales volumes in silicones and silicon products. The reported EBITDA was approximately NOK 1 billion, giving an EBITDA margin of 11% for the quarter. And as I said, this includes one-off effects amounting to NOK 250 million.

So the underlying EBITDA was approximately NOK 1.3 billion, representing an underlying EBITDA margin of 14%. As you can see, the results are mainly impacted by weaker markets for silicones and silicon products compared to last year, while Carbon Solutions delivers an increased EBITDA despite very weak market. And I think this is another proof of the very solid business model of carbon solutions.

On this slide, we have, as always, included the main financial numbers and financial ratios. I will not go into detail on all of them, but mentioned some main numbers. As mentioned, the EBITDA in Q2 was NOK 1 billion and NOK 39 million, giving an EBITDA margin of 11%. The EBITDA include losses of NOK 119 million on our currency hedging program, and this is reported in the other segment.

Other items were positive with NOK 37 million, which was quite much down from the previous quarter, and this is also negatively impacting the earnings per share for the quarter. We had nonrealized losses on power and currency derivatives of NOK 86 million, but this was offset by currency gains on working capital items of plus NOK 129 million. The net finance income was minus NOK 182 million for the quarter compared to a gain in Q2 last year.

And this is mainly due to a currency loss of NOK 53 million compared to a gain of NOK 71 million in Q2 last year. Net interest expenses have increased due to the recent interest rate hikes and amounted to NOK 124 million for the quarter. Tax costs were very high for the quarter amounted to NOK 193 million, and this equals a very high efficient tax rate of 76%. This high tax rate is explained by the low results in France and China in silicones, where the losses are not capitalized as deferred tax assets.

Let's then have a look at the divisional results, and let's start with silicon, the silicones division, where we had weak results. Total operating income amounted to NOK [ 3,054,000,000 ] for the quarter, which was down 34% and compared to the second quarter last year. This reduction is mainly explained by lower -- significantly lower sales prices and also lower sales volumes, particularly related to the Xinghuo maintenance stop.

The EBITDA was minus NOK 374 million, which obviously is not a satisfactory number. However, the weak EBITDA is mainly explained by lower sales prices and lower volumes, reflecting the very challenging market conditions. And as I said, in addition, the result was also negatively impacted by maintenance stop in China, amounting to approximately NOK 100 million and inventory write-down of NOK 70 million. So the underlying EBITDA was more around minus NOK 200 million.

Sales volumes were low this quarter, explained by a weak demand, but also the significant reduction that we've had in production related to the Xinghuo maintenance stop.

Let's then move to the silicon products division, which delivered strong results. Total operating income amounted to [ NOK 4,941 million ] in the second quarter and that was down 24% compared to the same quarter last year. The reduction in operating income is mainly explained by lower sales prices, but also lower sales volumes. The reported EBITDA amounted to [indiscernible] in the quarter, which represents an EBITDA margin of 23%. Lower EBITDA this year compared to last year is mainly explained by lower sales prices and lower volumes. But as we mentioned, the EBITDA was also negatively impacted by the accelerated maintenance, which we carried out at our Thamshavn and Rana plants. And this had an estimated impact of NOK 80 million minus for the quarter.

As you have seen, the prices for silicon and ferrosilicon, our main products have been declining. But these negative price and also negative volume effects have to some extent being mitigated by strong performance in our specialty segments, particularly in our foundry alloys business, but also in our Materials business, and also by a lower raw material costs, where we now see a declining trend. Sales volumes are, as I said, down partly due to weak demand, but also due to destocking effects, which, by nature, are temporary. The Carbon Solution division continued to deliver very strong results despite weak market conditions.

And total operating income for the quarter was NOK 1,162 million. which was an all-time high number for the division, and it was up 28% compared to the same quarter last year. The all-time high operating income is explained by higher sales prices and also inclusion of the newly acquired plant in Slovakia, although the financial impact from this plant is so far limited. EBITDA was NOK 354 million, up 32% from second quarter last year.

And this represents an EBITDA margin of 30%, which is a very good number considering the challenging market conditions. The strong EBITDA is mainly explained by good sales prices and also a favorable mix. As mentioned, our geographical positions and diversified product portfolio is also providing a very good stability in our sales. However, I should also say that higher sales prices are also partly countered by higher raw material costs. Sales volumes are somewhat lower this quarter compared to last year due to, as I said, challenging market conditions.

We will then look at some of Elkem's key financial ratios. The EPS was quite much down this quarter compared to previous quarter and amounted to only NOK 0.06 per share, while the year-to-date earnings per share is NOK 1.56 per share. The balance sheet is rock solid, and total equity amounted to NOK 26.1 billion as per the end of the quarter, and this gives an equity ratio of 50%. The equity ratio has been reduced from 53% as per end of Q1.

And this is explained by the dividend payment of NOK 3.8 billion in May. Our financing position remains very solid despite higher debt levels and a higher leverage compared to previous quarters. Net interest-bearing debt has increased to NOK 8.2 billion, and that is an increase from NOK 3.7 billion as per end of Q1. And as I said, the increase is mainly explained by the generous dividend payment of NOK 3.8 billion, which was made in May.

Based on last 12 months EBITDA, this gives a debt leverage ratio of 1.1. In 2022, the leverage ratio was clearly below target due to a combination of low interest-bearing debt and also very high EBITDA. A leverage of 1.1 is as such, more in line with Elkem's long-term targets where we have said that we want to have a leverage ratio through the cycle between 1 to 2x last 12 months EBITDA.

Going forward, I think it's reasonable to expect a somewhat higher leverage compared to the current level as the EBITDA is expected to be at a lower level compared to the very high level that we saw in 2022. Our debt maturity profile is very solid with low installments over the next couple of years following the significant refinancing schemes that we've had earlier this year. The maturities this year consist of predominantly working capital financing items in China which is regularly rolled over without any significant refinancing risk.

Cash flow from operations amounted to NOK 670 million plus in the quarter. This is in line with the first quarter, but of course, it's lower than the strong levels that we saw in 2022. Just to remind you, our definition of cash flow from operations include reinvestments. And that means that the maintenance investments that we have performed in Norway and China this quarter, are reflected in the cash flow from operations. And this is also explaining why the total investment level for the quarter is relatively high versus previous quarters.

Total reinvestments amounted to NOK 729 million for the quarter, and that was 128% of depreciation and amortization, which, is somewhat higher than our long-term target of 80% to 90% of depreciation and amortization. The reinvestments year-to-date are at the more normal level, 96%, and we expect that reinvestments will be more in this area, maybe a bit lower going forward.

The strategic investments amounted to NOK 733 million, which is in line with the first quarter this year, and the strategic investments are according to plan, and they mainly consist of the expansion projects in silicones in China and in France.

So with that, I hand the word back to Helge who will take us through the outlook for the third quarter.

[Helge Aasen, executive]

Yes. Thank you, Morten. I think to sum this up, we expect a continued weak market sentiment now moving into third quarter. I'd like to emphasize though that Elkem is very well positioned to benefit from demand recovery when it comes due to our strong market position and robust financials. Silicones market is expected to remain challenging. We plan to run at reduced capacity in the quarter to optimize product mix. Prices for silicon products is on a downward trajectory, going into the third quarter.

This will partially be countered or compensated by lower raw material costs, but we do expect higher capacity utilization following the completion of the maintenance projects in the second quarter. Carbon Solutions is expected to remain at a good level despite relatively weak markets. So this concludes our presentation.

And with that, I hand it back to Odd-Geir, who will take us through the Q&A.

[Odd-Geir Lyngstad, executive]

Thank you for that, Helge. First, -- there are not so many present in the audience today as there is a summer holiday in Norway. But if there are any questions, I would like to give the chance to anyone here. If not, we have received some questions on the webcast, and I'll start with some market-related questions. The first is if you can comment on the order book for the coming quarter by division.

[Helge Aasen, executive]

In silicon products, it's quite good, I would say, without being more specific than that. It is a combination of longer-term and short-term contracts. I would say, in general, in the current market situation on the commodity part of the business is very much purchase order based.

[Odd-Geir Lyngstad, executive]

And then going more to the market situation in China. If you see any signs of order intake in China, I guess, improved the order intake. And if we can comment a bit on the overcapacity of silicones and how much capacity has come online and what cost position and cost profile are compared to Elkem's?

[Helge Aasen, executive]

Yes, I think as mentioned in China, there is a higher portion of commodity products in the mix. And consequently, we don't really talk about order book for the quarter. It's more a question of short-term decisions. Quite a big portion of the business is actually done on weekly quotations. So I think that's about the order situation. You would like to add something, Morten.

[Morten Viga, executive]

Yes, if I may add. I think what's interesting now in China, apart from the fact that the market sentiment is weak is that we see not only small producers, but also the big producers now taking out capacity and big amount of capacity. And for us, that is a clear sign that things are starting to hurt for all producers. And that we probably will see a better supply-demand balance going forward. So for us, this is clearly a sign that something is happening.

[Helge Aasen, executive]

Yes, that's -- I agree with that. That's definitely a significant overcapacity at the moment, and a shakeout will be coming.

[Odd-Geir Lyngstad, executive]

There is a question related to what we just touched up on how we see the markets in China developing that if end markets are disappointing compared to what we expected earlier this year. If you can comment on that.

[Morten Viga, executive]

I can do that. I think generally, the market sentiment in China is clearly on the weak side. The recovery after COVID and after Chinese New Year has been slower than we and most other players expected. Having said that, we are clearly still on a positive GDP growth path. And there are also, let's say, differences between the various sectors. Construction is clearly on the very weak side still.

And we are now seeing that the government is trying to stimulate among other housing construction, which has come down to a very low level. That would be important for us when and if that starts recovering. Automotive is still quite weak, although the EV segment where we are particularly strong, is picking up and also other sectors have a lower growth rate than what we are used to in China.

But we expect that stimulus packages will improve underlying GDP growth going forward. The question is really when and how much.

[Odd-Geir Lyngstad, executive]

Then we have a couple of questions related to destocking. If we see an end to destocking and if we see still inventories with customers and if we have any insight as to customer stock levels, and also when we expect to see some kind of restocking to happen.

[Helge Aasen, executive]

Yes. I think it's a mixed picture, but as Morten, and we also commented in the presentation, significant capacity is now being idle in silicon in China. I think that's a clear sign that markets will return to balance. And in specialty, so we still see some destocking in EMEA and Americas. Very hard to say exactly when this -- when everything will be back in balance.

But a lot of producers are clearly taking measures now to try to balance the market, including us, where we have accelerated maintenance and are also optimizing product mix. And also more related to the results for the silicones division if we can say something about the EBITDA mix between China and rest of the world in that division.

[Morten Viga, executive]

No. Generally, we do not report regional financial numbers, so we'll have to stick to that principle. But we can say that clearly, the markets both in the Western world and in China are challenging for somewhat different reasons. In China, we see very low prices on commodities. In the Western world, the markets for and prices for specialty products are holding up quite nicely, but we see a significant still reduction in sales volumes.

And then, of course, we have to either sell the residual capacity as commodity products or we have to adjust our production, and we have done the latter one, taking down production in our Western facilities.

[Odd-Geir Lyngstad, executive]

Then some questions related to kind of potential for improvement for silicones. We mentioned capacity closures and the question is if we can assume that EBITDA for silicones should improve on the back of that. And related to that, what does it take to bring quarterly EBITDA back above 0.

[Helge Aasen, executive]

No, I think there are many signals that things are bottoming out and that producers are taking measures to balance supply and demand. So -- but for the third quarter, we still expect this to remain weak.

[Odd-Geir Lyngstad, executive]

Then a question related to CapEx. How much and what is the remaining CapEx for the capacity expansions in France and in China?

[Morten Viga, executive]

We are progressing very well on both those 2 projects and particularly the expansion project in China, which is by far the biggest. That is to be mechanically complete late this year and to be started up early next year. So cash-wise, we are approximately now 2/3 completed with that project, i.e., 1/3 left when it comes to cash outflow.

[Odd-Geir Lyngstad, executive]

Then a question, if -- I mean, the tax rate was high, as we have presented in the presentation today, and we get the question on tax guiding for 2023.

[Morten Viga, executive]

Yes. As I said, it's an extraordinary quarter with extraordinary low results for our silicones business, both in France and in China. And we have not, let's say, for -- in order to be conservative in our accounting, we have not capitalized these losses carried forward. And that brings the effective tax rate up to a very high level. I don't -- certainly don't expect that to be the situation going forward. But it's a bit difficult to give a specific guiding on the tax rate for 2023. But in a normal situation, we have previously guided the long-term effective tax rate to be between 20% to 22%.

And I think that's still a very, very valid guiding in a more mid-long-term perspective.

[Odd-Geir Lyngstad, executive]

Then we get the questions related to the prospects for the next year's dividend. And if we can say anything about the outlook for next year as dividend?

[Helge Aasen, executive]

I think I'd just like to say that Elkem is in a solid financial position, and we expect to pay out dividend according to our policy also next year.

[Odd-Geir Lyngstad, executive]

Then a question related to [indiscernible]. There was a release this morning about some grants for -- from EU. I don't know if the question was related to that. But if you have anything on that, Helge.

[Helge Aasen, executive]

Yes, that was just breaking news. We have been awarded a grant from the EU innovation fund, EUR 100 million. And of course, that's very good news. We are in a phase in the project where we are now building the industrial pilot line. And the location study for a full-scale plant will still be ongoing for a while. So -- but obviously, this will be a positive factor in taking that decision, but still remains to be seen, of course, what the conclusion will be.

[Odd-Geir Lyngstad, executive]

Then a question related to the acquisition of Vum, and which appears to be a strategic move towards growth and specialization. And if we can share some more insights about that position and how it will enhance Elkem's existing operations.

[Helge Aasen, executive]

Yes, it's a relatively small acquisition, but it gives us an opportunity to optimize the production in particular, streamlining production lines in Europe, in particular. And as I mentioned in my presentation, we also have other synergies and expect to bring a Vum up on profitability level in line with the rest of the Carbon division.

[Odd-Geir Lyngstad, executive]

Also a question related to financial position. We have a solid equity ratio of 50%. We have a low leverage of 1.1x, but how do we plan to maintain and improve these figures in light of challenging market conditions and planned investments in upgrades and digitalization?

[Morten Viga, executive]

No, we will still apply a very, let's say, disciplined CapEx strategy. We have reinvestments amounting to 80%, 90% of depreciation, and that will also be the level going forward. We will clearly be selective on strategic investments and really prioritize the investments where we, which support our strategy and where we have a very solid IRR.

Having said that, we also believe that our balance sheet is very solid, and that will allow for both, let's say, good strategic investments going forward and generous dividends in line with our dividend policy while still supporting a relatively conservative debt leverage ratio of 1 to 2x EBITDA. And we're confident that we will be able to meet all these targets.

[Odd-Geir Lyngstad, executive]

I think we have covered basically the topics that we have received questions on. So with that, I think that concludes our presentation for the second quarter. So thank you very much for listening in and participating.

[Helge Aasen, executive]

Thank you.