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Kloeckner & Co SE
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Ladies and gentlemen, thank you for standing by, and welcome to the Q3 2019 analyst and investors conference Call. [Operator Instructions]. I must advise you that this conference is being recorded today, Wednesday, the 30th of October 2019. I would now like to hand the conference over to your speaker today, Felix Schmitz, Head of Investor Relations. Please go ahead, sir.
Yes, thank you. And welcome to our Q3 analysts and investors conference call. With me today is our CEO, Gisbert Ruhl; our CFO, Oliver Falk; and our CEO for the Americas, John Ganem. They will guide you through the presentation. After the call, we will be happy to answer your questions in a Q&A session.With that, I would like to hand over to our CEO, Gisbert Ruhl.
Yes, thanks, Felix. Warm welcome also from my side. Let's switch as usual directly to Slide 4, the details of our last quarter, of the third quarter 2019. They were probably not a surprise after we published at the beginning of October our profit warning. So markets, especially in Germany and also in the U.S., were under pressure with this. Shipment has been down by 6.5%. Sales went down even more by 10.8% because of the weaker prices. Gross profit also significantly lower than last year, minus 14.6%. Here we had significant -- and you will see this later on -- negative windwall effects in the U.S. So we had to give up a lot of the positive effects we had in 2018 because prices were heading so significantly down in the first quarter this year. And then EBITDA accordingly also down by more than 50%, down to EUR 26 million. Reported EBITDA is even lower, EUR 21 million because of special effects of minus EUR 4.8 million.Very positive, the operating cash flow was EUR 82 million compared to last year where we had minus EUR 5 million. Here we had established beginning in the -- by the end of the first quarter, a very strict networking capital management and with this we will also have a very positive cash flow, operating cash flow by the end of this year. We're expecting here about EUR 150 million positive operating cash flow or even a bit more.Digital sales also went up significantly by 8 percentage point from 22% to 30%.Yes, digitalization, next slide. We're coming here meanwhile to a point where the digitalization will be more and more reflected also into our numbers. This took some time, maybe even a bit more than expected, which is not uncommon when you're exploring new paths like we did with our digitalization efforts. So we increased already, as mentioned, our digital sales up to, I would say, relatively remarkable number of 30%. But we had to do this also by convincing a lot of our customers to do digital business with us or to do the business online with us. Even we're certain to reach our goal of 32% by the end of this year.We also learned that this has limits especially when customers have to change their process. And against this background and also most recent progress in artificial intelligence, we developed the Kloeckner Assistant and I will dig now a bit deeper into the functionality of the Kloeckner Assistant because this is, in our point of view, really a game changer because we are able with the Kloeckner Assistant to turn every customer into a digital customer without the need that the customer has to change anything.If the customer is, for instance, typically mailing us and request for quotation by PDF because this request was created by his ERP system, then he can do this like in the past and the Kloeckner Assistant will then step by step digital this RFQ and will send in the end automatically an offer back to -- a digital offer back to the customer. The first step here is the easiest step, this is that we have to digitalize the e-mail or the PDF itself. The second step is already a bit more challenging, the interpretation of the request because these requests are typically completely unstructured.The most difficult part is then the interpretation of the description. If the customer wants for instance a con pipe 22.2 and VA2, then the Kloeckner Assistant has to match this with our product catalogue. In this case, it would be a construction pipe with a diameter of 42.2 out of stainless steel 1.43 or 1.Finally, then this request will be priced with our price affinity tool, also completely -- in the end also completely automatically and this price affinity tool will also take price sensibilities into account.The customer will receive then the offer within seconds and this is a big change compared to today where our offers like this, especially when they are more complex or when offers have even several hundred of positions, then it typically takes days and with our Kloeckner Assistant, it will only take a few seconds. Even if the customer, for instance, would send us a fax, it will only take a few seconds and then the customer can finally accept this offer and he is getting also within seconds all necessary documents.We have already implemented here our first prototype in the U.S. This system will now be developed and implemented step by step. So currently it's not fully automatic, it's if you like half automated and in -- and against the background that we are submitting in our distribution business in the U.S. and Europe and Europe except Switzerland and Becker Stahl, about EUR 2.7 million offers each year from which about, by the way, 40% are accepted to kind of mention how huge the efficiency gained will be with this Kloeckner Assistant. We expect here at least efficiency gains of EUR 100 million on a full year basis already in 2022.So therefore, this is for us now a real game changer because finally going forward, then we will reach the goal that we will have 100% digital customers because every customer will be turned into a digital customer.So we made also progress with some materials. We have now 43 vendors under contract, more than 450 registered customer and we also crossed more than the 10,000 products. We have now 10,400 products on the platform. We're increasing our footprint also by the way in countries where we do not do business at Kloeckner any more, like in Spain. We also have 2 strategic investors who are locked in already with convertibles and we will expand our offerings also now in other products like plastic and the Kloeckner Assistant in a somewhat modified way will also change the business with some materials. Here also customers will have the opportunity going forward to send us whatever they like -- a mail, a fax or whatever -- and then we will -- some will provide for these customers then different offers from different suppliers.Yes, with this, I hand over to my new colleague here about, I think it's your -- is it your first?
Yes, it's my first participation here.
The first participation here in our quarterly calls. And with this, yes, I hand over to Oliver Falk.
Yes, good afternoon. So let me focus on the EBITDA development. I'm on Page 7 now. So you see that our EBITDA came down from EUR 59 million to EUR 26 million year-on-year before special material effects. And with the EUR 26 million, we reached the lower end of our guidance, which we have given to the market of EUR 25 million to EUR 35 million.We are -- in quarter 3, we were heavily suffering from a very difficult market environment. As you can see in the graph, we had both a negative volume effect and an even more stronger negative price effect. The volume effect was negative with EUR 14 million, mainly due to weaker economic environment in Germany coming from the automotive industry and the machinery industry, a smaller effect in Europe was coming from a portfolio streamlining in France. In addition to that, in the U.S. we saw a general market decline, which led in total to the minus EUR 14 million. Price effect of minus EUR 41 million includes mainly a negative windfall effect from the U.S. and also the weak automotive and machinery industries had an impact to our price effect. A small positive effect was reached by the product portfolio adaptation in France.OpEx improved by EUR 10 million and the main driver here were lower personnel expenses and the initial application of the IFRS 16 contributed to EUR 12 million. So that in total, we come to an EBITDA before material special effects of EUR 26 million in Q3. The special effects of EUR 5 million include restructuring expenses of EUR 7 million, EUR 4.5 million of them caused by the holding -- the restructuring and EUR 2.8 million coming from France. And we got an addition in insurance compensation for storm damages of EUR 2.5 million in the U.S.On the next page, you see the cash flow and the net debt development. As Gisbert already mentioned, we achieved a quite positive cash flow from operating activities of EUR 82 million in Q3. And this was mainly impacted by a reduction of the net working capital by EUR 89 million based on our very strict net working capital management. With a CapEx before IFRS 16 of EUR 12 million, we reached a free cash flow of EUR 70 million. And the net financial debt was impacted of course by the free cash flow and we reached a net debt at the end of September by EUR 634 million, which is coming originally from EUR 684 million in June 2019.So on the next page. The next page demonstrates how we managed the net debt, including leases and excluding leases. After we had reached the peak in March, we constantly worked on our -- on an improvement of our net working capital and, therefore, reduced our net debt up to September to the figures which we presented to you. And we are aiming to further bring down the net debt to the targets which are shown here, meaning a net debt excluding leases of EUR 250 million as our Q4 target on group level.So now back to Gisbert?
Yes, right. Quickly for the European update, and then John will do the U.S. outlook update. So on Europe, yes, we expect now negative growth for steel demand between minus 0.5% and 1.5%. The only segment which is still good is construction, especially also in Switzerland. Manufacturing is heavily impacted also by the downturn of the automotive industry. So all machinery which is close to automotive is heavily under pressure.Energy, which is not that important for us, is more stable or more sideline development. And then automotive, with the heavily downturn, German auto production is, as you know, down by about 5%. The first 9 months also demand is relatively weak. So this of course together has -- with manufacturing has biggest impact of our business in Europe.Yes, with this, I hand over to John to explain us a bit more the U.S. development.
Yes, thank you, Gisbert. In the U.S., I think we're still seeing relatively decent GDP growth. The new number just came out a few minutes ago at 1.9%, little bit above expectation, but this is mainly driven by consumer spending. Clearly what we're seeing and from the steel demand perspective, is manufacturing definitely in a downward trend. Construction definitely seems to be the bright spot at this point with residential supported by lower interest rates, certainly in the near-to-medium term. The machinery sector is kind of spotty. Definitely, agriculture is way off, hit hard by the trade situation with China. We're also starting to see the industrial machinery sector, which was relatively strong in the first half, showed some weakness in the third quarter.The other manufacturing sectors, industrial equipment, are pretty positive, mainly again driven by that strong consumer spending. So we're seeing some positive development there, at least slight growth. Energy has certainly definitely slowed and that probably is going to continue to accelerate as we head into the fourth quarter and into 2020.And automotive is obviously down. Albeit the sales are holding up reasonably well. So we're down about 2% from a production standpoint, again falling interest rates will be supportive of automotive sales, at least in the near-to-medium term. And shipbuilding has been relatively stable from us. We see pretty good activity on the barge side of shipbuilding.So that's really the situation in U.S. Again I think really the manufacturing side of the economy is under some pressure. There's a lack of optimism and the uncertainty relative to trade and the unpredictable political environment is really kind of dominating the new cycle and I think is weighing on business confidence. And I think that's why we're seeing somewhat steel demand certainly in the second half of the year moving down even more than what we would expect on a seasonal basis.So that's it for the U.S.
Yes. John, thanks very much. And with this, we're coming to the final slide, outlook for full year 2019. Not a surprise. I think that shipments and sales are expected to decline considerably year-on-year. EBITDA is expected to come in between EUR 120 million to EUR 130 million before material special effects, which could be around EUR 20 million positive. And cash flow -- operating cash flow, as mentioned, should be at least amount to EUR 150 million.Yes, thanks very much. And with this we are now open for your questions.
[Operator Instructions] And the first question comes from the line of Carsten Riek.
I have 3 questions. The first one is on the inventory situation. As you guys mentioned, the entire industry is pretty much destocking. How far are we from the trough in your opinion? It could be the fourth quarter, especially the December, trough situation with regard to inventories at least in Europe. And to John, a question. How is the situation looking in the U.S.? We've seen already one company stating that the U.S. already started destocking quite heavily. Where are we with regard to destocking in the U.S.?The second question is more on the steel price realization. We have seen realized steel prices in the U.S. business drop by around 4% quarter-over-quarter or about EUR 50. Have we already seen the bottom here or will we see the bottom in the fourth quarter? And the last question I have and that is with regard to your comments on the automotive side. If we look at Becker Stahl, previously a very good contributor to your earnings, I would guess that this business is significantly under pressure. How much were the volumes of Becker Stahl down in the third quarter compared to last year?
Yes, thanks, Carsten. Yes, let's start with John with U.S. concerning inventory and prices.
Sure. From an inventory perspective, I would say that there is no question, we are going to see significant destocking here early in the fourth quarter with prices essentially peaking after the dead cat bounce in the third quarter in mid-September, which a rapid decline in pricing mainly driven by the fact that service centers en masse stopped buying and everybody went into a destocking mode.So I think no question we're going to see inventories continue to fall here in October and November. I would expect that to be -- to run its course by the end of November. We'll see inventories likely start to grow again, I think, in December as people have moved to secure volume at -- probably at the bottom of the price cycle. And then really as we head into the first quarter, we would expect some restocking to occur on stronger seasonal demand. The real question mark is again going back to the demand side of the equation as to whether or not we're going to see how much seasonal improvement we are going to see and really do we resolve some of these issues holding back manufacturing relative to uncertainty.From a pricing standpoint, no question, after we got a little bit of a reprieve in the middle of the third quarter, after seeing some really low prices at the end of June and into early July, as I said earlier, we saw prices then give away again in the middle of September and really fell even further down below the previous lows we saw. I think CRU just came out this morning with hot roll now reported for last week's transaction at $440 on a net ton which is just really incredible type of decline in just a 6-week period.I do believe now with mills announcing increases beginning last year that we are probably at the bottom of this cycle, not so much because demand is set to improve, it's clearly not as we head into the seasonally weaker period, November-December, but I think what has really happened is that the prices have gotten to such a low level that even the mini-mills are probably running into some profitability concerns. And now with the expectation that scrap is going to probably bounce up by $20 to $30 a ton in November, I think this really has kind of set the floor on pricing. I'm hopeful that we will see some improvement here, probably more modest as we go to the fourth quarter with maybe the improvement accelerating into first quarter depending on how the demand situation develops.
Yes, thanks, John. Olive -- Oliver for…
Yes, I think regarding Europe, we cannot say that we have reached already the bottom in Q4. We see, and that's quite similar to what John just explained, that the price tendency also on the supply side is still declining also depending on scrap. So we will see a price decline on the carbon steel side between EUR 15 and EUR 20 per ton for Q4. And of course you know that stainless and aluminum has had a different mechanics on that. So -- but that's the outlook for Q4. Looking further to next year, it will be very difficult, but again as John said, I think we have already dropped down heavily and we might reach close to the bottom line.
And then concerning Becker, so Becker is down year-on-year in the third quarter by 2.6% and quarter-on-quarter by 5.5%. So the reason why we are not suffering as much as the automotive industry in general is that we switched more also to industrial business or typically Becker had more than 50% automotive business, and this is now a bit lower than 50% and we compensated this partially at least with industrial business.
Just on -- Oliver, your comment on the -- whether we reached the trough or not, you said we have not yet reached the trough in the fourth quarter. Did you mean we have not yet reached the trough in the third quarter?
No, in the fourth. The statement was that we cannot say that we have reached the bottom in the fourth quarter.
Next question comes from the line of Rochus Brauneiser.
A few questions from my side. Based on the year-end net debt guidance and the further working capital reduction you're planning, can you give us a rough sense of how much the stock levels, your stock levels, will be down year-over-year as of the end of the year and how that squares against where you see the industry in Europe at the moment? Then related to that, I think you mentioned it already. What kind of dynamics would you expect in the current macro environment just on the basis that we are not receiving any incremental negative news coming from the trade front and the Brexit? And then as a third question, how do you see the EBITDA pass for the next 2 years under a scenario of muted growth in Europe and U.S.? What would be the main arguments that you are not getting back to EBITDA levels of at least EUR 200 million?
Yes, concerning the general fundamentals, so in Europe -- and maybe then John can do the same for the U.S. In Europe, generally what concerns me most is the automotive industry because I think this is not -- I think this is more a structural change and not only short term because of electrification and also more production, it's obviously being localized also because of tariffs. And then we will have gone forward, also impacts from autonomous cars, connected cars, shared cars. So all of this will have, in my point of view, a significant impact on the European automotive industry, which is in my point of view not really well prepared for this structural changes and these are, therefore, in my point of view, the highest risk because with this also all industries which are close to the automotive industry and which is not only the supply industry which is in Germany, especially also the machinery industries, would be impacted.And, yes -- and John for the U.S., what is your take?
Yes, I mean I think we would -- we definitely see a muted type of growth situation certainly in 2020 and into 2021. Again, I think a lot of it hinges on this whole resolution of this ongoing trade situation and whether or not we can get that resolved and eliminate that level of uncertainty which would help, I think, then build back some business confidence and we'd see business investment start to pick back up.I think clearly we've had a pretty strong run here. From an economic growth standpoint, the consumer has really kind of -- is carrying the day right now. How much longer can this last, at some point we're definitely at the tail end of this growth period and I think that's clearly going to weigh on steel demand over the next couple of years. I think we have positive demographics. So I think the long-term view is still pretty positive for the U.S.We are obviously concerned about the development of automotive long term. In the U.S., we're not as exposed to that particular market segment, a very small part of our overall portfolio. But nonetheless, it would certainly weigh on the overall market dynamics. And of course, so our -- we're building a strategy around that and how do we grow our business in the face of the somewhat weaker demand conditions and frankly how do we become more efficient and drive our cost structure down to be even more competitive.
Yes. And then concerning EBITDA in the next 2 years, so I really -- I'm really -- I'm very convinced that our digitalization efforts will now show significant improvement going forward, especially through this Kloeckner Assistant because here everything is in our hand. We depend no more on convincing customers and suppliers. It's really in our hand to implement this assistance, which is heavily supported by artificial intelligence. Without artificial intelligence, it would not -- this would not work. And when you have in mind that 60% -- about 60% of our cost in sales are administration costs, then you can imagine how big this impact will be only on the cost side.But then when you imagine that we will be able then to offer or to present the customer an offer within seconds where our competitors need days, also this will be a significant change. And with this, we should not only be able to increase the share of wallet of our customers. We also have then more time if you like in sales also to get new customers onboard. And, yes, and therefore I don't think that we will probably have that much from the -- push from the economy or support from the economy. But with this, we will realize the efficiency gains through digitalization by ourselves.Then your question what was concerning stock levels year-on-year, so they -- by the end of the year there will be probably 80,000 to 100,000 tons lower than by the end of last year. Is this in line with industry? Difficult to say. Here in Europe, we don't have any statistics. John, how do you see yourself in the U.S. compared to competitors here? You have better understanding.
Yes, I think we're well below the industry average for sure based on the MSCI statistics. Our stock levels in October will probably hit the lowest level we've ever recorded and that's still with relatively positive turnover. Our volumes in the U.S. are only off less than 2%. So with stock levels as low as they are, we should -- we're going to be close to under 60 days of inventory in October. And I would say that, Gisbert, probably a leading position within the industry from a inventory management standpoint.
Maybe one final question on consolidation. I guess there have been some press comments about potential combination of Kloeckner's and ThyssenKrupp's distribution business. And I guess you commented that option is no longer discussable because of the management change at ThyssenKrupp. At least that was commented in the press. And my question is what does management change at Thyssen change in terms of the industrial logic of such a combination. Would you consider this coming back at a later stage or how shall we interpret it?
Yes, so I would say that currently the management on the Thyssen side is engaged with other issues than the potential merger or whatever with Kloeckner. And so it's not necessarily the management change itself, but it's obviously the focus of the priorities they have. Going forward, in principle I would not rule anything out and -- but we have to see what the final strategy of Thyssen in the end is which is, I think, at least currently not 100% clear. And then the logic itself is also something which we then have to see and we have to figure out. There are of course -- there will be, of course, synergies on the one side, but there will be also dyssynergies on the other side. Putting or merging Kloeckner with Thyssen materials is also on the cultural front not an easy task. So there are a lot of things which we have to take into account. But honestly, I think in the next foreseeable future this is, in my point of view, no issue anyhow.
Next question comes from the line Marc Gabriel.
First question regarding the price effect. I mean there have been EUR 123 million this year. And of course additional EUR 42 million you lost on EBITDA on volumes. But I see the point that the price volatility remains an issue for the final quarter due to the seasonality and the destocking. But really what's your view for the -- as what was the main reason for that sharp decline in prices since beginning of the current quarter? I do not see that that is only destocking effect.And then the second question is 40% of your business is with the construction industry only and then 40% roughly with the automotive and mechanical industry. We have heard from, for example, Volkswagen today that production of cars went up in Q3 by almost 7%. And I thought that this would have an impact on the supplier industry as well. But you have not seen any -- you have no visibility yet that things are improving. Is that right?
Yes, so starting with your last question, we have not seen really an improvement so far in the third quarter or fourth quarter. This is when we're saying this, then we mean always Becker Stahl in this case and -- yes, and so far year-to-date production is down 9% and which of course heavily impacted our automotive business of Becker Stahl.And concerning the price effect, maybe we start with John in the U.S. Do you want to comment on this?
Yes, I mean as far as -- I believe the question was why did prices fall so significantly here in the first part of the fourth quarter. I think that is, really it's more of a psychological effect with so much of steel demand flowing through distribution. And I think the distribution business got very negative on the outlook for demand with all of the negativity surrounding the trade issues and you couple that with really kind of a downturn in all of the economic indicators related to manufacturing. I think that kind of combined to create this negative sentiment and I believe that point service centers lost confidence really in the fourth quarter and everybody pulled back buying patterns. And that brought the lead times in and I think we saw a sharp reaction from the mills in reducing prices, trying to keep the mills full.And as I said earlier, I think we've kind of now reached that point where prices -- it's very hard to see how prices can go much lower in the face of rising scrap prices. That doesn't mean that prices are going to rebound rapidly here in the fourth quarter. I think we just maybe found the floor, and then we'll see what the first quarter brings. But I think the deep downturn here in October was really more to do with overall sentiment relative to demand heading into the fourth quarter and the fact that we're still fighting kind of with an oversupply situation certainly on the flat wall side of the business with all of the restarted capacity that came about last year with the Section 232.
So regarding Europe, we do not see any negative price effect in the segment Switzerland and also not in the segment distribution Europe. There's only -- was Becker, so the services part, a small stake of EUR 5 million, which of course comes from the fact that Becker tries to substitute the weaker automotive volumes by industry volumes and the industry volumes are representing spot business, which of course is negotiated under the competition with others. And, therefore, they have had that negative price effects in Q3.
And how long will it take to get Becker back to double-digit margins?
That depends of course very much on the development of the auto business going forward. And as mentioned, I have there my concerns. And I think going forward, we will -- we structure also Becker to a certain extend so that we will have more industry business than in the past. And with this, we also have to change certain processes in at Becker Stahl, but then we have -- and this develops quite nicely, this aluminum business, which will compensate also part of the steel business for the auto industry. But coming back to double-digit margins is challenging.
And the restructuring, you have already done some restructuring, you mentioned France. Could we expect further restructuring expenses in the final quarter? And what could be a rough number here? And finally, the net debt to EBITDA, is that -- do you have or could you -- can you please remind us what covenants you currently have? And is that based on the financial debt including leases or excluding leases?
Oliver?
So the restructuring, we are -- we cannot give you a precise figure right now. We would like to repeat what we said at the beginning of the call that there might be smaller restructurings which we will do as a continuation of what we already started. So there will be smaller topics in Germany and also in France, which we will see in the fourth quarter.Regarding the net financial covenants which we have, we are currently adjusting some instruments regarding the definition of those covenants. Also our ABS program, that's under negotiations right now. It's a formal adjustment of what we do. But we have not any break or any fear that we are getting close to any kind of breakage of the covenants right now, but the opposite is true.
So there's enough -- whatever happens, there's enough.
Yes, was bullet proof.
Yes.
Next question comes from the line of Alan Spence.
I have 2 questions. The first one is a little bit more on U.S. pricing. You mentioned the rapid fall in pricing there in the first part of Q4. By the time you came out in preannounced, we are about midway through October and you've kind of been talking about a stabilization of pricing since then. Can you give us a bit of sense on what your underlying assumption is for U.S. prices in your implied Q4 guidance? Is it safe to assume that would be something like sub $500 per ton hot rolled coil?
Gisbert, are you going to answer that?
Yes, John.
Yes, I think we are -- we were expecting clearly prices to be under pressure in October. We felt that, no question, we were going to get into these mid-400 type of ranges, which we've clearly already achieved. And we kind of felt that was going to be the bottom based on where we thought scrap was going to settle. And really scrutiny of the scrap to hot rolled coil margin if you will or what the mills call the mini-mill margin, that really kind of tells us where the floor is going to be and we kind of sense that we're going to be in the mid-400s. We're not quite sure, we weren't expecting much from there then of a recovery just because we knew that demand in November and December, one seasonally and two with the current kind of slowdown in manufacturing, was going to be very challenging from the demand standpoint. So we didn't see much upside potential off that mid-400. The mills, as I mentioned, have come out and now announced price increases. I think their goal is to try to get it back to 500 if they can. It remains to be seen how quickly that will happen. It's going to be very difficult, I think, for them to achieve significant increases at all through the end of the year. Hopefully that answers the question.
And then just a second one, housekeeping. Could you please tell us what you're expecting for full year work -- sorry, CapEx, please?
CapEx.
For the full year?
For the full year?
Yes.
Okay. So we would get close to EUR 40 million to EUR 50 million. So it's by far beyond the levels which we have had in the year before, but not more than that.
Next question comes from the line of Matthias Pfeifenberger.
Couple of remaining questions from my side. Firstly, on the windfall profits, can you update us what do you expect for the full year and then also Q3 and Q4? Windfall losses.
Oliver?
So for Q3, we have calculated windfall losses of EUR 25 million, mainly coming from the U.S. So that's following the logic which John just explained. And for the full year, the figure we calculated is EUR 65 million.
EUR 65 million and EUR 25 million. Okay. So a lot of the questions today were around why the effects on the EBITDA was so harsh with basically the car weakness known for some time, the construction industry doing quite well. And actually when I look at the Chart #8, it seems like it took a bit of too excessive inventory position at the beginning of the year. And you basically made 2 wrong bets on the prices going up when they actually declined. So no offense there. I mean I know you for a very long time and taking inventory position has been part of the business model, but I also can recall times when you refrained from that, especially in the financial crisis, and you said you will never take direction of using the steel price. So my question is, is there no way that you could limit the risk of windfall losses and therefore limit the earnings volatility by just keeping a minimum inventory position at all times accounting for any seasonal demand patterns?
Yes, you are right, Matthias. So we did not really bet in the beginning of this year. But, yes, let me say it in a way, so it -- we could have managed it better than it was managed. And, finally, we also had some management changes thereafter and so we are -– we didn't change our policy, but we had some, yes, weaknesses in managing the inventory in the first quarter. So that's true. And we are working hard on reducing our risk further. And we made, as John explained, already significant progress. So being down to 60 stock days is really already a remarkable number. But with our digitalization efforts, we will even be able to reduce it further and with this also the risks of this high windfall losses. But on the other hand we will also of course reduce windfall gains, which is clear.
Of course, and my question related to the rest of the year, like on a really minimum level when it comes to inventories in the U.S., but you're still showing a EUR 220 net debt and, I guess, most of it is working capital or obviously operating free cash flow. You have a big working capital release in the fourth quarter when everybody is destocking. And I mean is this -- is there an execution risk to the EUR 450 million net debt? And also is this basically implying that you are fire selling parts of the inventory and that it will also cause additional windfall losses in the fourth quarter, right?
No. So there is no execution risk on the one side and so it could even be a bit better than that. And on the other side, you will then see in the first quarter next year that we will not have the same effect, which we had in the first quarter of this year. So we will manage -- so our goal is clearly to manage the networking capital more tight throughout the year and -- but we -- in any case, we have no fire sales or something like this planned because we don't have to. So we have -- as Oliver explained already, we don't have any financial risks, no any covenant risk, so it wouldn't make any sense now to reduce networking capital more than necessary.
And conscious of the time, but maybe one final one, the EUR 100 million efficiency gains as you call it from moving to 100% digital customers. I mean how can we think about that? It's probably reduced stock levels, less admin staff. But is this -- I mean EUR 100 million, it's a big picture, right? Can you maybe go into some more details how this is constituted?
Yes, so EUR 70 million to EUR 80 million of this EUR 100 million will be clearly cost efficiency and the remaining will be additional business. So additional business because we will then be faster than anyone else in the industry and we also can process much more offers than today. And therefore we are very, very convinced that we will reach this number, especially as this is now really in our hands, this is the difference than the past.
And the cost, is that largely staff? Or what's the lever here?
Yes, it mainly staff. So it's mainly, say, administration, which is a significant -- as mentioned, currently 60% of our saving is cost –- admin costs.
Next question comes from the line of Seth Rosenfeld.
I have 2 questions, please. First following up on Kloeckner Assist. You've talked a lot over the years about the digital push, improving your working capital management and reducing your operating costs. Obviously 2019 seems to be a year in which that hasn't yet delivered. Can you give us a bit more color going into 2020 and beyond, how Kloeckner Assist, you've higher confidence in this than past distribution and past digitalization investments? I guess one of the fears that you've heard from this community in the past is that the move to digitalization increases price transparency, takes away your own pricing power against one of your customers. Are you seeing that come through and particularly with regard to Kloeckner Assist, as you completely get rid of the one-to-one relationship with your customers, is there any fear that this is going to lead to even higher customer churn? Why would a customer stick with you as opposed to competing with or kind of pricing for other suppliers across the market?And then separately, moving to the U.S., please. You've talked a lot about your inventory destocking throughout the course of 2019, record low inventory by the end of this year. That seems in line with MSCI data for the broader U.S. market. Do you think that's sustainable going into 2020? The mills are arguing that service center inventories are unsustainably low and that just based on seasonality you're going to see a snap higher early 2020. Would you agree with that or do you think this is the new normal for service center inventories in the States?
Yes. Thanks. So I will answer the first question concerning the Kloeckner Assistant. I think we will -- with this assistant, we will be even able to increase our pricing power because we are so fast. So when we are able to give or submit an offer to the customer much faster than everyone else, especially when this is an offer with a lot of positions, then maybe also -- and then when we then also deliver fast, then maybe pricing will not even be such an issue like today where we have clearly difficulties, especially in our commodity business, to differentiate to our customers. But this is then a clear differentiation. Being faster than everyone else is a clear differentiation.And secondly, the relationship to the customer, no, I think we will have -- might have even more time to -- for the customer because we don't have all this [ save Edmond ] effort. So with this our salespeople can clearly concentrate and focus on the customer and also try to get new business from the customer but which I, on the other hand, expect also from the Kloeckner Assistant. So the Kloeckner Assistant is -- our point of view is really a game changer. And I can tell you also internally that the whole organization is very keen, that our country's CEOs are very keen to implement this Assistant. So there is a real pull effect meanwhile concerning digitalization with this Assistant because we're all seeing this high-efficiency gains. And then John, concerning the U.S. prices.
Yes, as far as the inventory situation, just to be clear, I mean when I say the historic lows I was talking specifically in October and likely in November. Typically in December, we'll see inventories come up a little bit as we prepare for obviously higher seasonal demand in January, in the first quarter. I would say that the industry as a whole clearly by just looking at the MSCI stats, we're managing inventories at a much lower level than we have historically. I can't speak for our competitors and what their plans are for 2020. I would say certainly our inventories would only rise in line with any expected increase in demand. But we also have some very, very aggressive goals in place relative to inventory management and in learning and being able to operate our business with much lower levels of inventory than we ever have in the past relative to sales.And really we're doing that again through some of these digital efficiencies that we're driving, certainly the efficiencies with our supply base on how we're managing inventory and ordering steel. And I think really partnering with our supply base and those mill partners who can deliver us the high level of delivery reliability will allow us to really structurally change how we manage inventory in 2020 and going forward, and our goal is frankly to get better and better month-after-month, quarter-after-quarter and year-after-year. And I think it's a top priority for us here in the U.S. for certainly and clearly it's one way we can mitigate some of the market price risk.
If I can just ask one follow up on that. Obviously, you made a lot of progress in the U.S. with regards to inventory management days on hand. Still there is a big windfall loss. If I compare your business to a company like Reliance Steel, I know you can't speak particularly to them, but they're your closest peer. They had stable FIFO gross margins in Q3 versus Q2. What's different about their business? What are they doing unique to Kloeckner and what are you doing to close that performance gap?
Yes, I would -- I can't really speak to the ins and outs of their business. Clearly based on the financial numbers, they have a much different business model than we do. They have a much different product mix than we do. You just look at their average selling price and average gross profit, they are much heavily committed to stainless and aluminum. Those products have not nearly been as volatile and the fact stainless prices have been moving up here in the last few months on higher raw materials surcharges. While we are much more carbon focused and really all of the pricing pressure has been concentrated in the carbon steel products. And frankly prices from where they fell, almost $400 a ton since middle of 2018 till now from -- I think high was $918 on hot roll to $440 now in October, there is really no -- there is no defense against that certainly in the carbon steel market place. You're going to have significant windfall losses in a constant falling market environment and especially when prices are falling to that degree. All we can do again is mitigate that by trying to run our business with as little inventory as we possibly can and that's what I referenced earlier.
Yes, and what now -- and what by the way not make sense for us now to try to acquire lots of specialty or stainless steel service center. So historically Reliance had always a much, much higher share of this kind of business. So it's difficult honestly to compare with Kloeckner and they also have a higher share of toll business. This is something which we're increasing currently. So we are working hard to get more customers on the tolling business, but strategy to try now to buy the remaining stainless steel service centers also. That would probably not make really sense and what -- especially also not create shareholder value.So we are more carbon related or we are 90% carbon related and this will in principle not change that much. But on the other hand we are -- from our IT systems, we have everywhere the same IT system and with further digitalization, this will take much more into account than in the past and especially now with the tools -- artificial supported tools like the Kloeckner Assistant, this will also drive change and differentiate us here also against Reliance going forward.
There is another question from the line of Rochus Brauneiser.
Just to get a better understanding of this Kloeckner Assistant tool, can you explain is this a software tool, is this from -- is the system developed from inside your Kloeckner and -- or is this an outside software platform which eventually anyone can use? So can we get a bit of a -- can you share how you see the barriers of entry and how long this technical advantage you might be able to harvest?
Yes, no, this is an internal development, so this is developed by Kloeckner.i. So this is a part of our digitalization efforts already in the past couple of years. And we're talking about several tools and in total these are 4 tools. So the first tool is the easiest, as mentioned, the digitalization of facts of a PDF, this is more standard software. But then the interpretation, the logical interpretation of, for instance, in request and RFQ, this could -- this works only with machine learning.So with Artificial Intelligence, this is something which we developed by ourselves. And also the third tool, the so-called Kloeckner Match, this is also a tool we developed ourselves here. The description of the material will be aligned to our Kloeckner product catalog. This is the most difficult -- this is a more difficult tool because the interpretation is not easy. When someone, as mentioned, is ordering a con pipe 42.2 and VA2, then we have to transform this description. So we have to find out what does the customer really wants, what is the material, what is the size and then we have to transform this to our product catalog, this is the Kloeckner Match. This is also machine learning. So this is the reason also why this takes some time.So we have to bring the knowledge, if you like, of our salespeople now into the machine. And then the third, this is the Kloeckner affinity pricing. This is also a tool we developed ourselves and with this we will price, also we will -- here we will take into account also sensibility, price sensibility. For instance, we know that customers who're ordering or the machine will then know who're ordering spot in the morning are probably a bit more price sensitive than in the evening or in the afternoon and also other issues will take into account here by the AI software.So the 3 main tools are developed ourselves and I would say with this we have also really competitive advantage for some time also because this is an ongoing development and I'm pretty sure that there is no competitor who is here as far as we are and, therefore, yes, it's a more long-lasting competitive advantage.
When you say that mostly this will be cost related, what would that mean in terms of potential labor restructuring and when could that happen?
Yes, okay, this is now happening gradually. So we have currently a system or the prototype we have in place is half automatic. So currently, for instance when the order comes in, when the order is digitalized and the sales guy is seeing the order on the screen and then he can correct the order, and this is by the way also something that the machine is going to learn. But, yes, this efficiency effect will come over time now in the next 2 or 3 years. And concerning labor, this can only go in 2 directions, so one direction is we getting more and more customers and the other direction is, if this is not the case, then we will need less and less labor. So that's how it works.
There are no more questions. Please continue.
Yes, if this is not the case, thanks, everyone, for this, in my point of view, a very fruitful discussion. And then we will hear or see us latest in our full year call. Thanks very much. Bye-bye, everybody.
That does conclude the conference for today. Thank you for participating. You may all disconnect.