Earnings Call: Q2 2023

Jul 21, 2023

Summary

Q2 revenue rose 11% YoY to $271 million, while EBITDA declined under expansion, launch and FX pressures. Net leverage was 1.0x; management expects line six to stabilize in Q3 and targets recovery in EBITDA per ton.

Good day everyone, and welcome to GIS second quarter 2023 earnings conference call. Joining us today is GIS Chief Executive Officer, Mr. Jorge Rada, GIS Chief Financial Officer, Mr. Saúl Castañeda, and GIS Investor Relations Manager, Mr. Arturo Morales. Please be advised that this call is for investors and analysts only. During this call, they will be discussing GIS performance as per the earnings release issued today. If you did not receive the report, it is available at www.gis.com.mx in the investor relations section. We encourage you to follow along with the onscreen presentation. All lines have been placed on mute to prevent any background noise. There will be a question and answer session after the speaker's opening remarks and instructions will be given at that time. Let me remind you that forward-looking statements may be made during this conference call. These are based on information that is currently available and subject to change due to a variety of factors. For more detail and a complete disclaimer, please refer to the earnings release. Also, all figures discussed are in U.S. dollars, unless otherwise stated. It is now my pleasure to introduce the GIS team. Mr. Jorge Rada will lead off the call. Good afternoon, and thank you all for joining us today. The year 2023 shows promising signs of recovery for the global automotive industry. The supply chain disruptions witnessed since the beginning of the pandemic are trailing, thus leading to an improved outlook, while pent-up demand in key markets has also contributed to the increase in vehicle sales. During the quarter, we have faced operational challenges in North America. Most of them linked to dynamic customer demand. The cost associated to launching of new products and the launch of the capacity expansion in San Luis Potosí impacted the business EBITDA. We will overcome this situation in the next months with the stabilization of the capacity expansion projects. GIS revenue for the quarter was $271 million over the quarter, with an 11% annual growth, performance attributed to Draxton volume growth and the expansion in value-added processes, as well as inflation-related price adjustments. The EBITDA was $14 million, lower than its annual comparative base, primarily due to the aforementioned challenges and effects from the appreciation of the Mexican peso. Following debt prepayments executed in the last months, our net leverage ratio currently stands at one time. During the quarter, the credit rating agencies, Fitch and HR, raised GIS credit rating to double A on a national scale. On other developments, on April 12, according to the resolutions of our annual general meeting, a cash dividend of 5 pesos per share was distributed to our shareholders. On April 13, the local notes program, GISSA 17, was fully paid in advance. With this, I hand the presentation over to Saúl. Thank you, Jorge, and good day everyone. The company's financial performance continued to show a positive trend, primarily following high volumes attained at Draxton. This achievement was due to the successful implementation of new initiatives and increased vehicle production of customers across different geographies at the face of a recovery in the global automotive industry's production pace. In the second quarter 2023, GIS recorded revenues of $271 million, growing 11% when compared to the $243 million achieved in the same period last year, mainly due to incremental volumes in both automotive castings and machining, alongside the recovery trend in the global vehicle production, the nearshoring effect in Mexico, and adjustments in price formulas. During the second quarter 2023, the company's EBITDA was $14 million, lower than that of the same period last year. This number reflects costs associated to the introduction of new programs and the start-up of line six in San Luis Potosí, coupled with the appreciation effects of the Mexican peso. As of quarter end, and after the debt repayment made after completing the Vitromex divestiture, net debt stood at $109 million, while the net leverage ratio remains stable at 1 time compared to the 1.9 times of last year, thus reflecting a lower debt and solid liquidity. During the second quarter, the company continued to achieve significant progress in its capacity expansion projects in line with its planned CapEx program. These expansions will add new casting lines and increase manufacturing capabilities, allowing us to meet the growing demand. Furthermore, GIS continued securing new programs, achieving approximately $49 million in the first half of the year. This performance shows the efforts to capitalize on the ongoing recovery of the sector and strengthening our market position. Looking ahead, in 2023, estimated CapEx amounts to $130 million, including investments related to previously announced casting and machining expansions, as well as the continued development of value-added processes. I will now hand the presentation back over to Jorge. Thank you, Saúl. Now moving on to the developments of the automotive industry. North America posted a positive second quarter with a 14% annual growth in vehicle production, driven by the recovery of the semiconductor shortages and improvements in the supply chain. Vehicle sales also advanced 13% on an annual basis, partially covering the pent-up demand on the pandemic. In Europe, both production and sales saw significant annual growth rates of 12% and 19%, respectively. Improved semiconductor supplies and reduced energy risks contributed to this performance, despite high interest rates and persistent effects of the Ukraine conflict. It is important to note that we expect this favorable trend to continue. China delivered a strong performance in the second quarter, posting an annual growth of 18% in both production and sales. This achievement can be attributed to the successful implementation of pricing strategies by OEMs, coupled with the existing incentives to stimulate the adoption of electric vehicles. Overall expectations mark that this positive trend will persist throughout the year despite geopolitical tensions. Moving on to Draxton's performance. Casting and machining volumes posted a significant growth, boosting sales by 14%. For the second consecutive quarter, achieved record casting and machining volumes after posting growth rates of 22% and 78% in these items. In North America, casting volumes increased 18% on an annual basis, while machining volumes grew 131%. Europe and Asia also showed a strong performance, with casting volumes up 26% and machining volumes 29%. Draxton's second quarter revenues increased 14%, with North America generating $124 million, and Europe and Asia contributing with other $124 million, representing 12% and 17% annual growth rates, respectively. Year to date, revenues reached $487 million, reporting an aggregated growth of 12% versus the same period last year. During the quarter, we faced operational challenges primarily derived from an exceptional customer demand and costs associated with product launches and the launch phase of line six of San Luis Potosí's expansion. Furthermore, the appreciation of the Mexican peso represented a $4 million impact this quarter. Consequently, the quarterly EBITDA amounted to $18 million, representing 70, sorry, 7% of revenue, lower than the margin achieved in the same period last year. Draxton will continue to focus on securing new contracts to produce automotive parts agnostic to electrification to supply hybrid and full electric platforms. Regarding Cinsa, quarterly revenues declined 21% due to a soft demand for household goods, both domestically and internationally. Quarterly EBITDA stood at MXN 23 million. Efforts to increase prices, develop new products, enhance customer service, and achieve commercial and operational efficiencies have helped to mitigate the impact of market contraction. In this sense, our focus for this year remains oriented to consolidate incremental revenue in the U.S. to accelerate market penetration for our proprietary brands and prioritize further efficiency enhancements. With this, I conclude my remarks for today. Thank you all for your attention, and we can now begin the Q&A session. Thank you. At this time, we will open the floor for your questions. Ladies and gentlemen, if you have a question, please use the raise hand function on your Zoom tool. Please make sure that the microphone is turned on. Our first question come from Carlos Alcaraz of Apalache Análisis. Please, sir, go ahead. Hello, Saúl, Jorge. Thank you very much for the space, and congratulations for the results. Just a few very quick questions. First, I would like to ask if you are looking to increase your leverage in the short term to continue expanding your installed capacity. When do you expect production in North America to stabilize and the EBITDA margin return to its positive trend? Thank you. You start with the first. Sure. Thank you, Carlos, for your question. First of all, I will say that priority at this moment is to consolidate the actual ongoing CapEx expansions. With that said, I will like to remind you that around $130 million were in progress to be deployed as CapEx projects for, as you know, line six, line seven in San Luis Potosí, but also to triple machining and entering into a new process that is called plating. So at this moment, Carlos, I will say that we are more focused on consolidate and deploy those CapEx expansions projects to stabilize those. As you say, we have a very healthy financial situation with a good and solid balance sheet, a lot of space in our leverage ratio. We are always looking for opportunities on the market, but I would say our top priority is concentrating on the first part that I already mentioned. I don't know if you want to comment. No, let me continue with the second part of the question. We are working already with action plans to improve the performance, especially of the new expansion projects that we have in San Luis Potosí. We are certain that during the third quarter, we will stabilize that expansion, the first phase. The second phase of the expansion, we're going to start operations in the fourth quarter. Actually, we expect to start validating products in that second phase, start in October. So October, November, December is going to be the launching of the second phase. We will call it, just for everybody to remember, line 6 and line 7. The line 6 is already running, but it's starting operations, will stabilize in the third quarter, and the last quarter is going to be line 7 being validated and start running in January. You will gradually see in the next months, a big difference in the results. Okay, I understand. Thank you very much, Jorge Rada, Saúl Castañeda. Have a good one. Thank you, Carlos. Thank you, Carlos. Our next question comes from Alejandro Azar, from GBM. Please, sir, go ahead. Hi, Jorge, Saúl, Arturo. Nice talking to you. My question is on the same path as the last one. If you could give us more color on the second quarter impacts. You already gave us the FX. Thank you for that. No problem. Can you clarify the amount of launching expenses, the other expenses regarding the start-up of line six, and how are we going to see that recovery, or the phase out of these costs? You already mentioned, Jorge, that the third quarter will have more stabilized production on the new line and then the other line on January. Could you help us on those impacts for the second quarter, please? Want to start, please, Saúl? Sure. First of all, good afternoon, Alejandro. Thank you for joining. I would like to start emphasizing that our comparable basis or comparison basis is also affected by the elements or issues that we already discussed. Also to remind you that during the second quarter of 2022, we had a favorable raw material indexation effect. I would say that was another one that hit us during the quarter. Probably at this moment, we do not have, or we don't get into details on each effect, Alejandro, but I could say that it's basically concentrated on those issues or challenges that we have regarding the expansion, the premium freight related to those, I would say delays on the launch of the line six. As you already mentioned, a major impact, and even bigger than the one that we had during our first quarter, was the FX effect. Just to give you a reference, during the first quarter, that impact was $2 million. We doubled, or we had that double of the impact during this quarter. I would say the rest of the elements will be probably in the same basis distributed on those aspects that we already covered. I don't know if you would like to add something. Let me rephrase the question. You had an EBITDA per ton, or EBITDA per casting unit of $182. That was more closer to $280 last year. Is that $280, $300 still on your mind once the new capacity stabilizes? Or is there any impacts that are here to stay apart from the FX? Alejandro, you are totally right, and I think you're talking a very important point. Our target is going to be to come back to the normal EBITDA per ton. Now we are in this situation right now, which we will put behind very soon. I think it's fair to say that we will come back to the 280 number, and our target is going to be to cross the level of 300. Okay? Just to give you the confidence that we have the action plans in place, and definitely we have to come back to that number. In addition to that, we know that the exchange rate in Mexico, everybody here knows that this is a very special situation right now. But we see that this is going to remain like this for several, maybe years. All the forecasts that we have seen indicate that the exchange rate will remain like that. Definitely the same as we did with the energy prices in Europe in 2021 when we made indexation formulas with the customers, we will have to work on negotiating with the customers to try to make formulas also for the exchange rate on the costs that are in pesos. Otherwise, you cannot continue like this. It's a very heavy impact, and we will work on that with the customers. So one more, if I may, Jorge. I was going to ask about if you are currently negotiating any other indexation apart from what you did last year. I do not know, labor, you already mentioned FX. Is there any Well, actually, FX, I really meant labor. I really meant labor because the labor in Mexico is peso based. Oh, I am sorry. Yeah. All the other indexations, we worked on that already. For example, raw material is indexed 100%, but we added other elements of the raw materials that were not indexed. Then we worked also on energy. Okay. Because in Europe, especially, the energy effect was variable during 2021 and beginning of 2022. Fortunately, we have almost more than 90% of the energy indexed already with formulas in Europe. Now the next step is going to be indexation of labor and exchange rate in Mexico because of the situation we are seeing right now. Okay. So currently you're only negotiating labor, right? Yes. Of course, there is another negotiation that is parallel, which is inflation, which is different from labor, right? That is in parallel, and we have done very good steps both in Europe and in North America to transfer inflation costs to the customers. Okay. Thank you. Thank you guys for the answers. Thank you. You are welcome. Once again, if you would like to make a question, use the function, raise your hand from tool. With no further questions, I would like to turn the call to the management. Thank you, and thank you everyone once again for your interest in GIS. Please don't hesitate to contact us if you have further questions. Have a nice day. Thank you. Thanks. With this, we conclude the conference of this afternoon. You may disconnect.