Good day, ladies and gentlemen. This is Alan Chapple, Director of Corporate Communications at Rain Carbon Incorporated. Welcome to Rain Industries Limited earnings discussion for the second quarter of 2022. With me on the call today are Mr. Jagan Reddy Nellore, Vice Chairman of Rain Industries Limited, Mr. Gerard Sweeney, President of Rain Carbon Incorporated, and Mr. T. Srinivasa Rao, Chief Financial Officer of Rain Industries Limited. Along with the earnings presentation, we also released management commentary on July 29, 2022. We've been receiving questions from certain investors and analysts regarding industry developments and the status of our expansion projects. Accordingly, Rain management will be addressing those questions. Before we begin, management would like to mention that some of the statements made in today's discussion may be forward-looking in nature, and they could be affected by certain risks and uncertainties.
The company's actual results could differ materially from such forward-looking statements. We will now start the discussion. Gerry, the first question is in regards to our operations in Europe. Can you provide an overview of the current energy situation and how it is impacting our operations in Germany, Belgium, and Poland? Will we be able to operate at optimum capacity over the coming quarters? Is there a risk of decrease in volumes for any of our products due to the energy crisis? If so, do we have any contingency plans in place?
Thanks, Alan. That's an important question. I'll provide as much detail as I can to address investors' concerns. We're not the only ones facing the issue of natural gas shortage in Europe, and many of our suppliers and customers in Europe may also see supply impacted by these shortages. First and foremost, we have the technical ability to substitute a good portion of our natural gas fuel with liquid petroleum products, and we are in discussion with European authorities to finalize the required permitting changes while building strategic inventories for such alternative fuels. To further address our contingency plans, we've hedged approximately 50% of our European gas requirements for the second half of the year. We're also constantly reevaluating and identifying the energy intensity of, and flexibility limits of each of our production units.
Management has developed different contingency plans that could see us strategically and temporarily reduce or curtail production of certain units at certain sites to ensure we optimize available gas supplies at all times. To address the final part of this topic in your questions, yes, we absolutely would see a decrease in volumes in certain product categories if the situation were to hit a worst-case scenario. That said, we remain hopeful that energy prices in Europe will fall to a point where our European customers could economically resume and/or increase their own capacity utilization levels.
Thanks, Gerry. Turning to aluminum, are we able to pass on these increased costs to customers given that LME prices are trending down toward $2,400?
Well, as far as the LME prices and the trend down from 4,000-2,400, that really has very little impact on us as a company. That more impacts the aluminum production possibilities itself. As a converter, our costs, our raw material costs and changes have always been reflected in our finished product prices. That comes at times with a certain time lag. As far as our ability to pass through increased costs to customers, we've been able to do that consistently as the price has grown, and we do that to this point. If prices were to drop due to demand fall off, that would create pressure on some of these costs.
We don't expect it would be anything that would last beyond, say, a one-quarter time period that could impact us if the market were to turn down, which right now it has not done.
Okay. Thanks, Gerry. Staying on the topic of aluminum, what is the recent impact on production among our European coal tar pitch and calcined petroleum coke customers? Also, given the high level of natural gas and energy prices, how much smelting capacity has been curtailed or shut down during the past six months? Finally, have we managed to compensate for the situation in Europe by finding alternative customers in other parts of the world, or are these volumes marginal?
Thanks, Alan. Rain is a global player, and we have very flexible and unique logistical capabilities, allowing us to competitively supply aluminum smelters around the world from all our sites. Our sales have never been limited to Europe, but have fluctuated with global markets and continue to do so. Historically, high prices for natural gas and coal have led to historically high electricity prices for aluminum smelters in almost all parts of the world. Those smelters, including Rain's customers, that have been the most impacted seem to be the ones that were more dependent on spot electricity purchases. That being said, several additional smelters will likely soon see their long-term electricity supply contracts come to an end, so their costs may soon also rise. Overall, smelting capacity has actually been increasing in certain parts of the world while declining in others. This is true for us as well.
This is mainly in line with each smelter's electricity contract price situation.
Okay to follow up, do you think Europe faces a structural risk of permanent closures of aluminum smelters along with other industries that RAIN caters to? If so, how do we plan to mitigate this risk? If we are required to expand our customer base outside of Europe, would that lead to a decrease in margins due to higher logistics costs?
Yeah. As indicated in our management presentation, certain European smelters operating in Scandinavia and Canada source electric power from hydro plants, and they're not impacted by high energy prices at all. RAIN is a global player, as I said earlier, with a highly advantageous logistical capability that allows our plants to source raw materials from around the world and send our finished products back out across the globe. While we have production sites spread across three continents, all of these sites are supplied by a blend of local and global raw material suppliers, and all of them send their finished products to both local and global customers, utilizing our established high volume logistical infrastructure network. Therefore, if there is market weakness in Europe, we are still well situated and already do supply the markets outside of Europe.
Thanks, Gerry. Given the drop in LME aluminum prices and China's economic slowdown leading to higher availability of CPC, are we seeing a moderation in CPC or coal tar pitch prices, or can we expect prices to remain at elevated levels due to supply chain issues?
LME prices are down from a record high of $4,000 and back down to $2,400 level during the second quarter. This is still a healthy price for aluminum smelters. We've not seen a production decrease correlating to necessarily the fall in the LME price itself. What we have seen is really smelters impacted to the extent that they're exposed to extremely high energy prices. From our perspective in CPC and coal tar pitch prices, we have not seen those prices come down. We have seen them level off. This is in relation to really a flattening of demand, you would say, prices reaching their peak, which are record levels in most instances.
We have seen some impact in the markets, in our markets related to the Chinese slowdown, due to COVID, and the lockdowns that resulted from it. Overall, you know, we have not seen to this point a drop in our coal tar pitch or our calcined petroleum coke prices. It is something that we're preparing for late in the year, as the markets continue to slow down.
Okay, Gerry, back on the topic of energy, what is our energy source for U.S. calcination plants? Natural gas, coking coal or coal? Also, what would be the likely impact on margins if U.S. energy costs rose?
For the most part, petroleum coke calcination kilns only require fuel during their initial heat-up. RAIN uses natural gas during those brief heat-up periods. Once kiln operation temperatures are achieved, the calcination process itself does not require supplemental fuel. After that, the process gives off heat, which most calciners waste by allowing it to just escape up the stack into the atmosphere. At RAIN, we have invested heavily in equipment at most of our calcination plants to capture that waste heat and use it to generate steam or electricity. We therefore have natural built-in hedges at these locations where we can sell our power at higher prices when the prices for competing energy sources such as coal or gas are higher. As a result, we currently do not see a negative impact in the U.S. .
In fact, we are seeing a likely increase in coal and gas prices as the winter approaches, since there would likely be increased demand in Europe for more liquefied natural gas shipments coming from the US.
Thanks, Gerry. Heading back over to Europe, what is the current capacity utilization of the new hydrogenated hydrocarbon resins facility in Germany? I believe the numbers are getting reported in the resin segment. If yes, how much percentage is HHCR of the total resins volume?
Currently, our new HHCR unit is operating at about 50% of its capacity, and we remain cautiously optimistic that the plant will be operating at 75% of capacity by year-end. Increased production and sales volumes will translate into lower production costs for this unit, which will help its profitability as well. HHCR products are indeed grouped under the resin sub-segment of our Advanced Materials reporting segment.
Thanks, Gerry. Are we seeing growing preference for European manufactured goods within Europe compared to goods coming from outside the European Union? If so, what does that mean for regionally produced products such as our advanced HHCR resins and coal tar pitch?
We're not specifically seeing any regional preferences to purchases of European manufactured goods by EU customers. While we have seen an increase in demand for our European-made HHCR product from our European customers, this has been due to multiple supply chain disruptions and cost increases experienced by our competitors in Asia while trying to deliver material to Europe. Our delivery distances to our European customers are, of course, much shorter, which leaves less chance of an unplanned shipping disruption and cost increases along the way compared to material that would come from Asian suppliers. In terms of coal tar pitch, we see that our European customers, like those in other regions, will generally choose whatever material they can receive at the lowest possible price, irrespective of its regional origin or association. As long as the quality is adequate and the supply chain is reliable, they will take it.
Thanks, Gerry. How are competitors coping with the various issues that we're facing in Europe? Have we seen any reduction in capacity from any of our major competitors in the carbon or advanced materials businesses?
Yeah, while we don't comment on specific competitors in the numerous industries where we are active, we can say that we have seen some of our competitors reduce their capacities for various reasons on all three continents where we have production facilities. There are various reasons, both directly and indirectly linked to the recent energy situation in Europe and the war in Ukraine in both the Carbon and Advanced Materials segments where we compete.
Thanks, Gerry. What is the potential impact on demand for Carbon products such as coal tar pitch and other Carbon products due to the slowdown of manufacturing in Europe?
You know, this is an evolving situation, so I just wanna be careful in you know, how we couch our response. At the moment, we really expect the third quarter volumes to pretty much across the board be in line with second quarter volumes. Beyond that period, it's really still too early to see how the European energy situation will evolve to impact us, our suppliers, customers and competitors. However, however it works out though, and whatever the new normal might be in the future, we're very comfortable with our ability to compete and to supply our customer base.
Okay, staying on the subject of coal tar pitch, what is our current CTP capacity utilization? What is the trend going forward, especially considering the smelter closures in Europe?
Capacity utilization for our pitch production during the first half of 2022 was around 80%. We currently don't expect that trend to change drastically as we maintain long-term contracts with our suppliers and our customers. However, we do need to watch the markets closely for any major energy-related developments which could have a you know, more immediate impact going forward.
Great. Thanks, Gerry. We now have several questions for Jagan. First, what is the current situation of our business in Russia, and are there still restrictions on fund outflows from Russia? Also, what actions is management taking to address this issue?
Thank you, Alan Chapple. As mentioned in our previous management commentary and Q&A sessions, Russia contributes about 8% of the RAIN Group's revenue. Basically, majority of that site's sales and raw material procurements are within Russia, and we have no material impact to our operations at this time. In regard to the fund flow, we are actually seeing how the developments will evolve and will comment probably at the end of next quarter. The company has, and will adhere to all applicable sanctions related to Russia.
Thanks, Jagan. The next question is about the new vertical shaft calciner and the rotary kiln calciner in India, which have been impacted due to a shortage of GPC. In fact, one of our rotary kilns in India was shut down due to this. Is there any ray of hope for a permanent solution in the near term?
As referred in the management comments, the Ministry of Environment, Forest and Climate Change in India released a draft notification for setting certain CPC emission standards at end of May 2022. Technically, there have been a 60 days time for implementation. However, there is no definitive time frame given for finalization of those standards or for the implementation of the final standards. What we can say with some degree of confidence is that, if the draft standards are adopted as final, Rain's two CPC plants in India, which are already equipped with, waste heat recovery generation and flue gas scrubbing systems, would comply with those emission limits without requiring significant investment.
Simultaneously, we are working with the government in India and the honorable courts to explain the clear environmental benefits stemming from India's proactive investments in such a sustainable technologies while we request for incremental RPC and GPC and CPC allocation.
Okay. Thanks, Jagan. Can you provide us some insight into the capacity utilization of our CPC facilities by region?
The calcination facilities are operating at about 70% capacity at this time, primarily due to the GPC import restrictions in India. Once the situation is resolved, we anticipate being able to increase utilization back to the mid-80% range. We are running that as we were running prior to the implementation of the restrictions.
Okay, moving on to the cement segment. Margins were impacted due to higher energy costs. Do we have captive energy to run these plants? In addition, what's the progress of our solar energy installations at the two cement plants and how much energy will they contribute once fully operational?
Rain solar power plant, the expansion projects are expected to be online by end of third quarter. This expansion will increase the renewable energy generation capacity in Rain Cement segment to 13.6 MW, which is about 6.0% of the segment's total energy requirement.
Okay, turning to our anhydrous carbon pellets. When can we expect commercial production of ACP in the U.S. ? Also, do we have any further clarity on the Indian ACP plant?
Referring to the management comments, we have sent a commercial scale shipment to a major aluminum smelter for testing and are awaiting their operational data and feedback. Actually, we are focused on optimizing and stabilizing the ACP production line and the performance of ACP in our calcination kilns. In doing so, we are gaining a better understanding of the cost of producing ACP and its benefits. With regard to the ACP plant in India, we will start work on that project once we have optimized our US plant's performance to avoid any issues in India and to incorporate any applicable lessons learned and best practices.
Thank you. In recent months, there's been growing concern that the global economy could be headed toward a downturn following a period of red-hot demand as we emerge from the depths of the COVID pandemic. With that in mind, what is Rain doing to prepare for a possible downturn? Do we plan to change any aspects of our business, for example, raw material procurement or our contracts with customers based on lessons learned from previous downturns?
While the past several quarters have indeed been favorable, what we experienced is not the new normal, and this correction should not come as a surprise to anyone after a commodity super cycle. The good news is that we are taking appropriate steps to prepare for a downturn trend. Our ongoing focus is on cost control, raw material acquisition, and reducing inventory levels.
Okay, moving on. You've spoken in the past about increasing capacity in our Engineered Products business through expansion or debottlenecking. Is that on hold? Or I'm sorry, does that still hold?
While we did not mention increasing the capacities of any units, we have undertaken a project to alter one of our production units in Europe to facilitate the production of both CARBORES and PETRORES engineered products to meet the increasing demand. As referred to in our management comments, due to the impact of the COVID lockdowns in China, we have seen lower demand for CARBORES and PETRORES during the second quarter. However, we are continuously monitoring the demand for these products and taking necessary steps to increase production as the market picks back up again.
Okay. Turning to R&D activities. Are there any new products under development that have the contribution potential of our advanced resins?
At this time, we have no new major R&D announcement to make, but we can say that our teams are continuously and actively researching the use of more sustainable raw materials and production methods, along with unique new uses for our materials. We want to commercialize HHCR and ACP fully before starting any other new projects.
Okay, thanks, Jagan. I have one last question for you. A couple of years ago, we announced the establishment of Rain Verticals. Is there any action on this front?
As we are focusing on mitigating risks associated with the energy availability and energy costs, we have not initiated any work on Rain Verticals. We will start the same after a few quarters.
Okay, thanks, Jagan. Our final set of questions are for Srinivas. First, considering that Rain's bonds are trading at $99.94, do we plan to be more aggressive in buying back the bonds?
Thank you, Alan. We are closely watching the company's cash position and the trading levels of our long-term debt. When the market conditions are favorable and we have excess cash, we will continue to pick up volumes as they become available to us. As mentioned in our earlier commentaries, our capital expenditure on major expansion projects are completed, and we will be using the excess cash towards reduction of debt.
Thanks, Srinivas. Can you provide an update on the timeline for refinancing?
Currently, the high-yield debt market is too volatile, and the potential for refinancing at lower rate of interest compared to our existing interest rate is not realistic. However, our long-term debt matures in Q1 of 2025, and we have time to refinance that. We will continue to watch the market for an opportunity to refinance, but we do not expect anything prior to Q1 or Q2 of 2023.
Okay, thank you. What measures is Rain taking toward minimizing its working capital requirement?
The company has used a significant amount of working capital finance during the peak prices of raw materials, as the majority of the working capital is tied up in inventories. We expect a downward trend of prices by end of the year and the release of cash from the working capital.
Thank you. In the second quarter presentation, we disclosed the phase out of our aromatic chemicals business in Germany. What are the likely top line and bottom line impacts due to the closure, and do we plan to restart the business in the future?
Closure of our aromatic chemicals business is not a material or major impact to our top line or bottom line. As mentioned in the presentation, the sale of 3,5-BMP has dried up, and the energy costs of operating the unit are high due to large consumption in the production process. The personnel cost in terms of severance payments will not be an impact, as we are shifting those employees to other parts of the business where we have vacancies or to replace external consultants.
Okay, as a follow-up question, what would be the impairment impact due to the closure of the aromatic chemicals plant?
A majority of the assets are fully depreciated. There's no impact. There is no impairment impact on closure of AC business. However, we will incur certain expenses like dismantling the plant and machinery and cleaning the land based on local regulatory requirements, which accounts for about $5 million that we have made a provision for it in the second quarter of 2022.
Thanks, Srinivas. Our final question today is about the impact of the depreciation of the euro versus the US dollar. Does it make our business more competitive?
The majority of our transactions are naturally hedged, and we will not have a material impact due to the fluctuation of the euro against the U.S. dollar. Even our debt is spread between the two currencies based on earnings in each currency.
Thanks, Srinivas. Thank you, Jagan and Gerry. Ladies and gentlemen, this concludes Rain's management question and answer session for the June quarter of 2022.