Good morning, and thank you for waiting. We would like to welcome you to the conference call for earnings for Q3 2019 for Tupy. All the participants will be connected only in the listen mode, and later we will have a Q&A session when further instructions will be supplied to you. If you need any assistance from an operator, please dial asterisk zero. This conference call is being recorded. The company would like to remind you that this event is also being transmitted simultaneously by the internet, by a webcast at www.tupy.com.br/ri, where you will find the slide presentation. The selection of the slides is controlled by you. The company clarifies that any declarations made during this conference call concerning business perspective, projections, operational goals, financial goals, concerning the business of Tupy, are forecasts based on the expectations of management in relation to the future of the company.
These expectations are highly dependent on the conditions of the domestic and international markets, the economic performance of the country, and also the sector, subject to changes. Here we have with us Mr. Fernando Cestari de Rizzo, Chairman of the company, and Mr. Thiago Struminski, Vice President of Finance, Administration, and Control. Mr. Fernando, you may proceed.
Good morning. I thank you for your interest and also your presence. On slide number three, I would like to say that we are very happy to see more graphic quarter, that the actions that we plan to have greater operational efficiency have been converted into results. We can see this in the evolution of the many indicators. This is the fruits of a renewed, more dynamic management, thus improving processes from end to end, from sales, manufacture, going through engineering, purchasing, and sales. Our revenue grew 1.8% in relation to Q3 2018, in spite of the drop in the physical sales volume.
Apart from a favorable exchange rate scenario, it is also due to our strict commercial strategy with better prices and an increase in the share of high-value added products, such as CGI, which went from 13% - 22%, and the expansion of the machining operation from 19% - 26%. Our objective is to continue making progress in these fronts, increasing our participation in the value chain of our clients. Gross margin reached 18.2% and increased 70 basis points in relation to Q3 2018 and Q2 2019. The best margin in the last two years. We believe that with the increase in our share in these products and a greater operational efficiency, we will reach even better margins.
We have reached also the highest adjusted EBITDA at the peak of our history, with margins of 15.4% and 14.1%, respectively. This growth is the result of the combination of two key factors for our operation: an effective commercial strategy, and continuous improvement in processes which give us productivity gains. I would like to stress that these margins do not reflect the total potential of our portfolio. As I said in the previous call, we are extracting more value from this portfolio with a new style of management. The innovation with new products from Mexico have improved, but they have not reached the standards we believe are good. We were able to grow, although we had a drop in volumes, and we have adapted ourselves in an agile way, preserving our margins from market fluctuations.
Thus, we triggered our defense actions, a set of actions that were predefined, including flexibility in transferring products from plant to plant, maximizing also the scale, and many activities involving reduction in fixed costs that were previously planned. I am sure we are on the right track. We have many opportunities to increase margins due to a better mix in products, new contracts, and operational efficiency gains. This increase in Mexico, which until recently had higher margins than Brazil, had its profitability hurt. There was a lot of growth in the volume in some lines, and this hurts economy of scale. Also, ramp up of very complex products and a learning curve. Thus, we are working on these, and certainly in the future, the results in Mexico will improve.
To give you an example, the percentage of products made in CGI Mexico went from 8% - 20% in the last two years. Finally, we increased significantly our operational cash generation, which reached BRL 155 million in the period, taking our net debt adjusted EBITDA ratio to 1.29 x, showing the resilience of our business model and will allow us to make the necessary investment to capture the opportunity that will arise in the next few years. To talk about the main indicators, I invite Thiago Struminski, our CFO.
Thank you, Fernando. Slide four, 147,000 tons, a drop of 4% in relation to Q3 2018. Of the transportation infrastructure and agriculture volume, 26% was totally or partially machined, 22% produced in CGI. On slide five, the revenue increased 2% to BRL 1.339 million. The factors that contributed were the product mix, revenue from services of engineering, exchange rate devaluation, and the ability to pass on the cost to the prices. In the domestic market, we saw a growth, 12% due to the stability. It is important to say that the recovery of the Mexican market is very important for the company. 63% of the revenue came from NAFTA. In this case, we have to say that in this region, we use many plants as hubs for export. 20% South American, Central America, 12% Europe, 5% Asia, Africa, Oceania.
In terms of application, 82% commercial and off-road vehicles, 13% passenger cars. On slide six, we see the revenue from transportation infrastructure and agriculture in the domestic market. An increase in light vehicles. There was a phase-out of some products. This was already planned, and also there was a drop in indirect exports. Slide number seven, the revenue from the export market had an impact due to phasing and ramp-up of products, and an increase in the share of high-value-added products such as CGI and machine products. This gave us an increase of 33% in passenger cars, 5% increase in light commercial vehicles, 11% in medium and heavy vehicles, and a drop of 15% in off-road, and also sectors like oil and gas, agriculture, and construction.
Slide eight shows the sales of hydraulics, 5% of the revenue. Internal and export markets had a growth of 15% and 5% respectively due to the increase in volume, price, and exchange rates depreciation. Going on to slide number nine, we see here CPV and operational expenses. CPV BRL 1.1 billion, 4% higher to that of Q3 2018, reaching a gross margin of 18.2%, a growth of 70 basis points. Also in this period, 5% drop in the cost of raw materials due to the price reduction in materials and also gains in efficiency. In spite of the increase of CPV and machining that require higher value materials. A growth of 10% in the expenses with labor, social benefits. We would like to say that looking at the previous quarter, Q2 2019, there was a 3% drop in this line due to actions to improve operations and reduction in overtime.
Operational expenses went up 8%. This variance is linked to greater expense with labor, freight, and third-party services. When compared to the previous quarter, we see a drop of 4%. Slide number 10, adjusted EBITDA reached BRL 207 million, highest amount, 5% increase in relation to Q3 2018, with a margin of 15.4%, a substantial increase in relation to Q2 2019, 80 basis points, and due to initiatives, internal initiatives, greater operational efficiency, new project in Brazil, and ramp-up of products in Mexico. At the bottom of the slide, net profit shows BRL 59 million in comparison with BRL 89 million in Q2 2018. This was affected by tax benefits due to the payment of interest on capital in 2018.
On slide 11, we see the variances in the main working capital accounts, an increase of seven days in the cash conversion cycle, higher inventory, BRL 62 million, and an increase of five days. This increase is due to the transfer of production from Mexico to Brazil in order to preserve our margins. On the next slide, number 12, we see the investments in assets intangible, BRL 59 million. These investments during Q3 2019 represented 4.4% of the revenue, and once again, they are lower than the depreciation and amortization of the period. Slide number 13 shows operational cash, BRL 155 million, firstly due to profit before taxes and also lower variance in working capital in comparison with the previous quarter. Slide 14, we show net debt, BRL 899 million, corresponding to 1.29 x adjusted EBITDA for the last 12 months.
Our obligations in foreign currency represent 98%, which is in line with our business. Most of this debt in foreign currency is represented by our bonds, which will become mature only in 2024. Now I would like to pass the floor to Fernando. He will make his final comments.
Thank you, Thiago. On slide 15, I would like to stress, after a beginning of the year with many non-recurring events, we have increased a lot our margins in spite of lower volumes at the beginning of very complex operations such as machining, on large-scale machining of components, CGI Mexico. This performance was based on a review of our organizational structure that began last year to bring more agility to the decision-making process and concentrating efforts on critical processes for our business. We hired new executives for key positions with experience in management of global companies, which, together with our internal talent professionals with a lot of experience, knowledge of the market, and technical capacity.
In relation to operations, we increased a lot operational efficiency of the Joinville plant with many actions related to reduction in materials consumption, optimization of the ovens, and also metal alloys and also less scrap and less absenteeism. This will be extended to other plants. We know that Mexico has higher margins than Brazil, but they are still in a ramp-up phase, and they are working on the ramp-up. We are working on many fronts within a growth strategy with profitability. Apart from the perspective of new contracts in 2020, we continue evaluating strategic acquisitions, which will bring efficiency gains and access to new products and geographies, and also the sharing of best practices for research and development in operations. The search for flexibility in the production process continues, adapting the company for scenarios with drops in volume and mitigating the impact on margins. Slide 17.
I would like to stress that this fluctuation is due to a different type of cycle, depending on each market segment and region. In other words, the diversification that is present in our business model is based on solid pillars and sectors that will continue for decades, clients that will continue for decades, and also due to the increasing global demand of the population for food infrastructure, transportation, energy. We continue to benefit the recovery of Brazilian economy. In relations of export markets, we see solid signs in the U.S. economy and in all the indicators, employment and consumption. We have had lower volumes due to high level of heavy inventory of heavy vehicles. We have also seen a drop in exports to the main economies in Europe with delayed investments in Europe.
These effects will be compensated by the product mix with more added value, an increase in the share of machining, services, and complex alloys in CGI and engineering services, as well as gains in efficiency, flexibility, and things that are being implemented more rapidly if volumes drop more. This will prepare the company for a new cycle of growth. It is also an opportunity to reduce our cost with overtime maintenance, energy with better usage. Slide 18. I like to stress that our business model is based on resilience, diversification, and a great percentage of variable cost, mitigating the impact of drops in demands. With the same economic effects that have an impact on our volumes, we also have the depreciation of the local currency, which help our revenue, and because most of our products are sold in strong currency. We have a dynamic operational model.
We want to respond in an agile way if we have further reduction in volumes. We are always working on this with our actions to defend ourselves. We transferred production, as an example, from Mexico to Brazil in order to have better efficiency in the use of lines and mitigating the effect of lower volumes in our margins. The results that we show today have been built in the last two years. They are the result of our strategic decisions. In the first nine months of 2019, in comparison with 2017, our revenue grew 47% and absolute EBITDA 41%. We count on a smaller base of assets, less plants, due to a rigid investment discipline. Also, we stopped some plants such as in Mauá and the sale of assets. We increased the unit value of our products, thus generating more value for the shareholders.
All of this is a result of the management aimed at results, which generates value in all the activities under our control. The operations in Mexico still have a great opportunity for the company in 2020. We increased significantly the margins after acquisition in 2012. It remained higher than in Brazil, the margins, until recently, when we had a great increase in volume, which thus hurt our economy of scale due to very complex products with less efficiency, but with a great potential in the long term. We continue adopting a methodology that is very strict in allocating capital with investments that are lower than depreciation. We continue investing in safety and also projects to increase efficiency. We increase cash generation, which allows us a comfortable situation.
Our products are known for their quality and technological innovation, and this is linked to investments made in R&D, as well as in partnerships that we've developed with universities in Brazil and abroad. Now we're searching to increase the look at our production system, which has continuous improvement in processes, and we are getting closer to the ecosystem of startups, aiming at improving our practices using Industry 4.0. Among the initiatives, I say we are working to use advanced mathematical modeling to choose materials and analytics, apart from many automation, traceability, and other initiatives. To conclude, the organizational culture of Tupy is based on our values, and this has sustained the delivery of solid results. We were able to preserve our concern with people, safety, and the environment. Even with a market that is more and more dynamic, but we are prepared to adapt.
But with always having focus on generating value for our clients, shareholders, employees, and community. I thank you for your attention. Now we will begin the Q&A session. Thank you.
Ladies and gentlemen, we would like to begin the Q&A session. To ask a question, please dial asterisk one. To remove the question from the list, dial asterisk two. This conference call is exclusively for investors and also professionals in the area. Our first question is from Mrs. Catherine from Banco do Brasil.
Thank you, Fernando, Thiago. Congratulations. Two questions. The first on off-road segments. We've seen a drop in revenue and volumes in off-road, and it is not picking up. When do you believe this sector will recover, especially in the U.S.? The second question, dividends. With this strategy of value added, can we see a change in the dividend policy?
Well, Fernando, the answer for the off-road market. In fact, we've seen a drop in global CapEx, especially due to the tension between U.S. and China, less investment in Europe. So we see a reduction of 1.2% in global CapEx in 2020 on a global basis. We see the construction market with a drop of 7% global market for next year.
The dividends. Concerning dividends, in the last 12 months, we distributed to our shareholders BRL 213 million, higher than 7%. We are evaluating the opportunity to distribute additional dividends in the fourth quarter. Our leverage is 1.29x, very comfortable, and if there are no projects involving acquisition, so we have the opportunity to increase dividends.
Thank you.
Our next question is from Mr. Marcelo Motta, JP Morgan.
Good morning. Two quick questions. Can you comment on the operations in Mexico? As you said, margins have potential to improve. I'd like to hear about the timing of this, and anything for 2020, 2021 and M&A. Is there anything strategic, any opportunities, new products, new markets? So how are the opportunities in M&A? If it's a initial evaluation products. Thank you.
Good morning, Marcelo. First, operations in Mexico. Evidently, we built a strategy to accelerate the product exchange. So we are renewing products. We are producing more sophisticated products that have a higher unit value. This discussion about the margin, we are attaching more value, more revenue per hour production from our plants when we use complex alloys and machining. I made a comparison with Q2 2017. If you see, sorry, nine months of 2017, our margin was a little lower in 2019. But we have 41% more EBITDA in the same period. That is our search. We understand it is also a cultural issue of the plants, the training of the employees to work with more complex products. We have more scrap, and we have more, and also the machining plant where we had problems in the first semester, now we are better. There is a lot of capture.
It means that in 2020, we will have a better operation. We also suffer due to economies of scale. We have two plants in Mexico. One is aimed at light commercial vehicle pickups, which is still strong. There is a forecast to continue strong with volumes. Since you have a product linked to certain machines, we were working even on Sundays on some machines. We were able to reduce this. We are working on a normal work hours, but in the other plant dedicated to off-road, demand dropped, and we did not have work even for weekdays. We are moving production from one plant to another. We launched also new products. We brought more products from Mexico to Brazil because of the favorable exchange rate.
We are attracting more products, and we want to keep the plants in Brazil at full speed, maybe reduce the volume in Mexico and here, I can have a better result in 2020.
Concerning M&A, our focus, Thiago speaking, is on structural foundry components. We are looking at complex geometry parts, especially heavy applications. Depending on the assets, there are markets where we are not present that could supplement our portfolio. We are looking at this all the time, and it makes sense for us in terms of strategy in the medium term.
Thank you.
Our next question comes from Mr. Breno Freitas .
Good morning. Thank you. I would like to know what you see for next year concerning Europe. You are seeing a drop in Europe, especially in countries like Germany, Africa, and Asia, also. Less activity in these regions.
We see Europe. We see less volume in trucks. We are strong also in products for Eastern Europe. Going back to the previous question, we study where the products are better to produce, and we continue transferring products between Brazil and Mexico, and so forth, also between plants in Mexico. Concerning other markets, we deliver products to Africa and Asia. Asia is strong. We do not see great changes for Asia. We see Brazil. We see growth in Brazil. The truck market should react. The machine market should react. Light commercial vehicles, we are launching new products now. We are increasing our share in programs where we were present, optimizing products in other vehicles. We see a strong light commercial vehicle market. We see a strong base, and we have a small share in Class 8.
We take care of demands of a U.S. OEM that use their engines and engines from other manufacturers. We believe they will privilege the use of their engines. Essentially, the off-road segment is going through a fluctuation, long production chains. We see a reduction in CapEx, adjustments in the whole chain, and initially, we have a greater effect and then adjustments. Still, when we talk about the plants and economy of scale, adjustments of our operations, and efficiency gains that we will have by launching new products. Since the end of 2018, we continue launching new products until the end of this year, a new machining line. All of this should bring us interesting results next year.
Thank you.
Our next question comes from Mr. Pedro Rogers.
Good morning. Congratulations for the results. Two questions. Three. Dividends. Is there an inventory of JCP for the company to use? Dividends in the form of JCP, or does it depend on the results of Q4? With the flexibility of the company and the drop in off-road abroad, can the company increase the production locally for heavy trucks? The off-road line in Mexico adapt export to Brazil? Brazil would be better supplied by local operations for trucks, and Mexico would export to Brazil. Is that possible? Within this question, we see Euro VI to be implemented in 2023 in Brazil. The OEMs will have to produce new engines, or will you use catalysts? Are you developing together with the OEMs these new engines? Thank you.
Good morning. I will begin with your second question. First on flexibility. Yes, there is. We are prepared. Tupy is very strong in heavy vehicles in Brazil, and this growth is in our results this year, and it will continue. This segment will grow more in the next few years. Fleet owners are better now at calculations, and they have to operate with larger trucks, heavier trucks. We always had this belief, and we positioned ourselves in this market because it is the only market in the world where you sell more medium-sized trucks than heavy trucks, Brazil. We have to sell more heavy trucks in Brazil because of the great distances. We are prepared for this. With the off-road plant in Mexico, we are creating flexibility for products for Class 8 U.S., for the current generation and new generations in 2023, 2024 in the U.S.
So we have products, some already approved in the U.S. As the Brazilian market reacts, if there is growth, we have this lever to transfer. We have a scenario with many alternatives available to us to explore any changes in the market. The Brazilian market, we believe, will grow. Yes, this is what we have heard from our clients. Now, regarding Euro VI in Brazil. Yes, there are OEMs that will convert current engines, current platform to Euro VI. Some are developing new generations to launch in Brazil. We are working with them in their developments, in the same platforms, and some foreigners that import. We might build these engines in Brazil. Most of our products are here. We export a lot. So it will be a reallocation, delivering products that we export currently, also in Brazil.
Thiago, concerning JCP, we used everything we had in the beginning of the year. So we have close to BRL 100 million on an annual basis, so there is no more space this year for more JCP.
Looking at the first question, truck markets, heavy truck markets. I heard that Mercedes-Benz, they have everything sold for 2020, and they are your client. Is it true that they have sold their production for next year? We've seen in the local OEMs data from the association that the domestic market is growing, but exports dropped because of Argentina and other markets. Can the OEMs grow, or are they close to the limit in terms of capacity? Do you believe they will have more shifts? Is it true?
Mercedes-Benz yesterday made an announcement that this is not true. The Chairman said this in Joinville. They have many vendors here. They are the largest client of Tupy. We are one of the largest suppliers of Mercedes-Benz. The fact is, Mercedes-Benz launched a new vehicle. It is selling very well, many orders. They have a strong demand for this vehicle. It is not true what was said, as you mentioned, that they have sold everything for next year. We make many products for this vehicle, engine blocks and other components that we developed and we machine for Mercedes. We see a favorable situation. The market will grow for heavy trucks in Brazil. Maybe due to investment in infrastructure, oil and gas in Brazil, and agriculture should grow. With this will bring a good portfolio for Mercedes-Benz. Also, suspension axles that we supply for this truck.
They have not sold out for next year. They have a good portfolio of orders. Yes, we have great expectations with Mercedes-Benz next year in Brazil.
Thank you.
Our next question comes from Mr. Lucas Marquiori, BTG Pactual.
Fernando, Thiago, good morning. Thank you for the call. Two questions. Please talk about the adjustment between plants. We see this in Joinville. Can you do the same in Mexico as you did in Joinville plant? There, you have a peak, now a small drop, and the efficiencies in Mexico, they had an efficiency of 60%, and today they're producing more products. I'd like to know, do you intend to recover the activities in Mexico, adjust the invested capital to extract more ROIC from that operation? Second, I'm looking at the expenses by segment. Your exposure for trucks, I can't see this. How much is for small trucks for urban distribution? We know that there might be a threat to electric trucks for distribution in urban centers. How much does this represent in your revenue here and abroad?
Lucas, good morning. Thank you for the questions. First, Mexico, we're not planning to close any plants as we did in Brazil. We're not planning to close plants, but we have moved products around to avoid stopping lines. We have many alternatives that we're using. We're learning in this process. What we did in Mauá taught us a lot, and we continue moving products around. This has brought extraordinary results. We have a cyclic industry. Our acquisitions involve finding more plants, and what we're doing now is what we want to do on a greater scale. We understand we can generate a lot of efficiency in an industry that's suffered due to migration to aluminum. We will have good opportunities for acquisitions and as we see. Yes, in Mexico, we have complex products, and we were not able to improve efficiency, but we didn't lose.
We have high-value products, and we are concentrating this production in some assets and creating flexibility, as I said in the beginning, because we had a problem with the economy of scale. Some markets grew more than we had expected, and we want to find alternatives for the clients. We took measures by moving production between plants. We see a drop in off-road. In the other markets, no great changes. In some sectors, growth. We believe we will produce volume in a more comfortable situation than in 2019. When we look at Brazil, we produced more in Brazil this year than in 2017 with one plant less. This is what we want. In 2015, 2016, we had a drop in the global market, Brazilian market. We operated with eight lines for blocks and heads. Now we produce much more with less plants.
That is the mechanism, and we are taking this to all the plants. Concerning the market that you mentioned, Mercedes-Benz brings some engines from Germany. Volkswagen brings Cummins engines from China. I do not believe we will have a strong growth of electric trucks. We have a product that we supply to Ford, an engine that they use in pickup trucks and also in vans. Other sectors, these engines are also made in-house. The leaders are Iveco in Europe, Mercedes-Benz, and in the U.S. market, it is small. They import engines from Europe, too. That is what we see. Pickup trucks, a small possibility of electric because they are different from trucks for delivery. We see a resilience of this model.
We launched new products this year for the three OEMs in the U.S. that are leaders in pickups, and we continue seeing these products continuing for many years, with growth in the next 10, 15 years as the U.S. market grows.
Thank you.
Ladies and gentlemen, the next question, Eduardo Nishio, [Brasil Plural].
Good morning. Thank you for the opportunity. Good morning, Fernando, Thiago. You had a drop in volume, drop in revenue, but a good margin. I would like to know, how is your initiative of flexibility in production? In this quarter, it happened between regions, Brazil and Mexico, and you talk about initiatives to have more flexibility in Mexico in the plants for off-road. Do we have any bottleneck? If the volumes continue low, how long will you be able to maintain higher margins?
Eduardo, thank you. The bottleneck of these operations is the approval time by clients. I told you that we have defense actions. We have predefined actions, and we are ready for these drops. We have many products developed between Brazil and Mexico and between the two plants in Mexico and the plant in Joinville. The objective is to maintain some lower cost products because we use a logic that makes sense. Mexico has other challenges, too. We have some raw materials that are more expensive than in Brazil. For example, the sand comes from the U.S. Every time I produce above a certain limit, then I have a problem in economy of scale. We begin to have work on Sundays. We spend more in maintenance with less efficiency. This combination, we are always fighting, creating alternatives. It is a very advanced process at Tupy.
Of course, there are limits in volume that we can shift, but it is a well-known process. What we plan today, we see the assets of the company with lower cost. We will continue in three shifts. The more expensive ones, one shift or two shifts. But as we gain efficiency, we turn off machines. That is the challenge. Lucas made a comment, revenue 60% in Mexico, here 80%. Which means that if Mexico becomes like Brazil, we gain capacity. That is the challenge. There is a maintenance culture to be improved, operation of the plant. They had better margins, but they produced simpler products. When we look at the indicators, they even improved. The products now are more complex, and that is the idea. This is what will guarantee the company in the next 15, 20 years. More modern engines.
Thank you.
To ask a question, please dial asterisk one. If there are any questions, please dial asterisk one. We are going to conclude the Q&A session. Now I would like to pass the floor to Mr. Fernando for his final comments.
Thank you. Well, once again, I thank you all for participating in our conference call and your trust as investors and analysts in our company. I would like to thank publicly our clients for the trust and partnership of many years and the opportunity to develop together solutions that will be used in the next decades. Finally, I would like to thank the team at Tupy for the excellent work that was done. We have a strong commitment on my part and my team to generate value to you, and we are available with our team to clarify any further points. Thank you, and a good day.
The conference call for Tupy is concluded. Thank you, and we wish you a good day.