Earnings Call: Q4 2019

Jan 30, 2020

Welcome to Granges Conference Call for the Fourth Quarter of twenty nineteen. Here in Stockholm, it's me, Johan Menkel, CEO of Granges and beside me, I have CFO, Oskar Helstrom. As usual, we will start this presentation with an update of Granges' performance during the last quarter and touch upon some more important events. After that, Oskar will take you through the financial results, and then we will conclude the presentation with a short summary and a Q and A session. Starting with the fourth quarter's 2019 highlights. In the quarter, we have taken important steps to strengthen our platform for future growth. In November, we announced the acquisition of Aluminum Konin, which will be our largest acquisition since we bought Noranda back in 2016. In the quarter, we also completed the expansion of the Huntingdon facility in The U. S. That will be an important enabler for continued growth in primarily the HVAC market. Another main theme of the quarter is the challenging market conditions. On the automotive side of our business, we saw a weak customer demand in Europe and Americas, where a continued decline in light vehicle production was further amplified by inventory reductions. Unlike the first three quarters of the year, we also experienced a lower demand from the HVAC and other customers in Americas. This is primarily driven by inventory reductions towards year end. As a consequence of the lower market demand, our sales volume declined by 11% year over year in the fourth quarter. Due to the lower sales volume and additional costs related to the ongoing expansion project, the adjusted operating profit declined to SEK144 million in the quarter. On the positive side, the cash generation continued to be very strong and the adjusted cash flow before financing amounted to SEK191 million. Finally, our Board of Directors proposed a dividend of SEK3.40 per share, which represent an increase of 6% over last year when we paid SEK3.20 per share in dividend. I'm very happy that we, in November, signed an agreement to acquire the Polish aluminum rolling company, Aluminum Corning. This is an important step in realizing our growth strategy as it will give us more capacity, new capabilities and access to new market niches. The transaction values the business to billion on a cash and debt free basis. That corresponds to an EVEBITDA multiple of 6.9 based on last twelve months earnings for September. This means that we will be able to close this deal at an attractive valuation level. The primary rationale behind this deal is to further strengthen our position in the European aluminum market by adding new capabilities and new attractive market segments. One of these areas that we specifically target with the acquisition is the future vehicles market, where the aluminum content per car is expected to increase significantly. Here, we intend to broaden our offerings going forward. Given the good fit with the existing Granges operation, we also see a potential for realizing synergies when combining the two businesses. Following the completion of the transaction, we intend to make a right issue with the preferential rights for existing shareholders of approximately billion. This will partly be used to finance the acquisition and partly be used for future growth projects. Closing of the transaction is subject to approval from competition authorities. We expect that closing will take place sometime in the second quarter of twenty twenty. As most of you know, we are currently running three material expansion projects in The U. S. And in Sweden. In the fourth quarter, we completed the expansion of the Huntington facility. We now expect to see 40,000 tonnes additional capacity to gradually ramp up over the coming quarters. Our target is to have 75% of the capacity available by half year, with full capacity being reached before the year end 2020. Have had a good start on the ramp up and are currently running at 60% of full capacity in the new assets. Most of the new capacity is contracted, but we have all out some room for flexibility during the ramp up phase. The sum of all contracted volume for the HVAC and other market indicates a more than 10% higher volume in 2020 than in 2019. The actual outcome will depend on the market demand. In Newport, the work with upgrading the rolling mills is progressing to plan, and the second rolling mill was completed during the fourth quarter. We have now begun with customer trials and product validations that are expected to continue through the first half of this year. In parallel with this, we will also start to upgrade our third and final rolling mill. In Finspang in Sweden, we are now onethree of the way into the site logistic improvement projects. When this is finalized in the second half of twenty twenty one, we will get more efficient production plant with lower production costs and additional 20,000 tonnes capacity. During the fourth quarter, we experienced continued soft market conditions for the automotive part of our business. If we look at some market statistics, the research firm IHS has made a further revision of their estimates since we presented our outlook for quarter four in October. At that time, IHS estimated a 3% global decline of light vehicle production in the fourth quarter. That figure has now changed to 5% decline. Together with continued reduction of the inventory in the supply chains in most regions, this led to relatively weak demand for Granges Automotive Materials in the fourth quarter. If we look at the estimates by region, we can see that the production of light vehicle was down 3% in Asia in the fourth quarter. Of this, China was up 2% compared with last year. On the customer side, inventory levels in Asia have come down and the heavy destocking that we experienced earlier did not occur at the same extent in the fourth quarter. Still, for quarter one, IHS expect a continued reduction in Asian light vehicle production of 8%, indicating that inventory levels may need to come down further. In addition, the recent outbreak of the coronavirus in China could pose a downside risk on the automotive production in the first quarter and this would in turn have a negative impact on the demand for Granges products. In Europe, light vehicle production is estimated to be 6% lower in the fourth quarter and the destocking in the supply chain increased significantly in the quarter. With a continued reduction in light vehicle production indicated for the first quarter, we expect the destocking activities to continue into 2020. In The Americas, the fourth quarter, the light vehicle production figures were negatively impacted by the General Motors strike that took place in October. In addition to this, we saw increased destocking also in Americas in the quarter. For the first quarter in twenty twenty, IHS estimates a decline of 5% in light vehicle production on the global level. Based on what we are picking up in the market and taking the continued destocking activities into account, we currently have a slightly more pessimistic view on the quarter one outlook for the automotive business. For the full year 2020, IHS expects the light figure production to be on about the same level as in 2019. If we then look at the Americas HVAC market, we can see that HVAC unit build in The U. S. Is expected to have increased by about 2% in the fourth quarter. Still, an uncertainty about the general U. S. Economy led to that most of our customers made efforts to reduce their inventory levels towards year end. This resulted in a negative demand development for HVAC materials in the quarter. Looking ahead, the HVAC unit build forecast indicated a stable outlook for the full year. If we then look into Granges sales volume development during the fourth quarter, we can clearly see the impact of a softer automotive demand and the destocking among the eight track and other customers. For the Automotive Materials, we experienced a double digit decline in both Europe and Americas. On the positive side, the sales volume in Asia increased by 2%, primarily driven by customers in China that increased their orders quantities in the fourth quarter. For the HVAC and other business in Americas, we saw a sales volume reduction with about 11% in the fourth quarter. This decline is not much driven by the end market demand, but from inventory reductions at customers before year end. We do believe that this effect is temporary and is not expected to continue into the first quarter. I will come back more to that when I comment on the outlook. When summarizing the whole of 2019, we can clearly see that the performance against our long term financial targets are impacted by two things: the challenging automotive market and the fact that we have, during this year, have carried out several very material expansion projects. Even though we are not satisfied with the sales volume development in this year, seeing a decline of 7% compared with 2018, we can note that this is fairly close to the benchmark figure for the light vehicle production that showed a decline of 6% in 2019. The lower volume and earnings in combination with an increased assets from the expansion investment had a negative impact on the return on capital employed in the year. For 2019, ROCE was 11.7%. We ended the year with a net debt of SEK3.5 billion, which correspond to 2.6x EBITDA. This is slightly outside our target range, but we expect to see the leverage ratio to come down going forward as we now start to utilize the new investments. Our Board of Directors proposes a dividend of SEK3.40 per share, which is an increase of 6% from last year. Given that the Andrea Jenner meeting approves the proposal in May, it means that 43% of the net profit will be returned to our shareholders. This is well within our target range. I would also like to highlight our sustainability performance for 2019. I'm very pleased that we have further increased our ambitions and can see good progress on many of our priorities. We have, during the year, continued to implement our sustainability framework across all of our operations and work to further align our local strategies with the global sustainability targets. At the beginning of the year, we became a member of the Aluminum Stewardship Initiative, ASI. A few months later, our Shanghai site received ASI Performance Standard certification. I'm also very pleased that we see good progress on many of our sustainability priorities when summarizing 2019. Examples of achievements include a significantly improved safety accident rate, an increased share of sourced recycled aluminum, which has led to reduced carbon dioxide emissions from purchased materials and services and high training participating in our annual Code of Conduct and Anti Corruption training. We have also accelerated the development of broader and more sustainable customer offerings, both through the acquisition of Konin and through organic product development. This is important from a commercial point of view as our customers are increasingly recognizing the importance of using sustainable materials. All in all, we have many promising sustainability initiatives in place to support our long term targets and to help make us a more sustainable and responsible company. With that, I hand over to Oskar for the financials. Thank you, Johan. As Johan has talked about, the sales volume continued to decline in the fourth quarter and reached three and forty seven thousand tonnes for the full year of 2019. This is 7% lower than the volume we delivered in 2018. As a consequence of the lower sales volume, the adjusted operating profit came down to SEK $866,000,000 for the year. This represents a profit per tonne decline from SEK 2,700 in 2018 to SEK 2,500 for 2019. For the automotive business, the lower sales volume has led to a lower margin. This is partly offset by improved margins for the HVAC business, where we had a profit per tonne increase for the year despite the lower sales volume in the fourth quarter. Key drivers for this are mix optimization and price increases in The U. S, supported by a positive development of foreign exchange rates. If we look at the fourth quarter financials and compare with the same quarter last year, we can see that the sales volume decreased by 10.9% to 77,900 tonnes, whereas the net sales decreased by 12.7% to SEK2.7 billion. The main reason for net sales decreasing more than the sales volume is lower metal prices than in last year. The net impact from changes in foreign exchange rates was positive SEK118 million compared with fourth quarter twenty eighteen. Looking at the earnings, the adjusted operating profit amounted to SEK144 million in Q4, a decrease of SEK 47,000,000 or 24.5% on prior year. The reduced operating profit is first and foremost a result of the low sales volume in the quarter. Q4 is the seasonally weakest quarter for Granges and with the volume reduction on top, this means that we are running at the capacity utilization below 75% in the group. Given that a large part of our cost base is fixed or semi fixed, this reduced the operational leverage in the quarter. That said, additional cost reduction measures and capacity adjustments helped to bring down the cost base in the quarter, if not one:one with the reduction in sales volume. We are continuing to focus on controlling the costs going forward. As you heard from Johan, we have now completed the expansion project in Huntington in The U. S. Net start up costs for The U. S. Expansion projects amounted to million in the fourth quarter and The U. S. Projects are expected to contribute positively to earnings as of the first quarter twenty twenty and onwards. Net changes in foreign exchange rates was positive SEK20 million in the quarter. Looking at the profit margin, the adjusted operating profit per tonne declined from SEK2.2 billion to SEK1.9000 in the quarter. Items affecting comparability amounted to in total SEK30 million in the quarter. Of this, 16,000,000 are costs related to the acquisition of Aluminium Konin and SEK 14,000,000 relates to the mining reduction in our European operations that we highlighted in our quarter three report. Including the items affecting comparability, the operating profit amounted to million in the fourth quarter. The profit for the period of SEK47 million corresponds to earnings per share The reason for the lower profit compared with last year in addition to the reduced volume is primarily related to a tax provision release for China high-tech tax in Q4 twenty eighteen. In 2019, we did the corresponding release in Q3, and this distorts the year over year comparison in the quarter. Worth to mention is also that the income tax in the quarter includes a onetime tax on dividend from the Chinese subsidiary of SEK 17,000,000. With the high-tech tax in China in place, we expect the effective tax rate for the group to be around 19% in 2020. By the December, the return on capital employed was 11.7%. During the fourth quarter, net debt was reduced by SEK 141,000,000 to SEK 3,500,000,000.0 or 2.6 times adjusted EBITDA on a rolling twelve month basis. We continue to see a very strong underlying cash generation in the quarter, where the cash flow before financing adjusted for the expansion investments amounted to SEK 191,000,000. This corresponds to an adjusted operating profit to cash conversion of 132%. We also continued to invest in total SEK123 million in our expansion programs. Of this, million are related to The U. S. And SEK32 million to Sweden. With the expansion investment in Huntington now completed, the positive EBITDA generation from this is expected to contribute to bringing the leverage ratio back down towards the target range of between one to two times adjusted EBITDA. Finally, I would just like to highlight that Granges has always been a business with a strong underlying cash generation and 2019 is no exception from this. If we look at the cash flow before financing activities and exclude acquisitions and CapEx for expansion investments, this amounts to 1,050,000,000.00 for 2019, implying an operating profit to cash conversion of 121%. This also means that we have been able to finance almost all of the SEK 1,100,000,000.0 expansion investments in 2019 with cash generated from the business. That's something that clearly illustrates the cash generation potential of the Granges business, especially in a less investment heavy phase. With that, I will hand over back to Johan that will provide an outlook for the fourth quarter. Thank you, Oskar. Looking into the first quarter of twenty twenty, we expect that the challenging market conditions will continue for the automotive business. In terms of year over year sales volume development, we expect to see low single digit decline compared with the first quarter last year. For Automotive Materials, we foresee a low double digit sales volume decline globally. For Europe and Americas, we expect low double digit decline as the light vehicle production is expected to remain weak and customers' destocking is likely to continue. In Asia, we expect a mid- to high single digit decline compared with last year, which is slightly better than the underlying light vehicle production in the region. Still, the recent outbreak of the coronavirus in China poses a downside risk to this outlook. First, it will most likely impact our automotive sales negatively in the first quarter and second, it will limit our production output due to short term governmental restrictions and extended holidays around the Chinese Spring Festival. For HVAC and other parts of our business, in Americas, we forecast a mid to high single digit increase in the first quarter. The new capacity in Huntington will gradually be ramped up and we have contracts in place for increased deliveries as of January. The destocking we experienced in the fourth quarter is not expected to continue in the first quarter. Oskar showed earlier that HVAC and other business has a slightly lower profitability than the automotive business. As a consequence, the change in end market mix between automotive and the HVAC and other business is expected to have a negative impact on the profitability in the first quarter. When looking further ahead, we will continue to work actively with innovation, efficiency improvements as well as a more sustainable customer offerings, which includes an increased focus on product development for electrical vehicles. With a strong commitment to constantly improve and develop Granges, we are well positioned to continue to deliver sustainable and profitable growth. To conclude the twenty nineteen fourth quarter report. In the quarter, we have taken important steps in strengthening our platform for future growth. We have announced the acquisition of Aluminum Konin and completed the expansion of the Huntington facility in The U. S. We continue to see soft market conditions in the fourth quarter, resulting in 11% decline in sales volume compared with last year. The adjusted operating profit was reduced to SEK144 million, but the cash generation remained strong with an adjusted cash flow before financing of SEK191 million. Finally, our Board of Directors proposed a dividend of SEK3.40 per share, which represents an increase of 6% over last year when we paid SEK3.20 per share in dividend. Although the market conditions are expected to remain soft in the coming quarter, we continue to be positive about the medium term outlook and are determined to continue to grow and strengthen our presence and position globally. Now we open up for questions. The first question comes from the line of Karl Bruckist, ABG. Your line is now open. Please go ahead. Yes. Hi, thank you and good morning to you Johan and Oskar. First of all, you mentioned ramp up percentage where, as you say, now was at approximately 60%. I was just wondering, would it be possible to receive some more insight into how you think the actual volumes might fall into the quarters of Q1 and Q2 if we assume, as you say, 75% ramp up by the end of the first half? Morning, Karl. It's Oskar here. It's a good question there. If we start just by saying, okay, so what have we indicated that we think is possible in terms of the ramp up of the actual production capacity? There, have said that we aim to have the 75% of that capacity available by the end of second quarter, as you state there. And we're and Johan also mentioned earlier now that we are progressing very well on that track. And we already now, in January, run at some 60% of full capacity. So I think that's a very positive sign. In terms of how we can fill this with volume then, we have indicated that for the full year, we expect the volume to increase with slightly more than 10%. But for the first quarter, we are a little bit more cautious because we have, of course, less of the capacity available due to the ramp up. So there, we are indicating mid to high single digit growth for the capacity. So we don't expect to reach the plus 10% in Q1. But of course, as we release more capacity along the year, we expect to see a larger increase year over year in the second quarter than what we saw in the or what we expect and indicate for the first quarter. I don't know if that's helping you a bit maybe. Yes, understood. And just another follow-up there. The volumes that you are now adding, are these the clear majority HVAC products? Or what's the sort of product mix within the volumes that you're adding now? It's a mix of products. It's relatively similar to the product mix that we already have in the Huntington facility, which means it's a large part of this is HVAC, and part of it is also the other products that we have in The U. S, so for instance, specialty packaging. But we are also introducing a larger share of automotive products in the Huntington facility as we, with the expansion now, have more capabilities to produce automotive products available there. And sort of concluding a little bit on that, it means also that the contracts now for the new volume that we have entered, and I expect that maybe that's what you're after here, they are taken with a little higher average price than the existing business in Huntington, partly due to product complexity and partly due to the fact that they have been renegotiated at a point in time where the general market price was slightly higher than the average old volume in the plant, so to speak. Understood. And then a follow-up here. If we then think about as you guide in the first quarter, we have perhaps slight negative volumes and also that you expect mix to be negative. But as we go into Q2 and Q3 and Q4, of course, now if we exclude Konin, what's your view here in terms of just the incremental volumes that you are gaining balanced by the mix impact and so on? Of course, we are very sort of confident that and happy when it comes to the HVAC business. We think that's developing very well with what we can see right now. I think the big question mark in this equation is what the demand will look like on the automotive side going forward. And I think that's a question that many ask themselves at this point. That's the uncertainty. But the HVAC part of the business, I think, is looking very strong at this point. Understood. And I think you mentioned in your annual report that Trillium grew 30% in 2018. How much did it grow in 2019? And would it be possible to get some insight into how much Trillium accounts for volumes today? I mean it's a good question. Johan here. We see a similar, I mean, development for 2019 as we did for 2018. And what we have said, we see clearly, I mean, wish from the customer level to have really a low level of flux remaining in the system going forward, especially for electric vehicles, where, of course, the product comes in very well. But I think it's difficult to give a more accurate indication for the near term. But in the long term, we see absolutely that the Trillium product could be up to, I mean, up to 20, 30% of the total volume. But it's still early days in this discussion with the customers. But there's a positive trend. Okay. And final question from me here. If we go to the Konin acquisition, is there anything you could say in terms of when during Q2 you expect to receive the announcement in terms of earlier or later? And then a follow-up, if you could just perhaps once more just remind us what sort of synergy potential you are seeing? Sure. You want to no, think, first of all, I mean, still, we're standing confident still that the quarter two will be the period when we can finalize this acquisition. But of course, as you know, it has to pass competition authorities, but still during quarter two. And I mean, there are several synergies as well that we see for the Konin acquisition. One is, of course, the general sourcing area, where we, as a larger player, can have a more beneficial sourcing program. We also see that we can basically reuse more scrap in this facility and also install what we call a closed loop with the customers. And on the sales and marketing side, we see a clear leverage on Granges Finspang's capabilities on product development and R and I to further develop the business. And the fourth area is really on the operational side, where we have a very good framework and methodology to work with the production efficiency, and we clearly see that we can have an impact here on the Konin. So basically, there are four main areas for the synergies. But I also want just to emphasize that the business the Konin business in itself is very healthy, has been so for many years, and it still is, of course, and have a very good customer base to grow on. Okay. And sorry, just one more question I thought of here. I think we there's been talks that Johnson Matthieu is a company that is expecting to open a battery component factory in Konin as well. I was just wondering, let's say that you establish a customer relationship with them. What sort of products would you potentially be able to deliver to a battery manufacturer such as them? Yes, very good question. No, you're right. They are opening there, and there are also other battery producer that already have announced or is still in the area. So of course, being in the Western Part of Poland is really the right place to be in order to be close to the battery producer. And if we look upon our potential here, you can divide them into three areas for flat products, and it's actually roughly around a market of 800,000 tonnes for flat rolled products for battery divided into three main parts. One is the battery cooling plate, which is basically the product that will yes, make sure that the battery is in a good temperature. The second area is actually foil, cathode foil for both prismatic and poached cell. And the third area is the structure part for the battery, where you have casing, etcetera. And it's roughly onethree each of these for the potential market. So I mean, the two last ones, the foil and the structure part of the batteries are totally new areas for Granges, where we can basically from the Konin asset, yes, deliver to this also new customer for Granges. So that's very, of course, interesting for Granges. Okay. That's all for me. Thank you very much. Thank you. The next question comes from the line of Julien Ratut. Your line is now open. Please go ahead. Hello, gentlemen. Two quick questions. The first one is regarding the Konin numbers. I'm honestly surprised by the severity of the volume reduction in Q4 in your business in the Automotive. Can you share some details about Konin performance? Were they affected by to the same extent or or to another one? Julian, it's Oskar here. I mean we totally acknowledge, of course, that the demand in the automotive sector has been very weak for the fourth quarter. At this point, we are not in a position to disclose the Konin numbers. I think that that's what you're asking for. But what we can say, of course, is Konin less or more affected? Well, Konin has a lower share of sales to the automotive part of the market than what Granges has today. So if you just take that into account, it would be fair to assume that Konin would see a less impact of the turmoil in the automotive industry at this point. Okay. And regarding China, could you share a little bit what is happening on ground? I mean, it seems like some plants are not restarting following new year celebration. Is that the case for you and yes? Yes, absolutely, Una. Yes, you went How late are you compared to normal schedule today? Is it couple of weeks? Yes. No, but it's been first of all, we have good control of our employees, and we have also implemented travel ban onto China and into China. But of course, all the companies in the Shanghai and many other provinces has been requested to stop all production. So as far as we know today, basically, 50% of all the production of light vehicle is stopped for one week until the February 10. So that's the situation. Of course, that means that, of course, the in the short term, the sales to these customers will be impacted. But of course, the good thing for Granges in a way is also for the business that we are exporting from China. We can produce these products for the Indian market, Thailand market, Mexico from Sweden, for instance, or from U. S. So I think we are quite well positioned to address kind of the global consequences of this. But for the Chinese market, there's not really an impact because the Chinese customer also has been requested to stop all production. Yes. You say 50% of auto production What we know today that basically 50% of the provinces there, including 50% of the production in China, has been requested to have a longer holiday. Okay. Very clear. Thank you very much. Thank you. There are currently no further questions. The next question comes from the line of Kenneth Toll. Your line is now open. Please go ahead. Yes, thank you. Just a small detail. You said that in the Huntington facility, you expected a 10% growth in volumes in 2020. But I was curious about the Newport volumes. What are you expecting in terms of sales volume there this year, please? Hi, Ken. That was a very fair question. And I think I was a little bit unclear when I made that reference. When we say the plus 10% expectation for the full year, that is actually relating to all the HVAC and other business, including the Newport plant. So the Newport is included in that figure. But the Newport volumes is expected to come commercial volumes out of the Newport plant is expected to come in Q2 and onwards because we are currently in the middle of running the customer and product validations there. So when we say 10% plus, that's for the whole HVAC and other business as we report that in our reports. So there will then there will be an opportunity to grow even further than in 2021, both in Huntington and in Newport. Have you sold those volumes yet or So yes, it's the answer to the first question is yes, there is an opportunity to continue to grow in 2021, absolutely. We have sold part of this. We have written long term contracts several customers, where we have increased the volumes year by year in those contracts to gradually get a larger share of that customer's wallet. So yes, to the second question as well there, part of the additional volume increase is already contracted in multiyear contracts. Okay, great. Thank you. Thank you.