Earnings Call: Q1 2019

Apr 26, 2019

Welcome to Granges Conference Call for the First Quarter of twenty nineteen. Here in Stockholm, it's me, Johan Menken, CEO of Granges and beside me, I have CFO, Oskar Hellstrom. As usual, we will start this presentation with an update of Granges' performance during the last quarter and touch upon some important events. Then it's time for Oskar to guide you through the financial results. After that, we conclude the presentation with a short summary and the Q and A session. Starting with the first quarter twenty nineteen highlights. First, I would like to say that I'm cautiously positive to how we have started the year in light of the increasingly challenging market conditions. On the automotive side of our business, the softer market condition that we started to see in the fourth quarter continued in the first quarter this year. And as a consequence of this, our sales volume declined by 4% year over year in the first quarter. The most challenging market is currently Asia and in particular China, but we did see lower sales volume of automotive materials in all regions in the quarter. The demand for HVAC and other business in Americas continues to increase, but we are currently not able to capture this growth due to limitations of available production capacity. Despite the lower sales volume and the adjusted operating profit remained fairly stable at SEK275 million, only SEK7 million lower than last year. Higher prices in Americas and favorable foreign exchange rates largely offset the negative earnings impact from the lower sales volume and the additional costs related to the ongoing expansion projects in The U. S. We currently have a very large focus on completing the expansion projects. Both the expansion of the Huntington facility and the restart of the Newport facility are on track, with start of production in quarter three. We are currently in the CapEx intensive part of the two projects. And in the first quarter, the combined expansion investment amounted to million. Because of the large investment, cash flow before financing activities was negative million in the first quarter. In the first quarter, we also launched a set of long term sustainability targets. It's my strong belief that going forward, good sustainability performance will be a prerequisite to maintain our value and relevance to our customers in the years to come. In order to ensure that Granges is in the forefront of this development, we have set ambitious and clear long term targets, which demonstrate our commitment to sustainability and our strong focus on integrating sustainability in everything we do. I will come back to and describe these targets in more detail shortly. During the first quarter, we experienced a continuous softening of the market conditions for automotive part of our business. If we look at some market statistics, the research firm IHS had made a quite substantial revision of the estimate since we presented our outlook for quarter one in January. At that time, IHS estimate was a decline of 1% globally for the first quarter, and that figure has now been revised to a 6% decline. Based on the signals that we are picking up in the market, I wouldn't be surprised if the actual outcome in quarter one is even lower than that. If we look at the regions, we can see that the production of light vehicle was down 7% Asia in the first quarter. Of this, China was down more than 12% compared with last year. On top of the reduction in vehicle build rates, destocking in inventory in the supply chain is having a further negative impact on demand for our products. The destocking is expected to continue also in the second quarter. And with what we see right now, the minus 2% demand development that IHS forecast for Asia in quarter two seems a bit too optimistic. In Europe, light vehicle production is estimated to be down 5% on last year in the first quarter and 1% decline is estimated for Americas. This pattern is largely expected to continue into the second quarter in twenty nineteen and is relatively consistent with how we are experiencing current market condition as well. For the full year 2019, IHS forecast a stable development of light vehicle production on a global level. Moving to the market for HVAC products. HVAC unit built in The U. S. Is expected to have an increase by about 5% in the first quarter. Looking into the coming quarters, we expect to see that HVAC buildup rates continue to grow. Here, we need to remember that we are currently capacity constrained in Americas and we will not be able to take part of this growth until our new production capacity becomes available in the second half of this year. If we then look into Granges sales volume development during the first quarter, we can see that sales volume in Asia decreased by 13%. The reduction is reflecting the lower vehicle production rate and the destocking at many of our customers, in particular China. On the positive side, sales to industrial applications continued to increase, but from low levels. In Europe, sales volume decreased by 4% in the first quarter, largely following the underlying market demand. Similar to Asia, the sales of materials to industrial applications increased also in Europe in the quarter. In Americas, sales volume was about 1% lower than last year despite the growing market demand for HVAC products. This slight volume decline is primarily driven by two things. First, we are shifting the mix towards more advanced product that require more rolling capacity, but has a higher margin. Second, we are running close to maximum capacity in our U. S. Plants and need to execute on productivity improvements to grow sales volume. With the large focus we have on delivering on the expansion projects, we have, however, not been able to simultaneously maintain the production efficiency in the current operations. I'm fully confident that we, once the expansion projects are completed, will be able to run both and the new equipment in a very efficient way. As I mentioned earlier, I strongly believe that good sustainability performance will be a future requirement for our long term competitiveness and to maintain relevance to our customers, employees and investors. Last year, Granges implemented a new group wide sustainability framework with 12 topics grouped into five sustainability pillars: ethical business practice responsible and sustainable sourcing sustainable operations diverse and high performing teams and sustainable offerings. As you can see on the slide, each of the five pillar is now accompanied by a set of measurable twenty twenty five targets, which demonstrate our commitment to sustainability and our strong focus on integrating sustainability into everything we do. I would like to especially highlight a few of these targets. One very important area is carbon emissions. We have set a target to reduce our direct and energy indirect carbon emission by 25% to 2025. For those of you who are familiar with the greenhouse gas protocol, this indicator covers Scope one and Scope two. In 2018, we managed to reduce this measure by 6%, driven by improved energy efficiency and higher share of renewable energy in our energy mix. To commercially benefit from our sustainability work, it will also be very important to demonstrate that sustainability performance of our products. We believe that our customers are increasingly becoming aware of the importance of using sustainable materials, and we will work proactively to provide them with credible sustainability performance data. Our target is that 80% of our products should have verified sustainability information available, and we have recently initiated a product aimed at establishing a foundation for how we can assess and communicate the sustainability performance for our products from a life cycle perspective. All in all, I'm very pleased that we can see good progress on many of these targets already for 2018. And we currently have many promising sustainability initiatives in place to support these targets and to help make us more sustainable and a responsible company. Now I hand over to Oskar for the financials. Thank you, Johan. As Johan has talked about, the sales volume declined somewhat in the first quarter. We did, however, see a smaller decrease in adjusted operating profit than in sales volume, and the rolling twelve month profit per tonne remained stable at SEK2.7000 after after the first quarter. For the automotive business, we experienced some margin contraction due to the lower sales volume in the quarter. But as you can see on the right hand chart, this is offset by improved margins for the HVAC business, where we had a profit per tonne increase. A key driver for this is the price increases in The U. S. If we look at the first quarter financials and compared with the same quarter last year, we can see that the sales volume decreased by 4.4% to 90,800 tonnes, whereas the net sales increased by 1.2% to SEK 3,100,000,000.0. The main reasons for the net sales increasing when the sales volume is decreasing are a slightly higher average conversion price and the net impact from changes in foreign exchange rates that was positive $293,000,000 compared with the first quarter of twenty eighteen. Looking at the earnings, the adjusted operating profit amounted to SEK275 million in Q1, a decrease of SEK7 million or 2.5% on prior year. The negative impact from the lower sales volume and slightly higher operating cost was partly offset by higher average conversion price and the net changes in foreign exchange rates that was positive million in the quarter. The net effect from U. S. Import duties was positive in the quarter, and this is due to a refund of SEK9 million following a decision by the U. S. Department of Commerce to grant exemptions from Section two thirty two tariffs for the majority of Granges products imported to The U. S. Following the granted exemptions and taking into account the current agreements with customers, we only expect limited impact of The U. S. Two thirty two tariffs going forward. And as you heard from Johan, we are getting closer to the start of production for the expansion projects in The U. S. Start up costs for these projects amount to SEK17 million in the first quarter. And in the second quarter, we expect to carry additional start up costs of about SEK20 million. For the full year, we expect the expansion projects to contribute positively to operating profit. Looking at the profit margin, the adjusted operating profit per tonne remained stable at SEK 3,000 in the quarter. There are no items affecting comparability in the first quarter, and the reported operating profit is, therefore, the same as the adjusted operating profit in the quarter. The profit for the period increased by 10% to million and corresponds to earnings per share of SEK2.44. Cash flow before financing was negative SEK173 million in the quarter. By the March, the return on capital employed was 15.5% on a rolling twelve month basis. During the first quarter, the net debt increased by SEK564 million to SEK3.1 billion or to 2.2x adjusted EBITDA on a rolling twelve month basis. There are two primary drivers behind this increase. First, the expansion investments in The U. S. That represents SEK $339,000,000 of the SEK451 million in fixed investments in fixed assets in the quarter. And second, the implementation of IFRS 16 accounting standards for leases, where the lease liabilities have been recognized by SEK269 million. Worth to highlight here is that excluding the effect from IFRS 16, net debt to EBITDA would be SEK 2 as of March. For those of you who would like to know more about how IFRS 16 impacts Granges financials, this is well described in Note one in our first quarter report. As for the development of working capital in the quarter, the typical seasonal buildup that we see in the first quarter has been partly offset by positive effects from the removal of U. S. Sanctions against Rusal. The consignment stock that Rusal operates at Granges Finspang facility has been restored, and Rusal has also reentered our supply chain financing platform. In total, this has a positive effect on working capital of about SEK 80,000,000 in the first quarter, and we expect a similar additional positive impact in the second quarter. When discussing debt, I would also like to mention that we, in the April, refinanced the debt portfolio and the credit facilities originally used to acquire the business in The U. S. Back in 2016. This was done in order to achieve better terms and prices as well as to prolong the maturity of the debt portfolio. For 2019, we are expecting the savings from the refinancing to offset the increase in costs from higher base interest rates. I will now hand over back to Johan Menkel that will provide an outlook for the second quarter. Thank you, Oskar. Looking into the second quarter of this year, we expect that the challenging market condition will continue. In terms of year over year sales volume development, we believe that quarter two will be relatively similar to quarter one with a mid single digit decline on a group level. For Automotive Materials, we foresee a mid to high single digit sales volume decrease globally. In Asia, we expect a high single digit reduction as the destocking in the supply chain is expected to continue. For Europe and Americas, we foresee a mid single digit decline. For the HVAC and other part of our business in Americas, we expect a stable development in the second quarter. When looking further into 2019, we will continue to focus on our growth initiatives. During the second half of next year, we will see new volume coming in as a result of the expansion projects in The U. S, as we talked about earlier. We are taking an active part in developing solutions for electrical vehicles, where we are currently in several very interesting customer discussions. We're also optimistic about our potential to further improve our operations in Europe and in Asia. To conclude the twenty nineteen first quarter report, although the sales volume decreased by 4% as a result of a softening automotive market, the adjusted operating profit held up well in the quarter. Our growth projects in America are proceeding according to plan, and we will have the new capacity available in the second half of this year. 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 I'll open up for questions. Thank you. And our first question comes from the line of Max Frieden from Danske Bank. Please go ahead. Your line is now open. Yes. Max here from Danske. Thank you. First on China and volumes and inventory reductions because you have a fairly good visibility and you guided for slightly better or less of a decline in the quarter. Then you said that the destocking in the supply chain is expected to continue in Q2. And I know it's difficult to estimate, but with your best judgment and your industry experience, how do you feel that the IHS estimates for the second half are standing for Asia automotive volumes? Yes. Max, thanks for the good question. As you well pointed out, we had fairly good visibility for one quarter ahead of us. And the guidance we have here for Asia is a high single digit decline in Asia. And it's not only China here. We also see a destocking taking place in other markets such as India and Thailand and Korea. So and I think that compared to IHS forecast for quarter two for Asia is you can say that they are a little bit maybe optimistic for Asia compared to what we see. Yes, exactly. That's my question. Because if you look at Q3 and Q4, they forecast 5.5% to 6.1%, if I'm not mistaken. That seems given where the sentiment is right now or given the double digit decline in car production in China, seems to me very optimistic, but you know this market much better than I do. So I'm just trying to get your view on those estimates for the second half, if that's possible. Yes. I understand, Max. I think we see them as slightly too optimistic. But I think what is important also, what we see is that China is we see a positive or a less decline in March, And also the commercial vehicle in China has actually had a growth. So I think the destocking and the decline is mostly relevant for other parts of Asia. Okay. And on U. S. Volumes, I thought if you look at the ramp up and if it's possible to give us some kind of guidance here in Q2, you're still going to see capacity restraints, but then is this going to be just a slight increase in Q3? Or are you adding on significant capacity already in Q3? Just try to help me understand a little bit the profile of the volumes coming onstream quarter by quarter, if that's possible? Absolutely, Max. So I mean both of the expansion projects that we're running in The U. S. Will become capacity will become available during Q3, starting off a little bit already in July, but taking off a little bit more in August. And then we foresee a gradual ramp up of the capacity during the second half of the year basically. So if you want to do some very simple math here, if you take the Huntington expansion there of the 40,000 tonnes, you say that it will be available gradually during second half of the year. That means that you will, at best case, have 25% of that capacity available in 2019, right? But we also know that we have a very high market demand here. So this will be very much dependent on our own internal ability to execute on these projects. And our ambition is to be at almost full run rate when we enter into 2020 in the Huntington plant. A little bit slower ramp up is expected for the Newport plant. Very helpful. And you still stand by your comment made in Q4 that if you take the ramp up costs that you have now in Q1 and Q2, then adding on the contribution to EBIT in Q3 and Q4, it's going to be a net positive for the full year? That's still the plan, yes, absolutely. And final question, price increases in The U. S, can you say how much in millions of Swedish krona that contributed in Q1? We don't give that specific comment, but we can say that we have managed to push through price increases of 10% on 50% of the volume in The U. S. Our next question comes from the line of Johannes Gronsilias from Handelsbanken. Please go ahead. Your line is now open. Yes. Hi, everyone. It's Johannes here, Handelsbanken. So I was wondering if you could perhaps elaborate a bit on how one should look at the building blocks for earnings in the second quarter. Because if I understand it right, you are indicating about 94,000 or 95,000 tons of volumes versus the Q1 volumes in that came in at 91. Is it fair to assume a very good sort of EBIT per ton on those incremental volumes quarter over quarter? That's my first question. And then I was also thinking about mix because it's obvious that you're gaining on relative basis volumes in HVAC and then auto volumes are coming off in the second quarter. Should one assume a negative mix effect in the second quarter? That's my second question. Johan, this is Oskar here. Two very good questions here, I think. First of all, of course, volume is a key profit driver for Granges. So if we are assuming that we have the same cost structure in Q2 that we have in Q1, of course, more volume will certainly help the profit there. As for your question on the mix, yes, we know that our automotive business is slightly more profitable, as we also showed on one of the charts today, than our HVAC business, of course. And since we are expecting the HVAC business in Q2 to be relatively stable compared to last year versus we have a decline or we foresee decline in the automotive business, that will mean a negative mix effect on profits for Granges. Adding to that, we will also have a geographical aspect of this, of course, because the most efficient production plant that we have is our facility in China. And that plant is where we had the lowest production cost, and that plant is supplying the Asian market primarily. And that means that we have typically a slightly higher operating profit for the Asian business within the automotive segment. So and Asia is also where we see the largest reduction in automotive sales. So there you have another mix component that will be a bit unfavorable for Granges in the second quarter. But is it fair to assume that the volume effect equals the mix effect? Or which one is greatest of those two sort of drivers on a sequential basis? I won't be able to comment on that today, unfortunately. Okay. Okay. Then on the CapEx side, could you perhaps update us on what you assume here for this year and possibly also 2020 when it comes to group CapEx? Absolutely. And as you know, we are currently running quite some extensive CapEx projects. And if you add that to our sort of base CapEx, we foresee that we will probably spend some SEK 1,200,000,000.0 of CapEx during 2019. The majority of this will be spent in the first half of the year as we are finalizing the projects in The U. S. And then we will gradually start some spending on the project that we have presented for Europe or Finspang in the second half of the year. Moving into 2020, of course, at this point, we will have finalized The U. S. Projects, and we foresee a quite large reduction as the only large project running then will be the European Finspang project. So then we expect about SEK 600,000,000 of CapEx for 2020 with exchange rates, I should say. Right, right. That's all for now. Thank you very much. Thank you. Thank you. Our next question comes from Karl Bokhvist from ABG Sundal Collier. Please go ahead. Your line is now open. Thank you and good morning. So I would like to follow-up on pricemix here. If we disregard raw materials and just look at your own pricing efforts or price pressure from customers, you mentioned the situation in The U. S, but could you shed some light on the pricing situation in both Europe and Asia? Karl, absolutely. I think that in The U. S, of course, we have seen a very good opportunity to raise the prices because there are very favorable market conditions for that. In Asia, the situation on sort of the competition and so forth is very similar to what we've seen for the last couple of years. And there, we know that we have had and are still experiencing in 2019 some price reductions. These price reductions are, however, significantly smaller than the price increases we see in The U. S. For Europe, market prices as such are relatively stable, but we are working a lot with our product mix in Europe. So we see slightly higher average conversion prices in Europe as well, but it's largely mix driven there. Okay. Good to know. And then if we look at HVAC volumes and you say that you expect them to be stable, but they were a bit negative year on year. I mean, you expect them to be stable, but how should we think in terms of the capacity limitations going into Q2 and until you expect to see some additional capacity from the expansion projects? Yes. Johan, I think in U. S, when it comes to HVAC and the business there is actually, as mentioned before, it's first is the mix change. We're also switching the mix into what we call higher margin product that demands more rolling capacity. That is one reason for the decline in volume. So and of course, having a large CapEx project running always gives some challenges to improve the productivity. So that is the second reason for the constrained capacity. But it's important to understand that the mix change that we are carrying out, of course, has a positive impact on the bottom line, basically switching to more high margin products. Yes. And then just adding to that, I think that the situation will not look very much different in second quarter than in first quarter here because the new capacity that will become available will become available as of the third quarter, right? So if you think about second quarter, it will be fairly similar to what we've seen in Q1. Okay. And then the third one here, when it comes to the Section two thirty two and The U. S. Tariffs, so you had a positive effect this quarter and you said that you should expect going forward a moderate effect. But I mean, given last year where you perhaps had some costs related to this, how should we think in terms of a year on year impact going forward now? No, but that's a very good question, Karl. If we start with just describing how now there are two parts here, of course. It's the antidumping duties and it's the two thirty two duties. If we start with the two thirty two, got some refund for twenty eighteen duties because we got exemptions for these. So that's a retroactive effect. We don't expect to get very much more refunds. We have some more exemption applications pending, that's will be of sort of smaller effects. And then we expect to carry some two thirty two duties going forward for products where we have not applied for exemptions. As for the antidumping duties, that was the large share of the costs in second quarter last year. Then we remember that we got those money back already within 2018, but it's a quarter to quarter, of course, it distorts the comparison a little bit. That cost will not come in 2019. But on the other hand, in order to avoid that cost, we had to move production as production to The U. S, we had to move that from the more cost efficient plant in Shanghai to the slightly less cost efficient plant in Sweden. And as a consequence of that, we have a lower margin on that U. S. Imports. So the cost is showing in second quarter this year as well, but sort of from another driver, if you understand what I mean. Yes. Okay. Thank you. Thank you. And we have a follow-up question from Johannes Gonsilias from Handelsbanken. Please go ahead. Your line is now open. Yes, hi again. I was just curious how you see the operations yourself because I was a bit positive surprised to see that EBIT per ton were pretty nice, although you didn't have great volumes in the quarter. Was that would you say, partly or fully due to very good operations over the quarter or more the pricing side? It's a good question, Johannes. I would say the pricing is a key driver here, clearly. And if we look about on the operations, they were generally running well, but not exceptionally well. I would say that it's more of a normal situation for that. So the primary benefits here is really on pricing. And as we know, currency rates are helping here. Sure, sure. Okay, that's helpful. Thank you. We have a question from the line of Max Lies from Kepler Cheuvreux. Please go ahead. Your line is now open. Yes. Hi, good morning. Just coming back to The U. S. Price increases, you mentioned you have been able to raise prices there about 10%. From the top of my head, I think you talked about 5% to 10% last year. So my question is, I guess, the volumes you were contracted last year will be renegotiated, well, next year, I guess. Do you expect them to sort of, well, come in at a higher level still? Or is it more, well, the same price increases you saw last year? But then you're talking about five to 10%. That's a good question, Mats. And I think that you're absolutely right here. We have been for 2018, we talked about some 5% to 10% on 50% of the volume. For this year now, we have been a little bit more positive on this ability to get the price increases through. And we are now, for 2019, saying it's going to be around 10% on 50% of the volume. Some of this volume is contracted for one year. Some of contracted for two or more years. But the point here is that what we do see is that we do see an opportunity to based on the market conditions and the high demand for our products, we do see opportunity to continue to increase prices for contracts that will be renegotiated for 2020. And we also see that the contracts that we are now taking on for our new capacity that will be available later this year, those prices in those contracts are taken at a higher level than what we have in our current portfolio. So we are positive for further price increases in The U. S. So for the capacity that you will sort of be able to supply during the second half, you have already signed contracts? Or are there more sort of tender contracts? We have started to sell that capacity already, yes. Good. And about the capacity increase and the investments made there, I guess, next year, could you sort of indicate, well, depreciations that will be sort of affected during next year when this capacity is in place? Yes. What we do see here is that I mean, we will start to depreciate these assets already this year, obviously. And what we see is that we will have a depreciation increase of some SEK 50,000,000 or so in 2019 compared to 2018. And then an additional SEK 50,000,000 or so for 2020 based on for these great. Yes, thank you. Thank you. And we have a follow-up question from Karl Bokhvist from ABG. Please go ahead. Your line is now open. Thank you. And two questions from me. I mean, you mentioned that you are switching to higher margin products in Asia. Could you shed some light on what types of products you are talking about here and in terms of end use and materials and things like that? So that's the first question. Then I'm continuously curious about thrillium and how is that progressing. Are you seeing strong demand? Have you started to sell volumes of thrillium? And going forward, how large share of volumes do you expect thrillium to be? Yes. Good question, Johan here. No, in terms of Americas and mix change, it's basically that we're giving priority to the HVAC customers and reducing the container business that goes into the food industry. That's on the high level, the mix change that we are carrying out. And about Trillium, we have basically also started to market and to sell Trillium into U. S. And Asia. We have several test orders also for this market. And we have a lot of customer quotations and discussions. And actually, on the recently, we actually was awarded a Trillium order for a charge air cooler for a global customer, both to Europe and Asia. And we are already in some EV applications for Trillium, for chillers, but also for battery cooling. So what I can say that we have I mean, the response is very positive. And now when we are intensifying our effort to launch this product on the market, we are positive to the future of this product. Okay. And then just a quick follow-up here. I mean, it's an of course, you can understand the benefits of the product. But do you expect to see higher selling prices of Trillium? Or will there be a gradual gradual decline of price to a more normal product value compared to your portfolio? I mean, will Trillium going forward be a very high margin product for you? Yes. Good. No, it's I mean, Trillium as a product gives much more feature for the customer, and therefore, it's also priced differently. And the benefit of Trillion will remain for quite some time and the value. So it will, for sure, be a product that you would price differently and also with a better, of course, overall margin. Also an important product, especially to being awarded new products for the battery cooling, where this flux residue is kind of really an issue for the battery cooling equipment. So there's a clear, clear advantage as well with the Trillium in terms of the for EV applications, I would say. Thank you. Thank you. And as we appear to have no further questions, I return the conference to the speakers. Okay. If no more questions, I would like then to conclude this session. Thank you, everyone, for participating in today's conference call. As usual, we received good and interesting questions. We look forward to our next call on July 18 when we present our second quarter report for 2019. Goodbye, everyone, and thank you.