Earnings Call: Q2 2018

Jul 19, 2018

Welcome to Granges Conference Call for the Second Quarter of twenty eighteen. Here in Stockholm, it's me, Johan Menkel, CEO of Granges and CFO, Oskar Helstrom. We will start this presentation with an update of Granges' performance during the second quarter and then go into the financial results. After that, we will conclude the presentation with a short summary and the Q and A session. To start with, I want to briefly go through Granges' current operations. Granges is a global aluminum rolling company with some 1,600 employees and an annual net sales of more than SEK11 billion. We have production facilities in Sweden, China and in The United States. About half of our sales volume is to the global automotive industry, where we are the market leader globally. The other half is split between the American HVAC market for building and houses and other niche segments in The U. S. When looking at the second quarter of twenty eighteen, we have continued to see a good development across all regions. Sales volume was 99,100 tonnes in the quarter, slightly higher than last year and in line with expectations. In Asia, sales volume was up some 0.9%, driven by good development in China. In Europe, volume was 0.4% lower than last year, although sales of heat exchanger material rose some 3%. In The Americas, sales volume increased by 0.5% from last year. We continue to see very good demand in The Americas, but growth is still limited by available capacity in our plants. Adjusted operating profit rose to million, up from SEK290 million last year and include cost of SEK27 million related to U. S. Antidumping duties on Chinese imports. Good metal management, improved operational performance in Europe and price increases in The U. S. Has contributed positively. Profit for the period was million. Earnings per share increased to SEK2.84 in the quarter, up from SEK2.55 last year. Cash flow before financing activities was SEK 125,000,000 and includes CapEx investment of SEK 166,000,000. We ended the quarter with a net debt of SEK 2,600,000,000.0, corresponding to 2.0x EBITDA on a rolling twelve month basis. We are currently working actively to mitigate costs for U. S. Import duties and don't foresee further costs related to Chinese import. The general tariffs of 10% that are effective from June also include imports from EU. The net effect of these tariffs is, however, expected to be limited for us. During the second quarter, the global light vehicle production increased by 4% compared to the second quarter last year according to the research firm IHS. In Asia, the market was up 6% in the quarter as production of light vehicle was increasing in China compared to last year. In Europe, light vehicle production increased by almost 5% in the second quarter, while in The Americas, the market was unchanged compared to last year. If we then look into the third quarter of twenty eighteen, the global vehicle production is expected to grow 4% compared to last year according to IHS. That comprises an increase of about 2% both in Asia and in Europe. In The Americas, light vehicle production is expected to grow over 9% in the third quarter. Our view isn't that optimistic as IHS, and I wouldn't be surprised if they came down somehow as the quarter proceeds. If we look further into 2018, the outlook for production of light vehicle is unchanged. IHS estimate a global growth of some 2% for the full year 2018. If we then look into Granges sales volume development during the second quarter, we can see that Asia was 0.9% higher at twenty two thousand five hundred tonnes. In China, the growth was 4.4% in the quarter. If we look at the first quarter and the second quarter combined, we have had high growth rate in the market in China and in India. In Europe, sales volume was flat at 17,800 tonnes. Sales of heat exchanger material was up some 3%, while sales of industrial products decreased in the quarter. In The Americas, sales volume was 0.5% higher at 58,008 tonnes in the quarter. That comprises a sales volume to the HVAC and R and other of 49,600 tonnes and to the automotive of 9,200 tonnes. In our local U. S. Operations, we continue to see strong demand. The import duties on rolled aluminum products from China is driving demand for locally produced products. Our growth is, however, still limited due to the fact that we are operating close to maximum capacity. From the second half of twenty nineteen, we will be able to add new capacity when the expansion in Huntington is ready. In May, we announced the decision to restart production at our facility in Newport, Arkansas, focusing on light gauge foil for various consumer applications. This is a great opportunity for us to use an asset we already own and entering a new market niche. The investment amounts to USD 26,000,000 and will be used to upgrade current mills and equipment. Production is scheduled to start in the first quarter next year and then gradually be ramped up. When fully upgraded in the second half of twenty nineteen, the capacity in Newport will be around 20,000 tonnes per year. We are currently in discussions with customers and have received a very positive response so far. Already in 2019, we expect the investment to contribute positively to earnings. Another important project is the capacity expansion in Huntington. The site work is progressing according to plan, with the construction of new buildings just started and all major equipment now being ordered. When finalized next year, the capacity at the Huntington plant will increase by 25%. Now I hand over to Oskar and the financials. 2018 has started very well for Granges, and the positive trend continues in the second quarter. And the second quarter is also the best quarter so far for the group. Although the sales volume remained relatively stable year over year, the rolling twelve month adjusted operating profit continued to increase to SEK $989,000,000. That's an improvement of SEK 110,000,000 compared with the run rate earnings a year ago. If we look at the second quarter financials in more detail, we can see that the sales volume increased by 05% to 99,000 tonnes, whereas net sales increased by 12% to SEK3.4 billion. The higher year over year increase in net sales than in sales volume is primarily driven by increasing metal prices. The net impact of net sales from foreign exchange rates was positive SEK 53,000,000 compared with second quarter twenty seventeen. Moving to the earnings. The adjusted operating profit amounted to SEK301 million in Q2, an increase of close to 4% on prior year. The increase in adjusted operating profit is primarily driven by improved metal management across all regions and a slightly higher average conversion price. Changes in foreign exchange rates had a net impact of positive SEK 16,000,000 compared to Q2 twenty seventeen. On the metal management side, I would like to highlight that we managed scrap metal very well in the quarter. First, we have been able to increase the recycling of internal scrap to a new record level. And second, we've also managed to increase the amount of external scrap used instead of primary aluminum, especially in our Americas operations. And this is important both from a cost and from a sustainability perspective. On the negative side, cost for countervailing and antidumping duties on products imported to The U. S. From China amounted to 27,000,000 in the quarter. As of 2018, we are rebalancing the timing of vacation expense in Americas to get a more even distribution over the year. Although this is neutral from a full year perspective, it has a negative impact of about SEK 5,000,000 in Q2 when comparing year over year. We will also see a negative year over year impact of about SEK5 million in Q4, balancing the positive SEK10 million impact we saw in Q1. In the third quarter twenty seventeen, we updated the assumptions in the useful life for certain types of assets. The consequence of this is a reduction of depreciation that has a positive impact on the operating profit of SEK 16,000,000 in the second quarter. As the updated assumptions have now been in use for four quarters, we do not expect any further year over year effects from this going forward. The adjusted operating profit per tonne reached SEK 3,000, which is SEK 100 or 3% higher compared to Q2 twenty seventeen. Excluding the antidumping duties, the underlying operating profit per tonne increased by 13% to SEK 3,300. There are no items affecting comparability in the second quarter, and the reported operating profit is therefore the same as the adjusted operating profit in the quarter. The profit for the period reached SEK $214,000,000 compared to SEK 192,000,000 previous year and corresponds to earnings per share of SEK 2.84. Cash flow before financing amounted to SEK 125,000,000 in the quarter. And by the June, the return on capital employed reached 17.2% on a rolling twelve month basis. During the second quarter, the net debt increased by SEK $269,000,000 to SEK 2,600,000,000.0. This corresponds to 2x adjusted EBITDA on a rolling twelve month basis and remains within our long term target range of one to 2x. Looking at the cash flow before financing in the second quarter, we can see that the strong earnings contributed with SEK $390,000,000. For the working capital, we, however, see a negative development of SEK 82,000,000 in the quarter, and this is primarily driven by two things. First, The U. S. Sanctions against the Rusal, that is a supplier to Granges from their Kubal plant in Sundsval in Sweden. And following the introduction of the sanctions in early April, Rusal closed the consignment stock of slabs at the Granges plant in Finspang, leading to increased inventory carried in Granges' books. As a consequence of the sanctions, Granges' supply chain financing program, reducing the amount of credit days Granges has for payments to Granges. In total, this is impacting the working capital and the cash flow negatively in the second quarter by SEK135 million. In addition to the issue with resolve, increasing metal prices tied an additional working capital of some million in the quarter. Excluding these two effects, we can see that the working capital was managed very well from an operational perspective in the quarter. Other operating items refers to taxes paid of S17 million and investments in fixed assets amounted to S166 million in the second quarter. Of this, S90 million refers to investments to maintain and improve the current production facility and million is CapEx related to the expansion in Huntington. During the quarter, we also distributed SEK227 million to our shareholders. And FX and other mainly refers to the SEC revaluation of loans denominated in U. S. Dollars. As we discussed in our first quarter report this year, new U. S. Trade legislation, both in terms of new tariffs as well as sanctions against Rusal, has had a large impact on the aluminum market. This development has continued over the last couple of months, and this is also something that has impacted Granges in both positive and negative ways. There are three areas that has an impact on Granges' business: antidumping duties on foil and sheet from China general additional tariffs under Section two thirty two and trade sanctions against Ruzal. On June 18, the U. S. Department of Commerce introduced preliminary antidumping duties on aluminum sheet from China of 167% valid retroactively from March 24. This comes in addition to the 31% to 113% countervailing duties on sheet that were already in place. This brings the total duty on aluminum sheet to well about 200%. Similar antidumping duties for Chinese aluminum foil was finally confirmed on March and will be valid for at least five years. As I previously mentioned, the impact of the antidumping duties was SEK 27,000,000 in Q2, and this was largely driven by the retroactive duties on sheet. To avoid being exposed to antidumping duties, Granges has transferred the production of all volumes imported to The U. S. From China to Sweden during the first half of twenty eighteen. We are now waiting for the last customer to finalize its validation. And provided that this is completed on time, we do not expect to see any further cost for antidumping duties going forward. We do, however, expect to see some increase in production costs for the transferred products due to the slightly higher cost position in Sweden compared with China. On the positive side, the antidumping duties has led to rapidly increasing market prices in The U. S, and this is expected to greatly benefit our domestic U. S. Business going forward. The general Section two thirty two tariff of 10% was presented on March 23, and the exemption for EU, Canada and Mexico ended by the May 31. So far, Granges has only carried limited additional cost to this, but the supply chain from Sweden to The U. S. Is exposed to the Section two thirty two tariffs. These tariffs are, to a large extent, by agreement being carried by our customers, and it may also be possible to recover some of the remaining costs to the metal price component, at least in the short term. We do, however, believe that the majority of our products should qualify for exemptions from the two thirty two tariffs, and we have filed for this with support from our customers. We expect to receive the answer from the Department of Commerce in early Q4. And after that, the impact to Granges of the new tariffs will be clear. As for the sanctions against Rusal, they prohibit U. S. Persons and limit non U. S. Persons to transact with Rusal after the October 23. As we have previously mentioned, one of the Rusal subsidiaries, the Kubal smelter in Sunsal in Sweden, is a supplier of aluminum slabs to Granges in Finspang. In Q2, we saw an effect of the sanctions on the working capital and cash flow, but this is a onetime effect that is expected to be reversed should the sanctions against the Resolve be lifted. And looking ahead, we've always had a multisourcing strategy for slabs. And since the sanctions were announced, we have reduced any risk for Granges by securing metal supply from non Rusal sources. Should the situation around Rusal not be resolved and the sanctions come into effect in October, we do, however, expect to see a slight increase in material and logistics costs in Q4 this year and in 2019. Needless to say, we continue to monitor the developments in this area very closely. I will now hand over back to Johan Menkel that will summarize the second quarter and provide an outlook for the third quarter. Thank you, Oskar. When looking into the third quarter of twenty eighteen, we foresee a stable sales volume to the automotive customers in all regions that implies a lower growth rate than the research firm IHS currently forecast of the market. For the HVAC business in Americas, we expect a low single digit growth in the third quarter. We are seeing a very strong demand, but have to turn down customer requests as we still have capacity constraints. The investment in new capacity in The U. S. Will come into effect during the second half of twenty nineteen. We're also reviewing capacity needs in Asia and Europe, and we are evaluating different ways to move forward. In total, we foresee a sales volume for the 2018 that is in line with the third quarter last year. When looking further ahead, we remain positive and see good market potential. We will continue to execute on our strategy to grow our business and maintain a solid and sustainable profit. To conclude the twenty eighteen second quarter report, we have continued to see a very good development during second quarter. Sales volume increased slightly to 99,100 tonnes, which was in line with expectations. Adjusted operating profit increased by four percent to SEK301 million despite having cost of SEK27 million for the antidumping duties. Good metal management, improved operational performance in Europe and price increases in The U. S. Has worked on the positive side. Cash flow before financing activities was SEK125 million. Return on capital employed was up to 17.2% and we ended the quarter with a net debt of 2x EBITDA. Our growth plans for North America are proceeding according to plan. The expansion of our facility in Huntingdon is set to be finalized in the 2019 and the upgrade of the Newport facility has just started and will be ready next year. We're also evaluating other projects in the region as well as in Europe and in Asia. Thank you. And now we open up for questions. Thank And we have a question from the line of Johannes of Handelsbanken. Please go ahead. Your line is open. Everyone. It's Johannes Grussellus, Handelsbanken here. I have two questions. Johan and Oskar and team, could you give a little bit more flavor perhaps on the ongoing investments? Are they proceeding into plan? Or how are you in terms of planning and budgeting, etcetera? Yes, absolutely, Johannes. Johan here. Yes, the current project we are running in U. S, the main one in Tennessee, Huntington, is progressing according to plan. We have basically completed the foundation work and started the construction work, and all the major equipments are ordered. And the product is running according to plan and both in terms of budgets and cost and time. So and as we stated, we will see this new capacity coming to the market on the second half of twenty nineteen. And we are also in a positive discussion with customer, which there is a strong request and need for this new capacity. And the second project in Arkansas, Newport facility has just started, but that is also according to plan and budget so far. I hope this helped, Johannes. Yes, sure. Think about the CapEx here and the risk that it could be higher or lower compared to your indication and your budget. Do you feel that there is a very low risk that we should see any deviation from the CapEx sort of? Yes. I mean we have a good experience of running major expansion projects with Ingranges, and we've always been successfully managed our projects. So and even this project are really going according to plan, we have a lot of experienced people with Ingranges. So I'm actually confident that we will be successful with these projects. Okay. Okay. Good. Thank you. And the second question is more near term, and that's on FX because on one hand here, you have, I suppose, a lot of tailwind from stronger dollar primarily. So I think that helps you. But then you have your hedging position. So if we look at the Q3 position the Q3, it's impossible to quantify that obviously, but I was surprised that you had a positive 16,000,000 here in the second quarter. How should we think about this effect in the third quarter is basically my question. Johannes, it's Oskar here. Think it's a fair question. We've had, as you say, quite good tailwind now in the second quarter in terms of FX. What you see here is we and to your right there, we do hedge our transaction exposures, which means that the positive or favorable development out of the U. S. Dollar as well as of the euro now in the second quarter here. You see that to some extent, but you will also see that coming through later because of it that is hedged. But on top of that, of course, we also have the translation effects. When we translate the earnings in our U. S. Business as well as translate the earnings from our Asian business to Swedish krona, And that is sensitive, especially then to the SEK dollar and to the CNY of course, but that's also quite tied to the dollar. So a stronger dollar here in Q2 has also had a large impact on the translation of FX. And that's why you see the positive effect being so large in the second quarter. Okay. Yes. That helps. I mean, then we should expect the third quarter total FX effect to be positive as well, I assume. Provided that the FX rates remains on the current level, you can expect the translation there to be positive for sure. And you will also see some delayed positive impact from the hedged transaction exposures. Sorry, guys. I also have a third question, which is quite important. So sorry for taking a lot of time here. But the effect here from antidumping duties on Chinese volumes into The U. S. That you quantified to SEK 27,000,000, Just to be clear on that one, I mean, own expectations and planning is that this number should be virtually zero, I guess, in the third quarter and the fourth quarter, thus providing that the final customer gives you the quality approval. Is that right? I mean this is something, of course, that is very high on the agenda. And because it's a large number and the anti duty rates are very, very high here, of course. So from the Granges perspective, we have finalized the transfers. We are producing in Finspang now all the products we previously produced So from our perspective and the internal work that we have to do, we have completed this. Then as we said, we are awaiting the final customer to confirm the validation, But we are confident that they can do that on time. And if they can, we will not see any antidumping duties going forward. And that's our belief. So work case, if this approval doesn't come, would it imply that you will pay like a few 100 sorry, a few million in acting duties? Or do you see the question? And should we think about an insignificant effect in all kind of scenarios in the third quarter from this? That is that in the end, it will be a commercial discussion with that particular customer, exactly how that will be handled in that case, I would say. Okay. Yes. Just to add to this, Johan here, Janis, that we've been successfully transferring all the volumes for all the other customers. So we are still confident that we will also manage this lost customer's transfer. And there are no further questions at this time. Please go ahead speakers. I stand corrected. We do have a question from the line of Emmy Ostland of ABG Sundal Collier. Please go ahead. Your line is open. Hi, good morning. I have a little a question on Europe. So it says here that your sales of industrial products were lower and I think overall sort of the volume decreased. What could you give us a bit more color on that? And will do you see this improving in the next quarter, please? Johan here. I mean, the main market for us in Europe are the bracing sheet for heat exchanger, and the industrial product segment has been a way to optimize our basically scrap. So we have given priority to the heat exchanger market. So it's a decision we're taking to reduce that group or that segment actually. Yes. Maybe to add on that also, I commented earlier on here that we have been very good in scrap handling and scrap recycling and so forth now, especially in the second quarter, but also, of course, in the first quarter this year, we saw some improvements. The better we are in reusing our internal scrap for our heat exchanger products into new heat exchanger products, the less industrial products basically we need to produce because producing industrial products in Europe is an alternative to selling the scrap on the market and taking a loss on the scrap. So from our perspective, you can maybe say even that, that it's a positive thing that the sales of industrial products goes down because that means that we are better at recycling our own scrap. Okay. Got you. So you're actually trying to sort of reduce this number actively? I wouldn't say we're trying to reduce it actively. What we're trying to do is we're trying to be reusing as much as possible of the scrap we generate into our core market products, which in Europe then would be the heat exchanger products. And if in an ideal world, we can reuse 100% of the scrap into those products. And in that situation, we will probably not sell any industrial products at all, if that helps. Yes. Okay. Well, thank you very much. I will get back into queue. Thank you. Thank you. And there are no further questions at this time. Please go ahead, speakers. Yes. Then no more question. Thanks a lot for participating and for good question, as always. We look forward to our next call on October 25 when we'll present our quarter three report. Until then, I wish you all a very nice summer. Thank you, and goodbye. This now concludes our call. Thank you for attending. Participants, you may disconnect your