Befesa S.A. (BFSA) Earnings Call Transcript

Ladies and gentlemen, thank you for standing by. Welcome, and thank you for joining the first half 2023 results of Befesa SA. Throughout today's recorded presentation, all participants will be in a listen-only mode. After a short introduction by the management, there will be a question-and-answer session. [Operator Instructions]. And I would now like to turn the conference over to Rafael Perez, CFO. Please go ahead.

Good morning, and welcome to the first half 2022 results conference. I am Rafael Perez, CFO Befesa. Today, we have with us Javier Molina, Executive Chair of Befesa; and Asier Zarraonandia, CEO of the company. Javier Molina will start with an executive summary of the first half. After that, Asier will explain the business highlights of the period, covering steel dust and aluminum salt slags recycling. I will then review the financials with a focus on cash flow, net debt and our hedging program. As here, we'll close this presentation providing an update on our growth plan as well as some thoughts about the outlook for the second half of this year. Finally, we will open the lines for the Q&A session. Before getting started, let me remind you that this conference call is being webcast online. You can find the link to the webcast and the first half results presentation on our website, www.befesa.com. Now let me turn this call over to our Chairman. Javier, please?

Thanks, Rafael, and good morning, everybody. The first half of the year has been characterized by a challenging macroeconomic environment. Despite these difficulties, Befesa has delivered solid results. Although revenue has increased by 8% compared to the last year, driven by the integration of the zinc refining operation in North America, EBITDA in the first half was EUR 95 million, 3% down compared to the previous year. The main driver for this decrease has been higher zinc treatment charge up 19% compared to last year, lower zinc prices, which are down 25% compared to the same period of last year as well as higher or up 25%. All these negative effects has been partially offset by averaging hedging price and lower operating costs, driving by productivity improvements and lower natural gas and electricity prices. Our aluminum business has continued to show strong performance during the first half of the year, benefiting from strong margins and a decrease in the energy prices in Europe. Asier will explain the performance of the steel and aluminum business more later. From the study point of view, during the first half, we have continued the integration in the U.S., including the zinc refining plant, which is improving its performance gradually with higher utilization rates. Also, in the U.S., we continue with the refurbishment works on the plant in Palmerton, Pennsylvania. In China, where the steel products continue to be weak, we continue to progress with the third steel dust plant in the province of Guangdong, one of the most prominent province in China. Nevertheless, as we explained in the past, we have modeled the speed of the investment and we are adapting to the current situation in China. With regards to the outlook for the rest of the year, overall, we expect a stronger second half of the year compared to the first half. This is based on expected overall higher volumes on the second part of the year, combined with a gradual decrease on coke price through the year and strong recovery of zinc price, which at the current level are scratching the [indiscernible] 04:46 . Finally, on ESG, we published away BSU report for 2022, which includes the reporting on European taxonomy 05:00 as well as a chapter on green metals, where we are very well positioned with low carbon aluminum as well as you will see. Before handing over to Asier, I would like to thank Uwe Lehmann for his contribution as CFO over the last year. As we announced, Rafael Perez has been appointed as CFO. Rafael has been part of the executive team of Befesa for more than 15 years, reporting directly to me. He has the required knowledge, experience, leadership skills and will be supported by a highly experienced team. The change in CFO will have no impact on Befesa and our ability to deliver the global growth plan that we presented at the Capital Markets Day in last November. Now Asier will explain the business performance in more detail.

Thank you, Javier. I will now provide an overview of the performance of the business during the first half of 2023. Overall, the first half of the year has been a challenging one, as explained by Javier, impacted by lower zinc prices, high treatment charges, high coal prices and still a weak environment in China. Befesa's total revenue increased by $43 million or 8% year-on-year to EUR 615 million in H1 2023, primarily attributable to the contribution from the U.S. in finding operations. Befesa delivered an adjusted EBITDA of $95 million, down $23 million or 20% year-on-year. This decrease was primarily driven by the lower zinc market prices. The main drivers of the year-on-year $23 million EBITDA developed in more detail on volume. Overall, approximately $2 million negative volume year-on-year impact, mainly due to the 6% decline in electric gas furnace, steel dust throughput primarily driven by the U.S. operation and the earthquake in Turkey. On price, overall, approximately $29 million negative price year-on-year impact explained by lower zinc and aluminum market prices. About $27 million from the steel dust business, around $3 million from the Alu Salt Slag business. I will explain later in more detail. On cost order, the negative impact from high coke prices have been compensated with lower operating costs in our steel dust and Aluminum Salt Slag business, in this case, mainly through lower energy prices. Turning now to the results from our steel dust recycling business. Steel dust delivered EUR 67 million EBITDA in the first half, down $28 million or 29% year-on-year. Overall, the year-on-year $28 million decrease in EBITDA was mainly driven by the 25% decrease in zinc LME market prices. The volume level was negative by around $2 million EBITDA year-on-year impact as explained mainly due to the earthquake impact and operation in Turkey and the U.S. operations beginning of the year. After the earthquake occurred in part in February, we successfully restructured operations in March at our plant in Iskenderun has been operating at normal levels in there. Total steel dust volume in the first half was 592,000 tons, which is 6% lower than the last year and reaching an average utilization rate of 17%. However, steel gas volume in Q2 has been 6% higher than Q1, and we expect this trend to continue. Overall, steel production globally has been weak during the first half of the year as it shows on Page 11, with Europe down 10%, U.S. less 3% and Turkey and Korea, less 7%. Despite this, in Europe, we achieved solid volumes will help to run our European plants and as a strong utilization levels. In China, volumes were weak driven by a delay in the recovery of the economy activity with steel production below pre-COVID levels. The price level was overall negative by about EUR 26 million year-on-year with main price components being EUR 27 million negative impact from lower zinc LME prices, down 25% or close to EUR 900 per tonne year-on-year to around EUR 2,600 per tonne on average for the period. EUR 6 million positive impact from higher zinc hedging prices, which is up 1% year-on-year to around EUR 2,350 per tonne average helped us to fully offset the unfavorable increase of zinc treatment charges, which was set up 274 per tonne for the year 2023 versus 230 per tonne in 2022. Regarding the cost of the level, the pressure from higher coke prices was offset by the positive impact through the productivity and synergies. With regards to the Befesa's coke price, after reaching an all-time high level in Q1, Befesa's coke prices started to moderate in Q2, 3% lower versus Q1. However, the first half average coke prices was 25% higher versus last year and is still around 90% above the 2019 to 2921 average levels. Revenue in the steel dust business increased by $49 million or 13% year-on-year to $403 million, mainly attributable to the contribution from the U.S. zinc refining operations. Consequently, EBITDA as a percent of revenue stands at 17% in the first half versus 27% last year. The year-on-year profitability decrease is mainly driven as explained by the lower zinc market prices, the unfavorable zinc treatment charge increase, the higher coke prices as well as the zinc refining operation contributing to revenue but not yet to EBITDA in the first half. As we saw on Page 9, zinc LME prices have significantly decreased in the first part of the year. However, zinc prices have historically rebounded strongly upon touching the C90 curve. This is something that we have seen many times in the past during periods of strong economy stress. Zinc price is currently clearing around the C90 cost curve, which sold balanced supply/demand and hence provide price support at these levels. Regarding coke prices on Page 10, you can see that after reaching an all-time high levels in the first Q 2023, Befesa's coke price saw a small reduction in the Q2 by 3% versus Q1. However, the first half 2023 average coke price is still around 90% above the 2019 to 2021 average levels. In Q3, we are starting to see further mobilization which hopefully will continue over the rest of the year. Natural gas and electricity prices continue to normalize during the Q2 back to average levels of 2021. Moving now to the results of our Aluminium Salt Slags recycling business. Aluminum Salt Slags delivered a strong first half with $28 million EBITDA in the first half, up 17% or $4 million year-on-year. The year-on-year $4 million EBITDA improvement was mainly due to the lower cost, primarily through lower energy prices, partially offset by lower aluminum market prices. Regarding volumes, our salt slags and SDL recycling volumes had slightly decreased by 1% year-on-year to 171,000 tons in the first half, primarily due to the ramp-up of the Hanover plant, which we completed in Liquid in the second Q. Our aluminum alloy production volumes increased by 3% year-on-year to 87,000 tonnes in the first half. With these volumes, we operated our plan at solid utilization rate of about 85% in secondary aluminum and close to 75% in salt slag on average. Overall, as you see in the EBITDA work, no EBITDA impact year-on-year from the volume level, the higher secondary aluminum volumes were offset by -- with lower salt slag treated. With regard to prices, aluminum alloy FMB market prices showed a 12% or around EUR 300 per tonne decrease versus last year to around EUR 2,250 per tonne average in the first half. This negative price effect was partially compensated with year-on-year higher aluminum metal margins and resulted in about $3 million negative price effect that you see in the EBITDA work. The cost or the level of the EBITDA work shows around EUR 7 million EBITDA positive effect year-on-year. This was driven by lower operating costs, mainly through the lower gas and electricity prices. Befesa's gas and electricity prices reduced further in the Q2, around 20%, 25% lower versus Q1 and back to 21 average levels. Befesa's average price of gas in the first half was approximately 50% lower year-on-year. EBITDA as parses on revenue in the salt slag segment remaining strong at about 5%. Now Rafael will explain the financial section.

Turning to Page 13 on hedging. Befesa's hedging strategy remains unchanged and continues to be a key element of Befesa's business model, providing same price visibility, lowering the impact from zinc price volatility and, therefore, improving the stability and visibility of earnings and cash flow throughout the economic cycle. Our seeking hedge book includes close to 300,000 tons of zinc payable, hedge equivalent to 65% to 75% of our zinc exposure, up to and including July 2025. Therefore, we have 2 years of hedges on our books and increasing hedging average prices, around 2,400 per tonne in 2023, 2,500 per tonne in 2024 and around $2,650 per tonne for the first half of 2025. In Befesa, we have been doing hedging for zinc price for more than 15 years. And it is right now in moments like this, with falling zinc prices cause weak economic outlook when the hedging proved value. The hedge book at current price levels has a mark-to-market value of more than EUR 100 million. Turning to Page 14, the cash flow, net debt and leverage results on the EBITDA to cash flow bridge, starting with 94.7% adjusted EBITDA and to the left, walking the right. Working capital was up by around EUR 28 million year-on-year. This is very much driven by the usual exporter seasonality impact with our cash consumption in Q2. Interest paid increased year-on-year by 13% to EUR 13.4 million in first half 2023. This was explained by 2 elements. On the one hand, the higher being applicable to the TB, which increased in December 22 by 25 basis points to [indiscernible] due to the increase in the leverage ratio. On the other hand, the year-on-year high Euribor from 2% last year to 1% to 3% applicable in first half 2023. As a reminder, our long-term capital structure consisting of a term loan B is 50% hedged against increases in the interest rates. Taxes paid reduced by 29% year-on-year to $11.4 million in the first half of 2023, resulting in an operating flow of EUR 42 million in first half, 34% or EUR 32 million lower versus the same period of last year, very much driven by the lower earnings. CapEX wise, in the first half, we spent $43 million in maintenance CapEx, including expenditures related to the final recovery of our Hanover plant and related to the divisional excellent projects in the U.S., normalizing for the Hanover recovery CapEx, regular maintenance CapEx amounted to roughly EUR 30 million in the first half. Gross [indiscernible] for the period was $10 million, including the remaining expenditure for the Henan project and CapEx related to the refurbishment project at Palmerton in the U.S. Overall, CapEx of EUR 53 million in first half normalized for around EUR 13 million for Hanover total CapEx will amount to around EUR 40 million which analyzed will be equal to approximately EUR 80 million, well aligned with $85 million to $95 million CapEx guidance for the full year 2023. After funding working capital, interest, taxes and CapEx, total cash flow amounted to minus EUR 8 million in the first half. Cash on hand stands at EUR 143 million, which together with our entire undrawn EUR 75 million recurring credit line provides Befesa with strong liquidity, well above $200 million. The EUR 567 million of net debt with EUR 191 million LTM adjusted EBITDA results in a net leverage of 2.96 at Q2 closing. Now back to Asier growth and outlook.

Thanks again, Rafa. As we have explained in the past, the decarbonization is a global mega trend that will the increased production of electric are furnace steel, making our natural market to grow significantly in the coming years. We have a well-defined growth plan consisting of 9 projects in Europe, China and the U.S. to capture the growth opportunities that we are seeing in the market. The first part of the investment plan will focus on the U.S. with the refurbishment of the Palmerton plant which has already started with the demolition works and 1 of 2 kilns and the signing of the EPC contract. As explained in the past, the refurbishment of the Palmerton plant consists of the agreed of the 2 kilns in the bank, one at a time in order to capture the growth that the North American market is going to experience in '25 and beyond. The first phase of the project will be completed by the Q3 in '24, while the second phase will be completed by the end of 2025. The second focus of the investment plan is China, where we are developing the third plant in the province of Guangdong. With more than 120 million people living in the province, Guangdong is one of the richest in the nation and the largest car manufacturing location in China. As explained in the past, our growth fully depends on Befesa, which means that we can accelerate to a slowdown the investment depending on the development of the basket where we want to grow. The current situation in China, characterized by a weak economy environment and weaker steel production makes us be more cautious and adapt to the situation in the country. We are monitoring the evolution of the market and don't expect to invest in the plan in 2023. Anyway, the question in China is not if the economic will recover, but when will it happen. Finally, on outlook, as explained by Javier, we expect a stronger second part of the year compared to the first half. From the volume point of view, we start higher volumes overall, we continued the strong operation in Europe and the U.S., with China gradually improving after a challenging economic environment in the first half. We also expect better performance on the EAFD plant in the U.S. From the price point of view, as I said earlier, zinc prices have historically [indiscernible] cost curve in the zinc by a supply down rebalance. We also expect coke prices to continue the normalization of prices that we are seeing in the Q3. Based on the above, we expect the strongest part of the year. And looking ahead, in Q4 we expect a strong earnings growth driven by better hedging on the very low zinc higher volumes and normalizing zinc and coke prices. Thank you very much.

Thank you, Asier. We will now open the lines for your questions.

Ladies and gentlemen, at this time, we will begin the question-and-answer session. [Operator Instructions] And we have the first question from Sandeep Peety from Morgan Stanley.

I'll take one at a time. So firstly, if zinc price and coke remain on spot of EBITDA should be expecting for 2023. Also, can you understand what assumptions implied in your end and upper end of guidance23:20 range in terms of China plant and zinc assets?

Thank you, Sandeep. Well, obviously, we were expecting the question. But as I said before, this is a combination of many things. What I can say is that the zinc prices has been affected especially in the last 2 months, and we don't expect that it's going to happen for the rest of the year. Today, it's above EUR 2,500. So we think that it's going to be the coal prices. What I can say is that we are watching in the next quarter that the price for the pit coke in where, as an example, European plants have dropped in the range of EUR 100. So the question is that it's a combination of all the headwinds that we are having, as I say, treatment charges in prices. China's valuation, seen the fining ramp up everything that has been affected to the first quarter. Well, we are considering that it's going to not affect or affect less in the second part of the year. Having said that, you know that we are not giving exactly assumption for the year, because at the end of the day every one of you are modeling, and we cannot enter into one by one assumptions. But this is a combination of everything that would make us to be in the position that the second half is going to be stronger than the first one, and we will land obviously in the low level of the guidance.

Very clear. And then the second question, today you have disclosed EBITDA of EUR 10 million to EUR 20 million from your Palmerton plant at EUR 60 million to EUR 70 million of CapEx. Based on those assumptions and CapEx of -- sustaining CapEx of $2 million per annum, tax rate of 25% and WACC of 8%, I get to an IRR of 17%. Can you help us understand how is greater than 30% IRR calculated and the payback period of 3 to 4 years?

Again, Sandy, this is a good summary of your calculation. Basically, you may ask better than me. What I can confirm more or less those amounts of investments, probably the amount of the EBITDA level and IRR, yes, I think that our calculation is in a range of 15% or above 15%. The main question here is how many tons you are considering that we are going to capture with the new situation of the American market in the future. So yes, we can confirm those things because it's the same that we were discussing in the November capital market. And there are not many things in the medium term. The storm is coming in the 2023 year, end of '22 and during the '23s as we are in the middle of a [indiscernible] storm. We see the future or the near future, start in '24, no change for us. So we do think that we are going to drive in the business in better waters in the future. So no changes and I think that we can confirm as we see the same for the Palmerton project as we explained it in the past.

Okay. And just an extension, so your implied profitability for zinc refining asset is $20 million to $30 million. Can you confirm that?

Yes. In long run, yes. I think that probably in '23 we are not going to reach this for the whole year. This is difficult because the ramp-up is in the first quarter especially and we'll [unintelligible] in the second quarter -- second half, sorry. And second how we see that the plant is more stable and '23, again, probably we will not reach those levels, but we're sure that 24 and onwards we will there in the 10% to 15% or even better year of '20, this is the maximum that refining hub.

The next question is from the line of Michael Hoffman from Stifel.

I have to ask because most of my coverage in environmental services has been able to use pricing on things like collection fees and what to pass through inflation. So why not have passed through the coke price increases in the EAS business through the collection charge?

Thank you Michael. Well, interesting question as well. I think that we have to make a difference. In aluminum, we are -- it's more sensible to the cost because the part of the same consider-- sorry, the price consideration is perhaps lower and is more sensible to the cost of the plants. That's why we are able to transfer the cost of the higher cost to the fees, and we are increasing this profitable [unintelligible]. In the case of the zinc prices because the competition in the market that we are and the percentage of the cost that for the steelmakers have this the ability to manage the residues makes it very, very difficult, that is an immediate transfer of the fees to the steelmakers. Long run, on a couple of years you can increase the level. We have as well some formula basis but normally based on the zinc prices. So it's not so clear that you can transfer immediately the fees and the cost for that. Having said that, once again, if you see the bottle half full it's going to be a temporary matter about the coke and energy prices. So at the end of the day as we are suffering this and coming back to the normal level will be enough to come the profitability good. But it's not -- it's true that it's not an immediate transfer system regarding the prices in the zinc business.

Okay. And then I'm not sure I totally heard or understood all the answers to the first person's question. What I think I heard was that zinc prices stay at the current spot market and coke prices continue to correct, will be at the lower end of the current guidance. So we should have modeled fowards about $200 million of EBITDA.

Michael, you listen more or less well. It is, again, it's a combination. I mean, if everything remains as it is, probably it's going to be dip, but we do expect changes in these 4, 5 effects that we are suffering in the first half. So again, zinc prices, we don't see it's going to be in this level for the year. It happens. We will see what the other FX have in the coke prices are getting down, definitely. I don't know -- we don't know now exactly the level of the drop, refining of the asset, refining in the U.S. coming better for the first second half. The synergies in U.S. are to come in the second part as well, we expect to deliver better. And then let's see China that looks like with the last announcement of some stimulus or whatever it could be, I don't know, if it's spectacular or not but probably doing better definitely than the first half. So the combination of all the FX has to be confirming the guidance. Other thing is that you put everything in the very, very bad situation, it would be difficult, but we don't see like that. We see that this is going to be again better performance in second half.

Okay. And then Rafael, what are we -- should we be assuming for operating cash flow for the full fiscal year now?

I think, Michael, if we go to the cash flow statement I think if you look at the CapEx, I mentioned in the presentation that it will be around EUR 80 million. Working capital, which is in the first half, -- minus the 8% I think that should part of -- a significant part of that should recover through the year. We can think about taxes at a very similar level to last year. And then the other bucket is interest rates, which, as you have seen, is slightly increasing. And we slightly increase in the second half driven by higher Euribor. So if you put everything together, I think total cash flow for the full year should be around minus EUR 40 million to minus EUR 50 million.

Okay. And that means we're probably at about an operating cash number of EUR 110 million to EUR 120 million compared to the EUR 43 million in the first half?

Yes. Which finally, if you convert that into the leverage ratio, probably we will end up the year with a leverage ratio slightly above 3x. But as Asier has explained, we expect a very strong 2024 and therefore the high peak in leverage will be temporarily.

The next question is from the line of Cameron Needham from Bank of America.

Look, first question for me. I'm interested just in terms of China, I'm interested to get into what sort of conversations you're having with customers or potential customers? And also on trend, has anything surprised you so far with this [unintelligible]?

You mean customers in general Cameron, right?

Yes, that's correct.

Well, tactically, I think that the conversation with the customer is to on what is going to be the production for the next months. And this is -- basically, they should consider the orders they have, how the steel prices are in terms of cost and then normally, this is the main topic that we are discussing with them. Normally, the contracts are in place. We have formula basis because of in prices in contained and everything is going well in terms of the break of the framework of the business. But the situation is that they depend a lot from the real estate, the construction new business in China because mariner Carport are producing long products like [unintelligible] so, so well, basically, they are suffering this. So the conversation all the time about the production and property, this is in general. The other point is in the Guangdong province, and I'm talking with the team makers getting more commitment for the future. And then I will say that the problem is really the production is a problem of the business framework or the contracts and so on. This is the main issue in China, which at the end very difficult to the rest of the conversation with all the areas and steelmakers.

Very clear. And then if I could, just a very quick spot. In the steel market there's been a lot of talk around green premiums. Given you're kind of with this market, zinc recycler, I'm just interested to get your thoughts here, do you think this will become a reality and is it already becoming a reality and starting to come into conversations at all?

I do think or we do think that this is already a reality. Other thing is what is the premium for this reality, right? I think that everyone is very interested in our thing in the U.S. market at a sample because it's the only one paying greenfield around the world and the conversation with the team makers, especially for [unintelligible] and for the future are considering as well some whole exchange of dust and waste and change for green zinc. So definitely, the answer is yes. I think and we think that is a reality. The world is not going to be back. I think that the green zinc in this case is going to be good but it's early to say if there is any premium on the back of this or how much premium is going to be that I consider that will be a whole premium for us.

Thanks very much. I'd like to jump back in the queue.

The next question is from the line of Lasse Stueben from Berenberg.