Befesa S.A. (BFSA) Earnings Call Transcript & Summary

Ladies and gentlemen, welcome to the Befesa First Half 2024 Results Conference Call. I am Hilda, the Chorus Call operator. [Operator Instructions] The conference is being recorded. [Operator Instructions] The conference must not be recorded for publication or broadcast. At this time, it's my pleasure to hand over to Rafael Perez, CFO of the company. Please go ahead.

Good morning and welcome to the first half 2024 results conference call of Befesa. I am Rafael Perez, CFO of 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 of the year. After that, Asier will explain the business highlights of the period covering steel dust and aluminum salt slag recycling. I will then review the financials with a focus on commodity prices, cash flow, net debt and our hedging program. Asier will close the presentation providing an update on the outlook for the rest of 2024 as well as our growth plan. Finally, we will open the line for the Q&A session. Before getting started, let me remind you that this conference call is being webcast live. You can find the link to the webcast on the first half 2024 results presentation on our website www.befesa.com. Now let me turn the call over to our Chairman. Javier, please?

Thank you, Rafael. During the second quarter of the year, we have continued the quarter-on-quarter performance improvement that we had started in the third quarter of last year, which confirms that we have left the world behind us already. The first half of the year has been characterized by solid volume across all businesses and markets despite a challenging macroeconomic environment. From the commodity price point of view, we have seen higher average zinc price compared to the weak price level that we saw in the first quarter. Total revenues in the first half of the year have reached EUR 621 million with total adjusted EBITDA EUR 103 million in the period, which is 9% higher than last year. But most importantly is the positive quarterly trend that have continued in the second quarter of the year with total adjusted EBITDA of EUR 55 million, up 22% year-on-year. Comparing with the first half of last year, the results have been impacted by lower zinc treatment charges, higher zinc hedging price and overall lower operating cost; which has been partially compensated by lower zinc and aluminum price. Asier will explain later in more detail the performance of the steel and aluminum businesses during the first half of the year. From the strategy execution point of view, the second quarter has been very successful across several fronts. We have extended the maturity of our debt for another 3 years until July 2029, which removes any refinancing risks that geopolitical instability would generate over the coming years. On growth, we have signed the acquisition of the remaining 50% of Recytech for EUR 40 million, which reinforce our leadership position in Europe. This transaction delivers value to our shareholders from the first moment and also provides a great strategic opportunity to increase capacity right in the middle of the European steel industry. Regarding hedging, we have extended our hedging book until the end of the first quarter of 2026 at record price levels taking the opportunity of the high zinc prices seen in May and June. Rafael will provide more detail about these transactions. With regards to the outlook for the rest of the year, we have narrowed the 2024 guidance to EUR 205 million to EUR 235 million EBITDA. This is based on the strong development we are seeing in the business and expecting that we achieve a stronger second half of the year. On growth, we continue to carefully execute our growth plans. The focus at the moment is on the refurbishment of Palmerton, which goes on track with the first kiln complete during the fourth quarter of this year and the second kiln complete during the third quarter next year. In the expansion of the secondary plant in Bernburg, we are moving forward with the required permits as well as the commercial contracts with existing and new customers. Finally, in China with regards to the third plant in the province of Guangdong, at the moment that investment is on hold until we see a market recovery and we are able to have the steel dust supply agreements with the steelmakers in place. Beyond these 2 projects, we continue to be very optimistic about the midterm outlook of Befesa over the coming years. We have already invested around 20% of the plan in the zinc refining plant in U.S. and in Recytech. We are investing another 20% of the CapEx in 2024 and in 2025 in the refurbishment of Palmerton and the expansion of the Bernburg plant in Germany. Next will be the salt slag plant in Europe and the expansion of Recytech representing another 30% of the plan. And finally, China would represent another 30% towards the end of the growth plan. As we explained in the past, we have [ modeled ] the speed of the investment depending on the different dynamics that we see in the different markets. 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 in the Q2 2024. The strong results in the second quarter of 2024 with an EBITDA increase of 23% year-on-year saw a continued quarter-on-quarter improvement since Q3 of the last year confirming the worst is behind us. In H1, the results were driven by stable volumes in a challenging environment, favorable decrease in zinc treatment charges, better zinc hedge, lower energy prices and synergies were partially offset by lower zinc LME prices. Turning to the Page 7, the consolidated results of Befesa. Befesa delivered an adjusted EBITDA of EUR 103 million in H1, which represents a 9% year-on-year improvement compared to the H1 of 2023. Let me take you through the main drivers of the year-on-year EUR 8 million EBITDA development in more detail. On volume overall, slightly higher volume across the market with a flat impact on EBITDA year-on-year. On price overall, approximately EUR 4 million positive year-on-year impact explained by lower TCs and higher hedging offset by lower metal margin on aluminum, about EUR 12 million from the steel dust business and around minus EUR 8 million from the alu salt slag business. I will explain in more detail later. On cost/other, overall approximately EUR 4 million positive impact mainly driven by lower operating cost in our steel dust and aluminum salt slag business mainly through lower coke, electricity and U.S. synergies. Turning to the Page 8, the results on our steel dust business. Steel dust delivered EUR 81 million of adjusted EBITDA in H1, which represents a 21% year-on-year improvement compared to 2023. However, down EUR 1 million or 3% year-on-year. EBITDA year-on-year impact from volume was flat mainly due to the slightly higher volumes in Europe, Turkey and the U.S. Total steel dust volumes increased by 3% year-on-year to 610,000 tonnes in H1 2024 representing an average utilization of 71% in line with the previous year. On price, overall positive EBITDA year-on-year impact of about EUR 12 million with the main price components being EUR 5 million negative impact from lower zinc LME prices down 7% or around EUR 180 per tonne year-on-year to around EUR 2,444 per tonne on average in H1 2024. This negative EBITDA impact from lower zinc LME prices was partially compensated with 2 positive EBITDA impacts. Firstly, EUR 6 million positive impact from higher zinc hedging price, around EUR 140 per tonne higher year-on-year on average. Secondly, EUR 11 million positive impact from the favorable decrease of zinc treatment charges, which was set up $165 per tonne from the year '24 versus $274 per tonne in 2023. On cost/other, Befesa's coke average price continued further normalization in H1 of 2024 to levels below the 2022 average price driving positive EBITDA impact. Operational improvement in the U.S. recycling operations have delivered positive EBITDA contribution as well in H1. All these positive impacts have been partially offset by inflation and other effects. Total impact of costs and others have been EUR 2 million positive in the period. Moving now to Page 9 with the results of our aluminum salt slag recycling business. Aluminum salt slag delivered EUR 22 million EBITDA in H1, which represents a 19% year-on-year decrease compared to the EUR 28 million in 2023. The year-on-year EUR 6 million negative EBITDA development was mainly due to the lower aluminum metal margin partially offset by lower energy prices. On volumes, overall flat EBITDA year-on-year impact. Our recycling volumes of salt slug increasing by 29% to 221,000 tonnes in H1 driven by the resumption of operation of the Hanover plant in Q2 of 2023. Our secondary aluminum alloy production volumes increase by 4% to 91,000 tonnes in H1. With these volumes, we operated our plant at a strong utilization rate of about 94% in salt slug and 89% in secondary aluminum on average. With regard to prices, overall negative EBITDA year-on-year impact of about EUR 8 billion mainly driven by pressured aluminum metal margins versus the previous year caused by a weak automotive industry in Europe. Aluminum FMB prices were 4% up with an average of around EUR 2,327 per tonne average. The negative price effect was partially compensated with year-on-year lower operating cost mainly due to the lower energy prices. Turning to Page 10 of key volume drivers. From a market point of view although global level steel production in H1 of 2024 stayed flat compared to the same period of the previous year, it has shown different results by geographies. In Europe, steel production increased 1%. [indiscernible] production in Europe continues at solid levels supporting the strong utilization levels in our plants. In the U.S., the steel production in H1 decreased by 2% while in China, total steel production was 2% down year-on-year. The production from our EAF steelmakers in China is still weak driven by a low level of construction caused by the weak real estate China is suffering. As a result, our plant in Jiangsu ran around 60% utilization and Henan at 30% utilization. Now Rafael will cover more details on prices, hedging and cash flows.

Thank you, Asier. Moving on to Page 11, zinc price and treatment charges. Regarding zinc LME prices, last year we saw a decrease of more than 25% in the zinc price down to the marginal cost of the producer. After that, in the first quarter the price has been moving sideways above the C90 cost curve with a weak average of $2,450 per tonne. In the second quarter, we have seen a rally in the zinc price touching $3,000 per tonne at the end of May and then moving sideways between $2,600 and $2,900 per tonne with an average of $2,830 in the second quarter. The rally was mainly driven by mining capacity being taken off the market due to low average prices. On treatment charges, nothing new. As we already mentioned, treatment charges for the zinc were settled in April at $165 per tonne for the full year 2024. This is around 40% or $109 per tonne lower compared to the $274 per tonne in 2023 and it is positively impacting our earnings in 2024. Turning to Page 12 on hedging. We have taken the opportunity of the brief mini rally in the zinc price seen in May and June to extend our hedging book further from the second quarter of 2025 until the end of the first quarter 2026. With this extension, our zinc hedge book covers 65% to 70% of our zinc exposure until March 2026. Therefore, we have more than 20 months of hedges on our books at increasing hedging average prices around EUR 2,500 per tonne in 2024 and around EUR 2,650 per tonne in 2025 and the first quarter of 2026. This level of hedging represents an all-time high level of hedging for Befesa and will provide around EUR 25 million of incremental EBITDA in 2025 regardless of what happened with zinc prices. We continue to monitor the market waiting for the next mini rally to extend our hedging book over the second quarter and third quarter of 2026. Once again we have demonstrated that we can take advantage of zinc price volatility by locking in future earnings and cash flows. Our hedging strategy remains unchanged and continues to be a key element of the Befesa business model providing earnings visibility and predictability, lowering the impact from zinc price volatility. Turning to Page 13 on Befesa's energy prices. The page shows the evolution of the 3 energy sources that we have in Befesa; coal, natural gas and electricity. With regards to coke price, which today represents around 60% of the total energy bill, the normalization that started in the second quarter of 2023 has continued further into the second quarter of 2024 to levels below the average of 2022, approximately 25% lower compared to the first half of the last year. This had a positive impact on our steel dust operations. Despite this positive trend, however, the average coke price in the first half of 2024 is still around 30% above the average levels from the years 2019 and 2021 precrisis. Regarding electricity, which today accounts for around 25% of the total energy expense, prices continued to decrease further in the second quarter of 2024 to average levels of 2021 and were about 25% lower year-on-year. This has a positive impact in our aluminum salt slag operations. On natural gas prices were 5% lower year-on-year. Turning to Page 14, the cash flow results. On the EBITDA to cash flow bridge starting with EUR 103 million of adjusted EBITDA on the left and walking to the right. Working capital consumption was up by around EUR 36 million, in line with the previous quarter, primarily driven by the usual first quarter seasonality and timing impact and without cash consumption in the second quarter. We expect to recover most of the working capital outflow throughout the year and especially in the fourth quarter as we have done in previous years. Taxes received in the first half of 2024 came in at EUR 3 million as a result of final tax assessment of previous years resulting in an operating cash flow of EUR 70 million in the first half, up 27% compared to the last year. CapEx wise, in the first half of the year, we have invested EUR 24 million in maintenance CapEx, EUR 15 million in growth CapEx mainly related to the refurbishing of the Palmerton plant in Pennsylvania and EUR 40 million in the 50% acquisition of Recytech. I would like to highlight that the Recytech acquisition is a great transaction for Befesa and our shareholders both from the financial point of view, but also from the strategic point of view as it enable us the development of a brownfield project in an excellent location requiring only a fraction of the CapEx needed for a greenfield project. Asier will explain in more detail later. The purchase price of Recytech represents 2.5x through the cycle EBITDA multiple and more than 40% return on the investment. This acquisition was contemplated in the full year CapEx guidance that we provided when we presented Q1 results and is also part of the strategic growth plan of Befesa. Back to CapEx. In summary overall, total CapEx of EUR 79 million in the first half of 2024. For the full year, we expect to invest a total CapEx of around EUR 120 million, of which EUR 40 million would be maintenance and EUR 80 million for growth in Recytech and Palmerton. Interest paid increased by 30% to EUR 70 million in the first half of the year driven by the year-on-year higher Euribor from 3.1% in the first half of 2023 to 3.9% applicable in the first half of 2024. After funding working capital, interest, taxes and CapEx; total cash flow in the first half of the year amounted to EUR 1 million. Cash on hand stood at EUR 108 million, which together with the EUR 60 million undrawn revolving credit line provides Befesa with EUR 168 million of liquidity. Gross debt at the end of the second quarter increased to EUR 754 million due to the use of EUR 40 million in the revolving credit facility to pay the acquisition of the remaining 50% stake on Recytech. Net debt in the second quarter closing increased by 4% to EUR 646 million compared to the previous quarter. LTM EBITDA increased by 6% to EUR 190 million compared to the previous quarter resulting in a net leverage of 3.39x at the end of the second quarter, down 2% from the previous quarter even after paying EUR 40 million for Recytech. Turning to Page 15, debt structure and leverage. Last week, we successfully completed the refinancing of the debt of Befesa consisting of EUR 650 million senior secured term loan B with a 3-year extension and with maturity in July 2029 as well as EUR 100 million revolving credit facility due in July 2028. The refinancing extends the maturity of Befesa's capital structure with no effect on our current leverage ratio and the same covenant-lite terms as previous debt. The TLB has a new margin of Euribor plus 275 basis points and includes a margin ratchet, which will allow us to reduce the margin by 50 basis points when leverage ratio gets below 2.5x. We are very pleased with the successful outcome of this refinancing transaction and the perception and the appetite to participate by both existing and new lenders has been very strong. The new financing together with our consistent hedging policy and cash flow generation profile provides the strong financial backbone upon which we base the future growth of Befesa with a strong focus on capital allocation discipline and leverage management. We clearly have the target to reduce the leverage ratio to around 3x by year-end and to keep the leverage around 2.5x in the midterm. To do so, we will focus on growth CapEx on those projects that will deliver immediate cash flows upon completion like Recytech. Also we will keep maintenance CapEx around the level of EUR 40 million over the coming years. Now back to Asier on outlook and growth.

Thank you, Rafael. Moving now to outlook and growth on Page 18. Let me start with some comments about the outlook for the second half of the year. As we expected and are seeing already based on the first half results, we expect solid earnings growth for 2024 driven by a combination of various positive factors. We must admit that we were very prudent with the initial EBITDA guidance for 2024 on the lower part of the range, which represents a worst case scenario. Based on the current estimates, we are narrowing the full year guidance to EUR 205 million in the lower end to EUR 235 million in the higher end representing a growth of between 13% to 30%. Overall volume is strong across markets despite a challenging macroeconomic environment with weak steel production in the markets which we operate. We expect to continue a similar market environment during the second half of the year. In Europe, our main market, we expect to continue operating at more than 90% utilization levels. Treatment charges and zinc price hedging will be stable in the second half of the year as explained by Rafael. Coal price, as explained earlier, is moving in the right direction and we expect to continue to normalize further. We still see different trends across the markets where we operate. But overall, we are in good track to achieve an average coal prices reduction of around 20% in the year. In the U.S., the recycling plants are operating well and we continue capturing the operational synergies during 2024, which are being materialized along the year and will deliver positive earnings contribution compared to the last year. Also in the U.S., the zinc refining plant is gradually improving its operating cost along the year. The plant is still in turnaround and ramp up. Today, the focus is on cost reduction to improve the profitability. We are reducing the headcount by more than 10% among many other operating expenses. However, the reduction of treatment charges together with the lower premiums in the zinc market will partially offset the improvement on the recycling business. We expect to achieve breakeven by the end of the year. In China, the situation remains challenging caused by a weak real estate crisis. In general, we expect the second half of the year to be better than the first half. Although we do not expect a recovery on the overall Chinese economy especially in the real estate sector, we expect to increase the capacity utilization step by step of the 2 plants that we are operating today. We are working on expanding the customer base to other provinces. We are targeting around 70% utilization in Jiangsu and 30% in Henan again driven by expanding our customer base. Finally, metal prices for zinc and aluminum. Regarding zinc prices, it is always difficult to estimate especially in the current environment in which high volatility dominates. We see a solid floor in the level of around $2,500. In Q2, we have been seeing volatility in price and we expect this to continue over the second part of the year. Market consensus for the H2 is around $2,700. Average zinc price in full year 2023 was $2,650 per tonne, which is pretty much in line with the average of H1 at $2,640. Regarding aluminum price and aluminum metal margin, we have seen a margin compression in the first half of the year, which is something that we expected given the high margin we saw last year. We expect this to continue during the rest of the year into the second half. In summary, and considering all factors, we expect a stronger second half of the year and adjusted EBITDA to be between EUR 205 million and EUR 235 million range. Looking ahead to next year 2025, we also see earnings growth driven by better hedging level, as explained by Rafael, volume growth, better performance of the steel refining in the U.S., a more favorable energy price environment. Moving now to growth on Page 19. Regarding our midterm outlook, we remain very optimistic. During the second quarter, we have made significant progress in the execution of our growth strategy with the acquisition of the 50% remaining of Recytech, of which today we own and control 100%. This is an excellent transaction in our main market Europe, which marks an important milestone in the European component of our growth plan. Europe remains our core business and the acquisition of the remaining 50% in Recytech represents the opportunity to strengthen our leadership position in this crucial market positioning us for further growth. The strategic location of Recytech will enable us to expand our EAF steel dust recycling services further in the heart of an area where EAF steel production will grow over the coming years by constructing a second kiln through a brownfield project in line with our strategic growth plan. We have a well-defined growth plan in Europe, China and the U.S. to capture the growth opportunities that we are seeing in the market. However, as Rafael explained, in this current challenging environment, we are cautious about the capital expenditures and we are adapting the CapEx to the dynamics that we see in the market. Decarbonization will drive EAF steel production in the key markets where Befesa operates, which will make steel dust production to grow in the coming years. Similarly, the electric vehicle trend will drive demand for aluminum in Europe and the U.S. in the coming years as the automotive industry looks for lightweight solutions. Our growth plan is well diversified across regions and markets, which provides us the flexibility to move in different speed depending on the developments that we see in each market. The first part of the investment plan focus on the U.S. with the refurbishment of the Palmerton plant, which consists of the upgrade of the 2 kilns in the plant, 1 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 in the Q4 this year while the second phase will be completed by the Q3 of 2025. In Europe with regards to the expansion of the secondary aluminum production capacity in the 16 plant of Bernburg in Germany, we are moving forward with the permits, authorizations and commercial contracts with customers. This project is in line with the expected growth of the demand for aluminum in Europe that we are seeing driven by the electrical vehicle penetration. Lightweight solutions are required to reduce emission and as a result, the aluminum content in cars will increase. Finally, in China, the third plant in the province in Guangdong is being on hold for the time being until we see a combination of a recovery of the market and we are able to sign long-term supply agreements with customers. Despite the current challenging market environment, we believe that China has all the ingredients for Befesa to run profitable operations. The penetration of electric car furnace is clearly increasing. They are implementing a strong environmental regulation and we believe that the first mover advantage is essential. In summary, the growth plan is being executed at good speed in U.S. and Europe while in China, we are more cautious and will wait to see how the economy recovers. Thank you very much.

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

[Operator Instructions] The first question comes from the line of Christoph Blieffert with BNP Paribas Exane.

I have a couple of questions on your U.S. operations, please. Can you provide an update on the synergy target in the U.S.? What has already been realized and what we can expect for the second half of the year, please?

We are always talking about the last EUR 10 million synergies to capture in the market that we see that we are going to get during the year. This is more or less the figure we were managing all the time for this year.

Okay. Can you give us a figure for the EBITDA contribution of the U.S. operation for the first half, please?

Christoph, it's Rafael here. As you know very well, we don't provide EBITDA breakdown by markets. It's something that we have been consistent since the very beginning. But I will reiterate what I clearly said; with the synergies that we are getting at the moment and with the existing operations, we are on track with the initial plan when we did the acquisition in July 2021. So in the range of EUR 45 million to EUR 55 million by the end of the year should be a good target for the U.S., which is basically the existing operations plus the synergies on top.

Okay. Can you help me understanding the reason for the delayed completion of Phase 2, please? And related to that, is there any risk of a material cost overrun associated with that?

Well, I don't think it's a big delay. I think it's a matter that during the Q3 of the 2025 year, always we have been with idea to delivering the second kiln there. So basically it's in that range and the project is moving okay in budget and timing.

Okay. And as a last question, what can we expect in terms of volume growth in the U.S. in 2025?

Well, I think that there are some projects for the steelmakers that are still on hold or with some delays not very high, but I think that in the range of 50,000 to 60,000 tonnes could be something that we have in mind that could be achievable.

The next question comes from the line of Brian Butler with Stifel.

When you think about the midpoint of the guidance being moved up about $5 million as the low end came in, can you maybe give us some color on kind of what's behind that $5 million increase? And then what really can drive the high end of that range getting to EUR 235 million? What needs to happen to hit that higher target?

Thanks for the question, Brian. Well, I think that the midpoint is a reference. I think that we are going to be there as we expected at the beginning and the range is coming basically because you know pretty well that the zinc price is the main matter that we don't know what is going to happen. So you can be depending on the level up and down on the range. But as well the coal price evolution that we are expecting is going to be keep going, but it is something open and as well final and everything goes well. So yes, the range we are comfortable and something like midpoint EUR 215 million to EUR 220 million could be a reference that we started from, you remember, the very beginning of the year telling that. So we are comfortable there.

Okay. And then on China, when you talked about the utilization of the 2 plants, one at 70% and the other at 30%, does that blend to 50%? So China, if you're thinking about it, is now kind of breakeven or is there still some additional savings there?

We think that it's not going to be a high contribution. I think that we can consider a breakeven, something like that. We are half in the middle of the year and we see that is more realistic to think about breakeven.