Hulamin Limited (HLM) Earnings Call Transcript & Summary

Good morning, everyone, and welcome to Hulamin's interim results presentation for the 6 months ended 30 June, 2022. I'm Richard Jacob, the soon-to-be-retired CEO. I'd like to take this opportunity to introduce you and welcome Geoff Watson, who is Interim CEO for Hulamin when he took over about a month ago, and will -- he'll lead Hulamin into the next phase. Also on the call today is Mark Gounder, Hileman's CFO. The agenda for this morning is that I'll make short introductory comments and a few key points. I'll then hand over to Mark, who will take you through the financial performance for the 6 months. I'll then make some comments about the operational performance of both Hulamin Rolled Products and Hulamin Extrusions and then finally hand over to Geoff for some comments on the outlook. Just a quick review and some comments of the first 6 months of 2022. Group sales were pretty much the same, marginally above this time last year. Rolled Products slightly lower and Extrusions -- sorry, Rolled Products slightly higher and Extrusions slightly lower. Global markets have pretty much lost a little bit of the growth and improvement momentum that you saw over the last 12-18 months, although the beverage can market still remains quite firm. In the local market, sales were marginally over 58,000 tons with beverage can sales continuing the momentum and strength. All the other markets in the local market were stable and a number of them, particularly the automotive market, remains relatively soft. Looking at the movements in working capital. Mark will definitely talk you through much more detail on that, but I can say that the higher average LME price coupled with marginally weaker rand has caused an outflow of working capital, but more on that to follow. Also, the other key point is to note, and you will see this in the operational review of Rolled Products, is that pricing has definitely firmed in our markets. A lot of that is to compensate the manufacturer -- us manufacturers for rising costs on a broad range of fronts, including logistics, energy and commodities. But as I said earlier, the markets are generally running out of the improvements in prices except for beverage can stock which remains firm and where demand is -- continues to outpace the supply. I'll now hand over to Mark who will take you through our financial performance for the 6 months.

Thank you, Richard. Good morning, all. It gives me great pleasure to take you through our financial performance for H1 of '22. With our increased focus on normalized earnings, which excludes metal price lag, our performance in H1 was an improvement from the competitive period as our business continues to strive to improve operating performance and returns. Revenue increased by 45%, largely due to increase in average dollar LME pricing of 38% and supported by weaker exchanges, while our group sales increased marginally by 1%, despite bulk of our planned maintenance program occurring in H1 of 2022. Stronger demand enabled an expansion of margins contributing to Hulamin's improved EBIT of 144%. Richard touched on already the higher aluminum price impact, which we experienced in the last 6 months. Coupled with higher stock levels, placed huge pressure on working capital, which negatively impacted our free cash flow to the value of ZAR 492 million. The improved profitability has translated to a 42% and 147% improvement to earnings per share and headline earnings per share, respectively. The negative impact on our free cash flow from the increased working capital has increased our net debt to equity by 18.5%. Overall, our H1 improved financial performance has increased our net asset value by 25% to ZAR 9.47 per share. Richard, can we move on to the next slide, please. Under salient features, the average dollar LME aluminum price was 30% higher with the average rand LME being 46%. It is key to point out that the success of our business is not determined entirely by the aluminum price, but the value added or the rolling margin, as we call it, that we can achieve. Just to remind my colleagues that for Hulamin, the price of metal is a pass-through. We do incur a metal price lag, which can be a profit or loss on metal from the time the metal is purchased to the time of sale. Over the long term, this profit and loss should not be substantial. I'm pleased to report that our normalized EBIT, excluding any metal price lag, improved by 445% to a respective ZAR 176 million compared to a loss of ZAR 51 million last year. Despite the global impact of the war in Ukraine on shipping rates, impact of commodity prices and general inflation on Hulamin's production costs, Hulamin has managed to mitigate these by optimizing on product sales mix and negotiating pricing to mitigate cost increases in order to maintain and improve our margins. Can we move on to the next slide, please? As at the end of June, we are 33% lower on our capital expenditure compared to last year. But the key item to remember about later is that we had a long scheduled stop in April, which has got the higher number in 2021. Our annual capital expenditure is on track to maintain our plant in good sound working order. Net debt has been impacted by the record LME pricing, the disruptions at the Durban Harbor and the impact of the KZN flood. If we move on to the next slide, where -- now earlier I mentioned our focus on normalized earnings, and I would like to orientate you on this slide of how -- with our focus on creating value by enhancing our normalized EBITDA, I'll take you through a bridge now clearly explaining the improvement from a loss of ZAR 0.10 per share last year to a profit of ZAR 0.71 per share this year. So to orientate you with regards to the slide, on the far left the index is cents per share, and kicking off with H1 results last year of 2021, a loss of ZAR 0.10 per share and then restated for stock adjustment that we did in December 2021, we come up with a loss of ZAR 0.06 per share. The total external impact on our results itself was ZAR 106,000 -- or ZAR 0.106 per share, which largely being commodity price increases of ZAR 0.80 per share and normal inflation coming through, mitigated by favorable or weaker exchange rate. That leaves you with the EBITDA after external factors of a loss of ZAR 0.112. The total controllable factors that positively influenced our results has been to the amount of ZAR 0.183, being largely the improved sales mix and pricing that I mentioned earlier. From a controllable -- from a conversion and admin costs, Hulamin managed to maintain a continued focus on cost optimization and tight controls. At the same time, there has been a positive contribution of ZAR 0.08 by increased scrap utilization. That takes us to a respective ZAR 0.71 share profit for the year and then adjusted by depreciation, net interest and taxation to a ZAR 0.36 headline earnings normalized per year. Can we move on to the next slide, please? Now it's very important to articulate in the last 6 months from our working capital, especially the impact of the rand LME on our business and especially so in the months of February and March, we reached peaks of well over ZAR 52,000 per ton purchasing on our raw material itself. And it was essential at that point in time that we followed a very close management of our working capital on a daily basis. And together with support from our customers, lenders and [indiscernible] as we managed to navigate the critical period itself. Moving on to explaining on our cash -- analysis of cash flow itself. The business managed to generate a EBITDA of ZAR 265 million, but at the same time, we experienced an increase in working capital of ZAR 687 million. On the next slide, I will unpack the movement on net working capital further. Richard, can we move on to the next slide, please? The net working capital increased from nearly ZAR 2.6 billion to ZAR 3.2 billion, largely due to the inventory value. Close to half of the inventory value is as a result of the higher average rand LME pricing, while the inventory value volume has increased by 5,000 tons. But it's important to understand the breakdown of our inventory value in light of the different stages of our production. So if you cast your eye on the far right-hand side, I've tabled the closing inventory value by the different types of inventory in different stages of our production process. So on the dark blue is rolling slab and remelt and scrap, which is actually raw material. On the light blue is actually finished goods, and the green is actually work in progress. And we've articulated the dollar LME and you see the peak of the dollar LME in February and March. Now the rolling slab is our raw material is higher by 4,000 tons. But coupled with that, our work in progress, which is green is 6,000 higher, while our finished goods is 5,000 lower. With bulk of our 2022 planned maintenance complete, we are in an ideal position to realize cash through converting our raw materials and WIP into sales in the second part of this year. Richard, can we move on to the next slide, please? Liquidity, the net debt has increased due to the higher ZAR or rand LME pricing and the increased raw material stock and work in progress stock. Although our net debt has increased, we are still within our covenants for all our ratios and commitments. With the record level of LME aluminum price experienced in H1, we ably navigated the critical period with support of our lenders, suppliers and customers. Our lenders in principle, have agreed to increase facilities, but our focus in H2 is to generate positive free cash flow, thereby reducing our net debt levels to December 2022. At this point, I'll hand back to Richard to cover the operational review.

Thanks, Mark. I'm now going to talk about some of the key points in the operating performance of both Hulamin Rolled Products and Hulamin Extrusions in the first half of 2022. Just some operational key points for Hulamin Rolled Products. We have experienced a higher average selling prices in U.S. dollars, which is a really fundamental -- fundamentally important profitability driver in the business. I'll show you a little bit more detail on that in a minute. Volumes, pretty much flat and a little bit below what you saw in 2021 on a full year basis at 196,000 tons annualized for the year -- for the 6 months. Can stock demand continues to firm, driving firm prices across the world and those tend to translate into our local market. And while the operations have been very focused on managing costs and particularly the runaway inflation that has driven rising costs in the number of global cost drivers, things like logistics, commodity prices and particularly, in our case, things like magnesium, silicon, manganese, iron hardeners that we use in the alloying of our aluminum as well as the energy prices in Europe that has spilled across for the rest of the world, gas and other energy costs have been quite keen over the last 6 months. So the business to maintain our unit class performance, I think, has been pretty good performance, and I'll show you that in a minute. Here, some of the key operational highlights for the 6 months. You can see the split between local and export volumes with the total volume being fairly flat for this period compared to the equivalent period last year, with local volumes still marginally higher than last year, although fairly similar. On the top right-hand graph, the dark blue graph shows the significant increase in selling prices that I was talking about, which we call the rolling margin, which is the price that Hulamin gets. Our safety performance in the bottom graph, although rising slightly, remains at global benchmark numbers, and we're still quite proud of our safety performance in spite of the fact that a few Hulamin employees were given [indiscernible] 6 months. This is quite a significant graph that we've showed you over the last few reporting periods. The dark blue shows the fully absorbed unit costs and you can see in the 2020-'21 period when volumes were under huge pressure, how the fixed costs affected the full year absorbed unit costs. It's obviously quite pleasing to see that as the volume has returned to the business in 2021 and 2022, how that operating margin, which is the green space above the navy blue blocks, has opened up quite nicely and definitely lays the platform for continued profitability going into the latter half of 2022 and 2023. Just a few comments on Extrusions before I hand over and introduce you to Geoff Watson again. Hulamin Extrusions, as you know -- as you may recall, is a business that only sells into the local and regional markets. The local manufacturing economy has been particularly soft in this period, particularly because Hulamin -- or because aluminum extrusions are used quite extensively in the automotive market and particularly with the loss of one of our customers as a result of the significant flooding in the Durban area in the first half of this year, volumes have been quite soft for aluminum extrusions in this first half. Global logistics issues also impact on the export of vehicles out of South Africa as well as Hulamin Extrusions' raw materials, recalling that up to this point, Extrusions is dependent on imports of extrusion billet. Lower sales have -- would obviously normally impact volumes and profitability. However, improved pricing and a little bit of support from metal price lag has meant that we've seen quite decent performance out of Hulamin Extrusions in the first half of this year and have pretty much maintained their profit performance in the 6 months. And I'll now hand over to Geoff to give you some comments about the outlook for the balance of 2022.

Thanks, Richard. And let me just say that Richard is leaving Hulamin after 32 years of distinguished service, and we offer him much thanks and good luck for the future. So firstly, my brief as Interim CEO is not just to keep the seat warm until a new CEO is appointed, but the Board is very clear that the role includes identifying areas for improvement and to start implementing them. Some context. Let's look at the performance, excluding metal price lag and focusing on underlying or normalized earnings, our performance in H1 was an improvement from H1 2021. That said, I recognize that our performance is not what our shareholders expect. And the market has delivered a share price, which was, I think, ZAR 260 Friday closing, that is less than the value of our working capital. My initial view is that there are opportunities to accelerate the improvement in business results. Some of these will be implemented during the H2 and others will take longer. So what is our focus for the next 12 months? Firstly, to provide some context, safety statistically is very good. The next step to take it to the next level is accelerating behavioral safety practices, and that will be accelerated in the second half. H1 production was below plan and yield on can body stock, our second largest volume product, was below target. The profit impact of this in a high fixed cost business is significant. Now the good news is that planned maintenance was skewed to H1 with no significant shuts in the second half planned. This will release sales capacity, and we have a full order book. Secondly, we have resolved a lot of the issues associated with the yield on can body stock and they will come through in the second half. Cash flow has been a significant issue. With lower volume than planned in H1, inventory has grown, while at the same time, the LME rose to over a record of 3,800. Now the last time I remember numbers like that was about 2008, so this is not a common occurrence to get to 3,800, but the impact on immediate cash flow was significant, and it affected the whole supply chain, not only here in South Africa but across the globe. And the supply chain in South Africa acted very responsibly with all elements of the supply chain trying to resolve the issue, and we were all able to trade our way through the problem. Now we need to get the raw material and work in process inventory processed and out to customers so that we can reduce our stock levels by approximately 5,000 tons and convert this into cash. Remember that excluding any value add that at $2,500 per ton for aluminum, the excess stock of 5,000 ton amassed to ZAR 120 million at the current exchange rate. So in H2, assuming aluminum metal price stays constant, we need to focus on bringing back the cash and reducing the debt. Next, we have started an in-depth business review to identify options and benefits of simplifying our business. If we keep on doing the same, we are likely to get the same result of marginal improvement rather than the jump that is required to deliver value to shareholders. I anticipate coming back to you at the time of reporting the 2022 full year results with our thinking in this regard. Our initial view is that there are opportunities to simplify the business to improve cost of production and return on capital employed. You'll notice that everything I've said so far is under our control. This means that improved performance is a function of execution, and we are not reliant on outside factors. At present, we have a full order book possibly excluding the automotive sector in the Extrusion business, although that should improve with Toyota in Durban coming back online. We have a supportive exchange rate. Now these factors could change. The world is an uncertain place. But given current conditions, we believe the business is capable of more. We are also of the view that with improved performance, we need to return cash to shareholders in the form of dividends and possibly share buybacks. We will apply our minds to this during H2. We have good equipment and highly skilled people, and I believe that improved performance does not require a magical complex new strategy. It requires simplification and improved execution. That is our focus. We look forward to coming back to you early next year to report back on our progress. Thank you all.

We have a number of questions that the audience has posed and [indiscernible] if you can read them out, and then we'll decide who answers which ones.

Thank you, Richard. We have 3 questions. The first one is from All Weather Capital, the name is Shane Watkins. His question is, is your rolling margin a rand margin or a percentage margin? He has a second question, which says because of the energy crisis in Europe, are you seeing competitors closing? Maybe we can just go through that question, and I'll ask the last question from Cobus.

Thanks, [indiscernible]. And so just maybe, Mark, if you could tackle the first one and Geoff the second one.

So going on to the first one, is your rolling margin a rand margin? No, it's not. It's a dollar margin, and it's based on our conversion -- adding value conversion price, but in dollar terms. Geoff, do you want to answer and/or add anything further and answer the second question?

Yes. Look -- will do, Mark. Europe is a complex place at the moment, as you all know. And energy, both electrical and oil and gas prices are going up very, very significantly, and it's affecting all sorts of things. It's affecting metal suppliers in the terms of smelters and remelt facilities that melt scrap to supply material to the manufacturers in Europe. But at the same time, it's also affecting the consumers of aluminum in Europe. And people are pointing to significant possibility of recession in Europe. And so it's affecting both ends of supply and then the demand end. Now so far, we're not seeing any impact of that, maybe it's balancing out. But our exposure to can sheet in Europe is still good. If we have concerns, it's probably more about what we would call common alloy or distributor sheet going into Europe at this point because that will be affected by demand. But so far, so good. We still have a full order book.

Thank you, Geoff. We have a third question from Cobus, also from All Weather Capital. The question reads: two questions from me. One, there has been a substantial recovery on the normalized EBIT. Can you give us an indication of how sustainable this will be in the coming years (excluding any material adverse events)? Second question, looking at your NAV per share of ZAR 9.93 close to 2/3 of this NAV is working capital. Can you give us an indication of what the uplift in the other 1/3 of the NAV would be if the plant, property and equipment was revalued upwards to market values (given IFRS does not allow to -- for this to be done)?

Thanks, [indiscernible]. I suggest, Geoff, you, tackle the first one, which is the sustainability of the improvement in normalized EBIT. And Mark, if you can maybe talk to the second one?

Yes. Thanks, Richard. I think I talked about at, while I was talking previously. But if we look at the short term, I think the sustainability of improvement is well founded. And I'm talking short term for the second half of the year, particularly with the lower maintenance load going into the second half. Now in addition to that, Hulamin has a very good base of what I would call manufacturing tools or manufacturing stability tools. And most of these are based on the Toyota production system of manufacturing. And Hulamin has a very good base in those but we need to take those all to the next level of maturity to attain the sustainability that you talk about in your question. That is certainly underway, and we'll be accelerating through the second half to enable us to leverage from those stability tools going forward.

Thanks, Geoff. Mark?

Okay. On the second part with regards to what makes up the uptake on the 1/3 of the NAV improvement? I can definitely confirm that it was not a revaluation of property and plant. That more or less stays flat around about ZAR 1 billion. The improvement is actually in equity based on our improved results of [ ZAR 0.5 billion ] improvement on EBIT last year, and coupled with a deferred tax asset raise last year. That improved our equity itself from just over ZAR 2.4 billion to ZAR 3 billion, which is a contributed positive impact on the net asset value. Thanks, Richard.

Any comments about what the number would look like if we were able to write back any of the recent write-downs?

No. You're talking about the property and plant itself, Richard? Because before we even do that, we wouldn't -- as exactly pointed out as IFRS, yes, we wouldn't -- there'll be a big critical exercise done by the business before we look at revaluing property, plant and equipment again. And right now, that's -- our focus is on actually improving the equity continuously. And from the outlook that Geoff just given and our focus on normalized earnings, ultimately, we're aiming to continue our improvement on equity via generating -- despite generating positive free cash flow, but generating a positive EBIT as a whole.

Thanks, Mark. Back to you [indiscernible], can you read out the next one?

Our next question is from [indiscernible]. The question is, has Hulamin bought back own shares in recent weeks?

I can confirm we have not bought any shares back in the recent weeks. It's been -- yes, we haven't done any share buybacks in the last period.

Sorry, we have a comment from Shane Watkins from All Weather. He says, I wish to compliment you on examining buybacks and dividends. And the next question is from [ Tanasha ] from [indiscernible]. He says, given the increase in net debt, where would you expect the debt level to be year-end 2022? Can you elaborate on the product mix that sits behind the full order book?

I guess the first question to be answered by Mark and then Geoff, if you can answer the last one?

Thanks, Richard. So we've clearly articulated and Geoff translated that releasing the work in progress in raw materials itself will translate, excluding the conversion, that itself will have a material impact of about well over ZAR 200 million. What we're targeting right now is a range between ZAR 800 million and ZAR 900 million right now, that's the range we're targeting, and we're quite confident would be able to get to within those ranges in the H2 barring all the other external factors, for example, LME pricing, exchange rates being round about the same where we are right now.