Hulamin Limited (HLM) Earnings Call Transcript & Summary

Hi. I'm Geoff Watson, CEO of Hulamin. And I have Mark Gounder here, as CFO, to talk about the 2022 financial results. Welcome to our shareholders, analysts and members of the media. Warm welcome to all. The agenda today, I'm going to make some introduction and highlights of 2022, then Mark will be talking about, in detail, the full year 2022 financial results. I have a short overview of the Extrusions business, and finally, our outlook for 2023. I'd like to start with safety, 2022 versus 2021. We were fairly much the same. We had an improvement in our medical treatment rates in 2022 over 2021, but our lost time injury rates were around about the same as 2021. The difference between the two, obviously, lost time injuries means you've lost more than one shift due to that injury. The medical treatment requires medical intervention from as simple as a Steri-Strip or stitch to -- or involve medical treatment, but doesn't involve lost time injuries. So you say, okay, we have 12 total recordable injuries, a total of medical treatments and lost time injuries last year. How does that compare to our peers? Are we doing reasonably well statistically or are we not? And if you look at our peers, just as other rolling companies that are similar to Hulamin, I put this in a total recordable injury rate. We'd measure the number of injuries per 1 million man-hours, and we come in at 2.1. If we look at our peers, the highest or the highs is about 4.2, roughly double ours. And the peers low is lower than us, about 1.9. And the issue for us is that while we're in the lower quartile of peers, 0 LTIs is the group target. And there are examples within our peers where plants, similar to the plant at -- in Pietermaritzburg, where there is no lost time injuries for 4 or 5 years, that's our target. That's our goal. And to accelerate the change, we've bought in a globally recognized adviser to work on elimination of risk as compared to minimizing risk. I'll give you a further update on that process when we get to H2 in the middle of the year. Key features, 2021 to 2022. When I spoke to you at the H1 release, I said that my initial view was that there were opportunities to accelerate improvement in business results. And the normalized EBITDA of ZAR 667 million, which was 339% better than 2021 and H2 at ZAR 449 million, shows the capability of the business. H2 was up 106% on H1. So what were the drivers for 2022? Firstly, local sales were up 7% and can products were up 22% or 10,000 tons in the second half. So why is that important to Hulamin? Local sales have a shorter cash cycle, and can products are our most profitable product line. Demand for beverage cans is growing at 5%, and there is a structural change that favors aluminum at the expense of plastic. Now secondly, metal cost reduced with scrap utilization increasing 15%. To understand the impact of this, remember that to produce rolled products, we can either use virgin aluminum for a smelter -- from a smelter like South32 in Richards Bay or we can buy scrap materials from both plant operations like bev can or recyclers and reprocess this in the material we can use. For us, scrap is a lower cost than pure molten metal or commodity remelt ingot. Thirdly, continuous improvement projects added 5,000 tons to capacity headroom by Q4. For example, in our casting plant, we were able to release 5,000 tons of capacity in the next step down from that. The hot line, we were able to release about the same amount of capacity. In coal rolling, similar. And in finishing, similar. You have to do it all in a lot or it doesn't give you the total amount that you need to flow through the plant. Now all of those continuous improvement programs added that volume to our capacity headroom, and we didn't have to spend a rand to do it. It all came from the metal ability of our workers, working with a structural program to improve costs and improve productivity. Lastly, commodity inflation was priced into sales contracts. For example, commodity inflation includes other commodities like magnesium, that are alloyed with the aluminum before rolling to give it the metallurgical characteristics you need to, for instance, to make aluminum cans. Some of these commodities can be volatile. EG Magnesium in 2021 moved between a range of about $3,000 a ton and $10,000 a ton. From halfway through 2023, we had contracts in place that enabled us to pass on commodity price increases that are included in our cost of metal, in particular. Having managed the run-up of aluminum prices to over $3,800 per ton in H1, a drop in H2 to trend levels and the jump in earnings has generated free cash flow of ZAR 388 million and reduced net debt levels from ZAR 1.23 billion to ZAR 0.84 billion. At the same time, it has enabled investment in longer cash cycle but higher-margin products in Q4, which will be earnings accretive in 2023. Lastly, in 2022, capital expenditure grew ZAR 73 million to ZAR 233 million as we work through the COVID maintenance backlog and recommenced improvement capital. So in short, the increase in earnings was due to the fact that we did what we said we were going to do when I spoke to you at the end of H1. I'm going to go over now to Mark Gounder to talk about the detail of the financial results.

Thank you, Geoff. Good morning, everyone. Moving to our financial highlights for the year. I am pleased to report the improved quality of normalized earnings of 29%, through delivery of a richer mix of products in our sales volumes. The focus with respect to 2022 was to improve the product sales mix and capitalize on the continued structural growth in demand for aluminum beverage cans. This saw local sales volume increased by 7%. The quality of mix improved conversion pricing, a stable cost base and an 11% favorable exchange rate positively contributed to a turnover growth of 22%, translating to a 756% growth in normalized EBIT to ZAR 565 million. While net working capital as a percentage of revenue reduced by 1% and net asset value improved by 11%, our cash generation ability from operating activities was 76% down, impacted by the volatile dollar aluminum price, resulting in our net debt to equity increasing by 4%. Under salient features, I cover the key drivers for our business. Average dollar LME pricing was 2% higher and average exchange rate was 11% weaker. Overall, group volumes were down 5% to 211,000. However, it contained a strong mix of higher margin products, coupled with local sales being up 7% to 95,000 tons. Both EBIT and normalized EBIT exceeded ZAR 0.5 billion this year. I will cover the improvement in EBITDA of 756% in detail later in this presentation. Earnings per share and headline earnings per share was down 50% and 46%, respectively, from 2021, largely due to ZAR 0.12 per share impact of higher interest charges due to increased market interest rates and average daily net debt levels, ZAR 0.81 per share impact of fully utilized assessed losses in 2021, and thus resulting in a tax expense for 2022. Normalized headline earnings per share improved by 28% at the back of improved pricing and mix with a stable cost base. A 46% increase in reinvestment of free cash flows into our plant post-COVID-19 delayed capital expenditure, resulted in an amount of ZAR 233 million being spent this past year. A 1% reduction in net working capital as a percentage of revenue to 19% was as a result of improved payment terms with key export customers by utilization of supplier credit funding facilities. As reported at the interim, net debt increased from ZAR 651 million to ZAR 1.2 billion as at the end of June, due largely to the steep commodity price increases as a result of geopolitical tensions. In H2, the group generated positive net free cash flow of ZAR 388 million, reducing net debt to ZAR 836 million as at the end of December. Using the bridge, I will cover the details explaining the 339% improvement on normalized EBITDA from ZAR 152 million on the far left of the bridge to ZAR 667 million in 2022, and thereby reconciling to our headline earnings of ZAR 325 million. Under external factors, the 11% weaker exchange rate resulted in a positive impact of ZAR 316 million, while inflation and commodity pricing combinedly negatively impacted the business by ZAR 485 million. Just to clarify, under commodity pricing, we've included hardeners and material costs that Geoff spoke about earlier, totaling close on to ZAR 136 million, combined with heightened inflation, electricity costs of ZAR 50 million and gas changing prices close on to ZAR 76 million. The impact of 5% lower sales was ZAR 35 million, while the positive impact of pricing and improved mix was as a result of the local beverage can sales growing by 14% as aluminum packaging continues to grow share of total beverage packaging market. Contracted prices for can stock firmed as can makers globally look to secure raw material supply. This resulted in higher sales volumes from the sale of beverage can material and improved margins over the comparable period. These product sales also supported increased scrap consumption with consequential benefits for our margins. Included in conversion pricing is the pass on of commodity surcharges that Geoff alluded to earlier. Tight cost management has dampened the impact of commodity and energy inflation, resulting in a stable cost base. Conversion costs were marginally higher due to higher cost of production for improved mix, higher maintenance costs, but was offset by improved scrap consumption of 3,200 tons, which lowered the increased conversion costs by ZAR 47 million. Admin expenses reduced when compared to prior year due to COVID costs approximately 40 million not being incurred this year and tight cost management. It does include a net realizable value write-down of excess internally generated scrap that was sold, resulting in a net loss of 32 million less net loss. Our Extrusions business financial performance movement of ZAR 43 million year-on-year was impacted by lower demand from automotive industry, load shedding, floods and product run out. Sales was 8% lower, resulting in an operating loss for the year of ZAR 11 million. Moving on to -- from ZAR 667 million taking off depreciation for the year, which was higher than last year due to investment in our capital, the net interest charge increased by 40% to ZAR 92 million, due to higher market interest rates and average net debt levels. The tax charge increased significantly to ZAR 149 million expense, as 2021 benefited from the one-off raising of a deferred tax asset, which produced a benefit of ZAR 115 million in 2021. This resulted in a normalized headline earnings of ZAR 324 million. This slide I've replicated the same bridge that I took you through in detail, but we have done it on an earnings per share more for [indiscernible]. On reflection of our net working capital, change in inventory was the biggest impact to our working capital in 2022. The reinvestment in stock from -- or up from 43,000 to 49,000 was the key driver, which means placing metal in the right part of the production process to level out the variability of machine output was the key initiative that we drove in 2022. We also benefited from the additional financing that -- for export customers that I alluded to earlier in the movement of -- a positive movement of ZAR 39 million in our debtors, even though there was a 22% increase in our turnover. Having covered the movement on EBITDA and working capital in previous slides, which significantly makes up operating activities, the investment in capital expenditure of ZAR 233 million was partially funded by cash generated from operating activities, resulting in a net cash outflow of ZAR 185 million. Our headroom for the year increased to just over ZAR 1 billion, largely supported by debt facilities increasing from ZAR 1.5 billion to ZAR 1.9 billion, which was effective from December with multibank support in our new facility. On the capital expenditure note, our capital expenditure increases -- increased in 2022 to cover delayed maintenance due to COVID-19. At this point, Geoff, can I hand over back to you to cover the operational review, please?

Thanks, Mark. Rolled products operational highlights for in 2022, and I've already alluded to these graphs in my presentation as has Mark. But the key issues are, while volume dropped 4%, that was offset, in particular, by an increase in domestic sales of 7% and in the second half by a 24% increase in can end, tab and body. That's 10,000 tons more. And costs, on the other side, the top right-hand graph, went up from 26,000 tons full year 2021 to 30,000 tons last year. I guess the issue there is the two things are linked, in particular, can end, tab and body and the pull on purchase scrap and the utilization of that scrap. So the two are related. Next slide. Extrusions were disappointing last year. Sales were 8% lower to 2,600 tons, and that was mainly due to weakness in the -- particularly in the auto market with floods in Durban, the port strike and automotive model changes. The extrusion market sales were down 8% in -- on 2021 and EBITDA was a loss of $14 million compared to a profit of $32 million in 2021. I'm pleased to report that recovery in auto demand is underway, and we're optimistic that the business will return to profitability in 2023. Okay. Having said that, 2022, very pleased with the results and very, very proud of my team for driving those results. But what does 2023 look like? Firstly, the market remains unconstrained in can products. And while demand in Europe and North America is flat, we do have a full order book in other products. The investment in coal rolling and coating capacity will start to add to earnings in H2, and I'll explain that a little later as we talk about capital with an increase of 10% in run rate by Q4 in can products. Domestic can capacity is being installed to supply the projected 5% cumulative annual growth rate over the next 5 years. So the demand is there. Scrap utilization will rise by a further 15%, with capital spend in H1. Pricing is in place to accommodate commodity price inflation for the full year. So looking pretty good. Looking at the longer term, capital spend will increase from ZAR 233 million to over ZAR 300 million in 2023. 2024, we'll go towards ZAR 450 million. In 2025, it's going to be more like about ZAR 350 million to ZAR 400 million. Hulamin is acutely aware that the return on capital employed is below the cost of capital. All CapEx is being thoroughly interrogated before funds are committed. 30% of the capital budget will be improvement CapEx to increase volume of value-add products and reduce cost. Phase 2 of the objective to increase scrap utilization is in the engineering phase, which will increase scrap utilization by a further 60% with earnings delivery by the end of 2024. Also, ESG projects, to the value of ZAR 150 million, have been identified, mainly in water and energy and will be the subject of the same capital -- rigorous capital evaluation as all other products, and discussion is underway to fund. As I said during the H1 earnings release, I would update you on the progress of identifying options to simplify the business. I'm pleased to report that the process has started with the exit of 3 products announced and underway, and with the release capacity going to can products. We are also simplifying at the subproduct level, with specifications being rationalized. In the cost area, a global benchmarking review has started to firstly identify areas where equipment has been added over many years to meet demand and can now be rationalized with multipurpose high productivity equipment. Secondly, to reorganize work balance and multi-skilled people to increase human capitalization -- capital utilization. Finally, investigating breakthrough technology to integrate multiple production steps, resulting in quantum steps up in productivity. I will update you on progress when we release the H1 results. So finally, the foundations are in place for a good year and plans in place beyond to sustain profitability into the future. I look forward to coming back to you with the H1 results and review of progress. Thank you very much. We're now going to move over to questions.

The first question is from [indiscernible] Assets Management from [indiscernible]. The question is, you disclosed revenue by product markets on segmental disclosure and packaging continues to lead in terms of revenue. I wanted to find out how profitable as the packing market or maybe provide us with the percentage of profits from packing -- from packaging markets?

Okay. That's a good question. If you look at our packaging products, it's probably somewhere around about 50% of our product mix. But if you look at our total product mix overall, the margin in packaging products is better than most of our other products, probably with the exception of plate, which is a very nice, high-margin product for us. The actual percentage of margin against other products is confidential -- commercially confidential. So I'm not going to talk in detail about that, except to say that can products fit very nicely with our equipment. It's been designed to do those products, and we do create a very nice margin with those products.

Our next question is from Raymond Stein from an undisclosed company. His question is, what is forecasted CapEx for 2023, 2024 and 2025?

Thanks again for that question because I think it's a very good question. I've already referenced a ZAR 300 million cash spend for capital in 2023, with 30% going into volume and cost initiatives. That climbs in 2024, particularly with the scrap utilization project, which can increase our scrap utilization by over 20,000 tons. And so we jumped to about ZAR 450 million. Then going to 2025, we drop again to a sustaining range of capital, probably somewhere around the range of about ZAR 350 million. The important thing in this is that 30% will be improvement capital, and it will be a little bit bigger percentage going in 2024 because of the scrap utilization project. But to me, it should give confidence to shareholders in the business that we're reinvesting in the business to sustain it, number one; and two, improve it.

Our next question, still from Raymond is, is working capital expected to reduce during 2023? And Mark will take that question.

Thanks. Really good question and needs to be fundamental understanding of our business. I make reference to a percentage of working capital as turnover. And I focus on that largely due to our dependency on commodity pricing and our inventory both in our turnover and our working capital. So right now, we're sitting on 19% turnover. So working capital, if you focus on the percentage, instead of the absolute value, I would like -- I would say, going into 2023, it will be dependent on the commodity price impact on inventory, but stable debtors and creditors.

The next question is from All Weather Capital. The question is, congratulations on a good operational result. Can you kindly elaborate a bit on the challenges you faced regarding load shedding in brackets, production-wise as well as demand-wise from your end customer? Also, can you touch on the inventory and working capital balances and where this should settle on normalized bracket highlighting any effector shut provided for an inventory build?

Okay. Let me start with that answer. Load shedding is a challenge for Hulamin. We supplied power a little differently to regular consumers as most industries are. The issue for us is that because of load shedding, we have had to invest in a significant amount of generator capacity to give us protection when load shedding, in particular, gets to Level 6. Now it's not load shedding for us exactly, it's called load curtailment. And load curtailment is an agreement between ourselves and other industries have similar agreements, whereby you shed particular pieces of equipment when you are required to do so according to a certain percentage. And we do that by turning off pieces of equipment. And we add to that amount of equipment, depending on how much is required by Eskom to balance the load. With additional generated capacity we now have on order, for -- it will cost us around about ZAR 20 million. That can give us protection up to Level 6, with the minimum of disruption. In other words, just taking down certain piece of equipment. So problem is running a generator costs you 25% more than it does to buy power. So yes, it does add to your cost and Mark has factored those costs into our plan for this year.

Thank you, Geoff. We have the next question from Major Markets by Peter. The question is, can you elaborate on funding options for the ESG projects?

Okay. There's various options right now. I'm not going to go into detailed specifics because we're still currently negotiating with the various entities. But there's various options around. I know a lot of the commercial banks have explored green funding. They call it green funding right now. And over and above that, if you look at the latest tax relief from grants that's been offered, so there are -- everyone's thinking out of the box to be able to fund businesses to get through South Africa as a whole during this crisis time. And what we're doing at Hulamin is exploring every single avenue to be able to think out of the box to be able to fund these projects currently. I'll probably be able to share a lot more when we get to our H1 results. By that time, we should have most of our negotiations completed by that.

I'll just return to a previous question -- included in the question on load curtailment and shedding was also a question about our working capital and what was happening with that, and then it might reduce to a more stable load. Firstly, we started off the year 2022 with our working -- particularly our inventory anyway, too low. And we had to rebalance that inventory as the year went on and placing that inventory in critical areas within the plan to allow for the variability in output. Now what is the right number? Our number is, in my view, too high at the moment. I think the number is somewhere between 48,000 to 50,000 tons depending on our product mix. And we do have opportunities from where we are now to bring it down to those sorts of levels with particular speeding up the velocity of scrap circulation in the plant, and that's what we're working on now. And it is starting to have an impact with a significant reduction in scrap inventory, in particular, year-to-date.

The next question is from [indiscernible]. The question is, what progress are you making to find a new permanent CEO?

Thanks, Volker, for the question, a question that I'm very interested in, of course. We are at the interview stage for hiring a permanent CEO. I'm not quite sure how long that will take. But once that process is complete, we will be making a selection, then there will be a notice period that the person would have to work through. So we're looking at somewhere around the middle of the year to perhaps early quarter 3 that a permanent person will be in place. Maybe a little earlier than that, but I think that's around about the timing.

The next question is still from Volker. It's says, "Mark, I'm concerned about your high inventory level. Any plans to reduce this?"

Thanks, Mr. [indiscernible]. As Geoff alluded to already, we need to rebalance our inventory, and he spoke about scrap. So if you look at how Geoff answered to the previous question, I think it covers your concern around inventory.

I think, Volker, also that the other issue is on inventory. Our inventory, particularly early last year and in 2021, was focused on short cash cycle products. And those products have one or two steps, maybe three in the production process. However, the margin is very low. When you go to higher-margin products, they have multi-steps in the projects, 5, 6, 7, in like gauge foil up to 15. And so the working capital to support those higher-margin products is a little higher as well. So it's not quite as simple as reducing working capital. You need to look very hard also at the product mix that you have and the return in margin to support that higher inventory level. And certainly, you could see from the results we had in the second half with a higher percentage of high-margin, longer cash cycle products, the return is very good.

Our next question is from Nedbank, Shiraz Mohiuddin. The question is, congratulations on your financial year 2022 results. Normalized EBITDA margin for 2022 is 4.2%. How successful has the Hulamin Executive Committee been in negotiating price increases to absorb commodity price increases to maintain or grow margins?

Okay. Thanks for the question. I did cover that in the presentation, but -- very successful. It's been a problem all around the world for all producers of heavy industrial products, construction companies. Everybody has been faced with a significant increase in commodity prices, from steel all the way through to magnesium. We're exactly the same. We have negotiated with our customers as they have negotiated with theirs to pass on these commodity price increases. That wasn't fully effective in 2022. It is fully effective in 2023.

Our last question is again from Volker. And the question is, "Mark, I am pleased to see that you are tuning attention to very important issues running Hulamin, such as scrap utilization and better product mix. Well done so far. We have come to the end of the questions.

Okay. Look, thank you very much for those questions. Thanks for listening to our presentation. I hope you enjoyed it. We're certainly very proud of the results, and I'm very proud of my team. Look forward to talking to you at all -- at the end of H1 with some results then.