PAO TMK (TRMK) Earnings Call Transcript & Summary

Dear ladies and gentlemen, welcome to the conference call of TMK regarding the presentation of the 4Q 2019 financial results. At our customer's request, this conference will be recorded. [Operator Instructions] May I now hand you over to Vladimir Shmatovich, who will lead you through this conference? Please go ahead, sir.

Hello, ladies and gentlemen. Thank you for taking the time to participate in our call. We announced fourth quarter and full year 2019 IFRS results. So after the formats of our release and the statements for the full year, we still have 3 divisions: Russian, American and European, although I think that anyone who follows us knows that we have sold the U.S. division, IPSCO, and as a result, we no longer have it in our company. However, since the consideration we received on January 2, the 2019 results still show this division. But again, for the reason that the sale was expected for a long time ago, we do not show in our release breakdown by divisions, although you still can see it in our financial statements. So speaking overall about our results, you can see the main trend. That's still the same since 9 months results where we see positive developments and positive dynamics of Russian division and negative numbers of U.S. division, which, I repeat myself, is irrelevant at this point as we have sold it. And that basically explains the movement of TMK numbers. So the revenue was down year-on-year, 7%. However, Russian revenue's up 6%, so almost mitigated. And full year adjusted EBITDA, down 2% to almost $700 million, which I must stress is significantly above consensus of analysts. And at the same, Russian division EBITDA is up 31% year-on-year. So again, the Russian performance helps offsetting U.S. underperformance. Net debt, about $2.5 billion at December 31. And again, I repeat myself, we received consideration for American assets on January 2, so this will be reflected in 2020 first quarter books. So speaking of meaningful events, obviously, sale of IPSCO again. So the amount we actually received on January 2 was $1.067 billion. That was obviously net of debt of IPSCO, so actual reduction of debt is more because IPSCO debt is gone as well. At the same time, there's still maybe some minor working capital adjustment, as it is customary in this kind of deals, and some other small adjustments. So this number may vary insignificantly in the future, but again, not much. So just to remind that we signed also 6-year master distribution agreements where Tenaris will be our exclusive distributor for OCTG line pipe in North America. Also, on the back of the transaction, S&P upgraded TMK's rating to BB- from B+, with a stable outlook. And Moody's changed its outlook to positive, keeping B1 rating, which, of course, is important for our fixed income investors. And what was more important to them, in January, we launched, and in February, completed -- so we launched in February, $600 million -- sorry, $500 million 7-year eurobonds issue, and the issue was quite successful. And as we now realized, very, very timely. We obtained coupon of 4.3%, and that's all-time record for Russian noninvestment grade companies. So that's the lowest coupon ever, and also the lowest coupon ever for 10-K. And that was very prudent given the need for us to refinance expiring $500 million Eurobond, which we'll do in April, so we secured financing for that. Again, most of the proceeds that we received from IPSCO went to refinance existing debt, and the remaining proceeds, most likely, we'll do the same. Also, on the operational side, we launched the new heat treatment facility at Seversky plant, and that's very important and aligned with our strategy to increase the proportion of high-grade products. And heat treatment, as some of you know, basically, is the way to replace some expensive alloys in pipes, just applying heat treatment technology and basically getting the same property. It's the same quality as those expensive alloys would do, so that will help us saving our OpEx. So we -- in terms of important events, that's pretty much it. Speaking of outlook, we still see the pipe consumption in Russia is quite stable despite all the turbulence that we see on the world markets, and especially global financial markets. Of course, we are not in a position to state that the coronavirus and all the consequences in various areas or otherwise that we see will not affect the Russian oil and gas service market, whatsoever. So we expect certain headwinds and our first quarter is not easy. However, overall, we don't see any sign of any significant reduction in drilling of pipe consumption so far. And given Russia's, basically, quite strong fundamentals and strong financial architecture of oil and gas industry, where governments adjust taxes and is quite flexible on those to basically mitigate the shocks -- to absorb the shocks of global market trends in oil price, be it upwards or downwards, so past crisis show that the Russian oil companies are quite sustaining to them and especially since the crisis were followed by ruble weakening, that's positive for us in the company. So we assume that no major effects will be seen. And especially, again, we don't know what talks to the impact -- Russian impact, how it will end up, but so far, Russia is against reducing significantly oil production, which means, again, quite stable consumption of pipes. In Europe, we all see that -- we don't see many major improvement. Situation, however, it is quite stable since our products in Europe are not related to oil and gas. So -- and again, investors have made the upgrade of our product lines lets us believe that situation will be at least stable there. And as has been said, and as Sergey, we rely on increasing proportion of high-end, high-tech products, and that's how we'll ensure our margins. Again, it's difficult to give specific outlook for year 2020, so we will aim at keeping our numbers stable. But of course, we're all watching how the global situation, and especially situation in all markets and oil and gas field service markets develops. So in terms of margins, again, we showed that Russian performance -- good performance of Russian division helped offsetting American underperformance. And we are more in good shape. We -- after my speech, Sergey Alekseev, our Chief Marketing Officer, will talk about the markets to give you some flavor, with some color on -- especially Russian market, which is now our main market. In terms of financials, you see our debt -- total debt increase as of December, but still was falling by certain inventory buildup. However, we had certain net repayments. And as I said, IPSCO proceeds were not reflected in those statements. And again, it is basically quite easy to build pro forma for yourselves, applying proceeds from IPSCO transactions, which I announced and which are stated in the -- in this press release. And obviously, all those proceeds went to decrease net debt, therefore, it's quite easy to calculate pro forma net debt as of December 31. Of course, since then, some movements happened. So life goes on both in terms of P&L and movement of working capital and CapEx, but still this straightforward pro forma calculation may give you an idea of our debt and leverage at this point. So again, that's pretty much it. Probably speaking of total debt, I should say that it decreased compared to September 30, both total debt and net debt. And obviously, this trend continued with receiving proceeds from the IPSCO deal. So overall, as I said, 2019 was rather a good year for us. And despite American underperformance, which again was caused by a very understandable reason, very long approval by antitrust authorities led to exits of customers from IPSCO and therefore, dramatic fall of IPSCO's results. But this was, as I said, mostly offset by performance of Russian division. And as a result, it showed numbers significantly exceeding consensus. And of course, we are, I guess, sorry to see, as well as you are, that we held trading like at 3x also in EBITDA, but that's life. So that's multiples that I think many of the companies around see. So at this point, I pass the word to Sergey Alekseev, who will give you some color about the Russian market, and then we'll go to questions. Sergey?

Thank you, Vladimir. Hello, ladies and gentlemen. To begin with the overall situation with the Russian market for the previous year, just briefly. So the market conditions were quite good, as Vladimir talked. So we had just very small decline, about 1%, in the overall consumption. And we also need to know that we faced the lower demand in line pipe segment, which was almost fully compensated by higher demand for industrial pipes, seamless and welded as well, and as well as quite stable demand for OCTG products, which is also very important for us. We do see the trend of growing horizontal drilling in Russia. And for the previous year, we have faced a number of 53% of the overall drilling in Russia. In comparison to the previous year, it was about 48%. So we do see that the market consumption is changing, and we're also changing our mix according to higher technological products, according to more premium products, according to more value-added products like products with special steels proprietary grades, products with more chromium source service grades, as well as we are going on developing our premium connections. We have introduced to the market our new connections, TMK UP CENTUM, which is 100% efficiency. And nowadays, we are producing more and more and supplying more and more customer needs with this type of the product. It's also very important to note that nowadays, we have very good and very efficient platform for dealing with the customer. For communication with the customer, it's our new R&D center in Skolkovo, which we just opened previous year. And nowadays, we are open for technological dialogue with our customer. We are more open with technological dialogue. We can develop more new innovative high-tech and environmental-friendly products as well as tailor-made solutions for our customers and special services for them. So we are able to do digital wins. We are able to do conceptual designing of the wells where our products are used as well as we are also simulating the behavior of pipes as they are used in the wells with external operational temperature and mechanical loads, so everything. Nowadays, we are practically ready for all the challenges of international markets as well, not only the Russian one. By the way, the premium part of the Russian market for OCTG, we have faced that double-digit growth for previous year, and we also increased our market share in this area as well. As for the export sales, I also need to know that the previous year was quite good for Russian dividend for the export sales. We increased our export supplies over 30% for the previous year in different product issues. And it was quite good for us that we have also entered some interesting niches with our products, not only in international, but as well as in CIS markets as well. Speaking about the fourth quarter, the fourth quarter in comparison to the previous quarters was -- we faced some decline, but we understand that it was mostly driven by the seasonal factors, and the demand was not so strong for industrial pipes and for seamless and rolled as well. But the OCTG purchases were quite strong, and the market showed quite good dynamics. As for the, let's say, our strategy -- for our further market strategy, I would say that it's a combination of several activities: to be more premium, to be more technological, using our customer-oriented approach with the focus of new products and services and solutions with the help of our new R&D center. Thank you.

Thank you, Sergey. At this point, we are ready for questions.

[Operator Instructions] The first question is from Anna Antonova, JPMorgan.

Congratulations for the good results for 2019. My question is actually on the domestic pipe market in Russia. So what's your view on the apparently increasing domestic competition, given the several new players entering the market and existing players ramping up capacity in OCTG, both welded and seamless, in the coming several years, including Severstal's JV with Tenaris, OMK expanding its capacities and several other players entering the market as well. So what's your view? And what's TMK's strategy to address this strategic challenge on the domestic market with your, basically, core markets?

Thank you, Anna. Thanks for your question and interest. We -- I'll try to elaborate on this question, although it was asked before, but I'll try to maybe give more color, rewarding you for your interest and persistence. In fact, yes, we did see some initiatives, some statements, some rumors about new competition in -- on Russian OCTG markets, but each case is different, okay? Speaking of Tenaris and Severstal, obviously, Tenaris' name attracts everybody's attention. However, the nature of the plants that they intend to build at Severstal is welded business. So -- and that makes sense, given Severstal's profile in terms of supply in flat products. We view weld OCTG, especially OCTG, as somewhat different niche of the market, which has little intersection and little competition with our core business where we want to go. Because the increased complexity in drilling, especially, horizontal and directional drilling, they have very, very limited use for welded products. And our major investments and R&D thoughts and marketing endeavors really goes into area of high-end pipes used for horizontal directional drilling, difficult drilling conditions. And these pipes are primarily seamless pipes. And the -- in recent year, the proportion of seamless pipes is generally growing or at least been stable. It depends on the period, but seamless pipes, in today's developed geological profile of drilling, is -- has quite well protected -- protective market. Obviously, welded OCTG do post certain competition for some more conventional use. However, there, this new Tenaris and Seversky plant is probably, first of all, compete with existing welded players such as OMK and Gazprom, Severstal in the organization So I would say that our -- here's quite limited. To OMK, they declared -- they announced that they're going to build seamless plants, which will be competing with us. But our -- another part of the strategy is a broad strategic relationship with major customers such as Rosneft, for example, where we signed long-term agreements for very broad range of products to supply, and our competitive advantage is there to supply this broad range. One seamless plant, no matter what kind of diameters, calibers of pipe it has, would be limited to certain size of pipes and, therefore, would represent to a limited competition to what we do. And of course, there's a long way for new seamless player to go through qualifications and certifications and final acceptance of its premium connections. So we think we'll use all the time productively to go even further ahead of competition. So again, we are not afraid of it. And some other statements or initiatives that we've heard on the market we don't believe are serious, so they're more in the PR area, we think, but those 2, I commented. So we're ready for the next question.

Appreciate it. And the other question is on your LDP business. Could you please either disclose the amount for large diameter pipes you produced and sold last year and/or comment on the trends that you expect versus last year, this year, and in the medium term?

Okay. Thank you for your questions. So yes, large diameter business, as we have explained recently, went through a difficult period caused by overcapacity and oversupply of products. And this, obviously changed the landscape of it and forced all the players to look for new ways to sell. So look for more of a niche sales, look more for exports despite more difficult logistics. So this business is not simple as this. However, it's still standing alive. We sold about 270,000 tonnes of large diameter pipes last year and -- in Russia. And we think that despite all the problems caused by overcapacity, with some creativity in sales and finding new projects, offering customers new benefits, it's still possible for this business to continue and generate certain positive results. So this year, we still have some projects to do. And we think that probably we'll do 4, more or less, on the level of last year. Maybe there are no big projects compared to Power of Siberia was, as we participated earlier, but nevertheless, we still try to find our niche. And basically, this kind of load, let's say, between 4,000 and 5,000 -- 400,000 and 500,000 tonnes, it means quite good utilization of our longitudinal capacity, which is 600,000 tonnes. So under the circumstances, we are satisfied how it goes.

And the final question, if I may. On your European division, last year and I think towards 2018, there were plans about potential sale or divestment of your European business. Could you please comment whether these plans are still on the table? And what are your thoughts -- after the selling of IPSCO, what are your thoughts around having or not having your European division within the group perimeter?

Sure. The strategy that we follow called for monetization of our international assets to reduce the leverage. And obviously, the sale of IPSCO is a perfect example of realization of the strategy since we did incur high leverage for both acquisitions and modernizations, which needs to be reduced. So we look to achieve that goal. Now monetization can mean different things. It does not necessarily mean to sell the assets. It means to monetize it, so to attach some public financial value, financial measurement to the asset. That's why we intended to IPO our European business. Didn't quite work because of the markets. However, all this preparatory work was done not in vain. So once markets are back, which, I guess, we'll have to wait for some time, but we believe they will be back. This asset is again ready to become public. And meanwhile, that was a good chance for us and for Romanian management to realize all the values, all the synergies of the assets and made us believe in it. So the asset is still good. So what was not good was the market, but the asset was good. As a result, we are consolidating our ownership there. And basically now we are going through with -- together with -- so, sorry, TMK, together with our Romanian division, is conducting a buyback. And we -- the mandatory -- we had to do mandatory offer to remaining shareholders. And to my knowledge, most of the shares have been bought. So there is a chance that this company may go private. But again, the -- that shows that we believe in this business and believe in its value. And again, we are open for future options, including going public or any other options. But again, the business is ready. We are not selling it now. It's developing, and we have good hopes for it.

The next question is from Timothy Riminton, Barclays.

Well done for closing the deal. It's great news and great to hear that you're going to be using that to decrease net debt. So the one of the questions I have is on working capital. In the past, you've seen quite big working capital changes quarter-to-quarter, and I understand a good portion of this is from the -- or was from the U.S. business. Can you give us any guidance about how to think about working capital in the future? Or will -- do you still expect fairly large moves, even though you've got rid of the U.S. business? Like to what extent will the sale of this division change those dynamics? That's my first question.

Thanks for the question. Yes, working capital is constantly our -- is our focus. And because of certain necessary measures to put the sales and increase the sales, so specific products in specific geographies, we have to increase it. That was a concern. Now we should say that by the end of the year, in the fourth quarter, we managed to reduce our working capital significantly. And that was not just because of -- and by the way, the sale of IPSCO is not recorded in fourth quarter. And this reduction was not only due to some natural reduction of working capital in the U.S. because of downturn in the U.S. business. But also in Russia as well, we acted on improving in terms of payments and to optimize all the elements of working capital. And the result is working capital decreased. And that's quite a positive change, which we are waiting for, not just waiting, but which we're working on for quite some time.

So you believe you can maintain working capital at generally lower levels now?

Yes. Well, of course, what's low level? It's a tough call. We know that our, for example, global competitors, who some of them want to grab some market from distributors, and they have to deploy the pipes all over the oilfields or servicing offshores, for example, where they have to leave the stock of pipe, they have different turnovers for working capital. But of course, we have our idea for what a normal working capital is. And we think that the level of working capital we have now is close to this optimum working capital. And therefore, we do not think it will significantly increase and go forward and may reduce as well.

Great. And so following on from that, I just saw a couple of headlines last week on Bloomberg about potential dividends. So I understand you'll be using the proceeds from the sale to reduce net debt now, but do you currently have any plans to pay out a special dividend or change your dividend policy? Or are you happy with where it is, especially given the current uncertainty in the market?

Well, we -- obviously, the decision is up to the shareholders. And from what we know as management, shareholders is still in sort of thinking process on updating both dividend policy and also together we think about updating the strategy. So at this point, we are maybe not in a position to give you clear guidance on where we go. Yes, in the media, there was some quotes that we may pay the dividends, so that may well happen. But so far, we don't make the decision. And as I otherwise said earlier, I expect some guidance from the Board and some guidance to the market to happen in the second quarter, maybe next month, maybe May, so we'll definitely give this guidance, but I guess we need some more time. So at this point, we're still in the thinking process.

Okay. Great. Understood. And on the OpEx side, if additional cuts were to go ahead and Russia took part in those, do you have any idea of what sort of impact it might have on your pipes business? I mean I understand a lot of your contracts are long-term supply contracts and -- yes. So do you have any idea of how it might affect your business overall? And then specifically on the types of fields to get object to these cuts, do older fields or new fields generally use more of your pipes in Russia at the moment?

Well, thank you for your question. And especially, the second part of your question shows that you really understand the matter. Of course, the limitation of well production must affect also service business somehow. And, obviously, limiting well production may somewhat limit the drilling. However, it's -- in Russia, it's happened before, this effect probably will be seen much less on oil companies' upstream CapEx because even to sustain the same volume or even slightly smaller volume of production, oil companies must constantly drill and/or repair or improve existing wells. And a lot of them are in sort of semi-depleted stage. And in the environment of low oil prices, and maybe some CapEx limitation on greenfields, oil companies pay a lot of attention to improve existing old oil fields. That's what we see now, especially in Western Siberia, to squeeze more oil from them, again, even to sustain oil production even if there's no growth happens because of OPEC deal. So the structure of demand for pipes changed a little bit. Maybe we may see somewhat less tonnage of pipes because of that. However, mostly the sort of second life or reutilization of those old wells happens by some sidetracking, by drilling new wells from the same pad to access more complex lenses. And more sophisticated pipes, maybe thinner walls, premium connection pipes are needed to do that. So the mix actually improves because of that. And that's why the limitation of oil production does not affect Russian market that much. And structure improves, for example, the share of horizontal production, and the direction of horizontal drilling improved to 53% since -- in the last 4 years or so. So we see very rapid improvements in the profile of Russian drilling. So despite overall maybe stagnation of tonnage over OCTG, we see improved mix. And we do not think that this would affect Russian drilling so much because still, the cost -- lifting costs in Russia are reasonably low. So production is still profitable, even under current prices and even, I repeat myself, same volume of production requires constant drilling and improvement -- including improvement of existing wells of existing fields. So we do not see any major impact on our business because of Russia-OPEC deal.

The next question is from Maria Fedorova, Aton.

Actually, I have 2 questions. The first one is, will you switch to the ruble reporting following the sale of American division? And the next one is on the IPSCO disposal. Will it be reflected in the result?

Sorry, the -- I think the connection wasn't good. Can you please repeat your questions? Because we couldn't understand. Sorry, Maria, can you please repeat again because the sound wasn't good, so we couldn't understand.

Oh, yes. Sorry, my questions are -- will you switch to the ruble reporting following the sale of American division? And the next one is when the IPSCO disposal will be reflected in your financial results.