RHI Magnesita N.V. (RHIM) Earnings Call Transcript & Summary

Hello, and welcome to the RHI Magnesita Half Year 2022 Results Webcast with: Stefan Borgas, CEO; and Ian Botha, CFO. [Operator Instructions] I would now like to hand over to Stefan to start the presentation. Stefan, please go ahead.

Thank you very much, and welcome from Vienna on this beautiful summer morning. For the half year, I want to start with the 3 main takeaways. First, we have delivered a very satisfactory top line and EBITA performance. Second, we are making even better progress on our recycling initiatives than our own ambitious plans. And third, following our investments and the restructuring of the company over the last 4 years, we are now a much stronger, more resilient, and more agile business. We are much better able to deal with the volatility that's there to come. Let's go into the details. In the first half of 2022, we achieved significant price increases, and we gained market share to restore our historic positions. We were able to do this because we choose to invest in building inventories in 2021, to keep our customers supplied with our essential products. Today's results show that this was the right decision. Our Steel business outperformed with a 4% increase in refractory volumes. It further restored our market shares in this area. We have realized EUR 293 million of price increases since the first half of 2021, reflecting the pass-through from the increased cost in almost all areas of the business. The price increases exceeded the cost increases in the first half by EUR 60 million, and that helped us to restore our EBITA margin to a more acceptable 11.8% EBITA, which is the level that we're aspiring too, at least from the 10.7% last year. I'm very pleased with the performance of our teams in terms of volumes, market share, and demonstrating the pricing power that we have, and the rigor that we have utilized to get there. We told you we could deliver this, and we have done so. Turning first to health and safety. Ladies and gentlemen, this is our core value, and here, we have maintained our strong overall performance. Injury rates were broadly in line with the very low levels of the first half of 2021. Our target, however, is to reduce lost time injuries, the more serious accidents to 0. This year, we are focusing on leading indicators in order to measure this better, and to prevent accidents before they occur. On the financial highlights, I'd highlight the 33% increase in reported revenues and a 47% increase in EBITA to a level of EUR 188 million. Our margin has been restored to 11.8% from the 10.7% last year, and we are able to pass on almost all cost increases very quickly now. It's the speed that has improved considerably since last year. We have a negative operating cash flow in the first half because the value of the inventory on our balance sheet has increased. But in fact, we have been successfully reducing inventory volumes. Therefore, this will have a positive cash flow effect in the second half of the year. Gearing is broadly in line with the year-end and with our expectations, as we have guided that it would be because of this cost and value increase of inventories. We are then, of course, targeting to reduce leverage step-by-step during the second half of this year. Let's go into our different businesses. In our Steel business, we saw a strong increase in both revenues and gross margin, not only due to the benefits of our price increase programs, but mostly because of it. We have made clear market share gains, or at least retained our market shares in every single region of the world. This shows also that customers have turned to us to meet their needs through a period of uncertainty. We are the largest scale global player in this industry, with the ability to deliver when supply chains have been disrupted. Let's look into the regions. The strong performance in Steel can be seen in every region. Our volume growth has been strongest in the Asian markets, with the price increase program delivering significant benefits there. It's good to see continued strong revenue growth in our target markets of India and China, which is exactly in line with our strategic goals. In the Industrial business, we've seen similar levels of revenue growth, 28% compared to the first half of 2021. Gross margins are traditionally higher in this business than in Steel, and they are up versus the first half of 2021. But the slightly lower margins compared to last year are due to a longer time that is needed to pass-through price increases before they are completely seen in the P&L. This process takes longer in the industrial sector due to the project nature of the business. It's just a longer cycle. I'm very pleased, ladies and gentlemen, to report excellent progress on recycling. Please be reminded that recycling is the single fastest and the most impactful lever that we can pull to reduce our CO2 emissions in the short term. So it's very important to us every day. It's also an additional source of raw materials for us, which increases our vertical integration and strengthens the local-for-local supply chain, especially in the EU where we've made the most notable progress. We announced our new joint venture with Horn & Company in March, and the benefits of this joint venture, which closed shortly thereafter, is already starting to come through. In the month of June, we exceeded our 2025 target of 10% recycling content, and we achieved 9.3% over the whole of the first half of this year. Our EUR 50 million R&D program on new technology for carbon capture and other solutions, is progressing well. We have 9 pilot projects in various stages of development. The EcoVadis renewed our Gold rating in June. This is an important rating for us because it's linked to the interest payments on our debt facilities. We have strong scores with other rating agencies also. They recognize our sustainability leadership within the refractory industry. I want to give you a little bit more details on our joint venture with Horn & Company as this is a really positive development, and it could become a model in other regions of the world also. Horn has been the largest collector of secondary refractory raw materials in Europe. Prior to this joint venture, RHI Magnesita was already a major customer of Horn. We have now taken a 51% stake in this company, and run this operation as a joint venture in exchange of cash and our own recycling assets which have been injected into the company. We are, in addition, investing many, many millions of euros of R&D money into technology, how to make refractory products with recycled content without reducing any of the performance of the refractory product. The next bottleneck for us was going to be how to get hold of enough secondary raw materials to increase our usage rate. This joint venture helps to solve that problem in Europe. And that's why we have been so able to accelerate quickly. The joint venture will also offer raw materials to the market. Please see technology example here. Our joint venture opened our new recycling facility admitted off in Austria, officially in April. The event was attended by the Austrian Vice Chancellor. The government is very supportive of our recycling ambitions. Recycling is not just about having the technology to make the final product, but to do it well, you need to collect, separate, store material efficiently, and to recycle it as soon as possible after it has been finished, using by the customer. This gives the best results. With this, I'd like to hand over to Ian, who will lead us through the numbers. Ian?

Thank you, Stefan, and good morning, ladies and gentlemen. The earnings performance in the first half of 2022 represents a strong improvement on the first half of 2021 when we began to see material cost increases, but there was a delay before we could realize the benefit of price increases. We are now seeing the positive effects as pricing has caught up with costs, and we are negotiating price increases on a more frequent basis. Reported revenues are 33% higher, mostly driven by pricing, with a small contribution from additional volumes, which were up 5%. The increase in revenues, combined with higher gross margin of 23.4%, delivered an increase in gross profit of 37% to EUR 373 million. EBITA at the first half is EUR 188 million with the EBITA margin up to 11.8% from 10.7% last year. Going below the line, our net finance charges of EUR 19 million compares to full year guidance of EUR [ 30 million ], plus EUR 6 million for pensions, and are in line with management expectations. Finance charges in the first half of 2021 benefited from one-off interest income of EUR 12 million on a refund of previously overpaid tax in Brazil. The adjusted effective tax rate increased to 24%, the midpoint of our full year guidance range of 23% to 25%. The increase is largely as a result of the reduction in our deferred tax assets, as the Austrian corporate tax rate is to be reduced from 25% to 23%. In line with our policy to pay an interim dividend equal to 1/3 of the previous year's full dividend, we've declared an interim dividend of EUR 0.50 per share. Moving to the revenue bridge. Here, you can clearly see the impact that our price increases have had with a EUR 293 million increase versus the first half of 2021 with a currency tailwind of EUR 73 million. Sales volumes were up 5%, but this was largely offset by mix. This is very much a story about increased pricing. The same pricing improvement of EUR 293 million flows right through to EBITA as can be seen here in the EBITA bridge. The price increases more than offset cost inflation of EUR 233 million. Overall, we are pleased with the EBITA performance in the first half, which puts us in a strong position to meet market expectations for the full year. Moving to the cost performance. Our weighted average cost of goods sold increased materially in the first half, up 19% year-on-year in constant currency and constant volume terms. Nevertheless, we have been successful at passing on these cost increases to our customers. We've set out on this slide the key drivers of the cost increases. And starting with third-party raw material, the weighted average cost of third-party raw material increased by 29% year-on-year. Whilst we are largely vertically integrated into the production of magnesite and dolomite, purchased raw material is the single largest category of costs in our COGS, and reflects the higher production costs faced by our raw material suppliers, particularly for energy and freight costs. We are working on the basis that third-party raw material costs will remain at elevated levels in the second half. Secondly, our energy cost is up 60% year-on-year, representing the highest increase. We continue to see high gas prices, most notably in Europe. We are over 60% hedged for our European energy requirements for the second half, which will partially mitigate against the spot prices that you see on the chart. It is likely that gas prices will remain high for the foreseeable future. Finally, on our outbound freight. Outbound freight was up 18%. Rates for our routes have been stable in the first half at elevated levels. We continue to experience poor sea freight reliability, but importantly, we are able to pass these cost increases through to our customers. The negative impact from the freight situation is an inventory issue, and we will find it hard to materially reduce inventories until freight reliability improves. Turning to raw material prices. Raw material prices are up year-on-year. But for magnesite and dolomite based raw material, you can see that we are still somewhere off the highs experienced in 2017 and 2018. We as RHI Magnesita, seek to maximize the volume of raw materials obtained from internal sources, as we have a cost advantage over other producers. Turning to our EBITA margin. Group EBITA margins were stronger at 11.8% in the first half, with a 3.4% contribution from vertical integration, and a refractory margin of 8.4%. Both the vertical integration and the refractory margin increased in the first half of this year. The refractory margin increase to 8.4% reflects the successful pass-through of higher production and freight costs to our customers. We do expect the vertical integration margin to soften in the second half due to higher cost of production, particularly for energy as well as currency movements. We continue to aim to increase the group EBITA margins towards the mid-teen level, as we see the benefits of our strategic initiatives coming through. Moving to working capital. Working capital increased in the first half by EUR 322 million to EUR 999 million. This was driven by an increase in the value of inventories and accounts receivable due to higher costs and higher refractory prices, as well as noncash currency translation increases, which totaled EUR 57 million, this given the strength of the U.S. dollar and the Brazilian real. Our inventory volumes reduced in the first half with finished goods volumes down 12% and our raw material volumes down 5%. This, as we have sought to improve supply chain efficiency across the network, even though freight conditions remain challenging. We will always be conscious of the trade-off between seeking to reduce our inventory volumes and maintain security of supply for our customers. This has enabled us to both increase market share and raise prices in the first half. Moving to net debt. As guided at the full year results and in our first quarter trading statement, gearing remained elevated at 2.7x at the 30th of June, broadly in line with the 2.6x level at the 2021 year-end. We continue to expect a reduction in gearing in the second half towards 2x EBITDA, driven by working capital reduction. We have refinanced EUR 600 million of debt facilities during the first half, extending the maturity profile significantly. Our average cost of debt is now around 150 basis points with around 70% of interest at fixed interest rates, and over 90% denominated in euros. Available liquidity is now EUR 1.1 billion, comprising both cash and committed but undrawn facilities. I'll now hand you back to Stefan.

Thanks, Ian. I want to talk a little bit about our strategic initiatives, our sales strategies first. Flow control sales have grown by 23% to almost EUR 250 million in the first half. It was difficult to make progress during the pandemic, but now we are conducting a lot of new trials with customers. We have held more than 270 successful trials in the last 12 months, with a success rate of over 85%. Our share in the isostatic market, a subsegment of flow control, has increased the most. Solution contracts have increased to 32% of revenue, continuing the steady growth towards our target of 40% in 2025. These contracts are very useful for us to keep market share, get really close to our customers and use our most advanced products and services to generate cost savings for our customers in their plants. In new markets, both India and China have delivered significant revenue growth of 40% and 32%, respectively, as we build our market share and increase prices in these target markets. The performance in China is encouraging, and it was -- as it was delivered during a period when COVID-19 lockdowns held back many activities in the country. This photo is from our recently constructed Flow Control Academy in Leoben in Austria in our global research center. We bring our customers to this facility for training in the use of our products, and in the discussion of new products to develop. It is very popular, and it's part of our strategy to increase flow control sales. Let's turn to the production optimization plan. We have been updating you regularly on the major projects that are part of our production optimization plan. Today, I wanted to remind you of everything we have achieved since 2019. We have closed 4 plants, expanded or upgraded 4 plants, and we have 3 projects remaining to be completed at Radenthein, Brumado and Contagem. At Contagem, we have redesigned certain elements of the project to fit with new local parameters, and it is now due to complete in the second half of 2023. At Brumado, the project has been affected by supply chain delays and higher costs, but the economics are still very attractive, and we expect to complete in the first half of 2023. In Hochfilzen, we officially opened our new dolomite production hub in Austria, in April of this year. This project has been a real success, completed on time and on budget, which is a remarkable achievement, given what has happened between 2019 and today. Radenthein is following close behind Hochfilzen, and it will become a flagship automated and digital plant in Europe. Most of the individual elements of the project are now completed, with the final stages being the integration of all of the new control systems and benefits occurring thereafter. You can see one of the new automated vehicles in operation here, which is delivering significant operational efficiencies and replacing forklift driving. The global growth outlook, ladies and gentlemen, is facing a number of challenges. Against this background, I wanted to make a few points about the resilience of our business in previous business cycles. Refractories are an essential product. They are vital for industrial production. They are not a discretionary spending item. Our business is correlated with our customers' production volumes, not with the prices of their products, for example, the steel price. Our customers' margins are much more volatile than ours due to their pricing volatility. You can see from this chart, which goes back to a look at RHI. Only before the merger in 2017, the company remained profitable and solid, even in the deepest of downturns. It sustained an average EBITA margin of around 10% at all times. The profitability of our steel customers over the same period was much more volatile. On top of this natural resilience, we have also made major investments in optimizing our production network, cutting SG&A, and driving growth through our sales strategies. All of this puts us in a strong position to face volatility in the future. In summary, we are continuing our strategic transformation across all of our targeted areas. We are confirming our position as a sustainable leader in the refractory industry through our efforts in recycling and R&D on carbon capture and on storage. We are well positioned for future developments in the steel industry. We are also a technology leader in our own industry, constantly developing new products and services, such as our innovative heat management solutions offering. Thank you for your attention. We are now very happy to take any questions that you may have. Thank you.

[Operator Instructions] Our first question comes from Mark Davis Jones from Stifel.

So to start with -- lots of moving parts. Obviously, a very strong first half recovery. But looking through the back end of the year, you've made a few comments. I'm just trying to work out how they fit together. But do you think you can sustain margins at around current levels, or suggestion is that gross margins or operating margins -- And to get to the sort of full year expectations, I'm assuming that means a notably weaker second half in terms of volume, particularly as you try and, I guess, shift through some of that inventory. So could you just give some indication of visibility volumes versus pricing? How much of the pricing is already in the run rate so -- we don't see any further benefit to that in second half, that sort of stuff?

Yes, margins should be sustainable. There is still some pricing to come because some cost has increased since the first -- in the second quarter. So that is still to come, especially in the industrial business. Volumes, of course, are the big question mark. Our order book looks pretty good until the fall. We have 6-month order book outlook in the steel business, more like 12, 15 months in the industrial business. So we're actually pretty confident about this. But there is a risk certainly in the fourth quarter. Therefore, we are careful about the volume guidance for the rest of the year because we don't know ourselves.

And on the freight and logistics side of things, we've heard from some people some suggestion of improvement, or beginnings of improvement anyway. You sound a little bit more cautious on that. What are you seeing in terms of progress towards a more on-time delivery and more stable cost situation?

Yes. It's an interesting question because there are so many moving parts here. There is a bit of a release on freight -- on ocean freight cost from Asia to some regions, or at least it looked like that during the second quarter. Very recently this has come up again though. But there's a very significant increase, a really very significant increase in Europe, in North America, in South America and in China on land freight cost. So trucking cost is going up very significantly. So overall, I wouldn't expect very much release this year.

Okay. And if I may, one final one. We talked previously about how much you can plan ahead for potential disruption to gas supply in Europe. Where are you on that? I know you've been putting some contingency plans in place.

Yes. Obviously, this is an area where we're working very, very closely together with our governments, especially in Austria, but also in Germany. We are investing over EUR 6 million at the moment, just as we speak. The construction is already happening in order to replace 20% to 30% of the fuels that we get from gas from the -- of the energy that we get, from gas to other fuels, in order to get a little bit more independent. And we're also participating into the build-up of gas storage in Austria, and there's relatively significant storage capacity available. We have booked some of this in order to build buffers here together with the government. This is a very much a hand-in-hand activity that's happening here. It of course, depends on how much gas we can, at the end, get to flow into these storage facilities. So at the moment, with these 2 measures, we're relatively confident that we can get through shortages in the level that they are being discussed at the moment.

Our next question comes from Harry Philips at Peel Hunt.

Just a question on the recycling, please. Obviously, Q2 you were saying, Stefan, you hit your 25% target at more than 10%. How do you take this strategy forward here in Europe and then elsewhere in the world? Do you need to do more Horn type joint ventures or can you greenfield, and just really the dynamics and the possible financials around that, please?

Great question. Actually, we're just discussing it ourselves. Obviously, our target for 2025 now is achieved in 2022, so we need to increase, and we will. We're just debating on what is the right target for 2025 because it depends on all these moving targets. How fast can we bring technology here in Europe. Europe is the leading region now, clearly. And how much can we translate the learning from Europe and the infrastructure from Europe into other regions. In Brazil, this is already working quite well. We've made great progress in China. India anyway is very strong, and North America, we still are a little bit behind here because it's a big country, it's difficult to say. So I wouldn't expect that we will make many more of these kinds of joint ventures because those businesses that we have found with Horn, are not broadly available in Europe. So we'll have to do more of our own investments. A little bit of CapEx will move into this segment. It's not dramatic, but we will probably accelerate the CapEx spending in order to move up to 15% or something higher than this. But we're, again, as I said, debating the 2025 interim target. And then 2025 is not the end of the road, either. Recycling is going to become a technology game, not anymore a waste management logistics game.

And then just a second question around market share gains. I mean, clearly, those look pretty punchy and clearly, the outperformance you achieved in the first half in steel is very impressive. I'm just wondering where those market share gains come. And I'm sure you saw last week, obviously, other companies have talked about market share gains as well. So trying to sort of work that one out in its conclusion, if you like, just the [ outcomes ] of gaining market shares, who's leasing?