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

Hello, and welcome to the RHI Magnesita Q3 Trading Update. My name is Elliot, and I'll be coordinating your call today. [Operator Instructions] I'd now like to hand over to Stefan Borgas, CEO. Please go ahead.

Thank you very much. Hello, and welcome, everybody, to the RHI Magnesita Q3 Trading Update. Today, I have the pleasure to join you from one of our plants in Khambhalia in India, whereas Ian and Chris are in our headquarter office in Vienna. At the beginning, let me give you the 3 key messages that you should take away from today's call. First, this is a real tough market environment. Our sales volumes have been weaker than expected. Our pricing is also lower as we forecasted. We don't see any signs of recovery anywhere yet, and we are continuing to manage the business very, very cautiously. Second key message, despite this weak environment, RHI Magnesita has been able to maintain a strong margin performance through price discipline, cost reduction and mostly through improvements. Third key message, we are continuing to work on the long-term structural improvements for our business that will help to sustain our profit growth despite the tough market backdrop. This includes digital upgrades, our new ERP system, business process outsourcing to Capgemini, a promising new product pipeline and expansions of our solutions offering. All this, of course, on the strategy of continuing to acquire companies. So these are the 3 messages: really tough market environment, efficiency improvements that could balance out a lot of the downside of this tough market environment, and long-term improvements in the making on which we are working for future self-help. Let me now briefly go a little bit more into detail on the trading environment before handing over to Ian to give you some insight on financials. We are now ladies and gentlemen in the third year of a global industrial downturn. This affects all of our customer industries and all of our end markets almost in all of the regions around the world, third year in a row in a global industrial downturn. In nearly all the regions, our demand is flat or declining, of course, with the exception of India. That's why I'm here, but it's good to smell some optimism from time to time. But even here in India, growth of the domestic production at our customers is more around 3% to 4%, then 5% to 6% and also due to significant imports from China. In China, there is massive excess production of everything, including steel, cement, copper, glass, all our customers, but also including refractory raw materials and refractories themselves, massive overcapacity. And what happens with this overcapacity, it leads to exports into all other parts of the world. China, more or less, in every industrial category is roughly around half of the world's production. Our customers in many non-China markets are affected by this, and their production volumes are lower as a result. And because RHI's market share is higher outside of China than in China, this also affects our sales somewhat negatively. At the beginning of 2024 of this year, we guided that sales volumes in our base business would be broadly flat. And then our recent M&A activities would add up to 10% growth to this. We now have seen experienced and continue to see actually a decline in the base business. And the contribution from M&A will bring us to around 5% volume growth in sales if we look at year-on-year. At the beginning of the year, we were criticized as being very bearish and sandbagging and conservative, and the situation now shows that it is even worse than our very careful forecast at the time. We are now in the third quarter, also experiencing competition from other refractory from producers leading to price pressure. The discipline is slowly eroding in the industry. We expect this because the key input costs have reduced for the industry. Pricing is 4% lower year-to-date. We had guided to 5% lower guidance. But in the half year, we were still a little bit hopeful that we wouldn't need to exploit the 5%, but now that trend has accelerated in the first quarter. The refractory market in general is oversupplied. And growth has been low and new demand is often countered by efficiency improvements of refractory performance that structurally results in a little bit lower refractory usage. This is why our strategy enables us to grow profitably through M&A and of course, through efficiency gains, especially by integrating these acquired companies into RHI Magnesita and that generates new efficiency potential. This allows us not to add any new production capacity to the market itself. We don't have any new M&A to report in the third quarter, at least nothing signed. But there's an updated timing for the completion of the ResCO transaction, which we now expect to complete in the first quarter of 2025. This long waiting period is especially difficult for our people. In both companies, RHI Magnesita North America and ResCO, who are actually doing an incredible job in focusing on their respective customers in the marketplace. Kudos to those teams. In the announcement we gave -- that we have done today, we've given you some further details on other internal improvements that we are working on to drive long-term efficiency gains. The first example I would like to draw your attention to is the development of our solutions contract business, which we now have branded for Pro. And we have expanded it to include advanced technologies such as robotics and digital technologies, recycling and waste management and decarbonization solution. This is a new, more holistic approach that brings together the full range of products and expertise that we can offer plus these new components that become more and more important for our customers. Our customers have responded really, really positively to this menu approach on a higher level. The share of revenues from solution contracts has decreased slightly in 2023 but that was because we made so many acquisitions and then, of course, the share of revenue came down. But with 4PRO now, there's an opportunity to grow this share again because the 4PRO approach is broader than we could offer in the past. The second thing I want to draw your attention to is the fact that we have begun to transfer our shared service centers to Capgemini. Capgemini is a leader in digital and process transformation as well as a very, very experienced shared service center operator. This transfer will deliver service improvements for our customers. That's the main driver here. But also better career opportunities for the employees that have been working in these shared service centers, some 750 men and women -- professional man and women that are now part of Capgemini and having a much better career opportunity. And of course, eventually also cost savings for RHI Magnesita. The work on our ERP upgrade is continuing as planned. This is maybe the biggest project that we're working on at the moment. It's a major 3-year project, which will result in a significant improvement in our entire core systems and our IT landscape. Finally, new business development in green steel projects continued also in Q3 with 2 new wins to add to the SMS contract that we announced in Q1. We are increasingly perceived as a vital partner for the development of refractory solutions for the new equipment and for the new technologies, which will eventually drive the decarbonization of the steel industry. Ladies and gentlemen, all of this has enabled us at RHI Magnesita to maintain our margins at a reasonable level, slightly above the 11% that we guided for the year. And especially have enabled us to continue to generate strong operating cash flow with close to 100% cash conversion. I'll hand over to Ian now for some more insights into the financials and the guidance for the rest of the year. Ian?

Thank you, Stefan, and good morning, ladies and gentlemen. We've been able to maintain a healthy margin performance in the year-to-date despite 4% lower pricing and fixed cost under absorption caused by low sales volumes. Reductions in input costs primarily on purchased magnesite-based raw materials and energy have helped us to keep our profits broadly stable as pricing pressure from competitors has increased. We've also been working hard. We keep on top of our SG&A, and we are seeing the M&A synergies coming through. During the second half, the price of alumina-based raw materials and electro-fused magnesia have increased significantly for reasons which are specific to these materials. The alumina price has increased 47% from the beginning of the second half and electro-fused magnesia has increased by 13% over the same period. We are not vertically integrated in these materials. So this will increase costs in the fourth quarter and into 2025. We have already started a price increase program with customers to counter this and to maintain our margins. Adjusted EBITA in the third quarter was similar to the first and the second quarter. This means that a strong step-up in EBITA is required in our fourth quarter to achieve full year targets. We do expect an uplift due to the normal seasonality in the cement segment and the timing of industrial project deliveries. We've got good visibility on the order book. But there is always the risk of profiles by customers, which could push some orders into the first quarter of next year. Taking into account the year-to-date performance and based on our assessment of the order book for November and December, we've decided to move adjusted EBITDA guidance down slightly to a range of EUR 400 million to EUR 410 million. This compares to consensus of EUR 413 million. Adjusted EPS is still expected to be in line with consensus of approximately EUR 5 per share as we will benefit from certain foreign exchange-related gains within net financial expenses. Capital expenditure guidance for 2024 was previously reduced due to the reclassification as an expense of spending on our digital architecture and in particular, our ERP upgrade. These costs will not be capitalized. This expenditure will be recognized within other income and expenses, and therefore, excluded from adjusted EBITA and adjusted EPS. As detailed in the first half, other items expected to be excluded from adjusted performance in 2024 are costs relating to M&A and M&A integration as well as some foreign exchange losses relating to prior year balances due to changes in exchange controls in Argentina. This does result in a higher level of OIE than the previous 2 financial years. The largest item here being the spending on the ERP upgrade. As Stefan highlighted, our cash conversion remains strong, approaching 100%. This is below the level achieved in the first half, but this is due to the normal buildup of inventory ahead of the cement season in the fourth quarter. Our working capital intensity of 26% at the end of the third quarter is expected to reduce to our target of 24% by the year-end as revenues increased in the fourth quarter and as this inventory is sold. Net debt and gearing are stable and we continue to benefit from significant available liquidity, attractively priced borrowing and a long amortization profile. Our gearing will end the year comfortably within the 2 to 2.5x EBITDA guidance range. We are continuing to manage our group conservatively throughout this period of weak demand, and we are pleased with the resilience we have shown in 2024 to date. RHI Magnesita remains well positioned for any recovery in customer demand with a potential for significant upside from operational gearing and recovered raw material margin contribution if that happens. Stefan and I would now be happy to take any questions you may have.

Thank you, Ian. Let's move to the Q&A.

[Operator Instructions] Our first question comes from Andrew Simms with Berenberg.

Just a couple of questions for me. Firstly, just on the demand picture. Obviously, you mentioned India is starting to see a bit of pressure, but also interesting, just what's happening elsewhere in the world? I mean, can you just give a bit of color around what you're seeing in the U.S. and Europe and there's maybe the differences in demand profiles there? And then secondly, just on pricing. You obviously mentioned pricing is now 4% year-to-date. I'd be interested in the split between steel and the industrial space, if you could give that, please.

Okay. So by region, yes, so India is growing a little bit slower than anticipated and that slower growth is on local production, not so much on the local demand. Therefore, you don't very much recognize it on the GDP numbers. But if you look at the local production, if you carefully read what large steel companies, for example, are publishing, Tata Steel, JSW Steel then you see that the imports are replacing some of the domestic production. Europe is shrinking, adapting simply to lower demand, very much driven by weak transportation and a weak construction industry. North America has been relatively resilient until the middle of the year, but is now also weaker on the industrial production maybe also in anticipation of the elections, but at least no growth this year in North America. South America, similar, flat. Nothing -- no growth here happening. It was weak in the first half of the year, could look a little bit better. But for the year, for sure, no growth there, either. Southeast Asia, demand okay, but very much flooded by Chinese imports. So production is actually going backwards, also in Southeast Asia. And Middle East is not growing as fast as last year obviously, because of the conflict there and the pause for some projects. Last but not least, China. China is really in a total restructuring of the entire industry. It's also recognized and openly discussed in the country. China has been operating on a quantitative economic model. Invest, build capacities, they will be filled and sold, and that model isn't working anymore. And the demand is already lagging behind production capacity increases for quite a few years. And this has now led to a situation where in [ CASI ], all basic industries steel, cement, copper, glass, aluminum, but also solar panels, electric cars, China has massive, massive overcapacities. The country knows this and is trying to adjust this, but that will take time. And during that adjustment period, a lot of these materials get washed on the world market. And of course, that reduces production in many, many especially smaller countries around the world. On pricing, yes, this ongoing weaker demand picture has -- is starting to lead to less discipline in the pricing behavior of the refractory industry. One has the sentiment that many refractory companies are now tired of being in a low growth or zero growth environment. They want to see growth again and they're going after market share and of course, that puts pressure on pricing. And of course, casualty customers take advantage of this. I think that's as much as...

And Andrew, with refractory prices being down 4%, the steel segment was down 5%. Industrial was down 2%. But as we touched on, this reduction is almost fully matched by the reduction in input costs as well as our action to reduce costs. The important piece here is that we're seeing this pricing pressure evident in all markets now, even those markets that have been relatively resilient through the first half of the year, Europe, North and South America.

Yes. And you will see the industrial price -- industrial projects price reduction still to come because those projects are -- have been agreed upon a year ago or even longer, and that actual reduction of raw material cost hasn't been reflected yet in the new project. So here, the real step down is still to come in industrial.

Great. If I could just quickly come back on your comment on China. I suppose earlier on this year, there was a hope that tariffs would perhaps stem some of the exports out of China. But clearly, China's own internal picture is tougher. It sounds like you probably expect it to get worse before it gets better. Is that a fair characterization of what we're thinking of in terms of Chinese exports everyone?

Well, look, I was recently in China and I had a chance to speak with a lot of people in the political environment also in the party, and they openly acknowledge that China is in this adaptation phase now, which will not go in quarters. It will take 5, 6 years or so. And it's a very clear and openly explained attempt to improve the quality of the economy by going downstream, by reducing waste, by improving environmental profiles by improving product quality, but of course, extending value chains, also by improving the export share of China around the world. So this is all acknowledged. And therefore, this is not a short-term issue. This is a structural adaptation that will be with us for, I believe, at least 5 years, maybe even longer than this. Tariffs, I think will not really fully address this first because not many countries actually are prepared to -- are able or willing to raise tariffs because there's neutral effects on this -- effect on both sides, right? So if you have a lot of export to China, then you don't -- you want to be -- you're careful on tariffs. The U.S. is kind of this extraordinary situation because the percentage of imports in the U.S. from China is actually not so high compared to many other countries. So tariffs are not going to be a unilateral solution. And if the tariffs increase massively, that will have a significant negative impact on total world trade. And of course, that's not good for anybody. So I think we need to live with a structural adaptation that comes out of the changed environment in China. This is the way it is.

We now turn to Jonathan Hurn with Barclays.

Just a few questions for me, please. Firstly, just coming back to India. I think in your opening remarks, you said, look, in terms of production growth, it's going 3% to 4%. We were expecting 5%, 6%. Can you just talk a little bit about the analysis and production growth in India going forward? Do you think it can get back to that 5% to 6%? Or do you think sort of the flood of imports coming from China is going to keep that production growth suppressed for longer? That was the first one. The second one is, again, on pricing, but just maybe looking to FY '25. Obviously, take on board your comments about industrial pricing getting tougher. But how should we think about pricing for the group in '25? Is it still going to be down again, 5% year-on-year? And then the third and final question was just on that sort of structural overcapacity in the industry outlook, I take your comments on China. But how do you think that overcapacity sort of goes forward? Do you think we can start seeing capacity coming out in some of the other areas globally?

Okay. So let me start with the pricing question. I think it's too early to give new guidance on how our pricing will be in 2025 overall. But I would estimate that it will get worse before it will get better. Because when raw material prices go up, it will take between 2 and 6 months depends on the sector in order to pass it through to customers. And during that time, our margins somehow get squeezed. And this is what we will see now in the next 3, 4, 6, 9 months. But in order to quantify this, I think we need a little bit more time, but we're -- but don't expect any fast recovery, at least not in the next foreseeable couple of 2 or 3 quarters. Is India's growth lower for longer or not? Well, a lot will happen. I think there's 2 factors that contribute to this. The first one is the structural demand in the country. There a lot of infrastructure projects. There's not -- there's no reason to believe why the India growth should substantially get lower. But the China import pressure also on the Indian market is a reality. And yes, there's a policy here that has made in India is to be preferred. But then when it comes to the individual transaction, as we say in German, the shirt is closer than the jacket. The low price from an importer from China often beats the domestically produced material that is maybe a little bit more expensive. So I think we also are well advised if we prepare for the India growth in our industry to be a little bit below the overall GDP growth and even the overall consumption of our customers' industry. So I would rather bank on 3% to 4% structurally for the next few years rather than on 5% to 6%. And if I'm wrong, then I'm very happy to be wrong and I would be happy -- I'll be happy about this. Third question, how is the overcapacity going to be dealt with? China is very responsible, I have to say, at least everything they say, everything they project and everything they do in the -- on the ground is very responsible. They're not dumping the world market. They're not -- they have intelligent people on all levels in the companies, but also in politics. They talk about ways to somehow control the exports. Of course, they want a larger part of the world market, but not in a bloody way. So I think we will not see a blood bath. I think as Stefan's view of the situation. The capacity adaptation in other parts of the world is already happening. Chile, for example, has just shut down the largest steel plant because they will structurally replace the production of this steel plant with imports from China. In Mexico, a very large steel plant also has been shut down already now. In Southeast Asia, Philippines, Malaysia, Indonesia, investments are down and capacity expansions are down because plant utilizations are at a very low level because of imports from China. European exports are not competitive anymore like in the past. So European exports have to be reduced. And as a result of this, capacities in Europe need to be adapted. In the U.S., I think it's a little bit too early to tell because we have to see the policies of the new government. But it's something that needs to be dealt with. And it will be dealt with, but it will be a longer adaptation process like I already described.

Our next question comes from Mark Davies Jones with Stifel.

A couple of things from me, please. Firstly, on the raw materials that are seeing inflation refreshes, the aluminum eletrofused magnesium, can you give us some sense what share of revenues those account for? And your level of confidence that in this more deflationary environment, you can pass those costs through in a pretty timely fashion? That would be my first one. Maybe we can take that one first.

Yes. So in general, we are very confident that we can pass on these higher raw material costs because they affect us and every other competitor. And as you know, raw materials make up 70% of cost of goods. So nobody can afford to absorb this really fast. So this will happen for sure, with a very high probability. With the caveat of this avocation process of, I don't know 6 months, maybe plus a little bit more over the course of the next quarters. Ian, anything to add percentage of our business?

We'll come back to you, Mark, on a more accurate number.

But alumina raw materials, Mark, are in all of our nonbasic products, the essential material bauxite-derived are normal priced. And electro-fused magnesium is a very large component of the commodity part of the magnesite-based materials. And if electro-fused prices go up, I think we can expect that the other magnesite-related prices will also follow. Therefore, it's a pretty broad increase affecting more or less the entire portfolio.

That ultimately then help your...

Not 14% or 45% -- not 13% or 45%, but lower than this because they are just components.

Yes. Well, hopefully, that will be helpful to your vertically integrated business ultimately, but we'll see that. The other question was on the ResCO delay on closure. Is that just a process timing thing? Or are you having to make some concessions in terms of the scope of that business?

No. We have one product line, and this is a dolomite bricks that -- where there's a concentration concern from the DOJ, we knew that from the beginning. Therefore, the ResCO dolomite business is up for sale now. We have started an official process on this. We have quite a few refractory producers that are interested in this. And hopefully, we can bring this to an end sometime over the course of the next 2 or 3 months. This is about a EUR 10 million revenue business from ResCO.

Mark, and just on your question on Illumina and on electro-fused magnesia, we're currently spending around EUR 80 million in terms of cost.

[Operator Instructions] Let me now turn to Harry Philips with Peel Hunt.

Just 2 questions, please. Just on vertical integration. I suppose, simple question is, what's the catalyst to get that moving back towards sort of through cycle averages? That would be interesting to hear. And then secondly, on the solutions selling and 4PRO, what percentage of sales -- I appreciate the comment about how the M&A would have diluted that percentage. But if I remember right, it was at circa 30%. Is that a realistic target in the enlarged business going forward? And just how different is the sort of pricing model around solutions versus more standard products, please?

All right. So Ian, I'll pass on the solutions percentage question to you later. On the vertical integration, what are the catalysts? Well, the catalysts are price increases by the price makers by the market makers. Sorry for this. And this is happening now. So just like Mark had suspected, there is a possibility that this will actually help our backward integration, right? Because that's where it should come from if the whole value goes up, then this is positive for us. On the solution selling concept, we generally don't have massively higher margins there, but it's a much more stable and sticky business. The good thing about this is that we don't negotiate on commoditized terms with customers. So it's a more stable long-term part of the business. The bad thing about the solutions business is about customer suffers with lower volumes. We also suffer because we get paid on a cost per tonne of steel and not on a price per ship refractory. And on the percentage, Ian?

So our solutions share fell down to just over 27%. It's not up very slightly. We've been up before the M&A at just over 32%. And certainly, our ambition at the first step would be to get it back up through the 30% level. Stefan, also just to touch on your point on backward integration. The impact of the decline in our backward integration margin on our earnings is pretty profound. We've seen over the last 2 years, our backward integration margin fall from 2.5% down to this temporary low of 0.8%. That's the equivalent of moving from EUR 85 million of EBITA contribution down to EUR 30 million of EBITA contribution. So it goes a long way to offsetting some of the very important contribution coming through from our M&A, unfortunately.

That's very clear. And just tidying up one final bit, which I missed. Just in terms of that dolomite brick line in terms of ResCO, was that a $20 million retail business? I just missed the...

$10 million. $10 million, Harry, yes.

We have no further questions. So I'll now hand back to Stefan Borgas, CEO, for any final remarks.

All right. Well, thank you very much for dialing in this morning and listening to us reporting from India and from Vienna. Just to summarize the 3 main messages of the day. This is a tough market. The lower sales volume, lower pricing is really a difficult environment. Despite this weak environment, mainly the efficiency improvements have helped us to maintain our margins. Third message, we use this time to continue to work on long-term improvements of the company, digital upgrades, process outsourcing, new products and expansion of our solution offering. Thank you very much for dialing in today, and we look forward to talking to you over the course of the next days and weeks. Goodbye from Khambhalia and from Vienna.

Thank you all. Goodbye.

Ladies and gentlemen, today's call has ended.