Tupy S.A. (TUPY3) Earnings Call Transcript & Summary

Welcome to the new episode of TUPY3 comments. I am Hugo Zierth, Investor Relations Manager. And today, we will talk about the second quarter results, our outlook for the second half of the year and also speak with our CEO, Harro Burmann, about his first 60 days managing the company. And today, we also have Ricardo Fioramonte here, our Vice President of Structural Components, to talk about the results. Ricardo, welcome back to TUPY3 comments.

I know, you were here on June 1, exactly 60 days ago. I imagine your schedule has been very full since then. So tell us a little bit what did you see throughout your journey visiting our operations.

Good afternoon, Hugo. Thank you. It's an honor to be here again communicating with our people and with everyone else. Well, these 60 days were really intense. Weren't they? We had the opportunity to visit all our plants here in Brazil, in Europe and also in North America. And it was interesting because I had told you that we were going to talk to the folks on the shop floor, right? We were going to listen attentively and deeply to the people who know well what we do, right? And I also had the opportunity to talk to customers during this period. But let's start with the shop floor, which is very interesting because I also got to know. It's rarely talked about, right? That took me that I found -- that I discovered because I didn't know it. And I found it very interesting, right? I had the opportunity to visit our team here at the distribution center in Jundiaí, a world-class operation, I'll say that upfront, an operation that has gone 8 years without accidents, right? Of course, it's a favorable environment, but people take care of each other. There is attention, there is strong leadership, right? And I always believe that when we have this positioning of taking care of people, everything else follows, right? So we look at the quality there, they have good quality, right? We see productivity gains of nearly or more than 50% because they optimize them today. They work in one shift. So that means we can grow a lot in the distribution sector. We are ready. We have the infrastructure and a motivated team. And one thing that really, really caught my attention is that 49% of the people who work for us in Jundiaí are women, so we have a female staff of almost 50%. I hadn't seen that in a factory like this or in a distribution center before. And another thing is that it's a young team as well. So those 2 things we talk about, the difficulty of capturing talent, we have managed to do there with highly motivated people, achieving productivity gains, taking care of themselves and half of this group are women. So it was a big surprise to get to know our distribution center. The second one right here in Sao Paulo, I went to Santo Amaro. In Santo Amaro, I was able to get a snapshot of my vision for the Tupy of the future, right? I saw automated machine lines there, right, with a high degree of automation, good synchronization. I was able to observe the application of the entire philosophy there on the shop floor, an AGV even passed by me, okay? So interesting, right? And I even asked myself, does this really work? Is it just for visitors to see, right? No, the little AGV stopped right at its address when I was coming along, meaning everything is synchronized and nice and nice. And those are the things that we are proud to see, right? It's the fundamentals being applied, the fundamentals synchronized in the day-to-day production, there are some fantastic electronic kanbans. There are warehouse CCPs there with plenty of visual management. And then, what I like the most, which is that vision we have is that I was able to walk along our engine assembly lines, Ricardo, and those of our clients, right? So we have manufacturing service there, right? We assemble engines for third parties, but also assemble our own engines. And then, for our engines, I had the chance to see our generators in that generator line and so on. So it is a factory that adds a lot of value, right? A factory that is what we imagine we can offer at Tupy, right, that we will make the casting, machine the casting and have the opportunity to assemble it, right? This is incredible value for the company, right? And it also breaks the paradigm that it's not just the volume of castings that will make us grow, right? But quite the contrary, right, what will make us grow much more will be the volume of value-added products, mainly machining and assembly. Then, we enter the world of foundries, right? Then, there's Joinville, right? Joinville impresses you just by arriving by its size, the sheer scale of Joinville, right? The installed capacity we have there, the lines for engines and foundry heads, which I think maybe the C4 might be a global benchmark, right, for quality, productivity. These are lines operating with high OE above 70% for a foundry. That is something significant. And one thing that caught my attention, right, because foundries, right, since we have 2 places in the world where there is full employment, right? Joinville's biggest pain point in this recovery was labor, right? And the team is already working so that this won't be our problem in the future anymore, right? We developed with our team an automation project for the finishing area, right, which is called, let's say, an automatic grinder, right? And I saw 2 of them working. right? And this removes an unsafe condition, improves quality and greatly improves productivity. So for the future, I saw that Joinville even already has a solution for its great pain, which is the labor in these positions that people today no longer have much passion for working in, right, which is at a grinding machine in a more aggressive environment. We have to flip the engine, tilt the engine on the line, which is something I saw, and it's not easy to work there. So I think that we -- I also saw solutions, right? Some solutions that are already in practice, and now, it's about replicating them, right, quickly to the other plants because we have plants in locations around the world where labor has a slightly higher cost like in Europe and like in Mexico, right? And then, particularly in Mexico, I was very enthusiastic. This being my latest visit, right? So it was one of those where you come back feeling inspired. There in Mexico, I was able to see and visit the 2 plants, right, which are strategically very well positioned, right, like in the Saltillo region. And it's interesting that there you see both things, right? You see a traditional foundry like ours, which is Saltillo. And so I had the great, great pleasure of visiting our Ramos Arizpe plant, right? They really put a lot of care in the design of that one as a plant.

It's the newest plant we have in that region.

Yes, besides being the newest even in terms of flow, it seems to be the most modern. It's the cleanest, most organized and even the best looking, right? You know those things that impress you when you arrive. You see an industrial complex that looks like it was finished yesterday. The team did a great job with the visit. So it was a really good visit. But more importantly, we observed these 5S aspects of the organization because that is part of the safety and quality culture. But what impressed me most there was the team's energy, okay, a team that is being revitalized, a team that knows the commitments they now have ahead of them, right? So the people we met there, they are very motivated. So what I saw in the short term, summarizing this first round, let's call it that, were motivated people, right, with very good assets, right? There is a very good technological capacity already installed, customers who want our products because everyone I visited the great news was that there were customers who want our value-added products, right? All of those I visited, the ones I visited were machined products, right? Total machining, not just the roughing, just as there will be opportunities for us to do assemblies as well. So I think that when we manage to transform all these opportunities, right, and the best practices I saw, we don't need to create anything new, right? If we make the best practice of each plant, the new company standard, our standard of quality, safety, and operational excellence will be at another level. And then, we will be delivering the value that we should have already been delivering and haven't yet managed to turn into results, particularly in this quarter, right? But moving forward, I think by simply focusing on these best practices, we will be able to have a standard far superior to what I saw in those visits.

Well, Harro, so based on everything you saw here and the opportunities to replicate the best practices across the plants, what is your priority?

Moving forward, moving forward. Hugo, it's quite simple. It's more or less about following this report, which is almost like a road map of opportunities, right? So what we've noticed are these differences in standards, let's call them, in these performance standards, right? We said that we need to normalize this. So I think it's the first time 60 days ago, I said here that we cannot improve what isn't stable. So we will have to stabilize operations, deliver this new standard, whether it's for safety, quality, operational excellence or productivity, it's this new foundation. It's this new foundation. So the stabilization of the new standard is priority #1 for me, right? And that will give us the productivity and quality gains we so desperately need to deliver the new products and this new volume curve that's coming our way. That's number one. Number two, talking to the people, right? The factories, it's interesting that the staff knows what they want to do, what's difficult to do and what they don't want in the plants, right? So I'd ask every now and then, right? So what can I do to help you, right? They say, "Man, get this part out of here," right? Look, how interesting that is? So I think that's where a lesson comes in, which I call portfolio management, right? We'll need to have the courage, Ricardo, to know how to choose. And I think the nonchoices will be the most decisive factor for our future, what is a nonchoice, right? We have to choose the right part for the right line and the right plant for the right customer, these certainties, let's say, these definitions, these 4 that I'm citing, and mainly, right, having the discipline to -- and we have some work to do ahead as well, right? The discipline of this allocation, let's say, of the right product in the right plant will lead us to a differentiated standard of excellence because today, I see that we make everything. So I cited the C4 line as a line that is a model line for us, right? Well, that line makes nodular, makes vermicular, makes gray iron, right? It could very well be dedicated to a single family of parts like our clients do, who are also our competitors because they have foundries and dedicate high volume to their lines. So we have several lines. And in some of them, we will have to make these decisions and dedicate high volume. So this last part was missing, right, still at the right volume, right? I think that this is the Phase 2. Once that is defined, these 2 definitions are very important, right, stabilizing the operation and having the right part on the right line, why? Because then I can automate. Automation comes as the third priority. And they aren't one after the other, they will all run in parallel -- as I told you, I've already seen the team developing solutions, which we will apply still this year for these machines in finishing and also in machining automation. It is fundamental for us to change the standard of safety, quality and productivity. So the big -- let's say, the big priority of automation is to change these standards where we still have incredible opportunities within the company. And then comes lastly, right, it is having this commercial discipline, right? And this commercial discipline also comes from this drive to add value, right? We want them to stabilize the operation, choose the right part and apply automation so it has the right cost, right quality and desired safety, but then it also comes that the next step is to invite customers to develop this new product with us, which we will be able to manufacture or assemble following this growth curve in value-added. The more value added, the better our returns will be, right? And with that, certainly, capital allocation and discipline will lead us to what we call having our ROIC above the cost of capital, which is the company's big, big goal.

And now talking a little bit about the second quarter results. We have seen a growth trajectory when compared to previous quarters. On the other hand, the result was still weaker than it was in the second quarter of last year. What is your view on the performance of this quarter?

This is the second consecutive one that we've done better, right? When we look at one in relation to the other, we are improving compared to the first quarter. And in the second one, we showed improvement, although not in relation to last year because I think we have to separate the external effect from the internal effect, right? The external effect is the exchange rate, right? If we do a quick calculation, we have an effect of BRL 104 million in our EBITDA from the exchange rate effect. So if we took our result of BRL 156 million that we obtained this quarter plus this BRL 104 million, we will be at BRL 260 million. We would be here commenting on how good our quarter was on the same basis compared to last year. So there is this effect, right? Of course, we try to separate the external effect from the internal effect. We didn't just sit here. We aren't just sitting around watching what's happening without doing anything. There are a series of initiatives for productivity, efficiency and also capacity management where we eliminated both fixed and variable costs, especially a very strong front in quality where we managed to claw back BRL 68 million of that effect, right? So I consider that we didn't cover the entire exchange rate effect partly because Ricardo, it is temporal, right? It has the entire effect of a quarter, it cannot be recovered within that same quarter, and we continue with these initiatives and the search for the recovery of this exchange rate effect. And I think another initiative that Ricardo is taking is that we are also looking at the volume effects that we are having going forward compared to the previous year. But I think the big news here was the cash, right? We came in again with very strong cash, right? There's BRL 303 million more in the quarter, right? That's BRL 500 million for the semester. So out of that, it was basically BRL 117 million. It was great management of inventories and stocks that the team is doing well. Well, I think in walking through the fabs, I could see that, right? We are already designing what inventory can be in the fab, what cannot be in inventory, there is opportunity, right? The team continues to work on this. And I think it's fundamental now that we're going to have this recovery in volumes to have these stocks adjusted and get the maximum benefit we can from this situation that is coming ahead.

I think another point that the market asks a lot about is leverage, right? The company generated plenty of cash, as you mentioned. But sometimes when we look at the debt indicator, net debt to EBITDA, we had a slight increase compared to last quarter.

Yes. Since our accumulated EBITDA has actually decreased over the last 12 months, we will have to work on this structural solution for EBITDA recovery, right? So there are some fronts that we have already mentioned here. We have several initiatives, both in capacity management and cost reduction and margin improvement from those commercial actions, led by Ricardo, which are fundamental for us to be able to reposition the company at the leverage level where it should be.

Well, speaking of the market now, Ricardo, anyway, we've seen a lot of good news coming from the United States, right? Orders from customers, close customers actually increasing their projections -- their projection. What do you have to tell us? What have you seen that has already impacted Tupy's results?

Very well, Hugo. We mentioned in previous calls about the rise in new truck orders in the United States since the end of last year, right? And I associated that with the robustness of our backlog. And as Harro commented, this has already turned into effective sales for us. We are entering or have now entered the second quarter on a sales volume growth trajectory that should be sustained throughout the rest of the year, right? Because our backlog remains strong based on what we observe, these are public data on these new truck orders in the United States that in both the first and second quarters of this year exceeded 100%, right? And this starts to reflect in an increase in truck production in the United States, right? So that is one of the factors. Now, it's not the only one, is it? I think there are 2 other important factors for us to mention. The second one is also not new. It's the massive investments in building data centers in the United States, in -- and we serve clients, right, who benefit from this factor in 2 ways. These are clients who supply machinery and equipment for building these data centers, but also engines for generator sets for backup power supply, right? And this has been reflected in increased sales in this segment as well, right? And finally, we don't talk much about it. We don't give it much highlight even because our sales in Europe among the 3 continents we serve are the smallest, right? But the truck market in Europe and even the light commercial vehicle market has been showing good performance. Trucks in the second quarter grew 11% compared to the previous one, that's in relation to the previous year, right, which undoubtedly benefits us and in a way, offset some of what we have been seeing in Brazil, which is still a market that shows no signs of recovery.