Vallourec S.A. (VK) Earnings Call Transcript & Summary

Hello, and welcome to the Vallourec Q2 and H1 2021 Results Call. My name is Rosy, and I'll be your coordinator for today's event. Please note, this call is being recorded. [Operator Instructions] I will now hand you over to Jerome Friboulet, Head of Investor Relations, to begin today's conference. Thank you.

Thank you for joining us. I am Jerome Friboulet, Head of Investor Relations. With me today to comment this results we have Edouard Guinotte, Chairman of the Board of Directors and Chief Executive Officer; and Olivier Mallet, Deputy Chief Executive Officer and Chief Financial Officer of the company. This conference will be recorded and a replay will be available. This is also audio webcasted on our Investor Relations website, and the presentation slides are available for download. Before I hand over to Edouard Guinotte, I must warn you that today's conference call will contain forward-looking statements and that future results may differ materially from statements or projection made on today's call. For your convenience, the forward-looking statements and risk factors that could affect those statements are referenced at the beginning of our slide presentation and are included in our annual registration document filed with the French financial market regulator, the AMF. This presentation will be followed by a Q&A session. Now, I would like to leave the floor to Edouard Guinotte.

Thank you, Jerome. Good afternoon, good evening, everyone. Let me start with a few highlights for the second quarter. Firstly, despite stable revenue year-on-year, our EBITDA and EBITDA margins both increased significantly at EUR 148 million and 17.6% of revenue, respectively. Our free cash flow remained negative, however, including some one-off financial restructuring fees. Talking about financial restructuring, it was completed on 30th of June as planned, setting Vallourec up with a much reduced debt at EUR 720 million and left with a strong liquidity close to EUR 1.2 billion. As far as operations are concerned, our savings endeavors continue well on pace with EUR 92 million gross savings achieved in Q2. Our commercial teams received and were successful in securing satisfying awards, notably in East Africa and Middle East, confirming the competitiveness of our offers. And finally, we completed the divestiture of Valinox as well as the acquisition of the minority share of Nippon Steel Corporation and Sumitomo Corp. in VAM USA, allowing us to control 100% of this subsidiary. As far as the outlook for 2021 is concerned, as you -- I'm sure you've all read from last week, we increased our 2021 outlook on 21st of July. We are now targeting an EBITDA between EUR 475 million and EUR 525 million leading to a free cash flow between minus EUR 240 million and minus EUR 160 million. We'll continue our strong efforts on cost savings throughout the year as well as strict cash control with a CapEx envelope kept at EUR 160 million. I'll now hand over to Olivier Mallet for a more detailed and in-depth review of our financials for this period.

Thank you, Edouard. Good afternoon, everyone. So I'll start on Slide 6 with the key figures of Q2 '21. Volume-wise, tons delivered were down 9.7% compared to a year ago. Q2 revenue at EUR 842 million was stable compared to last year and showed a plus 6% increase at constant exchange rate. EBITDA reached EUR 148 million, up EUR 105 million. Free cash flow, which included in Q2 non-recurring effect on [ this ] was negative at minus EUR 135 million versus minus EUR77 million in the same period of last year. On Slide 7, some details on the revenue evolution by activity and by region. In our largest segment, oil and gas, which represented 52% of our total revenue, revenue was down 10% at constant exchange rates. In North America, which remained stable and starting to pick up at the end of the quarter. In EA-MEA, revenue decreased, reflecting lower shipments as well as an unfavorable price/mix based on a lower backlog built in 2020. In South America, the revenue increased, reflecting a better price/mix despite an unfavorable currency conversion effect. In the much smaller petrochemicals segment, the revenue was down 40% year-on-year, mainly driven by lower deliveries linked to the oil and gas environment. On the opposite, in industry and other, revenue was strongly up, plus 66% year-on-year or plus 78% at sales exchange rates. In Europe, this was driven by higher volumes. In South America, it came partly as a result of higher revenue from the iron ore mine, reflecting both higher prices and volumes. Volumes reached 2.3 billion tons, up 23% compared to Q2 2020. Revenue in the industry market in South America increased as well, driven by volumes and prices despite an unfavorable currency conversion effect. Finally, revenue in the Power Generation segment was down 46% year-on-year, mainly due to the closure mid-2020 of our German plant in Reisholz that was dedicated to tubes for conventional power plants and to the disposal of Valinox Nucleaire on May 31, 2021. Moving to Slide 8, which shows some incremental detail on Q1 '21 revenue. The stable revenue year-on-year was explained by a negative volume impact of minus 10%, mainly driven by oil and gas in EA-MEA, which was partly offset by higher volume in industry and other in Europe and Brazil and showed a positive pricing effect of plus 16%. This positive price/mix effect reflected a higher contribution from the iron ore mine as well as a better price/mix in North America and South America. Finally, the global revenue evolution reflected a negative currency conversion effect of minus 6% related to the Euro-Real parity. Moving on the same slide to EBITDA. It reached EUR 148 million, EUR 105 million year-on-year, with a margin up 12.5 percentage points to 17.6% of revenue. It came essentially from the industrial margin growth at EUR 243 million versus EUR 236 million in Q2 2020, benefiting from several positives. A higher contribution from the iron ore mine in volume and pricing, the improved activity in oil and gas in North America and the recognition of the Nippon Steel payment of its residual fixed cost coverage obligation towards VSB for EUR24 million and as well from continued savings. These positive drivers did much more than offset the effect of the lower activity in oil and gas to EA-MEA. On the next slide, Slide 9, some comments on the most relevant lines of Q2 P&L below EBITDA. First, the operating income was strongly positive at EUR 200 million. This reflected, of course, the higher EBITDA as well the sale of the Reisholz buildings and land for EUR 70 million and the favorable decision of the Brazilian Supreme Court on the order so-called PIS/COFINS tax claim with a positive impact at the operating level of EUR 32 million. Then the financial income was negative at minus EUR 93 million compared to minus EUR 80 million in Q2 2020. This result reflected; first, stable net interest expenses, minus EUR 52 million and other financial charges of negative EUR 41 million. These other financial charges, including a negative EUR 64 million cost of exercising the option of the DBOT lease repurchase in Brazil. The net impact of the financial restructuring closing for EUR 18 million. And on the positive side, the effect of the PIS/COFINS decision for EUR 27 million as a consolation of the DBOT leasing debt for EUR 24 million, resulting from the exercise of the repurchase option. Third, income tax amounted to EUR60 million, mainly related to our Brazilian operations. And as a result of these 3 main blocks, net income, Group share amounted to a positive EUR 51 million versus a negative EUR493 million in Q2 2020. Let's move now to cash items. Starting on Slide 10 about the working capital to show you that net working capital requirement in days of sales decreased to 101 days of sales in Q2 '21 to be compared with 115 days in Q2 2020, reflecting the continuous improvement in our working capital management. On Slide 11, some comments about the free cash flow evolution, negative by minus EUR 135 million in Q2 2021 compared to a negative EUR 77 million in Q2 last year. First, cash flow from operating activities was up at minus EUR 15 million in Q2 this year compared to a negative EUR 65 million in Q2 2020. This improvement reflected mainly the improved EBITDA despite higher taxes paid and included as well, non-recurring debt restructuring fees for EUR 48 million and some cash out for adaptation measures. The working capital increased by EUR 92 million as a result of the activity recovery to be compared with a decrease of EUR 20 million last year, and CapEx remained stable at EUR 28 million. I will now conclude this part with net debt and liquidity figures on Slide 12. As at the end of Q2, Vallourec's net financial debt stood at EUR 720 million to be compared with EUR 2.214 billion on December 31, 2020, mainly, of course, as a result of the impact of the financial restructuring. And despite the negative free cash flow that we already commented for Q2, and that did amount to minus EUR 197 million for H1 2021. Our liquidity position was very solid with cash and cash equivalents of EUR 1.189 million at the end of the quarter, including EUR 460 million drawn on the revolving credit facility, which will be reimbursed at the end of July. And I will now hand over to Edouard for the outlook.

Okay. Thank you, Olivier. So moving back to the 2021 outlook. So as you know, we increased our guidance again for the full year results, targeting now an EBITDA between EUR 475 million and EUR 525 million, and a free cash flow between minus EUR 240 million and minus EUR 160 million. This would be the result of several evolutions. In North America, the continuous increase in the rig count. You may have noted that we are, as of last week, very close to crossing the 500 active rig in March. In Brazil, increased deliveries in both oil and gas and industry markets, combined with higher contribution from the mine year-on-year, even though on a sequential basis, we expect following the international consensus that the iron ore will start declining all along the balance of the year. In EA-MEA, we continue anticipating a sharp decline in oil and gas deliveries year-on-year, impacting both revenues and margins. And to the contrary, increased deliveries in industry markets. Across the Group, continuous saving efforts and strict CapEx and working capital requirement management, as highlighted by Olivier for H1. So these are the basis for an increased 2021 outlook. On these opening statements, we'll stop here and open for the Q&A session.

[Operator Instructions] And the first question comes from the line of Alan Spence from Jefferies.

I've got 3 questions, so I'll just take them one at a time. The first one is on the iron ore mine, there's a very strong production of 2.3 million tons, but that's annualizing above kind of the previously disclosed target of 8.7 by the end of next year. How were you able to push the mine so hard or achieve that rate in the quarter? Is that a sustainable production rate for the next few quarters? And is 8.7 the right capacity figure we should be thinking about by the end of next year?

So first of all, the mine has been operating at record level. So this production rate was achieved by what I would refer to as operational excellence. And everything indicates that this rate should be sustainable. And keep in mind, it will be completed by the ramp-up of our new treatment facility, also called the ITM 2, which will help secure these significant production levels going forward.

So should we think about kind of 2.3 annualized ton's the right number from next year onwards, did I understand that?

Yes. 8.7 million tons per year in 2022 onwards.

So that's below the current annualized rate in this quarter?

Yes. As I indicated, there is the -- Q2 is always a strong quarter. There's a bit of seasonality in our production. You have to take into account rainy season, which typically lowers production in Q1 in particular. So when we factor everything, the 8.7% is a reasonable annual average rate.

Okay. Fine. That's helpful, the seasonality comment. So the second one on the demand side, you've called out some weaker mix in EA-MEA and a better mix in South America. How do you see those 2 trends progressing in the next 1 to 2 quarters?

Yes. So this is what we indicated in the outlook. In Brazil, the activity continues to be very solid. And so we expect an increased year-on-year 2021 compared with 2020. To the contrary, in EA-MEA, we are basically suffering the impact of the low tendering activity and the low booking activity in 2020, which results in lower deliveries for our products in 2021, both in volume and mix. However, we are starting to see a progressive warm-up of the tendering activity in all these regions, which is why -- which has driven us to record significant awards and bookings, which will then translate into higher deliveries in 2022.

Okay. And my last one is just really a clarification. The DBOT leasing debt cost, the negative EUR64 million in P&L this quarter, was that cash or is there anything that you think about in the second half related to that?

So as far as the DBOT repurchase option exercise is concerned, where the cost will be around $64 million, depending on the Real-Euro exact price of that time. The cash out will take place in Q3, but we, of course, did recognize it in our accounts as of now as well as we did recognize the cancellation of the remaining DBOT debt that goes along with that. And as a reminder, the savings in terms of financial charges that we will get from that as from the exercise of the DBOT for the remaining life of the DBOT will be about EUR20 million per year.

The next question comes from the line of Vlad Sergievskii from Bank of America.

I have a few to start with U.S. I'm wondering if you can share with us at what rate or what capacity utilization your U.S. team will be operating in Q3? And how far are things from reaching the full capacity? Secondly, a separate question on annualized interest costs post-restructuring. What sort of annualized rate you will be doing in the next few quarters and is there any room to optimize those costs further, given your now pretty strong balance sheet and obviously very favorable debt market conditions right now? And lastly, again, obviously, you're highlighting an improved order intake in EA-MEA. When should we see it hitting the P&L? Is it only in 2022 or it has already helped the back end of this year?

Yes. Thank you. Can you confirm your first question, your interested in?

I was asking about CapEx utilization of your U.S. OCTG new interest rate and how far you are from reaching our full capacity there?

Yes. Okay. So let's see, the reality is we are running at the full available capacity, taking into account that through the manpower reduction that we implemented last year. Of course, the available capacity was significantly reduced compared with the nominal capacity of the tools themselves. So we are running at full speed. We are in the process of increasing staff and the corresponding available capacity, which we expect to ramp up progressively in Q3, Q4, and into H1 next year. As far as the financial costs, this is a question for Olivier.

Yes, Vlad. So on a full year basis, the pure interest charge that we will pay on bonds, RCF, and the realty loans will be around EUR100 million. As far as 2021 is concerned with the schedule of the payments, over H2, we will pay less actually than half this amount. But on a full year basis, keep this amount in mind. Of course, we'll try to optimize that if and when possible. Keep in mind though, that we are not completely free of doing what we want, in particular, as far as the bonds are concerned, there is a non-call 2 years period that we'll have into account.

And finally, on your third question with regards to EA-MEA, the answer is we expect to start to see an impact on our deliveries and invoicing only in 2022. Nothing significant in 2021.

That's great. If I can do a quick follow-up. How should we think about your working capital requirements from here? Because from c steel I remember that you can grow U.S. volumes with minimal working capital requirements, where obviously, distributors are taking care of that, while international volumes tend to be a bit more working capital heavy. So in that context, how should we think about working capital requirements of the business?

So maybe starting for 2021. It has increased over H1 following the increase in activity, the first recovery. Although, as I have commented in number of days, we have confirmed a steady and material improvement of our performance. Since the number of days at the end of Q2 was 14 days below Q2 last year. Typically, as you know, there is some seasonality as well. So that also it's always difficult to forecast. We may not face that material increase in working capital over the second part of the year. And then, if as we can hope over the next years, our activity continue to increase. Of course, there will be some working capital need going along with that.

The next question comes from the line of Kevin Roger from Kepler Cheuvreux.

Yes. The first one, sorry, but I will come back on that. I was wondering if right now, you would be ready to give us, let's say, one metric or something like that to get a sense of the sensitivity of your EBITDA to the iron ore price? If you can give us one metric or something like that related to the iron ore mine profitability? And the second question is related to the U.S. business, just trying to understand the contribution in Q2. Because on your slide related to revenue, you said that revenue were relatively stable year-on-year. And when you talked about the EBITDA, you say that you have an improved activity in oil and gas in North America. So I was wondering if you are basically guiding us for an improved financial performance of your U.S. business for stable revenue. And the third question, we have often talked about the free cash flow breakeven point, et cetera, at Vallourec over the past 10 years. I was wondering if you can give us the EBITDA that is required right now by Vallourec to be operating cash flow breakeven. So before the movement in working cap, especially, please?

Okay. Thanks for the question. So as far as providing more details and metrics on the iron ore mine, well, our financial communication is what it is. And we understand it generates more and more interest but it will stay at this format. As far as the U.S. activity is concerned, generally speaking, and keep in mind, we are comparing on a year-to-year basis, not sequential. But, generally speaking, both revenues and margins are improving quarter after quarter. And we hit the bottom in Q1 this year. And as far as the free cash flow breakeven point I'm handing it over to Olivier.

Yes. And maybe more specifically for the U.S. Yes, revenue is stable. We made very significant savings post COVID last year by laying off more than 1/3 of our global headcount in the U.S. We are improving operations, better utilizing our different production ores within the U.S. So all this is contributing to what I was mentioning as far as EBITDA was concerned, which is an improvement in the U.S. EBITDA in Q2 this year compared to Q2 last year. As far as the EBITDA necessary to get to a breakeven free cash flow before working capital change, I think we gave already the main figures publicly. I just said again that as far as pure expansion interest costs, it will be approximately EUR100 million per year. You typically have some other financial charges, unit to value swaps foreign exchange hedging and stuff like that for say, EUR 20 million or EUR 30 million every year. As far as CapEx is concerned, we already gave a guidance saying that for the next few years, we expect our CapEx to be somewhere below EUR 200 million per year. We will still have some structuring charges implementing the savings plan that we have launched, in particular, in Germany and in France, where it takes some time to be fully implemented and to generate a cash out. So we may have, again, a fewer debts in euros or cash out also during next year. And then it will decrease unless if we were to launch additional measures. And of course, there is a tax chart. As you know, the tax rate in Brazil is 34%, and we are very profitable at the time being in Brazil, in particular, in our mining operations. So depending on the price of the iron ore and the sensitivity to it, the tax charge may be say, between EUR 150 million to EUR 200 million per year or closer to $150 million.

Okay. And maybe sorry for it, I will try to ask the question in another way. This quarter in Q2, did you pay taxes elsewhere than in Brazil or Brazil was the only country where you paid taxes this quarter?

If I want to be very precise, not the only country, but most of it is in Brazil, I think.

[Operator Instructions] And the next question comes from the line of Guillaume Delaby from Societe Generale.

To be honest, I think all my questions have been answered. However, maybe I'm going to try to do a follow-up on the Middle East. So it is a question for Edouard, who if I remember correctly, is a very good expert on the Middle East. So my question is when I read your press release, when I listen as carefully as possible during the call, I had the impression that the tone is changing regarding the Middle East, especially when you say that it's going to impact deliveries as early as 2022. Am I correct, so maybe I can have a little bit of an additional color, just to be sure I'm not misinterpreting something?

Yes. I'm not sure that the tone is changing. If anything, we are confirming what we told you guys for the past few quarters. At the beginning of the year, we were seeing -- we don't see an uptick in activity in 2021, but we are expecting to see tendering resuming by the end of 2021 as a preparation for a progressive restart of drilling activity in 2022 and beyond. And basically, this is what's happening. So no change of tone, if anything, the confirmation that our expectations are actually materializing. And nothing else, nothing less.

We have no further questions coming through. So I will now hand back to Jerome for any closing remarks.

No. I will just thank everyone for their availability in this very busy analyst call day. There are many other companies releasing their results. So thanks for choosing to attend. And I wish all the lucky ones taking a break, a very healthy and active summer break. See everyone back in Q3 -- for the Q3 results. Bye-bye.

Thank you, everyone, for joining today's conference. You may now disconnect. Thank you.