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

Hello, and welcome to the Vallourec Q2 and H1 2022 Results Conference Call. Please note, this call is being recorded. [Operator Instructions] I will now hand you over to your host, Connor Lynagh, to begin today's conference. Thank you.

Good morning, ladies and gentlemen. Thank you for joining us for Vallourec's Second Quarter 2023 Results Presentation. I'm Connor Lynagh, Vice President of Investor Relations at Vallourec. I'm joined today by Vallourec's Chairman and Chief Executive Officer, Philippe Guillemot, and Vallourec's Chief Financial Officer, Sascha Bibert. Before we begin our presentation, I would like to note that this conference call will be recorded and a replay will be available following the call. You can find the audio webcast on our Investor Relations website. The presentation slides referred to during this call are available for download here as well. Today's call will contain forward-looking statements. Future results may differ materially from statements or projections made on today's call. The forward-looking statements and risk factors that could affect those statements are referenced at the beginning of our slide presentation. These are also included in our universal registration document filed with the French financial market regulator, the AMF. This presentation will be followed by a Q&A session. I will now turn the call over to Philippe Guillemot.

Thank you, Connor. Welcome, ladies and gentlemen, and thank you for joining us for this update on Vallourec's second quarter 2023 results. Before proceeding, let me draw your attention to Slide 2, where you can consult our safe harbor statement. Today's agenda is on Slide 3. I will start by giving you an overview of the highlights of the second quarter, followed by an update on the execution of our new Vallourec plan and a word on the market environment. Sascha will then take you through our Q2 numbers, and I will wrap up with the outlook for full year 2023. First, let's look at the highlights of the second quarter on Slide 5. On the second quarter of 2023, EBITDA was EUR 374 million, which reflects the EUR 214 million year-over-year increase. Our Tube EBITDA contribution was EUR 330 million, a strong increase of EUR 201 million year-over-year. This was supported by a 27% average selling price increase compared to Q2 2022. Mine & Forest's EBITDA was EUR 50 million, which was stable year-over-year. This result was driven by higher volumes, offset by lower iron ore prices. Our adjusted free cash flow was very strong once again, coming in at EUR 174 million. In the second quarter, we reduced net debt by EUR 132 million, leaving us with net debt of EUR 868 million at the end of June. This is more than EUR 0.5 billion lower than last year end of June. As we indicated in our early results announcement earlier this month, we confirm our outlook for full-year EBITDA to range between EUR 950 million and EUR 1.1 billion. Moving to our commercial and operational update. The international Tubes market remains strong. Drilling activity outside of the U.S. has remained on the rise, and we have continued to capitalize on this demand environment and capacity constraints at major suppliers in the form of higher prices. The U.S. market has continued to normalize from the very strong levels at which it began the year, but the headwinds that have driven this change are abating. We're seeing the supply-demand balance is improving, and we expect pricing to normalize at healthy levels. Meanwhile, our mine returned to higher production levels at the end of the second quarter, as expected. However, we expect it will operate below its full potential in the second half of 2023. This quarter, we signed 2 key memorandums of understanding or MOUs. First, we signed an MOU with Evonik, where we have agreed to work together to develop an innovative corrosion-resistant CO2 transport technology. The corrosive nature of CO2 makes the development of carbon capture, utilization, and storage infrastructure challenging. Solutions such as this could substantially enhance the development of this infrastructure. In addition, we signed an MOU with the Ministry of Investment in Saudi Arabia to expand the group's activities in the Kingdom. This includes innovations in carbon capture, hydrogen products, and other innovative offering of the Vallourec Group. We are pleased to further our scope of cooperation with customers in this key country. Finally, we announced 3 major offshore line pipe contracts for Brazil Buzios field. The 3 orders represent a total of 48,000 tonnes of high-end line buy. Let's turn to Slide 7 to review our new Vallourec plan. As a reminder, the new Vallourec was announced in May 2022. Our key objectives are to cycle-proof our business and drive best-in-class profitability versus the 2021 deadline. We plan to drive a EUR 230 million EBITDA improvement and a EUR 20 million CapEx reduction with a full impact starting in Q2 2024. For reference, our target 2024 industrial footprint is shown at the left. Slide 8 provides some color on a few of the near-term programs we are executing in the new Vallourec plan. In Brazil, the primary phase of our capability enhancement program is underway. Our plan remains on track. We have moved through several of the key steps of the process. As such, the shift of oil and gas volumes from Germany will be completed by the end of 2023. We expect volume and margin upside from Brazil at the completion of this investment program. In Germany, our activity rundown is ahead of schedule, and our Tubes production will stop in Q4 2023 as opposed to at the end of the year. The sales processes for Mülheim and Dusseldorf-Rath are both ongoing, and we continue to work with all key stakeholders to advance these sales processes. Now let's discuss the commercial environment. On Slide 10, we focus on the U.S. OCTG market, which is the largest market in our North American operations. The horizontal rig count, a proxy for our demand, fell by about 12% or 85 rigs in the second quarter. We are optimistic that drilling activity will stabilize in the second half. Meanwhile, OCTG prices in the U.S. have continued to moderate versus the high level they are same in late 2022. We will begin experiencing the effect of these lower prices in the third quarter, and we also expect somewhat lower volumes as distributors destock their inventory. However, looking at the chart on the right, you can see that the exceptionally high import volumes that were entering the U.S. market in Q4 2022 and Q1 2023 have moderated substantially in May and June. July data is still preliminary but confirms that imports will remain below the abnormal level seen in Q4 2022 and Q1 2023. Therefore, while we do expect market pricing to decrease from current levels, we are of the view that the pace of decline will slow and pricing will remain at healthy levels. On Slide 11, we can see that the international OCTG market has continued its positive trend in Q2 2023. Onshore and offshore winning activity has continued to trend higher across the world, and all indications are this will continue. We believe that globally speaking, capacity for premium OCTG is limited, and at Vallourec, in particular, we have demand in excess of our capacity. As such, the market has continued to see price increases, and pricing between the U.S. market and internal markets now relatively relative close to parity. It is worth noting that we experienced a more noticeable lag from our order intake to our shipments in addressing most of these international markets. Therefore, we will have a positive price tailwind in our results outside of the U.S. for the next few quarters. Moving to Slide 12. Looking at our Tubes business as a whole, Q2 2023 further the significant upward trend in profitability that began last year. We earned EUR 832 of EBITDA per ton sold, a substantial year-over-year improvement. This reflects the strong market environment and the success of the new pricing policies we implemented last year and strong execution by our Eastern Hemisphere operations. Sequentially, our results in Brazil also improved to drive margins higher. Our bookings have continued to show a positive price trend outside of the U.S., and customer activity remained solid, as discussed previously. Our investment program is on track in Brazil, and we expect an improvement in profitability in Brazil as this major capacity enhancement program comes to an end. Meanwhile, our German operations, which are still in the process of winding down, have thus far exceeded our expectations this year. However, we expect that we will see larger financial losses in this operation in the second half of the year. Turning to our Mine and Forest slide on Slide 13. Iron ore production was 1.9 million tonnes in the second quarter, which reflected our return to a higher position level. As you will recall, on [indiscernible], we obtained the necessary permissions from the steep mining and environmental for the full release of the Cachoeirinha waste pile. In the second half of the year, we expect provision sold to be around 3.6 million tonnes. Our production costs will also likely remain at the high end of the recent range for the time being. Both are related to the specific area of the mine we are exploiting at present. As such, we expect EBITDA to decrease sequentially in Q3. We have a permitting process underway to allow us to move our extraction activities to already identified high-quality reserves. We are currently engaging with state and federal regulatory authorities to execute this plan. I will now hand the call over to Sascha to comment on our financial results.

Thank you, Philippe, and good morning to everyone. Thank you for participating in our Q2 call. As you have seen from the pre-release, we have had a very strong quarter, better than expected, due to a few factors I will discuss momentarily. We also expect continuous strength in our results going forward based upon both improvements that are on our own control as well as positive sector dynamics. Starting with Page 15. All KPIs show an improvement year-over-year, and we equally advanced compared to the first quarter of the year. Particularly noteworthy is that we have reduced net debt further to EUR 868 million. As you know, generating cash flow is our key focus and important proof point that our initiatives are paying off. So what surprised us positively against our prior guidance of a similar Q2 relative to Q1, leading to the pre-release of earnings? We have had about EUR 15 million of additional EBITDA that you can think of as accounting-related with no uplift to cash. This includes a positive balance sheet revaluation of the forest as well as some of the German costs now recorded below EBITDA as they are fully related to the closure and, therefore, no longer classified as operational. We then have about EUR 15 million each true performance upside in our Eastern Hemisphere and German business. Eastern Hemisphere came in better than expected due to once again positive developments related to our business in Saudi Arabia, but also good results in Asia. Germany outperformed our expectations due to better volumes and lower costs, including lower energy costs. Moving to our Tubes business on Page 16. Volumes are lower year-over-year by 8% or 37 kilotons. This year-over-year decline is driven unsurprisingly by lower volumes in our to-be-closed German operations and also Asia, where we have applied our value-over-volume strategy. Germany is also the key driver for the sequential volume declines. As the average selling price per ton has further increased both year-on-year and sequentially, revenues are up. We have also further enhanced Tube's profitability. 26% EBITDA margin were EUR 832 per tonne. H2 is expected to be lower than Q2 but to remain at healthy absolute levels. We also will have significant EBITDA tailwinds from our ongoing new Vallourec initiatives going forward. On Page 18, mine production is up, the index prices down, leading to a 37% increase year-over-year in revenues. The average sales price per tonne is lower as the quality of the iron ore mine was worse in Q2 '23 compared to the prior year, leading to a lower realized price. What may seem surprising is that with increasing revenues, the EBITDA is basically flat. Here, I remind you that these are the segment results covering the mine and also the forest. The letter principally impacts both revenues and EBITDA. While the forest did not impact the year-over-year revenues, it did impact EBITDA through a price valuation effect following IAS 41. In this respect, we actually had a positive effect in both quarters, however, higher in Q2 '22 relative to Q2 '23. Adjusting for this forest revaluation effect, the pure mine EBITDA is up year-over-year in Q2. Please note that for the second half of this year, we do not assume such a positive revaluation effect. Over to Page 19. Revenues and EBITDA are up mainly due to better prices. We also continue to keep SG&A on a low level. The net income of EUR 159 million includes EUR 66 million other, of which the majority is related to asset disposals and predominantly restructuring expenses. Bigger items in this category included expenses for staff costs in Germany to be treated as nonoperating as well as EUR 10 million higher costs for the new Vallourec plan, driven by more German employees leaving with early retirement plans compared to severance payments. Moving to Page 20. Overall, we reduced net debt by a further EUR 132 million. This was driven by EUR 232 million adjusted operating cash flow. Going forward, we expect the financial cash out in H2 to be similar compared to H1 for a total 2023 amount of around EUR 150 million. The tax payments are expected to be higher in 2023 compared to 2022, even though the EUR 61 million payments in Q2 are probably on the high side for a run rate in the next 2 quarters to come. An adjusted free cash flow of EUR 174 million with hardly any change in working capital, which was also the key element explaining why our cash flow came in better than expected in Q2. Working capital will always show some fluctuations depending on the specific business developments. However, we are convinced that our many initiatives dedicated to improving our working capital are starting to pay off. In Q2, inventory and receivables improved while payables slightly deteriorated. The operating working capital improvement was then largely compensated by an increase of non-operating working capital, among others, due to lower tax credits. Total cash generation was EUR 118 million, impacted by restructuring and nonrecurring cash balance. For the full year, we expect around EUR 350 million, with a disproportionate amount to come in Q4 due to the closure of the operating business in Germany. Let me now hand back to Philippe.

Thank you, Sascha. Let's look at Slide 22 to discuss our outlook for the full year 2023. For the third quarter, we expect to see lower volumes and prices in the U.S. tubes market, which will be slightly offset by higher international pricing. In our Mine and Forest business, as previously discussed, we expect production sold to be somewhat less than the mine's normal 8.7 million tonnes per year cadence, and production cost will be at the high end of the recent range. Turning to the full year, we reiterate our full-year outlook for 2023 we provided earlier this month. We expect EBITDA to round between EUR 950 million to EUR 1.1 billion. In the Tubes business, this assumes U.S. market pricing decreases moderately from current levels and volumes in the U.S. market bottomed in the third quarter before increasing again in the fourth quarter. In our mine and forest business, we expect mine production sold to be 3.6 million tonnes in the second half of the year and assume a plant of 62% China index will be around $105 per tonne. We expect our total cash generation to be positive in the second half of 2023. Accordingly, we expect our net debt to decrease further from the current EUR 868 million level. Both of these outlooks exclude any potential benefits of asset sales. We continue to expect that compared to 2021 baseline, the full EUR 230 million effect of the new Vallourec plan will be visible in our earnings run rate in Q2 2024. We remain focused on creating an organization that can generate positive free cash flow through cycle and reducing our net debt to 0 by year-end 2025 at the latest. A few words to conclude on Slide 23. We delivered strong earnings and total cash generation in the second quarter due to favorable market conditions, our value-over-volume strategy, and strong execution. Our iron ore mine has returned to higher operation levels, though we expect it will operate below its full potential in the second half of 2023. We have a plan in place and underway to move our activities to higher-quality reserves. We are currently experiencing cross-current in our Tubes business as international prices and demand growth are more than offset by U.S. lower U.S. volumes and pricing but will remain upbeat around the medium-term outlook for this business. The execution of our major Brazil CapEx program is underway, with the shift of oil and gas production volumes from Germany to be completed by the end of 2023. As such, the new Vallourec plan remains on track, and we remain committed to cycle-proofing our business and balance sheet. Thank you for your attention. Sascha and I are now ready to take your questions.

[Operator Instructions] We will take our first question from Jean-Luc Romain from CIC Market Solutions.

It relates to the quality of the ore in the mine you mentioned. It has been lower recently. Is it just due to the fact that you are exporting another part of the mine, and you will be back to normal concentration quality, maybe in 2024? Or is there a weakening of the quality of the ore?

Okay. Thank you for your question. Well, first, it is important to keep in mind that we are a relatively small-scale mining operation versus some of our publicly traded peers. Thus, we can have more pay-to-play volatility in our results based on the specific portions of our reserves that we are exploiting. Right now, we are planning to extract some reserves that require higher levels of processing, which means somehow less sellable products with higher affiliated costs. Our plan is to move over time to higher-quality reserves, and the permitting to do so is currently underway.

[Operator Instructions] We will take our next question from Jamie Franklin from Jefferies.

So firstly, just on the Tubes volumes. Can you just clarify whether you expect 3Q volumes as a whole to decline or if that's just the U.S. volumes? And then secondly, if you can give any magnitude on that and just the mix of international and U.S. volumes and what we can perhaps expect for an exit rate at the end of this year?

Yes, volume decrease is in the U.S. But as we said, we expect Q3 to bottom up and Q4 to be higher. You have seen on one of our charts in Portugal, which was high in Q4 last year, Q1 this year, and now back to more normal levels. As a consequence, inventory at our distributors is decreasing, and we have a clear indication that now they are reaching a normalized level, which is a good proxy for the volume we could expect in Q4. Keep in mind that U.S. is not obviously 50% of our volume worldwide. So U.S. is less than 1/3 of our total volume worldwide.

Jamie, I think the second part of your question was related to volume, i.e., tonnage for the full year. I would guess around 1.6 [indiscernible].

Okay. That's great. And then just on pricing. So you're talking about international pricing continuing to show an improving trend. Can you give us any indication of what your base case assumption is for the magnitude of how much that continues to increase and how long it continues to increase for?

Well, first, as we have indicated, we started to see in challenged pricing at the level of U.S. prices, which is rather good news given the very healthy level of our U.S. prices. And what's important to keep in mind is the price at which we book and the price at which we invoice, and there is a time lag between order booking and invoicing on the international market. As a consequence, as we may start to see less increase quarter-after-quarter on our bookings and increase our prices and bookings. We will see the impact of the recent increase of our pricing on bookings on the invoicing that will take place in the next few quarters. So the positive impact of what we have observed in the last few quarters in gear is to come in our profitability on the engineered market.

We will take our next question from Kevin Roger from Kepler.

I was wondering if you could help me to understand a bit more the guidance that you have for H2 in terms of EBITDA. Because when I make some math, if we just focus on the U.S. and we assume some lower volume than something like $500 per price decline, what you showed in the presentation, if I'm not mistaken, that should be something like a 75-plus million EBITDA decline per quarter. You say that the German operation will generate some losses. Can you give us some color here? Because to be able at the end to reach your guidance, it means that this is at least EUR 75 million, EUR 100 million per quarter decline in the profitability from the German assets. So just if you can share with us some dynamics here by segment, if there is a mistake somewhere, or if it means at the end that in your guidance, you are embarking a very cautious stance in a way. And the second question, if I may. So the H2 guidance on the cash is to be positive, excluding disposal, but we do not have any update on the disposal process in Germany. So anything to mention here, please?

Okay. I will hand it over to Sascha to answer your question. But you're right. The 2 main reasons why it will be lower in Q3 and Q4 compared to H1 is the U.S. volume and pricing and the losses in Germany that will be mostly in H2. But now I hand over to Sascha.