Ferroglobe PLC (GSM) 2016 Q3 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the Globe Specialty Metals third quarter 2016 conference call.

(Operator Instructions)

I now will turn the conference over to your host, Joe Ragan, Chief Financial Officer. Please begin.

Good morning, and thank you for joining the Ferroglobe third quarter of calendar year 2016 conference call. I'm going to read a brief statement and then hand the call over to Pedro Larrea.

Statements made by management during this conference call that are forward-looking statements are based on current expectations. Risk factors that could cause actual results to differ materially from these forward-looking statements can be found in Ferroglobe's most recent SEC filings and the exhibits to those filings, which are available on our webpage, www.ferroglobe.com. In addition, this discussion includes EBITDA, adjusted EBITDA and adjusted diluted earnings per share, which are non-GAAP measures. Reconciliations of these non-GAAP measures may be found in our most recent SEC filings.

Now I will turn the call over to Pedro Larrea, our CEO.

Thank you, Joe. Good morning, everyone, and thank you for joining us on the call today. Before we go into the details of the quarter, I wanted to provide some context into the current environment and our strategy and priorities for the remainder of the year and beyond.

Our results were impacted this quarter by lower prices and lost sales primarily due to low-priced imports. This, despite our continued efforts to deliver significant improvements on cost and working capital, which has helped us mitigate the impact of this environment and generate positive free cash flow.

Next slide please. Net sales were $365 million in the third quarter, down sequentially from $398 million, primarily due to a 6% decline in the average selling price for silicon metal, quarter over quarter, which continued to experience pressure from low price imports. Silicon-based alloy selling price decreased slightly by 3% quarter over quarter. These declines were partially offset by an increase in average selling price for manganese alloys of 11% versus Q2.

Overall, Q3 2016 average selling price across all product lines was down 1% from Q2 2016 with manganese-based and silicon-based alloys already starting to recover, whilst silicon metal persisted in the lower part of the cycle during Q3.

In terms of sales volume in tons, silicon metal decreased by 5% quarter over quarter, silicon alloys decreased by 7% quarter over quarter, and manganese alloys decreased by 16% quarter over quarter -- reflecting some seasonality of demand for these manganese alloys over the summer.

Next slide. On this slide, we are providing you with more detail on the uptick in price and pricing trends. First, we have seen higher price levels in ferrosilicon and manganese alloys. Manganese alloys spot prices, which we will begin to realize in the first quarter of 2017, have been up sharply; approximately 30% in recent weeks as a result of the constraint on the supply side and the increase in ore prices. Ferrosilicon pricing is firming and has increased by approximately 10% in recent weeks.

Turning to silicon metal. After the significant price decline in the first half of the year and stabilization in the third quarter, we are now beginning to see indications of meaningful price improvements for 2017 negotiations. Underlying fundamentals for silicon remain sound; there is a strong end market demand combined with rebalanced inventories, production cost increases, and stronger economic growth in emerging economies.

Next slide. So let's turn our focus to what we are seeing today in the pricing environment and our outlook. As mentioned, we are starting to experience meaningful improvements in the pricing outlook for 2017. Some of the silicon indexes are reflecting this, with price increases of approximately 10% in the past two weeks. These improvements are driven by a few factors. Increased production cost, especially in emerging countries are already impacting the market. And while there is still low-cost supply, global inventories are now largely rebalanced. And importantly, we continue to see strong demand in our key end markets.

We are already in the 2017 contract negotiation season and are beginning to see these trends translate into improved prices. This is the first negotiation season in which Ferroglobe is marketing as a single unified company, and we are being aggressive and proactive about selling at prices above current index levels. We have taken decisive action in our contract negotiations and the prices we are securing are above the reported indexes.

As you know, we don't comment on our marketing strategies or customer negotiations, but to give you a sense of the quantum, all of 2017 contracts to date are closed at premiums sometimes as high as 15% above index prices. Moreover, we are taking action and changing our contract structures, removing all discounts for silicon metal. And going forward, we will be utilizing those index providers who modify their reporting criteria to better reflect the overall market. We are also favoring fixed price contracts with shorter-term agreements.

Overall, there is consensus in the market that our products are set for a significant price recovery in 2017, which we are already witnessing in most ferroalloys, and we are making sure that our own marketing and sales strategy takes full advantage of such recovery. Also, with the recent US election results, we expect a more favorable regulatory environment positively impacting our business.

Next slide, please. Our strategy of tightly controlling our cost is demonstrated across a range of factors and cost categories. One major component of our cost reduction efforts is our synergies implementation program. This quarter we raised our run rate potential target by 33% to $85 million. We are realizing these synergies quickly, with $60 million or nearly 70% of the total potential to be captured this year, and $43 million, 50% of the total potential, already realized through September. During the beginning of 2017, we are confident we can achieve the run rate level of $85 million.

Turning to our working capital, we exceeded our initial target of $100 million for the first two years within the first nine months, reaching a total of $136 million improvement in working capital. $83 million was captured through specific accounts receivables initiatives and $33 million through inventory reduction.

Next slide, please. It is important to note that we already achieved synergies, and the additional ones to be captured in the coming months are the result of the hard work of our 25-member synergies team. The slide shows just a sample of some specific examples of initiatives that have already been implemented. Some of them arise from the sharing of technical expertise across our production base, other synergies take advantage of improved purchasing procedures and enhanced purchasing power. Finally, overhead has been cut through headcount reductions and improved functional efficiency. The synergies program that has been developed ensures the long-term sustainability of these cost reductions.

Next slide. As an example of our achievements on the cost front, we have provided here the example of the production cost profile for silicon metal. This represents the greatest part of our revenues and business, and we have made significant improvements from a cost perspective over the past year. We reduced cost by nearly 15% for the first nine months of 2016, and by approximately 22% since January 2015. These cost reductions are mostly driven by sustainable long-term cost reductions, including power contract renegotiation, leveraging our diversified footprint, and improved technical performance further helped by low power pricing in Spain and lower prices for a number of our raw materials. This enhances our cost position in a sustained way, which will further benefit us as prices recover.

Next slide, please. One key benefit from our ongoing achievements on cost reduction is that we are well-placed to benefit from current price improvements that we are beginning to see for 2017. In addition to our leverage to price, we will also continue to look for further cost reductions in our business. As this chart shows, any modest improvement in production cost or prices will have a significant positive impact on our results.

Next slide. Combined, our efforts on costs offset a challenging price environment caused by low- priced imports. During the quarter, we delivered adjusted EBITDA of $12.8 million and generated free cash flow of $11.7 million. Working capital was improved during the third quarter by a total of $40 million, generating $136.5 million in working capital synergies year to date. This permanent working capital improvement results from a focus on improvement in inventory turns and reduction in accounts receivables days outstanding on a global basis. It also continues the positive trend in the past 12 months where we have obtained a total working capital reduction of $262.8 million; well ahead of the original three-year projection of $100 million. We will continue to improve working capital through the remainder of the year. And finally, our balance sheet remains strong. Current net debt at the end of the quarter was $430 million as compared to $413 million at the end of the prior quarter.

Next slide. Now that I have discussed where we are, I would like to focus on where we are going and specifically on how we will create long-term value for our company and our shareholders. As I mentioned, we continue to maintain our strong balance sheet, which will give us the ability to pursue both organic and inorganic growth when we believe it timely and opportunistic, ultimately creating significant long-term value for our company and our shareholders. We also systematically review our asset portfolio and consider actionable opportunities to improve our footprint and pursue value-enhancing, non-core asset disposals. As an example, the Company is currently pursuing strategic options regarding its hydroelectric assets in Spain and France. These discussions are at a preliminary stage and the Company will provide further detail as and when appropriate. And finally, we believe we have multiple revenue and cost levers to pull to create value, given our product and geographic diversification.

With that, let me turn the call over to Joe to go through the financial highlights.

Thank you, Pedro. Let's go to slide 14. Sales volume was 209,998 metric tons for the third quarter, down 9% from the second quarter, and net sales were at $364.7 million, down from $398 million in the second quarter. Average selling price across all products was $0.69 per pound, consistent with the second quarter.

We posted a net loss of $28.5 million or a loss of $0.17 per share on a fully-diluted basis. Excluding the impairment charges, due diligence and transaction costs, the Company posted an adjusted net loss of $14.6 million or a loss of $0.09 per share on a fully diluted basis. We reported EBITDA loss of $3.2 million for the second quarter, due to the impairment charge of $9 million for our mining operations in South Africa, as well as an inventory impairment charge of $4.3 million. Excluding those impairment charges, due diligence and transaction costs, Q3 2016 adjusted EBITDA was $12.8 million. Synergy attainment as well as cost controls offset the decline in pricing, resulting in a 3.5% adjusted EBITDA margin. Working capital was at $417.1 million, and we generated free cash flow of $11.7 million for the quarter.

Next slide. This slide demonstrates the trends we are seeing in terms of quarterly volumes shipped on a sequential basis. We experienced slightly lower volumes in silicon metal and our alloys business, based primarily on seasonality in our European business.

Next slide. As you can see on this slide, although average sales prices have declined from Q2, prices have begun to stabilize across the majority of our products.

Next slide. As Pedro mentioned, we are intently focused on lowering our cost base. This chart shows our significant improvements in 2014, which we have achieved through a systematic and holistic approach to cost benefit. We focused on delivering on the cost rationalization inherent in our merger as well as any additional opportunities created as a result of the enhanced position of the combined, more diversified group. All in all, production costs have been reduced by 13% year-to-date. As we move forward, we will continue to identify further opportunities for cost reduction.

Next slide. As Pedro already mentioned, we are focused on reducing costs and aggressively seeking opportunities to continue driving incremental revenue, both of which will enable us to generate free cash flow and maintain a strong balance sheet. We ended the quarter with a slight increase in net debt to $430 million at the end of the third quarter, from $413 million at the end of the second quarter.

Now I will turn the call back to Pedro for some closing remarks.

Thanks, Joe. Ferroglobe is a newly combined company with a unique strong market position and we are still early in our growth trajectory. We will continue to capitalize on our strong balance sheet and diversified products to drive earnings and deliver value to our shareholders. We believe that the Company is well-positioned to fully benefit from the recovery of our markets, which we have seen early signs of and expect to continue in 2017 and beyond. Consistent with our confidence in the underlying strength of the business and its improving outlook, the Board has decided to maintain the quarterly interim dividend of $0.08 per share.

With that, let me turn the call back to the operator to take questions. Thank you.

(Operator Instructions) Ian Zaffino of Oppenheimer.

As far as the contracting season, how much of the book is done? And then as you look at kind of what you are trying to achieve, what would be the mix, I guess, between some of these fixed-price, shorter-duration contracts or maybe longer-term contracts or variable. Maybe give us some color there and then I'll follow up.

We are right in the middle of the contract negotiation season. As we were saying in the presentation, we are seeing signs of meaningful improvement, both in the market environment because, really, there is the market and the indexes are starting to adjust to increased production cost in the importing countries because demand is there. But also remember -- this is the first year that we, Ferroglobe, are a single company and we are very aggressively implementing our marketing strategy as a single company. And that is achieving results as we speak. I mean, day in day out, we are getting approaches from customers and we are making sure we hold the line. We always get the answer back from the customer, saying, you have to go down, some competitors are going down, and we are holding the line. And we are achieving prices that are as much as 15% above the index.

Now, how much in terms of volume? That is I would say a question that is pretty much a North America-centered question because of the way the negotiation takes place in North America versus Europe. So, North America is pretty much a market in which contracts are closed on an annual basis. Europe is more of a quarterly and spot business. Now, in North America we are now at around 50% of our volume already contracted, and as I was describing, we are getting approaches from customers wanting to get index getting fixed prices for the full year. We are going back to them and saying, no, we are using fixed prices for shorter-term. That is the strategy we are using right now, so it's fixed prices for Q1, fixed prices for first half of the year, in our conviction that prices will go up in the rest of the year.

So, in the mix right now we are favoring clearly fixed prices, but it is true also that we have a significant volume of contracts that are longer-term, that were signed in the past and that will continue into 2017, and those are indexed contracts. So there is a good mix, I would say, of fixed contracts that we are signing now with prices going up and clearly above the index, and some other indexed volume that will benefit also from market prices going up.

And then just focusing on the discounts that you spoke about, how much of the book maybe was being discounted? And was that discounting more on the Globe side or more on the FerroAtlantica side? And when you talk about reducing those discounts, are you also talking about the off-take agreements too, or is that outside of the off-take agreements?

Sorry, I have said this publicly -- discount is out of our vocabulary. So in this negotiation season, there's just no discounts. That is clear. We are just not having any discounts, and as I was describing before, we are actually getting premiums. So the D word is out of our vocabulary, and that is clear in all our sales force. Now, we do have some contracts that come from previous years with small discount on the index that will benefit, as I was saying, on index prices going up as we speak.

But I guess as far as the legacy, how much was, so you're saying that legacy never had discounts? Or -

No. Yes, it did for 2016, okay. But that is virtually over and as we look at 2017, there is where we are just not accepting discounts at all.

So can you tell us maybe how much of the book last year in 2016 was discounted? If not that's okay, but just maybe --

I cannot give you the exact number. There is, again, there is a big mix of different -- I would say that in North America, most of legacy Globe's volume was fixed price. Most of legacy FerroAtlantica was index prices with discounts.

Paul Forward of Stifel.

I wanted to ask about the manganese business and the margins there. It's obviously good to see finished product pricing up. I just wanted to know how much of this was just passing along the sharply higher ore costs and are those ore costs impacting the costs you saw in the third quarter and maybe the fourth quarter, but can you potentially pass along these increased input costs into your new contracts for 2017?

Yes. Thank you, Paul. Actually, the way it is has worked is that ore prices started going up actually before the alloy prices went up. So, what we are seeing now when you look at indexes for both the alloys and the ores is that right now our alloy prices have reacted, and in the past two weeks, prices for manganese alloys have gone up as much as 30% in just two weeks. And that is, I would say, a late reaction to ore prices. So, actually spreads in the past couple of weeks of have increased very significantly.

Now, is that going to show into Q4? Q4 is going to have a mixture of still price lags, because our manganese contracts very often are priced to previous period. So even in the price of our alloys, we are not necessarily going to see full impact of index increase. But we are also going to benefit from ore that was acquired in the past quarters, not reflecting full price of ore either. So, I would say that it's not until 2017 that we will see full impact of both alloys and ores going up, and that today is actually a positive, so margins or spreads between alloy prices and ore are going up.

We have definitely seen that, just internationally coal prices are up sharply. I want to ask, well, a couple of things. First of all, what's your approximate reliance on externally-sourced coal and are those protected by fixed price contracts? And also are you responding to the tightening global market by considering increasing your own production rates at your mines in Kentucky?

Well, that's an excellent question. We rely on our own coal production basically in North America, and in South Africa to the extent it's not coal, it's charcoal, but it's also our own production. And Europe is where we rely on external sources. Now, it is also equally true that we have a hedging opportunity with our own coal production, so if prices still go up, we could increase our production in Kentucky and even source Europe from there. So that is always an option. But right now in Europe, next year, 2017, we will suddenly see an increase in the price of our purchases of coal in Europe, and we would just remain attentive to the possibility of sourcing from the US Now you need to consider that most of our competitors are just fully getting the impact of coal in their costs, whilst we are benefitting from our ability to diversify away that cost increase.

I guess I wanted to ask, I guess first of all, you are considering the sale of your hydroelectric assets. I want to ask about, I guess, first of all, do you have a position and outlook on what do you see the industrial electricity markets doing in Europe over the next few years? And how would that, if there is going to be a period of rising power prices in Europe, how would you respond, whether or not you sell the hydro assets, how would you respond by adjusting your production at your furnaces in France and Spain in response to potentially stronger industrial electricity prices?

Well, that's - so you're really asking two different questions, the first one which relate to the potential divesture of our hydro assets. We have published that we are analyzing different strategic alternatives, and we are in preliminary stages of that analysis of the different alternatives. When and if there are news around that, of course we will let the market know as soon as they happen.

Now, in terms of the power prices in Europe, look, our main silicon metal production base is France. Actually as Ferroglobe it's the biggest production base, and I can tell you that with our new power arrangement for the next 15 years, 2017, France is going to be the lowest cost production base in the world. So our costs are going to be the lowest in the world including China. We have secured a power price for 2017 and a good like 70% or 80% of our power price for 2018 and 2019 at such levels that, again, I was going to say I am confident, I am not confident, I am sure that we are the lowest-cost producer in the world.

Ian Corydon of B. Riley & Co.

The higher cost that you're seeing importers face, is that primarily for coal or are there other impacts there as well? And I just wanted to clarify if that comment was related to silicon metal or just your overall book?

It is mainly related to the silicon metal where the dynamics this year have been, how would I say, more erratic due to low-priced imports, and the fact that the increased cost in some of these importers relate to coal for sure, but also to power prices in the local jurisdictions, and to some extent also to foreign exchange evolution.

So that again nails down what I was saying before, is that fact that our diversified production base and portfolio allows us to adjust and to isolate from specific local events, whilst you have the, let's say the Brazilians who are very well off when the costs in Brazil are low but they suffer it fully when they go up, whilst we have that diversification ability. So, yes, it's coal but it's also power prices, other raw materials in those local markets and exchange rates.

And I wonder if you could give a little more detail around the inventory impairment and then the charges at South Africa mining asset.

Sure. We are just continuing to go around on some of our assets, specifically in China and Venezuela. That's where the inventory impairments occurred in, and those actually were impacting cost of goods sold from an analysis perspective. The other was a prior acquisition and related to goodwill that's carried on the balance sheet in the South African mining operation. So there were changes in the economic environment there and we had to actually write down that goodwill.

Got it. And last question, Joe. Both the depreciation and amortization and capital expenditures came in below what I was expecting. Do you have a sense for what you expect the quarterly run rate for each of those to be in Q4 and then going into '17?

The depreciation should run around $31 million-$32 million a quarter and the CapEx on a regular basis going forward should be about $25 million.

(Operator Instructions) Alexander Arapoglou of Caius.

I just had three very quick ones. Maybe I would just ask the first and we can go from there. Question is, could you explain a little bit about the pricing that you have been able to achieve, at least the early signs? It makes sense that you are a bigger company, you've got more sway. But on the other hand your geographic overlap is limited, US versus Europe. So, can you help us a little bit, clearly you don't want discounts. You're not accepting them. But what's driving your increased negotiating power versus last year?

Well, I think it's different factors, and I was saying, some of them are external. So it's the fact that there is increased production costs in some producing countries. There is a rebalancing of inventories and of course a strong demand in our key end markets.

Now in terms of ourselves, we have just adopted the view this negotiation season of what we should be doing and we are being very disciplined about how we implement it. I mean, I could give you just specific examples but the last week I was having this conversation with our sales manager and he was saying, look, we have this specific customer. We were offering this price. They are getting offers that are $0.06 below our offer, we should be going down. I was saying, no, no, no, Jeff, we are not going to do that. And we were even considering raising our offer. You know what, we got the order.

So it's really about being very disciplined. We are convinced that current prices are unsustainable and they are just going up. And it's being very disciplined about this, about not accepting discounts at all, and also because we are convinced that these prices are going up. It's a very honest conversion with the customers of saying we think we have to give shorter term contracts, because otherwise we are going to really give very high prices for the year as a whole. So, we are going to shorter-term to fixed prices and just being very disciplined about it.

The next question is on the US infrastructure structure spending to the extent that that comes through. Do you expect the US to be sort of a self contained market where you can capture some of that tightness, specifically; I was going to tie that into asking you about the EU just renewed its tariffs on silicon metals, 17%. The US has extremely high tariffs, basically prohibitive tariffs on Chinese silicon, but it doesn't have tariffs on silicon coming from the EU, which may price off China. So what are your thoughts on how kind of you can capture upside in the US given all of that?

Well, I think the infrastructure drive in the US is certainly very good news for us. I mean, it's going to increase the strength in demand of most of our products, so we will fully benefit. And as you were saying, the ability of importers to compete in this market as we speak is decreasing, and for the reasons we have already reviewed in terms of the increased costs in many jurisdictions.

Now it is true in the European Union, the duties are lower, coming from China. And it is also true there was news today in the newspapers of revised anti-dumping investigation procedures in the European Union and we will always remain vigilant of our ability to exploit all the regulatory alternatives.

And just on that, one final follow up on that. Is there, just for the benefit of everyone on the call, does the US really price off the EU with a spread for transport? Because if that's the case, should we think about it, okay, the EU prices off its tariffs off China and then the US of the EU, or is there a lot more to it than that that we should be aware of?

It is mostly that, but it depends a lot on the size of the demand in the US So if demand goes up significantly, then the question is whether there are enough imports from third parties that are able to play that, how would I say, that arbitrage between the European Union and the US And I think we are close to that point in which volume could be higher than the ability of third countries to play that, I would say, that game.

Thank you. This ends the Q&A portion of today's conference. I would turn the conference over to CEO, Pedro Larrea, for any closing remarks. Please begin.

Well, thank you, thank you very much. I appreciate your time and as I was saying before, we have presented poor results for this quarter, but we are looking at meaningful improvements as we look to the developments along 2017 and beyond. Thank you very much for listening.