General Steel Holdings' (GSI) Q2 2014 Results - Earnings Call Transcript

Aug.14.14 | About: General Steel (GSI)

General Steel Holdings, Inc. (NYSE:GSI)

Q2 2014 Results Earnings Conference Call

August 14, 2014, 08:00 AM ET

Executives

Joyce Sung - IR

John Chen - CFO

Analysts

Tony Tian - New Oriental Capital

Howard Chan - Caledonia Investments

Operator

Welcome to the General Steel's Second Quarter 2014 Earnings Conference Call. At this time all lines have been placed on mute to prevent any background noise. After management’s prepared remarks, there will be a question-and-session. Today’s conference is being recorded.

Before we get started, I am going to review the Safe Harbor statement regarding today’s conference call. Please note that the discussion made by the company during today’s call may contain forward looking statements that are within the meaning of Section 27A of the Securities Act of 1933 as amended and section 21E of the Securities Exchange Act of 1934 as amended.

Forward-looking statements involve inherent risk and uncertainties and as such the company’s results may be materially different from the views expressed today. A number of potential risks and uncertainties are outlined in the company’s public filings with the SEC. The company does not undertake any obligation to update any forward-looking statements except as required under applicable law. As a reminder, this conference is being recorded.

I would now like to turn the call over to your host for today’s conference, Ms. Joyce Sung. Ms. Sung, you may begin your conference.

Joyce Sung

Thank you operator, and welcome everyone to General Steel's second quarter 2014 earnings conference call. This is Joyce Sung, Investor Relations Manager for General Steel Holdings. Joining me on this call today from the management is CFO, John Chen.

Today before the market opened, the company issued a press release announcing our second quarter 2014 financial results, and posted a presentation for this call which we will be closely following and referring to. The press release and the presentation are also available on the investor section of our website at www.gshi-steel.com.

With that, it’s now my pleasure to turn this call over to John Chen, our CFO to provide you with an update on our operations, strategy and industry. John, please go ahead.

John Chen

Thank you Joyce and thank you everyone for joining today’s conference call.

We are very proud that our turnaround efforts at General Steel are now driving measurable improvements to our financials. We expanded gross margin to a 36-month high of 4.8% and earned positive EBITDA of $33.6 million which is a remarkable improvement of $54.4 million from the same period of a year ago.

Two key factors filled our achievements as highlighted on the slide number 4. Firstly, during the second quarter we lowered our average unit cost of rebar by 15.9% year-over-year as we continue to benefit from the cumulative contributions of our sourcing strategy, equipment upgrades and benchmark driven efficiency gains.

Secondly, we were able to hold firm on our pricing, as the industry fundamental significantly improved from the coldest winter low in the first quarter.

Turning to slide number 5. The balance of demand-and-supply for steel in China had steadily improved in recent months. On demand side, China’s overall manufacturing is showing a positive trend as the manufacture PMI supported by the central governments fiscal and managerial policies, marked four consecutive monthly right, from March to June.

We anticipate this, a positive trend will continue for the remainder of this year as the government is injecting mini-stimulus packages to lift economic growth. These mini-stimulus packages covered a railway construction for Central and Western China. And the infrastructure product that should drive additional demand for scale.

For example, China Railway Corp, the country's railway operator, this May raised it’s 2014 railway fixed assets investment budget by 27% from RMB630 billion to RMB800 billion which is the third rise within a year.

The investment will be used in the construction of 48 new railway products in the second half of this year which will certainly help to increase demand for steel, especially for the market in Central and Western China.

Meanwhile on the supply side, China’s total steel capacity continues to contract as capital investment into steel factor dropped by 8.4% year-over-year in the first half of 2014. And the central government is accelerating its efforts in cutting capacity.

This July, the MIIT announced the first batch of capacity to be closed by September 30, 2014, covering 44 iron-making companies, and 30 steel-making companies.

The phasing out of the outdated facilities will be equipped to a reduction of 25.4 million tons of iron-making capacity and 21.5 million tons of steel-making capacity. Once again, Hebei Province remains the top target with expected cut of 60 million metric tons of steel capacity by the end of 2017, which should present structural opportunities to other regional producers like General Steel.

At the same time, we also witnessed voluntary cuts by smaller steel mills that suffered from a combination of core profitability and bank stricter financing requirements to unqualified steel makers.

With the improving balance of demand-and-supply in the industry, it is increasingly more evident that market dynamics and competitive landscape will substantially improve in the coming months for qualified producers like General Steel.

According to the statistics from China Iron and Steel Association, 28.4% or 25 out of 88 major steel companies monitored by association, suffered losses in the second quarter of 2014. This is much improved from 45% or more than 140 out of 315 steel companies monitored in the prior quarter.

Given the improved industry and market fundamentals, we're confident that we are on track to achieve a profitability target earnings per share range of $0.08 to $0.12 for the second half of 2014.

And as you know, our Chairman has demonstrated his confidence in the company by injecting additional capital into the company by purchasing additional $5 million shares at a significant premiums to the market price this July. We firmly believe that we have the light long term strategies and growth prospects at General Steel.

Now, I'd like to share more data on operational highlights and go through the numbers in detail.

The second quarter steel improvements marked new milestones in our march towards earning positive net profits. Importantly, our diligent and discipline over the past couple of years, are now beginning to pay dividends as this quarter we saw contributions to profitability from our two major initiatives. Our sourcing strategy lowered raw material costs, our upgraded production lines and benchmarking programs reduced unit costs.

Correspondingly, we achieved a number of notable financial milestones. First, gross margin expanded by 1,020 basis points year-over-year to 4.8% and was highest over the last 36 months.

Second, EBITDA increased by $54.4 million year-over-year. Third, net loss narrowed by $28.8 million year-over-year to $11 million. And fourth, operating cash flows improved by $121.4 million year-over-year to $56.1 million.

The substantial improvement in gross margin demonstrated the success of our execution punctuating our focused efforts in lowering manufacturing cost. As highlighted on slide number 6, in the second quarter of 2014, firstly we have been proactively working closely with local leading SOEs to secure high quality and steady supply in key raw materials.

This April, we also signed a direct purchase contract with Rio Tinto to procure imported iron ore. We believe the ability to directly procure from one of the world’s largest suppliers will ensure timely deliveries of highest quality imported iron ore and effectively lower our sourcing cost.

This optimized combination of domestic sourcing from local SOE partners and direct import from Rio Tinto, enabled us to cut the unit cost of our key raw materials. As the unit cost of iron ore and coke decreased by 9.7% and 17.3% respectively from those of the second quarter of 2013.

Secondly, we fully utilized the two additional continuous-rolling rebar production lines launched at the Longmen Joint Venture in 2013. Based on our internal estimation, the two lines contributed to a overall savings in production cost of over RMB68 million during the first half of 2014 to the elimination of intermediate transportation with heating and outsource profit and cost, as well as to a higher rolling yield.

Thirdly, our benchmarking programs continue to drive the efficiency improvement in our operations. Based on our internal assessment during the first half of 2014, our units ferrous charge consumption per ton of rebar decreased by 3.2 kilograms per ton to 112.6 kilograms per ton.

And the comprehensive energy consumption per ton of rebar decreased by 9.4% year-over-year to 492.3 kilogram equivalent of coal per ton both leading the industry.

Overall, the average unit cost of rebar manufactured decreased by 15.9% to $428.4 per ton in the second quarter of 2014 compared with $509.5 per ton in the second quarter of 2013.

With these initiatives in place, and based on the total pricing environment, we’re confident to achieve sustainable gross margin expansion in the second half of 2014.

Looking at slide number 7, benefiting from a combination of stronger gross profits and discipline expense controls, this quarter we earned nearly $34 million in EBITDA and along the same line we also turned around our operating cash flows to an in-flow of $56 million providing us with a greater operating flexibility for the quarter's ahead.

In short, with the right strategies and the solid execution, we are confident that General Steel is well positioned for sustainable margin expansion when the industry eventually turns around. We anticipate that our strong procurement capability and the improved operational efficiency will continue to lower our raw material and production costs.

This [June] (ph) we have already achieved a positive net profit and we anticipate that recovering trend and the positive momentum will continue for us to achieve greater profits in the second half of 2014. Given our solid execution and improved market fundamentals, we anticipate additional margin expansion.

Now let us turn to slide number 8, of the PowerPoint presentation for more details on the second quarter financials. Please note that all numbers are discussed below are in U.S. dollars unless otherwise noted.

Total sales volume in second quarter of 2014, was $1.31 million metric tons roughly unchanged from the prior quarter but down 5.7% from the same period of last year.

Longmen Joint Venture accounted for nearly all of our total sales during the quarter. Meanwhile, although the pricing environment stabilized compared with the prior quarter, the average selling price of rebar still decreased significantly compared with the same period of last year.

The ASP of rebar and Longmen Joint Venture in the second quarter of 2014 decreased to approximately $450 per metric ton down by 6.8% for the same period of last year but roughly unchanged from $450.9 per ton in the prior quarter.

Reflecting the year-over-year decrease in both ASP and sales volumes, our total sales in the second quarter of 2014 totaled $588 million down by 10% from $653.7 million in the second quarter of 2013.

Driven by the lower manufacturing cost that we just discussed, our gross profit during the second quarter of 2014 totaled $28.1 million compared with the gross loss of $35.5 million in the same period of last year. Gross margin for the quarter was 4.8% which is the highest in the past 36 months.

SG&A for the quarter totaled $18.8 million, a decrease of 9.6% from $20.8 million in the second quarter of 2013. Included in the SG&A were G&A expense of $9.1 million and selling expense of $9.7 million in the second quarter of 2014. The effective saving in SG&A was mainly attributable to a headcount expense control.

In addition, we recognized a non-cash other operating loss from the change in the fair value of the profit share and liability of $2.9 million during the quarter, which was primarily due to the amortization of present value discount. This compares with a gain of $9.5 million in the same period of last year.

Correspondingly, driven primarily by the gross margin expansion, income from operations for the second quarter of 2014 was $6.3 million, an improvement of $53.2 million from $46.9 million loss from operations for the same period of last year.

Total other expenses for the second quarter of 2014 were $22.8 million increased from $16.8 million in the same period a year ago. The increase of other expense was primarily due to an increase of $5.4 million in finance expense and an increase of $1.1 million in foreign exchange loss.

Embedded in the total other expenses are mainly finance expenses of $26.6 million during the quarter which include finance and interest expense of $12.8 million related to early redemption of bank note receivables. $8.2 million relate to bank borrowings and non-cash financing cost on capital lease of $5.7 million.

We're satisfied with our capability to maintain our finance expense at this minimum level and we will continue our efforts to broaden our financing channel and flexibility to support our operations.

All-in-all net loss attributable to General Steel was $11 million or net loss per share of $0.20 in the second quarter of 2014, based on 55.8 million weighted average shares outstanding.

Now, let's take a look at our balance sheet items on slide number 9. As you know, managing available working capital and maximizing operating cash flow has recently been our top priority. We have been diligently controlling operating expenses, enhancing production planning and improving inventory management.

We have also continued to seek better collection and payment terms with our customers and suppliers. And we meanwhile have also gained financing and working capital support from our suppliers, customers and SOE partners in Shaanxi Province

As a result in second quarter, we substantially improved operating cash flows to an inflow of $56.1 million, which is an improvement of $121.4 million over the same period of last year.

Driven by the solid operating cash flow, General Steel had cash and restricted cash of $492.9 million as of June 30, 2014. This is an increase of nearly $28 million from $465 million as of the end of last quarter, and more than $60 million from $431.3 million as of December 31, 2013. Accounts receivable, net of allowance was $11.1 million, compared to $7 million as of December 31, 2013.

We closed the second quarter with an inventory level of $209 million, compared to $212.9 million as of December 31, 2013. Raw materials inventories totaled $137.8 million. Finished goods were $47.7 million and the remainder being other supplies.

We will continue to maintain inventory at a minimal level by matching procurement and production closely with customer orders and other market conditions.

As of June 30, 2014 the company had total liability of $3.1 billion. This included $875.5 million in short-term notes payable related to banks lines of credit, $680.6 million in accounts payable, $420.1 million in short terms loans and $279.2 million in customer deposit, which demonstrates our deep relationship with banks, suppliers, and the customers.

Lastly, before we open up for questions, let me quickly reiterate our second half 2014 guidance as displayed on slide number 10. As you may recall, on June 25, we issued press release announcing that for the six months ending December 31, 2014, we project sales to range from $1.3 billion to $1.4 billion, on sales volume of approximately 3 million metric tons.

Net income attributable to the company to range from $4.5 million to $6.5 million, and EPS attributable to the company to range from $0.08 to $0.12.

We continue to be excited about the changing market fundamentals for the steel industry in China. And as demonstrated in the second quarter, we anticipate that our strong procurement capability and improved operational efficiency will significantly lower our raw material and production costs.

It is our expectation that this combination of firm pricing and low cost drives, higher gross profits, and we see a clear path of earnings positive net profit for the remainder of 2014. We feel very comfortable about our regional market leadership and we fully expect this recovering trend and a positive momentum will continue well into 2015 and beyond.

That concludes our prepared remarks, and at this time we’d like to take your questions. And should you have any additional questions after this call, please do contact us afterwards. Operator, you may begin the first question.

Operator, we are open up for questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions) We have the first question from the line of Tony Tian. Please ask your question.

Tony Tian - New Oriental Capital

Hi, thanks for taking my call. My first question is for Changjiang, regarding the overall pricing environment for the steel industry now. It appears, the iron ore price has been extremely weak over the past several months, and continue to decline over the past – or year and half in 2Q, 3Q. And based on all the information you have, I just want to know, what’s your thoughts on the pricing trend for iron ore for the rest of the year?

If you see the iron ore price can reach the – some time can reach the bottom level, where the company consider taking advantage of that trend, and basically increase your stock of iron ore raw material in the coming quarters?

John Chen

Thank you, Tony. I’d like to take that question. Actually, you're correct that the iron ore price has been on a decreasing trend. I think we have witnessed the – as it is, iron price hovering around between $110 and $120 per metric ton recently.

And I think the major factor impacting the iron price is the combination of greater supply and lower demand. I think on the supply side, you probably know that according to some recent reports, the big three global iron ore producers, including Rio Tinto, Vale, and BHP Billiton are all raising their production plan for 2014.

Meanwhile, the Ministry of Commerce also announced its intention for the elimination of its old iron ore import licensing system. So, in an effort to further open the market and increase sourcing channels for domestic steel mills, this elimination will open up another door for steel mills to procure iron ore externally.

The greater supply from global giants and easier access for domestic mills will significantly increase the iron ore supply, I think. So, on a demand side, I think recent statistics shows a deceleration of steel output and as more outdated capacity gets squeezed out of the production, the demand for iron ore will likely remain low.

As a result, I think we anticipate the iron ore price will remain at this low level, or perhaps even decline further from the current range. Therefore we don’t plan to increase our inventory at this moment. Our major philosophy is to maintain this inventory level, inventory at a minimum level by matching the procurement and the production closely with customer orders and other market condition.

So, we believe the minimum inventory philosophy will help us to achieve the highest utilization of working capital and enhance our operation efficiency.

Hopefully, that will answer your question, Tony.

Tony Tian - New Oriental Capital

Thank you, John. That's very helpful. The second question is regarding your second half guidance, can you talk a little bit about what's your basic assumption for the guidance regarding the pricing environment for rebar whereas iron ore cost? Will you talk about the second half of the year guidance?

John Chen

Okay. Well, actually, I think, if you know that – in the second quarter our gross margin has significantly improved to 4.8%, and that's because the market condition actually improved quite a bit. The government has accelerated its plan to cut the outdated capacity in the steel industry.

And MIIT also announced first batch capacity to be closed by September 30, 2014 and phased out the outdated facility equates to about 25 million tons of iron-making capacity and 21 million tons of steel capacity.

So, this will actually reduce the supply in this market. And we think this improvement in the gross margin will continue in the second half of this year. And we have already seen the gross margin on the improving trend in the second quarter from breakeven point to 2% and then 7% in June.

So, going forward, in the second half of 2014, we anticipate the gross margin will maintain or even improve over that – that of the June level. So, we feel confident that the company can actually deliver on the earnings per share of $0.08 to $0.12.

Tony Tian - New Oriental Capital

Thank you, John. That’s very helpful. That’s all the questions I have.

John Chen

Thank you, Tony.

Operator

(Operator Instructions) We have the next question from the line of Howard Chan from Caledonia Investments. Please ask your question.

Howard Chan - Caledonia Investments

Hi, thanks for taking my question. I have only one question. You mentioned some small mills have quitted the manufacturing due to limited funding causes. So, how about your credit environment right now? Thanks.

John Chen

Thank you, Howard for your question. Actually, you’re correct, that some smaller mills got shutdown, either voluntarily or involuntarily by the government, and also some of the reasons of shutting down the mills is because they are out of line of credit from banks.

Actually, the current environment actually becomes much harder for private or smaller steel enterprises to get loans from banks. The banks have scaled down loans to steel companies weighing on the steel mills liquidity.

With that said, it’s been extremely difficult for outdated and land scaled steel enterprise to continue. And it has led to the shutdown of some of the smaller steel mills in China.

But for us, as the sole qualified steel maker elected by the MIIT in Shaanxi Province, we are able to secure sufficient support from local banks and government.

We also secure loan guarantees provided by Shaanxi steel and Shaanxi coal which are the top SOEs in Shaanxi Province. Unlike that, actually ensures steady funding source from banks for General Steel.

And meanwhile, we continue to get credit support from our suppliers and customers as well, which really helped us to utilize working capital and enhance our operating flexibility.

So, in light of the government's efforts in cutting over capacity and environment to protection, we anticipate the tighter credit environment to continue for smaller mills. Actually, that will benefit the whole industries fundamental and improved balance to supply and demand for steel.

Hopefully that answers your question.

Howard Chan - Caledonia Investments

Yeah. Just one quick follow-up. How many metric tons of iron ore did you procure from Rio Tinto this quarter?

John Chen

We formed this contract, the long term contract with Rio Tinto in April to purchase 1.5 million metric tons on a annual basis, and so far we have already purchased more than 700,000 metric tons from them. Actually this direct purchase not only ensures bulk and timely delivery of highest quality of iron ore, but also gives cost advantage as we enjoy a long term contractual term and rate.

The procurement of this 700,000 metric tons from Rio Tinto is relatively a small portion to our total iron ore consumption. But, we have already seen some initial results in lowering our unit cost of iron ore and enhancing the yield rate.

Hopefully, this purchase from Rio Tinto will get increased. This is only the initial cooperation with Rio Tinto. We think an incremental contribution from direct purchase from them will go forward.

Howard Chan - Caledonia Investments

Okay, thanks. The last one if I can, given the current market condition do you still think that steel markets will recover in the second half of this year? Thank you.

John Chen

As I said earlier in the prepared remarks, I think the government is trying to reduce outdated capacity and putting stricter requirements for smaller and private mills. MIIT released a plan in May which says the government would cut iron and steel making capacity about 90 million tons and 29 million tons respectively.

I think the government is very serious and very active in efforts to cut this capacity. So, I think this definitely - the government used - taken all the measures to distinguish qualified steel makers and unqualified steel makers.

With the unqualified steel makers facing higher cost in utilities such as higher electricity and water cost, as well as tougher credit environments. So, definitely the steel market will improve in the second half of this year with less supply and more demand by the government.

Howard Chan - Caledonia Investments

Okay. Thank you.

John Chen

Thank you.

Operator

(Operator Instructions) As there are no further questions at this time, I'd like to hand the call back to your speakers for today.

John Chen

Thank you, operator. Thank you for joining today’s conference call. If you have any further questions, please do not hesitate to contact us. On behalf of Mr. Yu and the rest of General Steel's management team, I’d like to thank you all for your continuous support and we look forward to speaking with you again soon. Thank you.

Operator

Thank you, sir. Ladies and gentlemen that does conclude our conference for today. Thank you for participating. You may all disconnect.

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