Evraz's (EVRZF) CEO Alexander Frolov on Q2 2014 Results - Earnings Call Transcript

Aug.27.14 | About: Evraz Plc (EVRZF)

Evraz Plc (OTC:EVRZF) Q2 2014 Earnings Conference Call August 27, 2014 10:00 AM ET

Executives

Alexander Frolov - CEO

Giacomo Baizini - CFO

Pavel Tatyanin - SVP, Head of International Business

Analysts

Seth Rosenfeld - Jefferies

Dmitriy Kolomytsyn - Morgan Stanley

Barry Ehrlich - Citi Bank

Sergey Donskoy - Societe Generale

Operator

Welcome to the Evraz H1 2014 Financial Results. (Operator Instructions). I must advise you today’s conference is being recorded Wednesday the 27th of August 2014. I would now like to hand over to your speaker today, Alexander Frolov, Chief Executive Officer. Please go ahead.

Alexander Frolov

Thank you very much. Ladies and gentlemen I welcome you all to our conference call to discuss the financial and operating results of Evraz for the first six months of 2014. I hope you have had an opportunity to download the company presentation which is available on our website. I would like to remind everyone that the matters discussed on this call will include forward-looking statements that are subject to many factors, risks and uncertainties that are described in detail on the second page of the presentation. We undertake no obligation to update any forward-looking statements.

The situation in the steel sector remain challenging. The global steel industry has continued to deal with excess capacity which keeps margin under pressure. In response to this challenging environment Evraz Board and management have adjusted certain corporate priorities in-line with this company’s long term strategy implemented changes, design to maintain competiveness. We believe that we’re beginning to see clear and positive result from our efforts. During the reporting period we delivered successfully against the targets operation plans, and cost reductions done at the time of our 2013 full year results.

Our operating strategy is building on our core value drivers. The economical efficient low cost production of steel making raw materials, iron ore and coking coal. Our high quality steel assets in impacted markets and the company’s competitive product portfolio encompassing and encouraging the range of higher value added products. In-line with our strategy we’re committed to four strategic priorities, cost cutting initiatives, selective investment in low risk high return projects, customer focus to leverage our leading market positions and deleveraging.

You will read some of our progress in respect of this priorities in the interim results announcement published this morning and we’re going elaborate on some of that in today’s presentation. You will find that agenda for today’s presentation on page two, now please turn to page four. Increasing health and safety conditions remain a key objective. It is with deep regret that I have to report that seven employees and six contractors lost their lives in work related incidents during the first six months of 2014.

Any fatality is unacceptable to myself and to all of the management team. We investigate the causes of all the accidents and ensure that corrective measures are taken. Unsafe behavior on the part of employees and contractors accounts for approximately of 90% of the accidents. Our priority is to change attitudes and particularly with our CIS facilities.

And now I’m handing over to our CFO, Giacomo Baizini for the detailed analysis of the first half year results.

Giacomo Baizini

Thank you Alexandra. Good afternoon ladies and gentlemen, we will begin with an overview of our performance in the first half of 2014. So please turn to slide 5, the volume of steel sales for the first half of 2014 amounts to 7.7 million tonnes. Revenue experienced a 7% decline to 6.805 billion compared to the first half of 2013. The decrease which primarily reflects lower selling prices as a result of over capacity of the global steel industry. EBITDA totaled 1.80 billion in the first half 2014 compared to 925 million for the corresponding period of 2013.

The 17% increase largely reflects actions taken by the company in terms of asset optimization and the implementation of cost efficiencies. A strong free cash flow performance of $444 million for the first half of the year allowed us to decrease net debt to 6.95 billion as of 30th of June, 2014.

Our net leverage considerably declined from 3.6 times at the year-end to 3.1 times, thereby strengthening the company’s financial position. Turning to slide 6, you will see the group revenues for the period decreased by 7% to 6.805 billion with revenues from the Group’s steel segment amounting to 5.898 billion or 80% of total group revenues. The decline in revenues was largely due to decrease in prices in-line with a general negative trend in steel pricing as well as the lag of domestic steel price in Russia and Ukraine and adjusting to the depreciation of the local currencies versus the U.S. dollar that occurred in the first half of 2014.

Steel revenues were also impacted by changes in the group’s product mix during 2013, 2014 due to the suspension of operations of Evraz Claymont Steel and Evraz Palini e Bertoli. The Evraz VGOK steel disposal and closure of the plate mill at Evraz ZSMK. While steel volumes of flat rolled steel products declined, the parts of semi-finished production was switched from internal consumption to external sales.

Lower sales volumes of flat rolled steel products were partially offset by higher sales of rail and tubular products. Overall the changes in sales mix contributed to a 1% decrease in revenues.

Iron ore revenues decreased by 26.8% to $659 million in the period primarily due to disposal of a number Evrazruda’s iron ore mining and processing facilities as well as the disposal of VGOK.

Group EBITDA increased by 17% to 1.80 billion in the period from 925 million in the first half of ’13 as a result of our asset optimization program and the implementation of cost efficiencies. Steel segment EBITDA in the first half is higher than in the first half 2013 as a result of these factors as well decrease in expenses in U.S. dollar terms at Russian and Ukrainian subsidiaries due to the local currency depreciation in the first half of 2014. Lower prices for coke and coal and iron ore also impacted positively the segments results.

In addition the steel segment EBITDA was influenced by the better performance of Evraz’s North America assets. The economy on the cost side was partially offset by decline in steel product sales prices and the lag in price adjustment in Russia and Ukraine following the currency depreciation.

Higher cost segment to EBITDA was related to a decrease in cost associated with Russian ruble weakening, portfolio optimization of Yuzhkuzbassugol, operational improvements and the increase in sales volumes of coking and steam coal.

Iron ore segment EBITDA was negatively impacted by falling prices for iron ore products which were partially compensated by decrease in cost. Now please turn to page 7 for a look at Evraz’s consolidated costs. The group cost of revenue decreased by 12% compared to the first half of 2013. This is mostly due to a fall in staff cost, auxiliary materials, semi-finished products, depreciation charges, transportation, raw material costs. The cost of raw materials are largest single cost item decreased by $88 million driven mostly by combination of lower coal and scrap prices as well as the shutdown of Evraz Claymont which consumed purchased scrap for scrap for steel making in the first half of 2013.

This decrease was partially offset by an increase in iron ore cost due to lower inter-group sales resulting from the disposals and shutdowns of certain iron ore assets in 2013.

Evraz has also implemented operational improvements that resulted in the optimization of yields of the Russian steel mills and also helped decrease the cost of raw materials. The cost for semi-finished products fell by 56% primarily due to a lower consumption slab purchase from third parties by Evraz North America’s assets which were substituted by shipments from Evraz NTMK mill in Russia.

The transportation services decrease of 22% related to the Russian ruble weakening and a slight decrease in production volumes on one hand and tariffs increase on the other. Staff costs decreased by 14% or a 137 million reflecting the impact of factors including local currency weakness in Russia and Ukraine, the disposal and optimization of assets and our personnel optimization programs.

Total depreciation, depletion and amortization cost of goods sold decreased by 22% against the first half of 2013. The depletion charge was significantly reduced in the coal segment driven by Yuzhkuzbassugol due to the revision and detailing of future mining plants and lower mineral deposit depletion. In addition, remaining useful lives of plant and equipment were reassessed and extended at Evraz Russia and Ukraine steel mills. Again this was accompanied by a decrease of the US dollar amount of depreciation at our Russian and Ukrainian sites due to local currencies weakening.

And now please turn to slide 8, last year we initiated a number of the operating efficiency and cost cutting programs. The plant provided for stock optimization including a head count reduction in related G&A costs, reduced coal and iron ore mining costs and operational improvements such as improving yields in both raw material and conversion cost in our steel mills. As you can see the cost cutting initiatives are ongoing operations yielded a total savings of approximately $98 million. The optimization of the company’s asset portfolio shut down disposals of unprofitable or non-core operations in both steel and mining led to a further $59 million effect. In addition the increase in production of both Evraz North America and the Raspadskaya mine contributed another $36 million.

On whole implementation of the efficient of proven plant resulted in $193 million improvement in the first half of 2013 broadly in-line with the full year target of $400 million.

Turning to slide 9, you see the free cash flow for the period was positive at $440 million, due not only to improve business performance but also as a result of the disposal of Evraz Vitkovice Steel. 90.4 million of the disposal proceeds were paid out in dividends in July but the rest is being retained to reduce debt. You can see the calculation of 444 million in the chart. Cash flows from operating activities before changes in working capital increased by 31% to $970 million reflecting better operational results compared to the first half of 2013.

In first half 2014, the $126 million out flow in working capital was mainly related to the repayment of a $312 million payable to Yuzhny GOK, a supplier centered to Evraz DMZP in Ukraine. CapEx reduced from 365 million -- sorry to $365 million from $492 million as a result of the ongoing CapEx optimization program. Proceeds from disposals mainly EVRAZ Vitkovice Steel amounted to $296 million.

Now please turn to slide 11 for our debt bridge and net leverage. So as you can see on the slide we started 2014 with total debt of $8.166 billion and net debt of $6.534 billion by 30th of June, 2014, our total debt decreased by almost $700 million to 7.479 billion. As previously mentioned our net debt decreased by 7% to 6.95 billion meaning that net leverage decreased from 3.6 times to 3.1 times. This put the company in an increasingly secured financial position.

So if you now turn to page 12 you can see that during the period we repaid short term lines totaling $1 billion, part of which were subsequently redrawn. In January 2014 we borrowed $70 million under a U.S. Ex-Im guaranteed facility to refinance part of the Evraz ZSMK rail mill CapEx. All of this, together with a number of minor scheduled repayments, resulted in a decrease of debt.

Cash and short term deposits as of 31st June, 2014 amounted to $1.353 billion compared to short term debt of $1.244 billion. After the reporting period on 12th of August, 2014 we signed a 425 million five year syndicated pre-export financing facility which now covers most refinancing needs until Q4, 2015.

We look now at the business by region so please turn to slide 14. Evraz Russian operations was the major contributor to consolidated EBITDA generating $1 billion, 15% more than in the first half of 2013. Evraz North America EBITDA was also strong at 129 million increasing 59% compared to the prior year first half. In addition Evraz Ukraine improved it's performance to 53 million of EBITDA compared to 40 million in the same period of last year. EBITDA of Evraz South African operations was a negative 12 million due to weak economic environment in the region.

On slide 15, you will see the results of our Russian Ukrainian steel operations. In general Evraz’s Russian steel making facilities continue to operate at high utilization rates which were close to full capacity. Steel product sales volumes increased by 6% mostly as a result of higher sales of semi-finished products driven largely by changes in the product mix. As previously mentioned steel revenues were also impacted by changes in the group’s product mix.

Sales volumes of construction products were broadly stable by drawing competition from other Russian producers with revenues impacted by lower prices. Sale of rail goods increased due to sale of rails upto 530,000 tonnes in the period compared to the 390,000 tonnes in the first half of 2013. The rail mill at Evraz ZSMK is gradually ramping up rail output after the completion of the modernization program and in the first half of this year we commence shipment to Russian rails of 100 meter rails. The average cash cost of slabs decreased to $292 per tonne from $369 a year earlier.

Turning now to page 16, you will see that Evraz North America steel assets performed well backed by an improving economic environment and outlook. The total sales volumes were broadly stable and revenues increased by 5% driven by higher sales of rails and tubular goods. Suspension of the unprofitable Evraz Claymont operations resulted in a decrease in sales volumes of flat rolled products but improved for profitability of the flat rolled division.

Performance of the tubular product group benefited from the oil and gas renaissance in North America promising market fundamentals in large diameter pipe business as well as operational improvements at Evraz pipe mills. Overall volumes of tubular products grew by 22%.

As a result of the successful completion of the rail mill modernization and steel making upgrade projects at Evraz Pueblo, rail sales increased by 21% supported by strong demand and good customer relations.

So please turn now to page 17 for some results of our coal business. Total coal sales volumes increased by 17%, external sales grew by 41% driven by production ramp-up at Yuzhkuzbassugol Osinnikovskaya-8 [ph] mine and the Raspadskaya mine as well as higher sales of steam coal produced by the Kusheyakovskaya mine which was not operational in the first quarter of ’13. However the performance of our coal segment in the first half of 2014 was negatively impacted by lower prices in-line with global price trends which offset the increase in volumes.

Blended cash cost decreased to $55 per tonne of coke and coal concentrate in the first half of 2014 compared to $66 per tonne in the first half of 2013 and $63 in the second half of 2013. The growth of coal production both at Yuzhkuzbassugol and Raspadskaya as well as the mine portfolio optimization program contributed to the reduction of coal concentrate cash costs.

Please now turn to page 18, iron ore segment revenues decreased by 27% to $659 million in the first half compared to 900 million in the first half of 2013, due to lower sales volumes for internal consumption as a result of the disposal of Evraz VGOK and the optimization of Evrazruda assets.

This decrease in sales volumes was accompanied by lower iron ore prices. During the period approximately 77% of Evraz iron ore consumption was satisfied by the group’s own operations compared to 95% in the first half of 2013 predominantly due to the disposal of assets in the iron ore segment.

Cash costs for iron ore products calculated for an Fe content of 58% decreased from $66 per tonne in the first half of 2013 to $52 per tonne in the first half of 2014 mainly as a result of the disposal of high cost operations.

Turning now to page 20, we can review CapEx. With a number of major capital intensive projects now successfully completed we will focus on low CapEx and fast payback efficiency projects which have a projected internal rate of return of at least 40%. We have already announced projected CapEx spending of a maximum of 900 million for each of the year’s 2014 and 2015 and in first half 2014 CapEx amounted to 365 million which in-line with this plan. To summarize then on page 23, despite the challenges of the current environment and the number of developments across the group during the period sales volumes were broadly flat and the financial results reflected weaker steel and steel raw materials price environment.

We recorded an EBITDA of 1.80 billion and an EBITDA margin of 15.9%. Our asset optimization cost efficiency actions achieved a $193 million gains and our CapEx of $365 million is in-line with CapEx on annual CapEx of $900 million.

Once again we’re committed to development CapEx spending only on projects with a high RRR. Lastly the company’s deleveraging program is on track to reach a net debt to EBITDA ratio of less than three times. Thank you very much for listening to our presentation. We’re now ready to take your questions but as ever I would also draw your attention to the additional information which we have compiled in the appendixes.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Seth Rosenfeld of Jefferies. Please go ahead.

Seth Rosenfeld - Jefferies

Just two separate questions, first trying to dig into the impact of FX on your operating cost both in Russia and in Ukraine. I believe this is quantified in the release impact on the iron ore cash costs but what is the impact of the FX movement’s on your coal mining operations and also on steel making, any details will be much appreciated there. And then secondly I was wondering if you can give a bit more color on the rational for the growth in the sales of semi-finished steel products. Was this due primarily due to just weaker domestic demand for finished products and also if you can explain what the margin impact is in semi-finished products? Thank you.

Giacomo Baizini

Yes, so to deal with that second -- okay, I think Alexander would like to deal with that.

Alexander Frolov

You can start with that --

Giacomo Baizini

Yes, okay, so I will start with cost. So, on the Forex effect I think it is, it's easy to say on the coal -- well first of all the cost reduction effects that we’re showing on page 8, the 193 million we’re showing excludes the effect of Forex. If you would like to get an estimate of the effect of Forex on our cost of revenues I think you should look on page 7, and going through those items and weighing out what is dependent on Forex. So for example raw materials generally are not if we start on from the top page 7 nor our semi-finished products. The higher items that will be linked to that will be staff costs for example where the majority of our staff costs are in Russia.

And to a certain extent electricity and natural gas which are related to tariffs in Russia. So the Forex effect you can take merely looking at the average exchange rates for the first half of 2013 and the first half of 2014.

So that was my first part of the question.

Seth Rosenfeld - Jefferies

And just follow-up on that, I mean in the release you say that for iron ore for example the cost of iron ore has fallen from 66 to 52 of which just under $7 is due explicitly to ruble devaluation. Can you provide something parallel to that for coke and coal at least?

Giacomo Baizini

Yes we haven't made the calculation but if you like we can follow-up with an estimate. As you can imagine it is merely an estimate not an exact calculation. And it's easier to do for the iron ore and coke and coal because they are largely based in the CIS.

Alexander Frolov

And Seth, could you repeat your question because I didn’t quite understand it.

Seth Rosenfeld - Jefferies

Yes. Just on your steel sales you saw very big increase in volumes of semi-finished products in the period. I was wondering what the rational of that growth was and it's an ultimately implied perhaps a weaker domestic demand for your finished products. As a follow-up to that, if you can just comment on what the margin impact is of selling semi-finished rather than finished products.

Alexander Frolov

Well I think that major impact I think is because of closure of Palini instead of rolling semi-finished in Italy. We started to sell this material to the market and I think because Palini operations was close to breakeven. There was not any material impact on EBITDA here and it has nothing to do with the domestic market because domestic market of CIS is stronger than it was last year, I mean the construction season is better.

Operator

Thank you. Your next question comes from the line of Dmitriy Kolomytsyn of Morgan Stanley. Please go ahead.

Dmitriy Kolomytsyn - Morgan Stanley

The couple of questions that I’ve is would you be able to give us some guidance for the remaining part of the year. I think the third quarter we only have one month left, September and I think I’m pretty sure you already know what sort of prices you are booking right now and if you can tell us what you see in North America which has been very strong this year as well as on the Russian market? Also I just wanted to understand the situation with imports of long steel. We know that the situation has changed in the past couple of months. Imports have been very low up until June-July and then they have started increasing. What do you see right now and what’s happening with prices for long steel at the moment?

Alexander Frolov

I will start with domestic and probably then probably Pavel would give you more color on the United States. As I said construction season here was quite strong. Prices are still stable. As we see some sliding down let’s say for certain products in certain regions for September but we don’t see any major decline yet. And we also don’t see a lot of imports coming. So, I think that we’re relatively positive that a good situation would come for at least for another couple of months. And then for U.S. Pavel please?

Pavel Tatyanin

As far as lead product is concerned the pricing is largely unchanged with a little fluctuations from month to month but no major developments, so pricing is pretty similar to what we saw in the second quarter. As far as tubular business is concerned large diameter pipes that is primarily long term contracts with pricing largely fixed to scrap pricing. So you can watch the recent changes in the scrap pricing in North America and do your math there. OCTG, clearly in the United States pricing is improving with more impact to be seen in the fourth quarter that is the result of the most recent finalization of the anti-dumping case against unfair competition from various countries.

We also understand that Canada is pursuing similar investigation into unfair imports of OCTG pipe into their market. No decision or no resolution has been granted yet but we believe that if decision is somewhat similar that would have positive impact on pricing. On the rail side of things in North America blended weighted average prices are sliding slightly on the back of increased import pressure primarily from Japan but we believe that from the volume perspective and our ability to improve the mix of the sold rail we can somehow through significant extent mitigate this price weakness.

Dmitriy Kolomytsyn - Morgan Stanley

And one last question that I have on your efficiency improvement plan to achieve $400 million of savings, efficiency savings this year. What ruble assumptions do you use for the second half of this year to achieve the target?

Pavel Tatyanin

As I mentioned the figures on page 8 exclude the effects. So there is no like for like basis and so the 400 million also does not include any Forex effects.

Dmitriy Kolomytsyn - Morgan Stanley

Okay so I guess I misunderstood. Okay, thank you very much.

Operator

Thank you. Your next question comes from the line of Barry Ehrlich from Citi Bank. Please go ahead.

Barry Ehrlich - Citi Bank

I have two questions, I think so 2014 so far has been a year of flat domestic demand in Russia but rising overall output to devour imports. When and under what circumstances do you expect overall domestic demand in Russia to begin to grow again? And then my second question there have been some anecdotal reports of steel and related industrial facilities in Ukraine being temporarily shut down due to restructuring and personnel issues. How -- if this is in fact occurring effecting your operations at all? Thank you.

Pavel Tatyanin

We’re hearing reports that are significant part of the Ukrainian steel mills have been halted, they did in several stages to the best of our knowledge. They blew up [ph] blast furnaces and coke ovens down to the minimal level and then followed with the rolling mills. As far our operations in Ukraine are concerned we have our operations in (indiscernible) which is relatively remotely located the regions where the fighting is taking place. Infrastructure is still working, rail networks are available. So our gas supplies and energy, we are experiencing certain energy reduction in availability which so far are not impacting our overall production volumes but if this continues if the volume (indiscernible) is amplified we would have to reconsider the overall production volumes.

As far as the pricing is concerned, to the best of our knowledge slab prices are going up in the black sea area for the lack of Ukrainian material, rolled products and plate in Europe will follow. We believe with certain lag but we don’t know when this will happen and what sort of quantum this will take but clearly the reduction of -- the temporary reduction of the Ukrainian steel supply will have some impact on the pricing.

Alexander Frolov

Okay. And speaking about Russian domestic market I think for long term projections we’re using focus in 10 year growth. On the other hand we believe that at the moment that the situation is defined more by like say new facility is coming to the market and at the same time decrease of Ukrainian exports and the result of this two trends as I’ve said the market is relatively good and we’re running full capacity.

Operator

Thank you. Your next question comes from the line of Sergey Donskoy of Societe Generale. Please go ahead.

Sergey Donskoy - Societe Generale

I’ve one question on your coal division specifically on Raspadskaya. This particular company is still struggling breakeven on EBITDA level and we’re not seeing right now significant improvement in the coal prices especially on the international front. Assuming that coal prices stay put, what would you be the further steps towards this company as it continues to obviously burn cash on free cash flow level. Do you expect further cost savings in the second half of the year from expanding production? Or would you be at some point forced to take say a more radical approach?

Alexander Frolov

I guess there is -- two reason main problem of Raspadskaya, is Raspadskaya mine itself. And it has been struggling let’s say to recover from 2010 accident and then from the smaller accident in May 2013, we expect significant increase in production there and we are putting less in production (indiscernible) within the next month. So I think that after that it must become at least cash neutral and then of course let’s say we continue working on cost cutting measures.

Operator

Thank you. Your next question comes from the line of (indiscernible). Please go ahead.

Unidentified Analyst

I have two questions, could you please comment on your possible sales of your North America operations and do you consider Eurobond buyback? Thanks.

Giacomo Baizini

So I guess I will start with -- on the Eurobond buyback we have no concrete plans on that at the moment. And I will pass over to Pavel regarding your question on the sale of North America assets.

Pavel Tatyanin

We’re considering it -- this is a company we’re considering various options to raise funding to develop our North America business we have a very good and detailed strategy developed and approved by our Board but we do not have any immediate plans whatsoever with respect to selling a stake in the company. This is our core assets and we don’t have any plans to sell the business. We remain committed to our North American assets.

Operator

Thank you. Your next question comes from the line of (indiscernible). Please go ahead.

Unidentified Analyst

I have two questions, one concerning the financing side of the business and the second on the operation side. First of all just wanted to understand in terms of the product mix how do you see that going forward over the next 6 to 12 months. You’ve told that due to the changes in the product mix there has been some negative impact on the financial performance. So is the product mix going to change in the second half of this year? What do you see on that front? And also if you could mix that with your guidance of how you see the competition volume as you mentioned in the presentation that due to stiff competition the operations have been affected. And secondly on the financing side your guidance of 3x net leverage can we take that guidance as a long term view or you still need to revise it a bit lower maybe going forward? Thank you.

Giacomo Baizini

I will start with the second part on the net leverage. Once again we have given no guidance on net leverage. What we have always said is that we have a dividend policy which state that we will not pay dividend out of regular profits until the leverage falls below three times.

Alexander Frolov

And regarding product mix, we do not expect any major changes over the second half of the year. And speaking about competition as I’ve said new competition is significantly mitigated by decrease of imports and then we have to see next year what the balance is going to be.

Unidentified Analyst

Just a quick follow-up on that, do you actually see debt levels coming down further or majority of that -- majority is ’14 and ’15 will be refinanced?

Giacomo Baizini

So in terms of the maturities for the rest of 2014 and early 2015 we have this facility that we have just set up finance facility, so we’re looking to refinance those. The next maturities that we have to deal with are in the fourth quarter of 2015 and we will refine our approach in the next few months on that.

Operator

(Operator Instructions). There appears to be no further questions at this time. Please continue.

Alexander Frolov

Okay. If we don’t have any further questions I would like to thank you for participation in our call and we expect you to join us for the full year 2014 result announcement. Thank you very much.

Giacomo Baizini

Thank you.

Operator

Thank you ladies and gentlemen that concludes our conference for today. Thank you for participating and you may all disconnect.

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