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Braskem S.A. (NYSE:BAK)

Q3 2012 Conference Call

November 9, 2012 9:00 am ET

Executives

Guilherme Mélega – IRO and Corporate Controlling Officer

Carlos José Fadigas De Souza Filho – Chief Executive Officer

Analysts

Frank J. McGann – Bank of America/Merrill Lynch

Fernando Valle – Citigroup Global Markets

Operator

Good afternoon, ladies and gentlemen. At this time, we would like to welcome everyone to Braskem’s Third Quarter 2012 Earnings Conference Call. Today with us, we have Carlos Fadigas, CEO; Marcela Drehmer, CFO; and Guilherme Mélega, IRO and Corporate Controlling. We would like to inform you that this event is being recorded and all participants will be in a listen-only mode during the Company’s presentation. After Braskem remarks are completed, there will be a question-and-answer section. At that time, further instructions will be given. (Operator Instructions)

We have a simultaneous webcast that may be accessed through Braskem’s IR website, www.braskem.com.br/ir. The slide presentation may be downloaded from this website. Please feel free to flip through the slides during the conference call. There will be a replay facility for this call on the webcast. We remind you that questions will be answered during the Q&A session will not be posted in advance on the website.

Before proceeding, let me mention that forward-looking statements are being made under the Safe Harbor of the Securities Litigation Reform Act of 1996. Forward-looking statements are based on the beliefs and assumptions of Braskem management and on information currently available to the company. They involve risks, uncertainties and assumptions, because they relate to future events and therefore, depend on circumstances that may or may not occur in the future.

Investors should understand that general economic conditions, industry conditions and other operating factors could also affect the future results of Braskem and cause actual results to differ materially from those expressed in such forward-looking statements.

Now I’ll turn the conference over to Mr. Guilherme Mélega, IRO of Corporate Controlling Officer. Mr. Mélega, you may begin your conference.

Guilherme A. Mélega

Good afternoon, ladies and gentlemen. Thank you for participating in another Braskem earnings conference call. Today, we’ll be commenting on our results for the third quarter of 2012.

First, we would like to remind you that pursuant to Federal Law 11638 from 2007, the results presented in today’s presentation reflect the adoption of International Financial Reporting Standards, or IFRS. Note also that as of the second quarter, the company began to recognize investments in jointly controlled companies using the equity method and no longer base it on proportionate consolidation.

In addition, unless stated otherwise, for the periods presented, Braskem’s consolidated results reflect: the proportional consolidation of Refinaria de Petróleo Rio-Grandense, until the first quarter of 2012; the full consolidation of Cetrel as of the second quarter of 2011 to January 2011. and as of the fourth quarter of 2011, the polypropylene business acquired from Dow Chemical. Information in today’s presentation was reviewed by the independent external auditors.

Let’s go to the next slide where we will begin our comments. Slide 3 shows Braskem’s highlights in the period. Braskem operated its crackers at higher capacity utilization rate utilization in the third quarter, which averaged 92%, increasing 4 percentage points from the average rate in the previous quarter. In the seasonally strongest quarter of Brazilian thermoplastic resins demand, the Brazilian market registered significant growth of 18% to reach 1.3 million tons.

And Braskem had competitive strong growth for the interim revenue sales volume of 951,000 tons, the higher sales volume was one of the main factors influencing EBITDA in the third quarter, which reached R$930 million increasing 10% previous quarter. Excluding their non-recurring cost of R$108 million on EBITDA in the second quarter.

EBITDA growth in the period was 26%, in U.S dollars, EBITDA in the quarter was R$459 million, 7% high. It’s part this strategy to admire the capacity strength Braskem will be doing operations at the PVC in butadiene plants, which should already reached normalized capacity utilization levels during the third quarter.

Regarding with this strategy to diversified income, Braskem continues to make progress on his greenfield project in Mexico. It entered into an EPC service agreement with the consortium formed by Odebrecht, Technip and Ica Fluor. Meanwhile construction has reached 14% conclusion and the project is on schedule to start back in 2015.

The company also launched its pre-marketing phase that was in a commercial in the local market. Also in the quarter Braskem had a little bit of accrual for $300 million in the financing companies seem for the projects payment structure, which positive to the lines of revenue bring the total $3.3 billion, our line-up with its commitment to maintaining financial aspect, Braskem’s prepaid of R$400 million along with the BNDES. Those arrays were less attractive than existing opportunities in the local market. So, the Company also prepaid the last loan with financial covenant.

And let’s move now to slide four. this slide shows the performance of Brazil’s thermoplastic resins market along with Braskem’s performance. Demand for thermoplastic resins reached $1.3 million count in the first quarter a strong growth of 18% on the previous quarter.

In addition to the quarters in strong seasonality when the production chain gears up for a year-end purchase, there’s strong demand also demonstrated from the sales measures adopted by the Federal Government. The Braskem’s thermoplastic resins sales contained at the local market, we grew by 93% from the second quarter, maintaining its market shares stable at around 70%. comparing to the third quarter of last year, Braskem’s sales grew by 11%. We’re expecting the expansion of six percentage points in the Company’s market share.

Let’s go now on to slide five. EBITDA in the third quarter versus the previous quarter, in this slide, the sales of sector is influence of EBITDA in the third quarter of 2012 compared to the previous quarter. Braskem’s consolidated EBITDA was R$930 million, go 10% from R$645 million in the second quarter.

Excluding the impacts from non-recurring items, which in 2011, R$108 million EBITDA in the first quarter grew by 26%. A stronger sales volume growth in resins and basic materials was one of the main factors driving EBITDA growth, which generated an effective volume of R$262 million in the quarter. The 17% drop in our naphtha price reference for the naphtha’s price was insufficient to our naphtha price in the period, which followed the downward trend in the spreads in the next spot markets, resulting in a negative contribution margin of R$93 million. The 3% depreciation in the average U.S. dollar exchange rate generated a positive impact of R$73 million, which consisted of a positive impact revenue of R$296 million and a negative impact on costs of R$223 million.

The R$29 million increase in fixed costs with an SG&A expense was basically explained by the higher sales volume, which generated higher expenses with distribution. Note that Braskem remains focused on improving its competitiveness and continues to work hard to reduce its fixed costs.

Let’s go to next slide please. The slide shows the change in EBITDA in the nine months of the year compared to the same period of last year. The year-to-date Braskem’s consolidated EBITDA was 15% lower than in the same period of 2011. The higher sales volume and the U.S. dollar appreciation, which generated a positive impact of R$796 million where insufficient to the contraction in spreads for the resins embedded petrochemicals, which were created by the 23% and 13% respectively in line with its four months.

The operations between the two periods resulting from the size, and increase in costs and expenses of R$331 million, which is basically expanded by the higher expenses for distribution following the consolidation of the assets acquired in late 2011, and by the higher supply of this project, which have been affected by the lower production volume of the Brazilian asset base of our backhaul in the top is now, we are maintaining slowdowns.

Let’s go now to slide seven. Slide seven shows Braskem impact. On September 30, the total consolidations for that stood at R$8.4 billion increasing 2% from the balance of June 3. As a result, of the $250 million increase of 2021 and above, now having the increase in Braskem’s bridge loan for the Mexico project of $195 million, which will be repaid once the project finance is structured.

In Brazilian reais, gross debt was R$17 billion increasing 2%. At the end of the period, 69% of gross debt was denominated in U.S. dollars. Meanwhile, the balance of cash and investments increased by 8% to $1.9 billion, which is expanded by the higher cash innovation, in line with its strategy to maintain adequate liquidity, Braskem’s debt amortization coverage stood at 31 months.

And considering the three standby credit lines totaling $600 million with covenants increased to 35. The Company’s consolidated net debt in both Brazilian real and U.S. dollar remain virtually unchanged between the quarters at R$30.2 billion and $6.5 billion. Some 85% of net debt within M&A denominated in the U.S. dollar.

The stability in net debt and the 6% reduction in EBITDA in the last 12 months to $1.7 billion due to the lower spread in export market, financial average, by the net debt EBITDA ratio to increase from 3.55 times to 3.77 times when measured in U.S. dollars.

In Brazilian reais, the leverage ratio was 4.02 times in line with the previous quarter. Note that after excluding the total balance of the Company bridge loan for the Mexico project, and the respected cash financial average measured by the net debt EBITDA ratio falls to 3.92 times in Brazilian reais and 3.67 times in U.S. dollars.

In September, Braskem prepaid the last loan with financial covenant. The Company also prepaid in the quarter, the R$400 million loan with the Brazilian Development Bank, BNDES, which have financial conditions in terms of that were less attractive than other short-term in the single-digit market.

On September 3, the average debt term was 15.5 years in line with the average of 15 years at the end of June, considering only the portion of denominated U.S. dollar, the average bad term for the loan 21 years. The Company’s average debt cost in the third quarter was 6.27% and 8.29% in reais.

Let’s go to slide eight. slide eight shows CapEx in the nine months of 2012, maintaining its commitment to making investments with return above the cost of capital. Braskem made operational investments totaled R$1,385 million around R$575 million for 40% of this amount further located to capacity expansion projects and operational improvement of this aspect.

For the project in Mexico, Braskem invested R$34 million, which this amount proportional to its equity interest in the project. The restructuring of the project finance, which had the revenue and approval for a total of $3 billion, received approval in the third quarter for an additional $300 million from PVC. For 2012, Braskem’s total capital expenditure is estimated at approximately R$1.7 billion, which 40% going to capacity expansion projects.

Let’s go to the next slide. The slide nine presents the macroeconomic scenario and the outlook for the petrochemical industry. The scenario remains market buying stability. Europe’s financial crisis continues to influence both the development of emerging economies and the U.S. economies, which had shown signs of recovery, but this growth may now also be attracted by the effects from Hurricane Sandy. The scenario is further aggravated by the geopolitical issues in the Middle East, which pressure oil prices and consequently, naphtha prices, which is the main feedstock used by the petrochemical industry. As a result, profitability in the petrochemical industry continues to be affected. In the short-term, we expect a high volatility in export spread to continue.

However, the gradual recovery in industry profitability is expected for revenue in 2013. In Brazil, the stimulus measures adopted by the government are expected to support the recovery in economic growth as well as stronger demand for the chemical products. The measures implemented by the government include increasing import duties on the 100 projects related to various industries such as field petrochemicals, fine chemicals from our tariff and capital groups, and reducing electricity tariff.

The expectation is that these measures combined with distinguished measures adopted earlier this year, and the proposals submitted to the Federal Government by the chemical industry competiveness more to support industry growth will lead to a new cycle of investment in Brazil. The World Cup in 2014 and the Olympic Games in 2016 should also serve a important growth drivers for the Brazilian economy over the next few years.

Let’s go to next slide, the slide 10. On this last slide, we present the main areas on which management is currently focused on. In line with its strategy to strengthen its business and boost its competitiveness drop in revenues committed to supply its main consumer market and wanting to build any industrial policy for Brazil that boost ramp in the countries for petrochemical and plastic chain.

The Company also remain focused on continuing to improve its partnership with clients and consequently expanding its market share in Brazil. On fully capturing the synergies from the conditions of quarter and the PP assets in the United States and Europe.

on continually improving its operational efficiency by cutting costs and adding value to its product portfolio. on ensuring the reliable and efficient operations, and the capture of additional cash at its new PVC and butadiene plants, which adds value to the existing streams. on building and concluding its financing structure for its greenfield project in Mexico.

Note that this project, which is fully aligned with Braskem’s strategy to increase the diversity and competitiveness of its feedstock also further strengthens the Company’s presence in North America, which currently has one of the world’s most competitive gas reserves. And all these will be done without losing sight of maintaining the Company’s financial solidity in a scenario marked by a global financial crisis.

That concludes today’s presentation. so let’s move straight to question-and-answer session.

Question-and-Answer Session

Operator

(Operator Instructions) The first question is from Frank McGann from Bank of America/Merrill Lynch. Please go ahead.

Frank J. McGann – Bank of America/Merrill Lynch

Yes, I was just wondering if may be you could give a little bit more color on the expansion in Mexico and timing and how you see that fitting into the broader demand supply situation in the U.S. and Mexico. And then secondly there has been talk of some asset sales the only ones that we mentioned relatively small, but I was just wondering how you see asset sales as part of your plan to manage the balance sheet?

Carlos José Fadigas De Souza Filho

Hi, Frank, it’s Carlos Fadigas. Two very interesting questions, let me start by talking about Mexico. First of all the project schedule to start up at least 2015, from June 2015 about 30 months from now, it’s right now on time, on schedule. Although we haven’t signed the project finance package and that is expected to happen over the next month. Both Braskem and Idesa, 65 ownership by Braskem and 35 ownership on the JV by Idesa, a local Mexico chemical company. So the two shareholders of the JV have advanced funds to the projects so it has happened on time and on schedule especially because we keep money forward ahead of the financial package that as I said, it’s scheduled to be signed over the next one month.

Most of the equipments have been brought what we call the long lead items and mentioning that first of all, it reduce the uncertainty of the start-up once we had already brought these equipments and on top of that, we found very interesting price conditions in Europe to buy this equipment at the point of time in which Europe is the lacking industrial demand, the $3.2 billion project. and we are going to bring on line 1,050,000 tons of high density polyethylene and low density polyethylene. And when you compare that with the capacity additions in North America, but more specifically in the United States, the data we have from CNEI shows that only is more debate on that should happen between now and 2015.

So that’s majority additional capacity you come on stream in the U.S. between 2016 and 2017. So we do have the first project to operate in North America. the first three projects should be brought in line in North America. specifically, CNEI has, they mentioned that only 1.3 million tons on top of our project would be adding to North American capacity. and as you know, that’s ethylene not polyethylene capacity is 1.3 million tons and as you know, which is less than 1% of global capacity production of ethylene.

So naturally it has returned from 16 to 17 when we have new projects come on stream, and then we are going to have a different competitive scenario that we are glad, we’re going to be adding the first capacity in North America.

and on top of that, more important emphasis that our project is 4% in the domestic market in Mexico and it’s actually mix brought into the U.S. but right now, the market has a back of more than 1 million tons. So even with this, on top of our credit, the Mexican market (inaudible) that’s important (inaudible) be able to the vast majority of this capacity in the domestic market, have an export in that U.S.

Regarding the sale of assets, and we have to choose that perhaps as mentioned that currently the distribution business have to be sustained. So we want to brought the demand of (inaudible) discussion that right now, Frank, the potential fee of assets we are looking into, we will not be touching anything that is considered strategic progress.

So if and we sell any assets two criteria should be considered. The first one is, naturally we have to be selling. We have a better return. We have to be selling project to be putting money on a better return projects. So it’s very basic logic of any M&As there will be assets someone who is willing to pay more for that putting more value on that, so we can fund projects like Mexico, projects like (inaudible), and the second criteria is that naturally, we won’t be touching anything that is considered strategic for Braskem more specifically anything that is related to polyethylene, polypropylene and PVC, ethylene, propylene capacity, it is the new core of Braskem.

Frank J. McGann – Bank of America/Merrill Lynch

Okay, thanks. If I can just follow-up maybe just in terms of the outlook that you’ve given for the fourth quarter in 2013, it seems relatively cautious and I was just wondering how you see relative to the say, EBITDA generation that you have in the third quarter, as you’re looking out on an annual basis say, for next year. Do you think that the capacity issues that could pressure margins and might make it difficult to see upside to EBITDA next year or do you, are you more optimistic on that?

Carlos José Fadigas de Souza Filho

Yeah. If we talk about 2013 when you compare that with this year, I think that we have two or three local Brazilian projects that should help. The first one is end of the tax advantage to import in Brazil. And that something which has been part of the Brazilian Senate, but will become effective only on the turn of the year. So that should be go as a better competing field, very well important projects that most of the states in Brazil won’t to be able to keep providing and sometimes 9% tax advantage of the import.

Also we are going to have a full year or almost a full year with the increase of the import tariff for full year. This year October 1 effective an increase in import tariff for polyethylene that is from 14% to 20%. So we had three months in this year benefitted by that and we should have at least nine months next year. The increase is carried to either finish at October ‘13 or (inaudible). So we’re going to have at least nine months next year compared to three months of the year of these benefits.

And the third point would be the increase of Brazilian GDP, we are having a very tough year, as we know, Brazil is supposed to be on emerging country and we’re going to have a growth activity of 1.5% that is actually larger than the U.S. So you should get back to something around 3.5% that seems to be the general consensus in Brazil. So these financing Brazil should help for us increase profitability as you look to ‘13 compared to 2012.

The point we don’t know about and it’s a huge point have to do with the global economy. and since 2008, I don’t know whether you’re really similar to ours, that the volatility has increased the net visibility has been very tough to predict but it is going to happen, we have tough turn from 2011 to 2012, with a lot of capacity shutdown and year it self, we started this year with only 55% transition rate in our ethylene lines, and we also saw a softening in demand in Europe this year.

So one thing to be very closely monitored is what is going to happen with both China and Europe in 2013 and that may bring a huge impact in petrochemicals. My final comment would be about the exchange ratio, I don’t see the net change in exchange ratio from the Brazilian reais to U.S. dollar. So although it’s important statutory to one that at least now don’t see (inaudible).

Frank J. McGann – Bank of America/Merrill Lynch

Okay, really helpful. Thank you very much.

Carlos Jose Fadigas de Souza Filho

You’re welcome.

Operator

(Operator Instructions) And the next question is from Fernando Valle from Citi. Please go ahead.

Fernando Valle – Citigroup Global Markets

Hi, good afternoon guys. Just a quick question, you have previously talked about a project to lower taxation on asset purchases, so I just wanted to see what’s the status is on that project? Thanks.

Carlos Jose Fadigas de Souza Filho

Fernando the project you’re mentioning is a proposal put forward by the Brazilian Chemical Association that worked together with the Brazilian Development Bank and also with Petrobras should produce a set of policies, proposal of policies should give to Brazilian chemical sector, a new dynamic, a stronger dynamic and help bring more competitiveness to this sector. That was the result of a world class roughly 10 months, second half of 2011, most of the first half of this year that has been presented to the boardroom back in May of this year and since then we’ve been actively logging for the approval of these proposals. It brings three sets of proposals, one talks about lower taxes on the raw materials that’s the most impactful in the short-term. A second one talks about lower taxation on investment.

so CapEx in Brazil is reduced and the third one talks about innovation technology and incentives for innovation technology especially these innovations associated with green economy, green chemicals.

As I mentioned we’re longing for an approval, we have been seen other sectors being aggressive. the need of other sectors being aggressive and actually Braskem has been benefitted by some of these broader incentives like the incentives on exports that is called [Integra] like the increase in import tariff that covered 100 products and included in this 100 products is the polyethylene. but we have to see our proposals, or our policy that targets really the Brazilian chemical Industry.

It’s very hard for me to tell you when and if, when we have this approval. And actually I do believe, we’re going to have these approval at some point in time, it’s critical, our we’re longing for this approval and using the average of the Brazilian Chemical Association.

The Brazilian chemical industry is a very relevant one for the Brazilian economy, which consider in due stability at some point it is the third and the fourth largest sector of the Brazilian industry and we do hope that some benefit at some point more likely in the beginning of the next year. We’ve been working very hard to, but it’s hard for me to tell you when the government we will make a decision on that.

Fernando Valle – Citigroup Global Markets

Yeah, understood, thank you.

Operator

Thank you, and the next question is from [Fernando Ramos] from GBM. Please go ahead.

Unidentified Analyst

Good afternoon. Thank you for the call. Just a follow-up question regarded to Ethylene XXI project, in Mexico there have been, after you look all newspaper say and you have both you’re having some problems with the workers union and that actually you’ve a violent incident in your facility, so right now you can give a good information about these, it is difficult to affect in some ways, somewhat to start the portfolio? Thank you.

Carlos Jose Fadigas de Souza Filho

Fernando, first of all unions in Mexico is very strong in sometimes it become violent as a nation. We first of all we have been investing a lot of time and effort in creating a working environment in a set of salary plus benefit that really differentiate this project from other job opportunities in the region. The State of Veracruz is very committed to this project. The Governor of this state is very committed to this project, it’s a huge investment of capital in this state, and we have got the support of the Federal government and of the state of Veracruz in handling our relationship and helping our relationship with the employees and also with the unions.

Having said that, we haven’t had anything relevant, by relevant I mean something that could really change the schedule of the project that would stop work inside the project, and Braskem actually has a good track record in dealing with unions, with in review be it in the United States although we had a strike in the U.S. but we never stopped the production of the plant it was on strike.

So we want to keep working with the local unions as I mentioned we already have a differentiated set of salary plus benefit to these workers. We have the full support not only of the current President Calderón, but also we have already had contact with the elected president, Enrique Peña Nieto he knows the project. We have discussed this project with him and he is also 100% supporting the Ethylene 20,000 project in Mexico.

(inaudible) who knows the project quite well, he’s been at the project site several times and he has been also supporting us.

So all in all, it will remain a point of attention because of the way some of unions behave, but at the end of the day, I think we are doing all the possible and right thing to do with towards that and I do not expect that to be a major problem or to cause any major problem to the scheduled project Ethylene XXI.

Unidentified Analyst

Okay, thank you very much.

Operator

(Operator Instructions) We have no further questions at this time. I’ll turn the call over to Mr. Carlos Fadigas for closing remarks.

Carlos José Fadigas De Souza Filho

Well, I'd like to thank you all again for joining us for this call. I would like to apologize for the delay in the beginning of the call and we’re going to be working hard for that to make sure that it will not happen again, and my final comments has to do with our strategy and the management commitment to and this strategy remain confident in the long term, we will be doing all the possible thing to increase profitability of the business. We will be working hard to reduce the costs. We’d be working hard to add value to the product that stem out of our [massive] progress.

We’ve been working with the Brazilian authorities to bring back competitiveness to Brazilian industry and more specifically to the chemical industry and to Braskem and we’ve been successful in some of these fronts. We’ve been completing our Ethylene XX1 project on sched, on budget and we actually have a good track record of greenfield projects to deliver them on schedule and on budget. So that’s our commitment. If we are going to have most likely going to have core profit at (inaudible) different than what we been seeing so far, and by that I mean we will follow a profitability. On the other hand as we move to the longer term for ’13, ‘14 and then finally ’15, we do expect Braskem to increase its profitability as there is more economic growth as we bring Ethylene XXI projects on stream and on top of that as the overall profitability of the chemical industry improves.

So it’s been – I see a challenging couple of years, but we’ve been keeping our strategy, our keeping our focus and increase profitability back again.

Thanks again for your time. And I wish you all a good weekend.

Operator

Thank you. This concludes today’s Braskem’s earnings conference call you may disconnect your lines at this time.

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