Vallourec SA's (VLOUF) CEO Philippe Crouzet on Q4 2016 Results - Earnings Call Transcript

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Vallourec SA (OTCPK:VLOUF) Q4 2016 Earnings Conference Call February 22, 2017 12:30 PM ET

Executives

Etienne Bertrand - Head of Investor Relations

Philippe Crouzet - Chief Executive Officer

Olivier Mallet - Chief Financial Officer

Nicolas de Coignac - Senior Vice President North America

Didier Hornet - Senior Vice President Eastern Hemisphere

Jean-Pierre Michel - Chief Operating Officer

Analysts

Alessandro Abate - Berenberg Bank

Nick Green - Bernstein

Guillaume Delaby - Societe Generale

Raphael Veverka - Exane BNP Paribas

Geydar Mamedov - Kepler Cheuvreux

David Farrell - Macquarie

Amy Wong - UBS Securities

Robert Pulleyn - Morgan Stanley

Maria-Laura Adurno - Goldman Sachs

Etienne Bertrand

Good evening. You know me, Etienne Bertrand. I’m the Head of IR at Vallourec. Tonight, we will present you the full-year 2016 results. With me, Philippe Crouzet, CEO; Olivier Mallet, CFO; Jean-Pierre Michel, COO; Didier Hornet, Senior Vice President Eastern Hemisphere; and on the phone from the U.S., Nicolas de Coignac, Senior Vice President North America.

I would like to inform you that this conference will be available on the – the conference call on the web. This conference will be recorded and the replay will be available. It’s audio webcasted on our Investor Relations website at www.vallourec.com, and the slides will be commented by the management during the presentation, which will be also available for download on our website both on the homepage and on the Investor Relations section in the financial results page.

Before I hand over to Philippe, I must warn you that today’s conference contains forward-looking statements and that future results may differ materially from statements or projections made on today’s call. For your convenience, the forward-looking statements and risk factors that could affect those statements are referenced at the beginning of our slide presentation and are included in our annual registration filed – document filed with the AMF.

This presentation will be followed by a Q&A session and we’ll get alternatively questions from this room in Paris and from the people who are logged on the web, or on the call especially for [indiscernible].

Now, I would like to leave the floor to Philippe. Philippe?

Philippe Crouzet

Thank you, Etienne. Good evening to you all. I’ll start by providing you an overview of the achievements of the year before leaving the floor to Olivier for some more comments on the financials.

Let me quickly remind you how the year 2016 was. It was a tough year for the oil and gas sector as a whole. It’s the second year in a row of massive CapEx decrease in exploration and production, which is a key driver for our oil and gas business. You see a 23% fall in CapEx following a 25% in 2015. This has never been seen before and more importantly, it’s impacted all the regions, except the Middle East.

Of course, this resulted in a lot of pressure on all the supply chain. And you see on the right hand side of the slide some indication we use the U.S. index on our OCTG prices fell during that period. So we were exposed to a significant drop in our volumes and simultaneously in our prices.

Thirdly, we start to see some signs of recovery in the U.S. OCTG market in the second-half, you see the blue curve on the chart in the middle after hitting a low of 500 – approximately 500 weeks operating in North America. By the end of May, we ended the year with 658 end of December. So this is the first sign of recovery, but only in North America so far, because in the rest of the world, we yet have to see this kind of trend materializing either in the oil and gas business or in other businesses of the group.

The consequences of that environment are shown here and I think it’s good to take a longer-term view. You see that our sales in 2015 were down 9%, but more importantly, down to approximately half of what we were shipping two years ago in 2014. What this graph says is that, we probably reached the trough in 2016, in fact, in the first-half of 2016, you see that the second-half of the year is up compared to the second-half of 2015, up exactly by 11%.

This change in trends is, of course, due to all the efficiencies implemented by the industry, which made profitable drilling which were not profitable before, notably for the unconventional drilling as the result of the successful implementation of the OPEC agreement in November. But we think it’s also reflective of the fundamentals driving our business, which should lead to recovery of the drilling activity, which is, of course, driving our oil and gas business.

And here is a reminder of those fundamentals, of course, to sustain growth in oil demand is one, but it is not the most important factor. Field depletion is the key factor. There is a need to put in production approximately 5 million barrels per day every year to just maintain the current Forex supply. And we see certainly see some of that’s behind the progressive rebalancing of the oil supply and demand expected into 2017 and this is shown in the graph below from the International Energy Agency.

So probably this is going to happen this year supporting the price of the barrel, of course, and supporting the recovery of the drilling activity. So looking at more short-term approach or period, it is clear that we have signs – effective sings of this recovery taking place in North America. Hopefully, other regions will join. And anyway, this is necessary. This is recovery of the global E&P and drilling activity is necessary to avoid a new oil counter short.

So in the meantime, while all these events were taking place, we decided to focus on what we could do internally, and we decided to implement a transforming process in order to prepare the company to benefit from the recovery. And here’s what we’ve achieved in 2016. The transformation plan we announced in 2016 is probably familiar to you. And I’m pleased to say that we’ve been successfully executing all the key initiatives of that transformation plan.

We are in the timeframe on all initiatives as we announced and this is very encouraging. And I remind you that this is planned. It is design – was designed to reposition the group for more competitiveness and long-term profitable growth, of course, when global market conditions improve.

Now starting with Europe, we’ve completed the reshaping of our European operations. We’ve closed two rolling mills in France Deville-Les-Rouen and Saint-Saulve. We closed a threading line at Muelheim in Germany. In Scotland, a heat treatment line located in Bellshill near Aberdeen was closed in Q4, as announced And we’ve also signed in the first weeks of 2017 a final agreement with Apco Metal for the sale of the majority stake in the steel mill in France, and we have completed as well the disposal of our heat exchanger tube activity.

So the reduction in our – the resizing, I should say, in our European operations, is mostly done in terms of equipment and installations and of course, the impact on the job position is going to show in the coming months. The other side of the transformation plan is to create new production hubs and both are in place.

First in Brazil, we finalized October 1, the merger of our Brazilian operations into the new Vallourec Tubos do Brasil, which will enable significance industrial and administrative synergies, especially in the area of steel production. And the second production hub in China is well in place. We finalized the acquisition of Tianda Oil Pipe by end of November of last year. This is a major transaction for the group as it will allow us to develop the highly competitive offer, combining our valve technology and competitive production – very competitive production costs.

On the financial side of the equation, as you know, we successfully raised close to €1 billion with capital increase in H1, and we’ve reinforced as well our partnership with Nippon Steel and Sumitomo Metals Corporation. I will come back to this later on.

Lastly, we’ve announced the new organization of the group, in fact, mid-January aiming at strengthening our customer focus in each of the four new regions created at optimizing the use of our global resources and adversely our development in the organization will be effective early April 2017.

As a result of these of various initiatives, we’ve rebalanced our global capacities and we now have a much more competitive setup. With Europe’s share in the group’s total production capacity decreasing by half between 2014 and 2017 and representing now 23% of our total capacity to be compared with 65% just seven years ago. And Asia now is expected to represent 18% of our total production capacity by now -- by 2017.

So we now benefit from a unique position with leading an up-to-date state-of-the-art rolling and finishing capacities in our four regions and this is what will allow us to serve better our oil and gas customers and, of course, enabling us to leverage the expected recovery of our market for the future.

Now back to 2016, a few words on our cost adaptation. We’ve of course been very focused on that. In line with our targets, we continue to reduce our SG&A costs and we’ve achieved €150 million of savings in 2016 after €130 million in 2015. This is in line with our Valens plan target. We’ve continued to adapt our headcount to the low level of activity and of course consistent with the reshaping of our industrial footprint. The total headcount is down 12% versus end of 2015 and 24% versus end of 2014, of course including the recent acquisition of Tianda, but excluding as well the divestiture of the steel mill of [indiscernible].

And lastly, we’ve been very strict in our CapEx use. Our CapEx were below €200 million in 2016 at €175 million and this is of force very, very strict. If we take a longer term perspective, we confirm our targets of EBITDA improvement for the path of course, which is within our control. Costs and optimization of our network across, firstly, the Valens original target was €350 million of savings for full year 2017.

We’ve already achieved €130 in 2015, €150 in 2016, so €350 million will be over achieved in 2017, no doubt. In February of 2016 we’ve increased that target to an additional €400 million, but over the period 2016 to 2020. We’ve started that with a nice €150 million of savings in 2016, which means that the remaining €250 million should be overachieved as well over the four year period.

And on top of that, we confirm €350 of additional contribution to EBITDA coming from our change in scope, the acquisition of Tianda for example and from the new groups. We’ve stated that part of the total €750 million of additional contribution to EBITDA is related to increase of activity and you will note that this increase of activity, we have already gotten it in North America as I have already mentioned.

Lastly, and that was the financial side part of our transformation plan, we’ve considerably reinforced our balance sheet and liquidity profile doing the year to, firstly, a successful capital increase in April, which allowed the group to raise close to €1 billion and, second, through the commitment of new bank facilities in May. So, our – the end of the year medium and long term undrawn committed credit facilities amounted to €2.3 billion and all this, of course, provides the group with the flexibility to implement its strategy and the ability to fully benefit from the market recovery.

I now leave the floor to Olivier.

Olivier Mallet

Thank you, Philippe. Good afternoon to those I didn’t see before. So let’s move to some figures. Starting with the key objectives we had provided the market back a year ago in February 1, 2016. There were two objectives: free cash flow and net debt. The first one was to be at about minus €600 million at stable working cap. This has been achieved minus €574 million at stable working cap. And on top of that, we have significantly reduced again our working capital by €179 million leading to a free cash flow of minus €195 million. On the debt side, the objective was to stay at the maximum net debt of €1.5 billion by year-end. And we ended up slightly below €1.3 billion.

Let’s have first look on the key figures starting from the revenue, which highlights the difficult environment still in 2016. Since our full year revenue was down 22% due to both volume and pricing, we will come back on that. It’s interesting to notice that the Q4 was on a significantly better trend with Q4 revenues down only 3% compared to a Q4 2015. And this is due to what you see on the left hand side of the slide, with volume down 9% on a full year business, but 18% on the last quarter year-on-year and this is fully due to the very strong rebound we are experiencing in the U.S. as of today still with very difficult pricing situation 2016.

EBITDA was negative €219 million in 2016 as well for the first time since many quarters, Q4 2016 slightly better than Q4 2015 at minus €63 million. I already commented full year free cash flow, again, on the fourth quarter it almost at breakeven, this is due to the very good Q4 performance in terms working capital.

Quickly on this slide, which shows a bridge for the full year 2016 revenue highlighting the fact that volume goes again down in 2016 compared to 2015 with on top of that quite significant negative price mix impact mostly of prices of course and almost no currency impact 2016.

Having a look on the breakdown in our revenue by market and by region, no big change by market, oil and gas is still of course our largest segment by far at 60% of our total revenue in 2016. More interestingly the evolution by region where you see the quite large drop in North America revenue within our total revenue from close to 30% in 2015 to below 20% in 2016 due of course through the decrease in the oil and gas activity in the USA and despite the nice rebound, we are starting to experience in this part of world in the latter part of 2016.

A few words on the P&L from revenue to EBITDA, with revenues down 22% and despite very good monitoring of our cost with very good adoption of all our variable cost and to a large extend of our fixed cost well, the industrial margin was impacted the drop in activity, volume and price wise and was down by €213 million compared to 2016. We continued to decrease our SG&A by almost 13% in 2016 leading to a total decrease of 21% over two years and we have already commented the EBITDA figure. Below the EBITDA, the operating income was impacted by some restructuring charges, or impairment charges taken mostly in H1 at the time where we announced our restructuring plan in Europe, although these charges were lower than the one taken in 2015, especially the impairment charges taken in 2015.

Material to other comments on this part of the P&L some increase in our financial charges largely due to a lower ForEx result than in 2015, leading to a negative net income slightly reduced compared to the one of 2015.

Let’s move now to some cash flow items. Starting with free cash flow, the first line is the cash flow from operating activities minus €199 million in 2016, slightly lower than 2015 due mostly of course to the decrease in the EBITDA. Again, a good performance in terms of working capital, down by €179 million.

It’s actually even more than that, because you should not forget that at the end of the year, we integrated all of the working capital from Tianda acquisition and from the VSB a full consolidation there was as well some negative ForEx effect. So that the performance in terms of reducing our working capital is really quite good in 2016. And CapEx was down to €175 million slightly below the objective we had given you at the end of the year, which was about €200 million.

What does it mean in terms of net debt evolution? I won’t comment the free cash flow, we have already done that. On the right hand side of the slide, you see the effect of Tianda acquisition and VSB debt full consolidation, which are exactly in line with the figures we had given you in February last year. So that at the end of 2016, the net debt was €1.287 billion, which is leading to a quite satisfying year-end ratio at the end of 2016 of 34%.

From a liquidity and financing point of view, the key elements at the end of the year are that we have on our balance sheet €1.3 billion of cash in front of €1.5 billion of short-term debt, and on top of that €2.3 billion of long-term undrawn committed bank facilities. And as a reminder, we have extended the €1.5 billion of these bank facilities back in July that was up most of it more than €2 billion will be available until 2020.

And I will give the floor back to Philippe for the outlook.

Philippe Crouzet

So let me give you our thoughts on where we currently stand and the way we foresee 2017. We expect clearly continued volume growth in OCTG in the U.S. all along the year. The demand is very strong, as I speak, and is driven partly by restructuring of the distributors, but now clearly by the higher final demand – final consumption for OCTG on the market and then this is really we think pretty sustainable.

In the meantime, we have experienced a significant surge in the scrap prices starting at the end of 2016, it’s pretty consistent with the change in many end markets using scrap. And so we’ve matched this by price increases that we announced in December and January, but of course, they should mostly impact the second-half of the year.

During the first-half, we expect the surge in scrap price to largely offset the positive volume effect of the rebound in drilling activity. So this is for the U.S. and really this is the major factor in terms of activity. Regarding our outlook for the year and the rest of the world, what we see is that the sanctioning of new large projects, especially offshore projects by IOCs has not yet restarted.

And so deliveries for the year 2017 should mostly rely on the backlog contracts that we – that were awarded last year mostly by NOCs and at pretty low prices and lower than the ones we – of our deliveries at the beginning of 2016, which were based on higher prices coming from 2017 orders.

As far as Petrobras is concerned, Petrobras issued a new five-year business and management plan. And we therefore, on the basis of that plan expect that their drilling activity to remain broadly stable in 2017 compared to 2016.

As far as other group businesses are concerned, we expect to experience still a low demand in a competitive pricing environment. We especially expect some slowdown – a progressive slowdown in the conventional power generation activity in China due to recent government decisions.

For our industry activity, we do not expect significant change on this particular market segments with the exception of the sub-segment of iron ore, where prices are clearly rebounding. So this is a positive. And of course, we expect to benefit – to continue to benefit from the impact of our transformation plan, especially in Europe.

So therefore, based on the current ForEx and market conditions, we target and full-year EBITDA to improve by €50 million to €100 million compared to the full-year 2016.

So thank you for your attention. We will now answer your questions.

Question-and-Answer Session

Operator

Our first question is coming from Alessandro Abate from Berenberg. Please go ahead. Your line is open.

Alessandro Abate

Good afternoon, guys. Just a couple of questions. If you can give a little bit more color on the recovery of OCTG in the ex-U.S. market?

And the second question is related to the momentum of demand in the U.S., which seems to be very, very strong at the moment. What kind of risk do you see from potential capacity that’s going to come on stream if, let’s say, the OCTG price exceeds a certain threshold to justify increase of capacity. This is clearly also including well the OCTG producer? Thank you very much.

Etienne Bertrand

Hello, this is Etienne. Could you just repeat the first question, because there has been a misconnection between here and Paris platform.

Alessandro Abate

Sure, Etienne. The question is, if you can give a bit more color on the timing of the recovery of OCTG momentum in the ex-U.S. market. Usually, there is always a lag of three, four months, five months. I was wondering whether you see the things strengthening in terms of potential order intake, in terms of your utilization rates relative to the U.S., or if not, when do you think this will positively affect your underlying utilization rates and profitability?

And the second one, the momentum in the U.S. OCTG is quite strong. So, what is the risk that you see that if the OCTG price keeps going up also on the boost of raw material cost, there might be an expansion of margin that may actually tweak further utilization rates at facilities now are not really working at full speed, or you think that momentum for rig count is so strong that you basically see very little risk coming from this potential increase from the supply side? Thank you.

Philippe Crouzet

Maybe on the first one ex-U.S. Alessandro. And you mentioned a pretty short delivery time between recovery in North America and an ex-U.S. if I understand well. In fact today, they’re not correlated. I think we’re really faced with two completely different situations and in fact three if I want to be more specific.

North America, you know the situation and Olivier or Nicolas will comment. This is a clear rebound and clear recovery in all the areas and there are more than in the past where the break-even is lower than $55 per ton. And that each project is relatively small amount of CapEx, so easy to start, easy to finance.

Outside the U.S., most of the projects, which are being delayed at the moment are big projects, billionaire projects. And so it’s logical that it takes more time to get to a positive decision, a final investment decision. And on the other hand in many cases, there’s still a lot of engineering work to develop to lower the break-even point.

And so I think there, at best we expect some positive final investment decisions to be taken in the course of the second-half according to what major oil companies are stating and not all of them and anyway with an absolutely no impact in terms of delivery, given the delivery time over 2017. So that’s what we really think that this universe of IOCs, and mostly geared at offshore projects will not significantly significantly impact our activity in 2017.

The third group of customers, of course, are at the NOCs, and they are continuing to with our drilling activity. As you know, they were the ones not to slowdown as much as the others and they will not, of course, rebound as much as North America. In between are the independents. It’s theoretically a smaller category. Today, it’s probably a more relatively a bigger category, but they are faced with the same challenges than the IOCs in the offshore operations.

Olivier Mallet

So maybe a few additional comments on what we see in the U.S. market as of today, both in terms of demand and supply. First, on the demand side, very clearly there’s a strong rebound that has taken place since at the end of last year and that we believe is very healthy. It’s driven by three levers. The first one is, of course, the increase of the rig count and therefore the final consumption. As you know the average rig count number in 2016 was 510 active rigs. Already as of today as of the end of last week, we are at 751 rigs, so definitely a very nice rebound sustained by the WTI price increase.

The second factor is destocking/restocking moves that have taken place. Until early Q3 2016, there was a destocking where all the distributors in the USA and the end-users very likely were trying to cut their inventories as much as possible. And this was impacting, of course, demand addressed to us.

As of today, they are for restocking and they have to increase inventories in order to follow the increase in final demand and to keep what they typically like to keep, which is about five months of consumption in inventories.

The third element, which is specific to us to Vallourec is that, we have regained market share all over 2016 and we’re benefiting from a full-year of effect of that in 2017. So that’s frankly speaking, our issue as of today in the U.S. is not about the demand, is about rehiring as quickly as possible newer shifts in order to be able to follow the demand without having to extend our delivery time to our customers.

Alessandro Abate

Thank you.

Olivier Mallet

On the supply side, for what we know which is a seamless supply environment, it’s quite stable, I would say, Just two new elements, one U.S. Steel, which is one of the biggest – if not the biggest producer in the U.S. has announced a few weeks ago that there were shutting down permanently two mils, including one seamless mill in Lorraine. So this is a definitive cut of capacity in the U.S. market.

On the other hand, but this is not new, Tenaris has announced that they will start somewhere in 2017, a new rolling mill Bay City, knowing, which would be interesting to follow that the production costs they will have from regional will certainly be higher than the one they had from export from Mexico, so this will be an interesting piece to follow.

Alessandro Abate

Thank you very much. Thank you.

Etienne Bertrand

Okay. We’ll take the next question from Paris now.

Unidentified Analyst

Hi, excuse me. A few questions if I may regarding 2017 guidance and how do you give the guidance. Could you please give us more color on the assumption for the U.S. when you say current market conditions? What’s U.S. rig count level are you taking into account to build the guidance and also in terms of price? What is the assumption, you say that is going to be H2 that it’s less than 10%, more than 10%?

Regarding the restructuring, what would be the impact for 2017, you say that in 2016, it’s 150 million, can we expect more than that in 2017?

And then the final question, if we understood that in 20187, the EBITDA would be negative. Can we assume that clearly the 2020 objective that you announced at the time of the capital increase are not any more valid, meaning that the 1.2 billion, 1.4 billion EBITDA guidance is dead, if I can say that? Thanks.

Philippe Crouzet

So, on the first one, some more color on the U.S. again. From a rig count assumption it’s difficult to follow. Actually we – to be very transparent. We had a first assumption in our budget that was an average rig count for 2017, which was below what we see as of today on the market. So we are from time to time as of today revising up our assumption for the – activity for the rig count in the U.S.

In terms of prices and raw material cost, the situation is as follows. On the raw material side in the U.S., we use scrap essentially. And as you know, the cost of scrap has increased quite significantly since October, November 2016 by good $100 per ton. We have announced two price increases. One is $75 per ton for deliveries in Q2, and the second one of $125 per ton for deliveries starting in Q3 with the caveat that this price increase do apply to what we call spot orders, but not what is called program customers, which are the customers with whom we negotiate typically every six months and in some cases every year their prices.

So there’s is a sort of a lag effect in the price increase knowing that the program customers probably represent about 80% of our sales in the U.S. market. In other terms, in H1, we’ll definitely benefit from the favorable volume impact in the U.S. sequentially compared to the end of last year to H2 2016.

But this will be to a large extent offset by a negative squeeze between the current raw material cost increase and prices that will mostly impact H2, of course, the situation will change in H2, where we will continue to benefit from favorable volumes. And on top of that, we will benefit from this price increase, which would be at least as a high as the year increase in the raw material.

So this is a situation for the U.S. which means that all in all 2017 compared to 2016, there will definitely be a plus in the EBITDA, we’ll generate on the U.S. market. As far as the saving are concerned, as you said, we have generated before inflation €130 million in 2015, €150 million in 2016. We don’t give the precise number for 2017, but it will be again a very good year in terms of savings with three main elements.

In that, one, the continuation of all of the action plans that have been launched everywhere in the world to cut cost progressively. Second one, which is that the PSE, the [indiscernible] Phase in France is taking place is is being executed as of today. People that were working in the oil [indiscernible] ratcheting down are leaving now, so this will be a strong saving year in France and in Europe.

And the third one is that the number one objective of the merger in Brazil between VBR and VSB was to generate savings which were really two different entities managed with different people, different organizations, so there is a lot of room for rationalization. This is true for many support functions, quality, maintenance, and so on and so forth. It’s true as well, by the way, for inventories and working capital management. So, all this will lead again to a quite nice 17 year in terms of savings and marginally implementation of our transformation plan.

Olivier Mallet

The third question, your third question, Kevin was about the midterm perspective that we provided in the last April, I guess. There were two components, one was what I will call the South help, the homework, these are the €750 million additional contribution both on savings and from the new roots and extended scope that I referred to in my presentation. We do confirm that figure. The other part was the market conditions and what we said at that time is that if in 220, we come back to the same volumes and prices as we experience in 2014 we would much higher of course than 750.

Just as a reminder the bridge between 2014 and 2015 from the top of my mind showed that the collapse in volume and price was equivalent to 900 million EBITDA. So now the story is, of course, if we come back to the volumes and prices of 2014, I have no doubt that some significant chunk of that 900 we will get back. Now, whether we come back and how fast we come back to those volumes and price is really a matter of opinions, what surprised me is that over the last month as we’ve read very different opinions regarding where the old markets is going. None of these opinions and I am referring to oil companies to consulting firms, etcetera seems that we will not – we will stay where we are today. Part of the road back to 2014 we get.

Few people honestly saw we will get back to those levels, exactly with the majority we may stay slightly below volume wise, maybe more price wise and there is one scenario which is the scenario of contrary and scenario if I may call it, it is a complete disruption, supply being unable to follow demand and then triggering very significant price increase in the oil, of course figuring much more drilling activity. So what we are saying today is on what we control what is under our control.

We are confident, I even mentioned that we knew it a bit 750 million south help I might say, savings or contribution, additional contribution by saying that part of it is depending on activity recovery, which is true when you make savings on purchasing, for example it is partly related to volumes. More confident now to say that part of this will have already arranged and we will keep.

What comes from activity volume wise and price is probably more unpredictable the given the differences I referred to between the various segments of the oil and gas. Part of the road we are getting part of the gap we are filling in North America and probably we will come pretty close to where we were and the rest of the world honestly it is still too early to say. We take a question from the platform, Tracy.

Operator

Our next question is coming from Nick Green from Bernstein. Please go ahead your line is open.

Nick Green

Good evening. Thank you for taking my call. Two questions please. Are you able to give a free cash flow guidance for the year 2017, on a closing net debt balance for the end of the year? Because if I understood right, you’re guiding to EBITDAR of somewhere between minus €102 million to minus €150 million, CapEx maybe around €200 million if you can keep it low again. And under those numbers, you’re posting, unless you think there’s large working capital benefit, a very large free cash flow outflow, which would mean net debt could be rising back to the pre rights issue level.

Are you comfortable guiding to those kind of numbers? Do you feel you have shareholder support if your net debt but does go back up there? And can you just discuss as part of this question, how you will handle the December 2017 bond refinancing, the €650 million is due, if you’re free cash flow is negative again? That’s my first question. Thank you.

Olivier Mallet

On this question we gave a question, to be precise on the EBITDA for 2017. The other parts of the puzzle are quite easy together. From a CapEx point of view we are starting 2017 with the same kind of envelope that the one we studied 2016 with. So, something wrong €200 million. Of course at the beginning of the year it is much more difficult to assess what will be the working capital level at the end of the year. So looking forward to the end of 2017 the activity was to boom completely everywhere if there would be an increase in working capital.

If it is that the case, we have demonstrated in particular in 2016 that all the efforts while doing internally to improve our performance in terms of working capital is getting us the means to offset what is triggered by the increase of activity. Just two additional commands on what we are doing on this working capital side. One, it is an inventories, we have a plan called rate invent or reduce inventories, which is very much a lean management related. You know that lead management does allow to cut cost, but as well for reorganization of the floors in the plans to cater inventories,. Our objective in 2016 was to cut inventories at the given activity level by about 10% and we have achieved slightly more than that and this will continue of course.

Second topic, when we have made a lot of progress and we can continue to make progress is about receivables where we have significantly reduced the amount of bad debt of over dues in 2016. About the broader financing question, as you have seen we have lot of cash on our balance sheet, so no issue of course for the bond that is maturing now. And we have, which is another element that some of you will look at legitimately, very nice gearing situation at the end of 2016, 34% which is probably better than most of you had in mind that gives us a very larger head room, even if we generate a negative free flow which will be the case again in 2017. So no reason for being concerned in this regard.

Nick Green

Okay. So just to confirm that, you’ll probably intend to refund that – to fund that bond with cash as opposed to issuing new bond, and you do expect to be free cash flow negative for the year, but it’s not a big concern. Is that what you said?

Olivier Mallet

We have cash, on top of that of course we permanently monitor the bond markets, so I am not telling you that we will never issue a bond, we are monitoring that and we will be ready one day. When we will feel it is good time to do it to insure a bond on the market.

Nick Green

Okay. Thank you. And then the second question was on Slide 20 from your presentation. You showed that you added €300 million of net debt went from the consolidation of Tianda and VSB. Can you talk through please, the revenue tonnage and EBITDA consolidation impact of those two? It seems slightly odd to us that the average selling price of the Group revenue divided by tons has seen such a marked increase on Q3. I’m wondering if that’s partly influenced by some of the consolidation treatment around Q4. Thank you.

Philippe Crouzet

The €300 million are two-fold 158 for Tianda acquisition, exactly the price that was announced a year ago. And the other part was a full consolidation of VSB debt. It is of course generating EBITDA, it has started in Q4 already in Brazil and Tianda will generate a positive EBITDA in 2017 as well. So that’s a part of the transformation plan, which is related to the change of perimeter is confirmed.

Nick Green

Sorry, I just meant, of your Q4 results, are you able to tell us, of the tonnage, how much of that’s being benefited by a consolidation adjustment, a perimeter adjustment? Same for the revenue, same for the EBITDA?

Olivier Mallet

In terms of Tianda, I guess it was zero.

Olivier Mallet

Yes, Tianda it was end of December, so the consolidation in terms of tonnage and revenue for Tianda will be in 2017 only.

Nick Green

Yes.

Olivier Mallet

And you know the figures for Brazil, where the capacity of VSB is 600,000 tonnes. We were consolidating that on a proportional basis at 56%. And it’s now consolidated to 100% and same story for all the figures.

Nick Green

Is that from October forward, is it?

Etienne Bertrand

Take a call now from the room.

Unidentified Analyst

Out of the more or less €150 million of cost reductions you achieved last year, how much did inflation eat up?

Olivier Mallet

Slightly less than €50 million, mostly in Brazil.

Philippe Crouzet

Now most of the inflation is in Brazil. Yes.

Etienne Bertrand

We take another question from the room.

Guillaume Delaby

Yes, Guillaume Delaby, Societe Generale. One question. I understand what you mean regarding pricing in 2017. So H1 is likely to remain weak, H2 is likely to be better. However, I know that you don’t like when we talk about average selling pricing, but average selling price in Q4 is much better than Q3. So my question is that, excluding Tianda which of course bring some further complicity, but excluding Tianda, could we take average selling price in Q4 2016 as a good, let’s say, proxy for Q1 and Q2?

Olivier Mallet

As you rightly stated, I hate when you speak about selling price, because it’s not that meaningful it will be impacted like every quarter and every year by the mix evolution in our sales. Just keep in mind that the average selling price in the U.S. market is significantly lower for oil and gas than in all other geographies. So there’s a more share of U.S. sales increase in out of those sales, the lower the average selling price is, which doesn’t mean that the profitability is lower because it is good on the U.S. market, but be very careful with this average selling price story all right.

Etienne Bertrand

Tracy?

Operator

Our next question is coming from Raphael Veverka from Exane. Please go ahead, your line is open.

Raphael Veverka

Yes. Good evening. Thank you for taking my questions. First, on pricing, and more specifically pricing in the rest of the world, I’m wondering if you could give us some color on the expected negative price impact we can expect in 2017 because of lag effects from a tender issued last year at weaker prices. And where there are incoming tenders with the NOCs, you see today’s scope to raise pricing in this rising raw material cost environment?

Philippe Crouzet

Maybe to give you some color on the tendering activity. So we secured some 2017 volumes following large tenders in 2016 under price concessions at typically double-digits decrease. That’s what I can indicate. Now, it is clear that we are making all attempts, sometimes with success to increase our prices in the coming tenders, so typically this is happening in Saudi, which run bookings on a quarterly basis, so we are making some attempts under successfully some cases to start increasing prices.

Raphael Veverka

Okay. And then second question is on the U.S. market coming back there whether you could give us approximately your current capacity utilization – sorry, your operating rates, and how you see the industry operating today, at least, for the seamless part?

Philippe Crouzet

Yes, Nicolas, can you hear us?

Nicolas de Coignac

Yes, I do hear you. Do you want me to answer this, Philippe. So currently, well in the U.S. we’re running at approximately 75% of our market capacity in all our facilities and still ramping up. So it’s definitely a much better spot to be for our assets. Do we – we see the rest of the industry? We see that this is now the case for the majority of our competitors too.

But we don’t see yet a lot of ERW being restarted although this may eventually happen in the coming months. As you know, the first plants to be idle has been under ERW, some will not restart, but at a point in time, we may see some of them restarting if there’s a scarcity of the offer on the market for seamless.

Raphael Veverka

Okay, very clear. Thank you. And my last question was just to come back on inflation, so you talked about €50 million impact in 2016 within Brazil. Is that – do you expect a similar roughly impact in 2017, or are there any changes in that? If you could give us any guidance, that would be great?

Olivier Mallet

I would say relatively similar about inflation is slightly getting reduced in Brazil, but on the other hand, it is getting slightly higher in Europe, or in the USA. So same order of magnitude maybe slightly more in 2017 than in 2016.

Raphael Veverka

Okay, okay. Thank you very much.

Etienne Bertrand

Any questions here in Paris?

Geydar Mamedov

Hi, Geydar Mamedov from Kepler Cheuvreux. Just one question finally. We understand that there’s some lag effect in terms of pricing that will negatively impact your H1 international markets have not yet started to rebound you will still have negative pricing effect in the Middle East. So I wanted to just to understand whether we will have a very different two semesters in 2017, namely having a very negative H1, and could we expect a positive H2 EBITDA, or this is in your view much too optimistic? Thank you.

Olivier Mallet

So I’d say it’s very too early here to say if we go by big region. In Brazil, we don’t expect massive changes, except if the iron ore is continuing to go up and up, which actually goes behind our original assumptions, which is good news.

On the Middle East market and this backlog question, what is happening as of today? When you compare 2017 versus 2016 is that, the deliveries that have taken place in H1 2016 were based on orders taken mid-2015 at still a relatively good prices and margins. The orders that has been taken in mid-2016 for deliveries in H1 of Q3 2017 has been taken in many cases at much lower prices. And this is the origin for this negative price backlog effect that would be the negative in the bridge between 2016 and 2017 global EBITDA.

Then what will be the situation in H2 2017? There is typically eight, nine months delivery time effect, so a significant part of the year is already booked. And then what will happen at the end of 2017 and beginning 2018 will depend on the new orders to be taken in the coming weeks and months.

As Didier was starting to mention, we have at least the feeling in this part of the world that prices will not go lower. They have been stable for a while now and for each tender Didier is making with all my support, is best efforts to start raising prices again, because this is more of the market sentiment we have knowing that the volumes themselves like in the U.S. are restarting as of today. So that is difficult to increase prices in this part of the world.

The second element on which we lack visibility is the second part of the Europe or the U.S. market. So far although I have been telling you analyst for two years that you would be surprised by the rebounding of market in the U.S. We have been ourselves surprised as well and we continue to be surprised by the – what is the trend of increasing demand in the U.S. So what will be the situation in H2, it’s of course difficult to predict. Here the backlog is very short, we deliver in less than two months typically so that any change in the volumes in the prices can have a quick impact on our P&L.

Philippe Crouzet

Tracy, next question.

Operator

Our next question is coming from David Farrell from Macquarie. Please go ahead, your line is open.

David Farrell

Hi, good evening, I’ve got two questions please. Firstly, if I look at the geographic revenue breakdown, North America was up €65 million quarter-on-quarter that’s understandable, but Middle East and Asia was up €134 million, can you just talk to that very large increase please? And then I was hoping you could explain a bit more the leverage to iron ore prices, how much are you selling into the local market in Brazil? And what kind of pricing do you get relative to China? And kind of a follow-on from that, what pricing, iron ore pricing are you assuming in your updated guidance?

Philippe Crouzet

Okay, Didier on the Middle East, yes.

Didier Hornet

Yes, on the Middle East, I think this is what Olivier was commenting a bit before. We benefited in 2016 from a very good backlog in the first semester, both in volume and in price. This is explaining the growth of revenue in Asia and Middle East region.

David Farrell

I’m specifically talking on fourth quarter versus third quarter? Is there a volume thing into the Middle East, we see so much larger volumes?

Didier Hornet

In the fourth quarter compared to the third quarter, this may have been some specific large orders that we have to deliver in that case in North Africa.

David Farrell

Okay thanks.

Philippe Crouzet

Second question about the iron ore price, the key parameters to have in mind is that our mine in Brazil does produce about 4 million tonnes of iron ore per year and we sell to third parties, because we don’t need it, about 3 million tonnes per year. So that while directly exposed to the valuations of the international prices, we are benefiting from that as of today. I won’t comment on our assumption as of today, but I don’t think that we are too aggressive in – regarding this regard.

Olivier Mallet

But maybe, Olivier here. I would add something that I’ve explained only to analyst is that the price that you referred to is the Fe 62% CIF China where you follow that every day. It’s right now about $95. What we take into account for internal sales is the local price, so you need to deduct the cost of freight, the cost of FOB so it’s just from a mine to another mine. So this is largely different from this, but the reference is the valuation in terms of percentage that we see internationally. So don’t take 3 million tonnes multiplied by $95, you will be a little bit disappointed.

Maybe we take next question also Tracy.

Operator

Certainly. The next question is coming from Amy Wong from UBS. Please go ahead.

Amy Wong

Hi there, most of my questions have been answered, actually one more last. Pricing increases, I just wanted to revisit that. You said, you announced two pricing increases of $75 each. Can you comment one and another, this is actually being sticking with your customers? And how they – what’s the attitude of in terms of responding to this pricing increases and what’s the – will you also be able to pass on to your program customers as well, the full extent of the pricing increases that you’ve announced?

Philippe Crouzet

Nicolas, maybe you answer.

Nicolas de Coignac

Sure. Amy, so it was not two times $75, it was one $75 and one $125, so making it $200 a tonne. So definitely as explained by Olivier previously, it is sticking but more to the spot orders and mainly for Q2, part of this being as commented already, offset by the evolution of the scrap. And for what is concerning the program, the customers, we are entering currently into the negotiation for H2 and we are putting this very firmly in front of them, so it’s too early to state that we definitely do expect this to stick.

Amy Wong

Got you. Just – also a question just to revisit some of the guidance that was given at the third-quarter about the first-half of 2017 looking very similar to that second half of 2016. Does that still hold and is that the shape of the 2017 we should be expecting?

Philippe Crouzet

You know that I’m always cautious when it is about what will be H1, what will be H2. It depends on so many factors that I have to be cautious there, but may be slightly better than what was the overall comment in the business environment for H1 we made a few months ago, but no very large variance either. And let’s again be cautious versus – H1 versus H2, and many elements can impact that. So I don’t want to make you too optimistic on H1 either.

Amy Wong

Okay, thank you very much.

Etienne Bertrand

Turning now to Paris, because we are running out of time. Quick question in Paris?

Unidentified Company Speaker

No.

Etienne Bertrand

To London? Tracy?

Operator

Yes, the next question is coming from Rob Pulleyn from Morgan Stanley. Please go ahead.

Robert Pulleyn

Hi, good afternoon or good evening gentlemen. So just two more questions from myself please. So firstly, just looking at the language in the outlook statement, it say, you know based on current market conditions and could I just probe as to what exactly that refers to in light of the guidance to 2017? Is that conditions right now and does that imply that the guidance assumes zero improvement in your markets including the U.S. through 2017? I just like a little bit of clarity around the exact wording there?

And secondly a housekeeping question, you were kind enough to give the utilization of your U.S. mills at 75% currently. Would you also be willing to provide that for the other regions as that would be very helpful? Thank you.

Philippe Crouzet

Okay, if I may, a comment, although it’s probably, the one who wrote that sentence is Olivier, but my understanding of what market conditions refer to is the dynamics we are seeing as we speak. We see very strong positive dynamics in North America and we do not see a similar movement elsewhere. So what we assume what’s behind our target for the year is clearly no significant recovery outside the U.S.

And not that we think that the mines are not changing, they are changing. We – when we talk with customers, they are all reopening a number of projects. They are confident that they can lower their breakeven quite significantly, but our statement is that the time between their decision to our deliveries is beyond the end of 2017, that’s what we mean.

In terms of North America, today as we speak and as mentioned by Olivier, the number of rigs in operation is already 50% above the average of 2016. So let’s take that as a basis for our assumption for the whole year. And of course on top of that some will have to be added regarding inventory and rebuild. So this is basically when we refer to current market conditions is, it’s what we are experiencing today, it means by the way as far as North America is concerned that we do not foresee any collapse of that dynamics. We think it’s sustainable as we mentioned and so this is what it means. On top of that of course we refer to current ForEx conditions and then this may change quite significantly along the year.

Robert Pulleyn

Okay. Thank you.

Philippe Crouzet

On your second question Robin, in Brazil the activity level is lower than in the US, definitely for two reasons because the local market already is about alternate across the stadiums, it is still impacted by the depressed macro environment in Brazil. This being said, as it is not fully what matters so much, what matters to us more because it is very high end stuff is what we sell to Petrobras and as we said it’s stable compared to 2016. As far as export is concerned from VSB it is depending on the African, Middle East market which is not clearly restarting as of today as already stated.

In Europe, big change of course because the all in capacity has been divided by two. So that the utilization rate that was pretty low is now at quite good level as expected, since we have eliminated some duplications in terms of rolling mills and in terms of steel as well with the divestiture of a majority stage in the Saint-Sauve steel plant. And finally in China, the business model of Tianda is to run always at a very high level of activity to sell to the very large Chinese market where it is more of commodities and then to make a little bit more money.

Although it makes money in China as well by exporting OCTG tubes, so far mostly API, and we are starting to sell the very first premium tubes for – and heat-treated in Tianda, and treated with premium connections in our other facilities in China and Indonesia or elsewhere in the world.

Robert Pulleyn

Okay, thanks for the color.

Olivier Mallet

Tracy just to finish, I think we’ll take the very last question and then we will end up the conference call.

Operator

Certainly. The last question is coming from Maria-Laura Adurno from Goldman Sachs. Please go ahead.

Maria-Laura Adurno

Actually all my questions have been answered. Sorry, thank you.

Olivier Mallet

Thank you, Maria.

Jean-Pierre Michel

Maybe if I may as an answer to the non-question, short additional comment on the way I perceive the oil companies state of mind. It’s clear that they’ve done a lot of homework as we are doing to reduce their cost and lower the break even on many of their projects. It is clear as well that confidence is building up, of course in relation with the way the oil price is kept about $50 per barrel, but now this being said, from this perception to pushing the button and triggering a major project, I don’t think the level of confidence is yet there.

So, and there is a big uncertainty of course about what the OpEx will do at the end of June when the agreement in – November 2016 comes to an end, and this is waiting above everything we can say outside the US.

The US is driven by very specific market conditions, big demand, lot of confidence based on recent – including some recent political changes, the confidence is very strong, very high and the rest of the world, I think we are not yet there. We are progressing in the direction, but we are not yet there. Sorry not to be more specific about the rest of the world for 2017, but there is a real special context.

Philippe Crouzet

Thank very much for listening the conference call of tonight. Thank you and bye, bye.

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