Vallourec SA (OTCPK:VLOUF) Q1 2019 Results Conference Call May 16, 2019 12:30 PM ET
Jean-Marc Agabriel - Head of Investor Relations
Philippe Crouzet - Chairman
Olivier Mallet - Chief Financial Officer
Didier Hornet - Senior Vice President, Development and Innovation
Nicolas de Coignac - Senior Vice President, North America
Conference Call Participants
Jacob Green - BTIG
Jean-Luc Romain - CM-CIC Market Solutions
Johnson Imode - Bloomberg
Jean-Francois Granjon - ODDO
James Evans - BNP Paribas
I will now hand you over to your host, Mr. Jean-Marc Agabriel, to begin today's call. Thank you.
Thank you for joining us for Vallourec Q1 2019 Results Presentation. I am Jean-Marc Agabriel, Head of Investor Relations. With me today to comment these results we have Philippe Crouzet, Chairman of the Management Board; Olivier Mallet, Member of the Management Board and Chief Financial Officer; Didier Hornet, Senior Vice President, Development and Innovation; Nicolas de Coignac, Senior Vice President, North America.
This conference is available by conference call. It is also audio webcasted on our Investor Relations website. A replay will be available, and the presentation slides are also available for download.
Before I hand over to Philippe Crouzet, I must warn you that today's conference call contains forward-looking statements, and that future results may differ materially from statements or predictions 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 documents filed with the French AMF, the regulator. This presentation will be followed by a Q&A session.
Now I would like to leave the floor to Philippe Crouzet.
Thank you, Jean-Marc, and good evening, everyone. It's my pleasure to present our first quarter results and prove, once again, that we are well on track with our recovery plan.
Let me start on Slide 5 with an overview of the quarter and the main takeaways we want to leave you with. First, Q1 recorded a strong performance both in revenue and in profitability. Revenue enjoyed a healthy double-digit increase, essentially driven by EA-MEA regions, as we have flagged when we reported on Q4. EBITDA posted, again, a material rebound, moving from a loss of €5 million last year Q1 to a profit of €67 million. We have now crossed the mark of 200 -- exactly €220 million on a rolling 12-month basis, and we demonstrate that way the solidity of our profitability recovery.
Second, another major accomplishment of the quarter is, obviously, the cash flow performance. We were able to reduce free cash flow consumption by almost €100 million compared to 2018, thanks in addition to the higher EBITDA to decrease net working capital requirement over the period. We reduced the working capital requirement by 4 days at the end of Q1 2019 at 117 days compared to 121 days last year, and this is fully consistent with our objective for the year.
Third takeaway, our liquidity position remains sound. End of March, we had a cash position in excess of €1 billion, including a €600 million drawing on our banking facilities. The undrawn and fully available amount of these facilities was at €1.5 billion. And our net debt was at €2.1 billion at a level fully compatible with our banking covenant.
Lastly, a few words on market trends and outlook, and of course, I will be elaborate a little more at the end of this presentation. But let me just confirm the 2 levels we highlighted with our annual results, namely: firstly, we continue to anticipate market recovery in the oil and gas market essentially driven by the EA-MEA; and the second point is that we remain fully confident in our ability to deliver an additional €200 million of savings at least by the end of 2020 and partly, of course, in the course of 2019. And we are progressing well on that front. Our targets for 2019 are unchanged. We still look for strong increase in EBITDA and an improvement in working capital requirements, measured in number of days.
On the next slide, Slide 6, we rapidly go through the key figures, therefore, top line first. Volumes and revenues recording double-digit growth, respectively, plus 11% and plus 19% and 17% organic growth. Such an improvement was broadly based, globally based with almost all regions recording this double-digit growth. And of course, as I already mentioned, it was largely driven by the contribution of oil and gas activities in the EA-MEA and positive price mix effect in North America, whereas Powergen declined, impacted mostly Middle East and Asia region.
As far as EBITDA is concerned, so continuous progress, reaching €76 million. And this is perfectly consistent with our objective of a strong improvement in profitability for the full year.
And thirdly, we reduced our free cash flow needs, free cash flow consumption by almost €100 million. And this is the result both, of course, of the improvement in cash flow from operating activities and of the continued focus on working capital management.
I now hand over to Olivier to elaborate in more details on the financial results.
Thank you, Philippe. Good evening, everyone.
So let's move first to revenue on Slide 8 with the main points by market. Starting of course, with oil and gas, our largest market with 2/3 of our revenue, where revenue is up strongly by 37% year-on-year or 33% at constant exchange rates. This strong performance was driven firstly by EA-MEA as the bookings reported in 2018, which doubled compared to 2017, translate now into revenues. In North America, revenue growth was mostly driven by the price increase effective as from Q3 last year.
The Industry & Other revenue were also up nicely, plus 31% or plus 34% at constant exchange rates. This was a result of high revenue in Brazil notably from our iron ore mine.
And finally, Power Generation was significantly down. This market continues to suffer from declining demand for conventional power plants, in particular in Asia. This is why we have decided to launch the process you are aware off of divesting our assets dedicated to this market.
Switching now to a more detail on revenue and EBITDA on Slide 9. First, as Philippe already highlighted, revenue growth was strong in Q1. It was made up of a positive volume effect of 11% and a positive price mix as well of plus 6%. The industrial margin increased by 63% year-on-year to €168 million, adding 4.5 percentage points of margin. This reflects higher volumes, favorable price mix and the positive impact from the savings generated with our Transformation Plan. Tight cost control continued on SG&A expenses as well, reduced by 8% and being 2.6 percentage points less than last year compared to sales. All these positive evolutions led to this strong improvement of €72 million in the EBITDA. You can note that the impact of the new IFRS startup 16 was a positive €8 million.
On the next slide, some comments on the rest of the P&L. The first comment being that the operating loss was minus €19 million, reduced by €111 million year-on-year, thanks to the EBITDA improvement and to lower charges for asset disposals, restructuring and other and no impairment. You can note that the increase on the line amortization and other depreciation is mainly due to a negative €7 million IFRS 16 impact on this slide. Financial charges were up as a result of higher interest charges related mainly to the H1 2018 bond issuance as well as foreign exchange result from hedging of commercial operations and a negative €3 million IFRS 16 impact. Finally, net loss was reduced by €80 million.
After these comments on our P&L, let's move to cash, which, as you know, is our very first -- top priority. Let's start on Slide 11 with working capital management with the same slide that we presented to you in Q4, which puts into perspective the evolution of our net working capital requirement days for each quarter since 2014. Our Q1 performance confirms our discipline in this regard. Indeed, net working capital requirement was at 117 days of sales at the end of Q1 '19 compared to 121 days at the end of Q1 '18. This number of days of sales is also lower than for all previous years. This achievement in Q1 is consistent with our objective to reduce the number of days of working capital, both on a quarterly average and at the end of this year.
This leads to our comments on free cash flow on Slide 12. As Philippe mentioned in his introductory remarks, cash flow performance improved markedly year-on-year with an outflow reduced by €95 million year-on-year, including a small €5 million IFRS 16 positive impact. A bit more than half of this improvement came from better cash flow from operating activities driven by the EBITDA revamp. The rest came from working capital. It has increased like every year in Q1, but this seasonal buildup has been reduced, thanks to a good performance in cutting the number of days of sales year-on-year.
A few words on net debt on Slide 13. At March 31, 2019, it's true that €2.125 billion after reclassification of €58 million to lead that under the new IFRS 16 standard. This increase of €126 million in Q1 reflects the free cash outflow of Q1, partly offset by asset disposals and other items for positive €33 million. This positive notably includes contribution of Sumitomo Corporation for €51 million to a capital increase of our U.S. subsidiary, Vallourec Star, pro rata its holding percentage.
To conclude my part, liquidity on Slide 14. Vallourec liquidity is strong with a cash position of €1.072 billion as of the end of March 2019, and on top of it, €1.5 billion of undrawn committed bank facilities. So all in all, we have access to a total liquidity of €2.6 billion. As a reminder, we have no major banking maturity before 2021, thanks to the extension of €600 million bank facility that took place 3 months ago.
One word as well on our banking covenant, which is tested, as you know, once a year, at the end of December. Still at the end of March, we give you the figure. This banking covenant is estimated at 78%, well below the limit of 100%. This ratio is not impacted by the implementation of IFRS 16.
With these words, I now give back the floor to Philippe.
Thank you, Olivier. Before I move to the outlook, I'd like to come back, and this is Slide 16, to our Transformation Plan and all our internal efforts to further accelerate our recovery. Basically, it is around savings, mainly in Europe and in Brazil. As we announced last February, we target a total €200 million of additional savings to the €445 million that we already achieved end of 2018. And on top of those savings, we'll improve our financial performance, in addition, by divesting the assets related to conventional Powergen, as mentioned by Olivier, which, today, are not generating profits.
In Europe, our savings plan is mostly focused on Germany. We've done most of what we had planned in France. It does include a broad range of measures, procurement, efficiencies and obviously, head count. We are advancing well as far as head count is concerned out of the targeted 600 job reduction by 2020. 135 exactly of our employees already left the group by March 31. And I remind you that those figures, those job figures, do not take into account the potential impact of exiting the core Powergen business, which, in Germany, is 1 mill of approximately 300 employees.
In addition to what we do in Europe, we will continue to improve our savings initiatives, especially in Brazil where we focus on improving productivity, including sourcing and inventory management as well.
Now moving to the outlook, Page 17, outlook per region and markets, limited changes, indeed. Regarding oil and gas firstly, in North America, we observed a market slowdown during the first part of the year. Visibility is honestly quite low for the second half. There are contrasting trends at play on the one hand on positive side. H2 could benefit from the recent rebound in the WTI prices, following the massive drop at the end of last year. But on the other side, this could be somewhat counterbalanced by increased cash discipline from operators and some other factors. So hard to be very specific about second half in North America.
As opposed to that uncertainty regarding EA-MEA, we are very confident that the recovery underway in our oil and gas activity is solid and sustainable. And this is supported by our strong backlog and strong bookings.
In Brazil, oil and gas activities should remain broadly stable, and the recovery will take off in 2020.
If we now look at industry, we see mixed trends according to region. In fact, Europe remains under pressure, while Brazil should benefit from an improved macroeconomic outlook and positive trends for our mine operations.
So based on all that and moving to the last slide, Slide 18, our outlook for 2019 is basically unchanged. We continue to expect the recovery in the oil and gas activity, essentially driven by international markets. And we confirm the targets that we communicated last February, namely: strong increase in EBITDA, supported by market trends and our additional cost savings program; the continuous working capital improvement. You know that there is some seasonality with the peak outflow in H1. However, our target is clearly to continue to diminish the number of days of working capital both on a quarterly average and on a year-end perspective. And lastly, our CapEx envelope is unchanged at around €180 million. So based on all these objectives, we reiterate our confidence that the group would respect its banking covenant at the end of 2019.
This concludes our presentation, and we are happy to answer your questions.
[Operator Instructions] And the first question comes from the line of Igor Levi from BTIG.
This is actually Jacob, on for Igor. So Brazil used to be one of the largest markets for you in the last upcycle. And you mentioned a little bit in your presentation that Brazil is in this wave of recovery that should commence in 2020. Could you talk a bit about what are the moving pieces that might need to fall in place in Brazil? And how large an -- of an opportunity for you guys this could be? Could Brazil return back to the levels seen back in 2013?
Thank you, Igor, for your question. In fact, the word recovery is more applicable to our industry, nonoil and gas activities where, really, we suffered a significant slowdown over the last years. The macroeconomic environment was very bad in Brazil. And so this is ongoing. And so this is part of our activity in Brazil and moving in the right direction, mostly driven, as we speak, by automotive and more specifically, heavy vehicles.
Now as far as oil and gas is concerned, the reason why we have a positive view of the years to come is that, firstly -- well, in fact, there are 2 factors. Firstly, clearly, Petrobras is back on track. They -- you've heard, of course, very significant crisis over the last years, which kind of capped their project. They did not invest as much as anticipated, although they kept on drilling, of course, but not as much as they had planned. And now they are step-by-step quarter after quarter improving their balance sheet situation, enabling them to dedicate more resources to drilling. So the last version, which they update every year of their business plan is clear about their commitment to invest more and more specifically, in upstream and more specifically, in presold areas. So this is one reason for our positive view.
And the second one is that in the meantime, during the crisis, the market, the Brazilian market, especially the offshore areas, were open to international oil companies and quite a number of them and the largest one, the one with the most resources came and then both blocked offshore and presold areas. And there are projects moving forward relatively rapidly for all of them. So all the big names are putting a lot of focus and resources on projects, which will -- and again, this depends only on them and on them getting their permits from the various authorities, they should start -- we should start to benefit from that trend as of next year, 2020. So first, the IOCs will advance and with plenty of resources dedicated to Brazil, and parallel or a bit later, Petrobras will come back as well. So these are the fundamentals of our positive views regarding the Brazilian market.
The next question comes from the line of Jean-Luc Romain from CM-CIC Market Solutions.
You are mentioning good backlog in the EA-MEA currently. Could you give us an indication on the bookings in Q1 '19 compared to Q1 '18 on EA-MEA, maybe not exact figure but a kind of indication if that's possible?
So we did not give an exact figure in the press release, so we won't do that verbally. What I can tell you is that the tendering activity is still at a very nice level, and our bookings follow. Our bookings are as well supported on top of the revival of the activity of our customers as well. From the good competitiveness, we have now achieved with [indiscernible] in China that contributes to that. So in short, the answer to this question is that bookings stay at a good level.
Are your price increasing?
In terms of prices, what we see in the EA-MEA market is a trend for increasing prices, not at the pace that we have observed in the U.S. in 2017 and '18, and I would say globally at the lower pace. And depending on the geographies, depending on the products themselves and which leads, in some cases, in some niches of high-end products to now more significant price increases. But so far, the rebound in our revenue and results in this part of the world has been more driven by better volume, better customer mix, better mix in general than by pure price increase.
[Operator Instructions] And the next one comes from the line of Johnson Imode from Bloomberg.
I wanted to do just ask for a bit of clarity around the Middle East and Europe contracts. Because previously, you've referred to multiyear agreements expiring. So has the upturn come more from the fact that these have been renewed? Or rather the underlying demand?
Johnson, let's say you are right, we have frame agreements typically with some large IOCs or typically in the North Sea. So let's say this frame agreement are still valid and delivered more volumes as the business is restarting. For example, in the North Sea, it's a very dynamic region today. But let's say the growth that Olivier was talking about is coming from an increased tendering activity, a significant increase of tendering activity, a significant increase of heat ratio that we are achieving, so that's delivering the contract level we have on the volume and let's say step by step allowing us to increase prices also.
Okay. And I think previously, you said these -- that the lag is over like to 6 months for these kind of contracts. Is that still roughly true? Or it's longer term, obviously, than in the U.S., which is Star?
Let's say you're right in a sense that we typically renegotiate pricing for the frame agreement we have on the 6-month basis, yes.
The next question comes from the line of Guillaume Delaby from Societe Generale.
Could you please maybe provide some more color about when [indiscernible] restructuring? If you can maybe talk to us about the timing, what are the next steps and when we might see that in your accounts?
Well, you will see that all around the year. As usual, those kind of restructuring movements since we did not plan to close a mill except [indiscernible]. I will find a buyer for the 1 related to Powergen, but the other ones are more like reorganization, like redesigning the flows, let's say efficiencies, productivity. Basically, the cost reduction on the labor side is a permanent process. It's not comparable to a full restructuring as the one we implemented in France where you close a mill at a given date. So it's an ongoing process or month after month, quarter after quarter, we reduce the head count according to the development of the new organization. So this is for the labor cost, but there are many other initiatives in this German recovery plan. And the -- some of them are related to renegotiating, let's say, the procurement conditions, and this as well shows up all along the year, depending on our consumptions based on the new pricing. So it's really a quarter after quarter, and of course, we report periodically, not on a quarterly basis but -- regarding the amount, total amount of savings.
[Operator Instructions] There is another question in the queue, and this comes from the line of Jean-Francois Granjon from ODDO.
Just two question, please. Could you come back on the U.S. markets? And could you be more precise what you expect for the second half in terms of the trends? Do you expect some recovery or more stability? So could you just be more -- could you just precise what you expect for these such markets? And the second question concerned with financial costs. We see a strong increase for the costs -- financial costs during the first quarter. What do you expect as well for the full year? Do you expect some more volume, €200 million financial costs for the full year?
Nicolas, the one on North America is for you.
Nicolas de Coignac
Yes, with pleasure, Philippe. Jean-Francois, the trend as explained by Philippe earlier, what we see in today is that there has been currently a slowdown in the first quarter. We expect some erosion still in Q2 as we're seeing the rig count also coming slightly down. It's now down from the 1,000 rigs threshold. We don't, from all the intelligence we gather from the markets, believe that Q2 will probably be the trough of this decrease in the rig count. And when discussing on the marketplace, I think that for the remainder of the year, probably, the operators that plan on decreasing rigs is offset by those planning on increasing rigs. So really, we believe that the second half of the year is difficult to identify, but we still believe that Q2 will be the lowest point. As of the same time, really, all the fundamentals on the markets are good. WTI stands pretty steadily about $60. The rig count didn't collapse. It's adjusting week after week. What we hear from the distributors is their inventories is also leveling down and reaching a decent point or a targeted point for them. We see some opportunity for improvements but still with very little visibility so far.
Jean-Francois, again the second question is for me. As far as the increase in financial charges in Q1 is concerned, it's made of three elements. One is pure interest charges that are linked to the bond we issued in April '18 and to the fact that we have grown some bank rate lines in Q1. The second part about the equal importance, which is due to the -- some foreign exchange losses when we hedged commercial operations when the spread between the LIBOR and the EURIBOR does increase, which has been the fact, it does cause a little bit more. And there's a third one, which is a pure accounting impact from IFRS 16, which takes place for €3 million. So this is for Q1. If we look for the full year -- if we compare to full year '18 seen from now, of course, there can always be some changes, seems to be a much more limited with, in particular, some foreign exchange losses we had for various reasons last year that are not supposed so far to happen again; the fact as well that we have reimbursed some of the lines we have drawn in Q1; and the fact, finally, that the weak appreciation of Vallourec Star that's had a financial positive impact. So much has increased probably on a full year basis than in Q1.
[Operator Instructions] And we do have another question in the queue, and this comes the line of James Evans from BNP Paribas.
I've got a couple. Just wondered if you could talk what about the rationale was for the capital increase in the North American division. I was under the impression it was one of the more profitable plants in your -- in the group. So just wondered why that needed the capital infusion. And then secondly, just wanted to ask about what you're seeing about the raw material cost being flat. If I look at some of the markets out there, it looks like there's been quite a good reduction so far in Q2. I thought that would be quite a big tailwind. So is that being offset by some other raw material costs that we can't see increasing? Or do you just expect this to be passed on to customers with price reductions in the U.S. in particular?
So on the first one, James, you're perfectly correct. Vallourec Star is not a point of concern in terms of profitability. The fact is that in the last few years, during the oil and gas prices in the U.S., Vallourec Star turned into the red in terms of cash flow as well. And as you may remember, there was a stronger cash-out in the year 2011, '12 when we did build our new rolling mill in Ohio. So all these led in the past to a capital structure of Vallourec Star, which was optimal, and we just decided to improve that through an internal recapitalization. But again, you are correct, the cash flow generation of Vallourec Star as of today is good. And there is no bigger CapEx or big anything like that, that is being forecasted and that would require a cash infusion. And by the way, this recapitalization has been supported by our minority shareholders, Sumitomo Corporation, which has put €51 million in cash in this operation, which improves both our debt and our equity and is as well some sort of message from Sumitomo Corp. about the quality of the relationship we have with them in the U.S. And the fundamentals, which they see as we do, has been good on this North American market.
On your second point, raw material evolution, just as a reminder, we buy a lot of scrap in the U.S. It's our main raw material to quite a large extent in Brazil as well. And in these 2 geographies, scrap costs went up very strongly, essentially in the H1 '18 and a little bit further, I would say, in Brazil in part of Q3. The point there is that it has been a strong negative in our P&L 2018 compared to 2017. The raw material cost to make it simple, maybe it's too simple, have stabilized since mid-last year. So that in Q1 this year, it's poorly still a little negative, I would say, but that should disappear soon now. You are correct as well when you say that over the last few weeks, we may have observed a slight decrease in the cost of scrap in the U.S. and in Brazil. So it could be a positive going forward. But so far, it's not marked enough to really take that into account, and these are volatile raw materials. So we stay cautious in this regard, and this is why we speak more about the stabilization than reduction of these costs.
And if I may, James, as far as iron ore is concerned, it's as well a material, which we use in Brazil and indirectly in Europe to our JV with ThyssenKrupp and Salzgitter. They do buy iron ore. This is being strongly inflated. As you know, the prices of iron ore are going up steadily, both due to the catastrophe, which took place in Brazil and as well for other climatic reasons in other regions of the world. But as you know, we are producing our own iron ore, and we are low on iron ore, which means that this overall, if we include both our performance with our mining activities and the raw materials, it's not detrimental to us.
There are no further questions in the queue [Operator Instructions]