International Conference Call
WEG S.A.
rd
3 Quarter 2010 Results
October 28, 2010
Operator: Good morning ladies and gentlemen and welcome to the audio
conference call of WEG S.A. 2010 3rd Quarter Results.
Thank you for standing by. As a reminder, this conference is being recorded and at
this time all participants are in a listen-only mode. Later we will conduct a question
and answer session and instructions to participate will be given at that time. If you
should require assistance during the call, please press the star key followed by
zero (*0).
To obtain the quarterly results press release or the presentation that we will be
using during this conference, please go to WEG’s investor relations page at
www.weg.net/ir.
Before we proceed we would like to clarify that the statements that may be made
during this conference call relating to WEG’s business perspectives, projections
and operating and financial goals and to WEG’s potential future growth are
Management beliefs and expectations, as well as information that are currently
available. These statements involve risks, uncertainties and the use of
assumptions, as they relate to future events and, as such, depend on
circumstances that may or may not be present.
Investors should understand that the general economic conditions, conditions of
the industry and other operating factors may affect WEG’s future performance and
lead to results that may differ materially from those expressed in such future
considerations.
With us today in Jaraguá do Sul we have Mr. Laurence Beltrão Gomes, Finance
and Investor Relations Officer and Mr. Luís Fernando Oliveira, Investor Relations
Manager. Please go ahead sir.
Mr. Laurence Beltrão Gomes: Good afternoon everyone. It is a pleasure to have
you at WEG's 3Q10 results conference call. We will make a quick presentation with
general comments and some additional details leaving ample time for questions
and answers later on.
So starting on slide number 3 we would like to highlight some aspects in this
quarter. Firstly the contribution that the acquisitions that we have recently
announced had for our revenue growth, both ZEST in South Africa and Voltran in
Mexico are now fully consolidated.
The other aspect is that we were able to grow out of Brazil, which is particularly not
worthy when one considers the appreciation of the Brazilian real during this period.
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Much of our business can be characterized as the late cycle as we depend on
investment in capacity expansion, which normally happens after consumption has
already recovered. The late-cycle characteristic is most evident in areas such as
GTD.
Still the result of the recent auction of renewable energy has left us optimistic about
the prospects for wind energy in Brazil, a new alternative for the country. We have
already some sales in this segment, mainly substations and wind farm
infrastructure as connections to the electric grid, and we can continue to further
integrate our solutions.
Moving to slide 4 we have the main figures of 3Q10. We emphasize that revenue
growth occurred both in the comparison to 2Q09 and the previous quarter. This
means that the gradual recovery of the market, as we have said on several
occasions in recent quarters, is becoming increasingly clear. We call your attention
to the fact that comparison of revenues accumulated in the first nine months we
are almost on par with 2009.
Recovery has been stronger and more evident as we have also highlighted before
in the short cycle products, which results in a poorer sales mix and have negative
impact on margins. This is evident in comparisons of gross margins, Ebitda and net
margin. We will address these issues in more detail later in this call.
Turning to slide 5 we highlight the Brazilian industrial production data published by
IBGE, which helps to put the results into perspective. The recovery of the Brazilian
industrial production continuous very robust with accumulated rate, growth rate of
over 14% in the first eight months of 2010. It seems clear that the recovery goes
beyond simple inventory rebuilding and the occupation of the idle production
capacity. We are in the early stages of a cycle of investment in industrial capacity,
which seems consistent as indicated by the expansion of 28% in industrial
production of capital goods accumulated by August 2010.
Outside of Brazil the data point to some moderation in the pace of recovery, but
does not confirm another economic slowdown. We highlight the strong growth
achieved in the foreign market: in real 30% and in US dollars 41%. Remember that
this growth was obtained in the context of another period of appreciation of the
Brazilian real. The consolidation of the acquisitions was beneficial, no doubt, but
we would have observed revenues increase even adjusting for the R$ 85 million
net impact of the consolidation. Growth of the domestic market must be considered
in the context of changes in the product mix.
Moving to slide 6, which shows the distribution of revenues among the various
regional markets and the physical presence of WEG in the world. The domestic
market has maintained a relative stability of its relative importance, both as a result
of the appreciation of the real as for its good performance.
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Outside of Brazil we highlight the growth in exports over the previous year. North
and Latin Americas are recovering well, albeit at moderate pace. The US continues
to be supportive with OEM-driven demand and increased market shares. We have
strong market positions throughout Latin America. Asia remains strong especially
in China and India. Africa also continues to perform well and is one of our good
markets outside of Brazil. Europe continues without major developments, not
particularly dynamic, but no signs of further worsening.
On slide 7, please, we can clearly observe the changes in product mix. The
recovery has been driven by short-cycle products as it is quite clear; consumer
goods continue to perform well, the favorable credit employment and income
conditions in Brazil stimulate consumption of durable goods such as whitewoods.
Investment in expansion of industrial capacity is still increasing. BNDES'
performance has been very important in Brazil, extending the PSI credit program at
favorable terms and rates. In other markets we have the combination of recovery of
demand and market share gains. In T&D we have already seen a more clear
recovery, even though these are longer-cycle products. In electric power
generation, however, we are more focused in distributed generation from
alternative sources of energy. The prospects are attractive, but the recovery occurs
at a slower pace.
Now I would like to call Luís Fernando Oliveira to give some additional details on
the quarter.
Mr. Luís Fernando Oliveira: Hi, good afternoon everyone. We are now moving to
slide number 8 where we have the cost of goods sold breakdown. We had already
described some of the effects that we are going to be seeing here, the first one is
that the comparison with 3Q09 is a difficult one, since that was a quarter with a
very good product sales mix and this has an impact on the gross margins.
We have achieved good results in controlling costs and having operational
improvement in this year and those results are becoming increasingly more
apparent. Although the occupation of productive capacity has improved, we have
not reached yet the ideal dilution of fixed costs, which causes impact on the cost of
factoring and increases the relative importance of the other costs here in this
breakdown.
Cost of major raw materials (steel and copper) has increased. We have been able
to neutralize these impacts by adopting a careful exposure management policy and
also by diversifying our sources of supply.
In slide number 9 we can see the margin. Our gross margin shows the effects in
the product mix in this quarter as we discussed early. Ebitda margin showed the
same effect of the product mix, but on the positive side we are getting
progressively more successful in our efforts to control operating expenses. The
change in net margin has been even smaller. Here we have a positive net financial
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result of the appreciation of the Brazilian real against the US dollar, which has an
impact on liabilities, and the relative appreciation of the Brazilian real against the
euro, which has a positive impact for us on receivables.
On slide number 10 we have the analysis of the change in Ebitda. The positive
changes in gross revenues, the higher prices and volumes of sales, mix changes,
the incorporation of the acquisitions to a total of R$ 180 million being offset by a
currency appreciation which produces a negative impact of R$ 43.6 million. We
also had a negative effect of cost of goods sold to the total amount of R$ 161
million as a result of the poorer product mix.
The negative impact of the increase on operating expenses (many general and
administrative expenses) is quite small in this quarter, as are the changes on the
profit-sharing scheme that we have, the PWQP. The net effect of all those changes
is an absolute negative change of R$ 45.6 million or minus 17.8% and a decrease
on Ebitda margin to 17.6% in this quarter.
On slide number 11 we have the graphic representation of the cash flow. We can
see that the cash flow for operating activities remains strong despite the pressure
on working capital as is usual in moments of deceleration of revenues growth.
Cash flow for investing activities showed the continuation of the investment in
capacity expansion and acquisitions. We also have been pursuing a lengthening of
our debt profile with positive impacts on the flow from financing activities. The
variation of the cash accumulated in the first nine months is largely positive in
2010.
In slide 12 we have the debt and net cash positions. The positive cash generation
situation that we have just described allows us to maintain a net cash position even
after the payment of the first half of 2010 dividend - that we did in August - and
some acquisitions related to obligations that we paid during this quarter. We have
highlighted the lengthening of the debt profile over the past few quarters with new
borrowings from BNDES at very attractive rates, giving us comfort to continue our
investment program.
As a matter of fact, the investment program and the evolution of investment
program over the past few quarters can be observed on slide 13. Here you have to
consider in the normal condition from quarter to quarter we continued to invest in
expanding production capacity anticipating better demand conditions in the near
future.
The highlights of the Capex programs are the new high-voltage electric motors and
generator plant in Hosur, India, and the new commercial electric motors plant in
Linhares in the Northeast of Brazil. Both plants should begin operating late in 2010.
Of course we continue focused on the areas of greater demand. Flexibility and the
speed of deployment of the Capex program is the main characteristic that we have
in this program.
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This pretty much concludes the presentation and we are now ready to entertain
any questions that you might have for us. I would ask the operator to please go
ahead and conduct the Q&A session. Thank you.
Q&A Session
Operator: Excuse me. Ladies and gentlemen we now would like to start the Q&A
Session. To pose a question please press star one (*1). To remove your question
from the questioning queue press star two (*2).
Excuse me. Our first question comes from Ms. Verena Wachnitz with T Rowe
Price.
Ms. Verena Wachnitz: Hi, good afternoon everyone. Just a few questions: you
mentioned your costs, how you are managing suppliers and I am just wondering
with the recently implemented new minimum price to calculate import tax, if this in
any way is making it more difficult, do you think it will make it more difficult for you
to import steel? That is my first question.
And my second question is just on the margin recovery and the speed of the
margin recovery. Could you give us an update when do you think we go back to
normalized levels and maybe you could relate back to the speed that we will see
the better order book especially in TD to translate into revenues and Ebitda
generation?
Mr. Oliveira: Sorry Verena, can you repeat the second question?
Ms. Wachnitz: The speed of margin recovery, when we will see them normalizing
and when we will see the contribution of TD and GTD normalized?
Mr. Oliveira: Well, first on the materials side we do not have many details of
minimum prices for imports and that kind of thing; what I can ... what we can say is
that we have been pretty active on managing the import of ...
More than the import actually it is actually part of this general management or
exposure to the FX rate. It has been able to have as spread out supply as possible,
try to reproduce as much to the extent possible the international price of steel. We
have been implementing that for a few years, we are becoming more sophisticated
on that, we have implemented that more intensely. So far we are pretty content
with the results so far.
It would be hard to tell you if there are any changes that would make that more
difficult. You have to remember it is not only imports, it is also having production
outside of Brazil, it also works towards that. So we have a few options; we can
always, for example - and we did that from time to time - we can negotiate price ...
cost in Brazil under different conditions with our suppliers. We are large enough to
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do this kind of thing. So even if it comes to that - I am not saying that it comes to
that - but if it comes to that we do have other options as well, ok?
In terms of the margin recovery it is going to take time; it is really a matter of having
a more normalized situation in terms of all the different divisions working in a more
… all systems go way. We are still seeing some reflections of the slowdown that
we had last year; as we go on those reflections are going to become weaker and
weaker and weaker and there is going to be a more normal situation and we
should trend up towards a more normal margin level. Eventually it is something
that is going to happen over the next few quarters.
Ms. Wachnitz: Ok. Can I ask you one more related to margins? I guess I know
your SG&A as a percentage of revenues went down; but in absolute terms it did
increase significantly. Is that related to shipping costs or ...
Mr. Oliveira: The sales expenses especially tend to have a more variable
characteristic, so revenues go up, sales expenses typically go up as well. The
administrative, general and administrative expenses are more fixed in nature and
those are the ones we have been more successful containing. We are paying a lot
of attention to that part of the P&L. It has been receiving lots and lots of attention.
Ms. Wachnitz: Maybe the acquisitions also had an impact on that number if these
companies have higher SG&A ratios and ...
Mr. Oliveira: I mean, it is down compared to the previous quarter, if I am not
mistaken, and about the same level - selling expenses and talking about - about
the same levels that we saw before, so it is hard to do much more than we have
done especially in selling expenses. In selling expenses it is really a reflection of
scale: the more scale we have you do have a little bit scope for reduction; but other
than that it tends to be very variable.
Ms. Wachnitz: Yes thank you.
Operator: Excuse me. Our next question comes from Mr. Larry DiMaria with
Sternage.
Mr. Larry DiMaria: Hi good morning. A couple of questions: you talked about
growth outside of Brazil; it looks like quite a bit of it probably came from the
acquisitions; is that right or ... if you back out the acquisitions it looks like you are
sort of flat outside of Brazil; is that right?
Mr. Oliveira: You have to remember: we said this increase from acquisitions in
revenues was R$ 86 million and if you look at the numbers compared to 2Q for
example numbers went up from almost that number in dollars, almost US$ 80
million. So even considering, even adjusting for the acquisitions we had organic
growth outside of Brazil.
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Mr. DiMaria: Ok and then as it relates to growth outside of Brazil also you
mentioned you are taking some market share I think in the US; how big is that,
where is it coming from?
Mr. Oliveira: It is basically we are getting a larger piece of the pie especially in the
OEM part of the business; for example it might be some situation like a large OEM
works with five suppliers for example and we just instead of having 20% of that
business we went up and had like 25 or 30% of that business. It is just like
dislocating some of the weaker players in this business and not necessarily having
new clients, but grabbing a larger piece of the existing clients’ pie and that has
been a driver for us in the US especially.
Mr. DiMaria: Ok, that would be like (inaudible 22:06) and something like that or ...
Mr. Oliveira: It is in general terms, in the large OEMs and even the smaller ones
and you also have to remember we are executing our Q&D strategy in the US as
well, I mean, we do have ... Q&D is a new business for us, it is not directly related
to the industrial equipment business - it is GTD - but it is a brand-new business for
us. Anything that we get there goes straight to the growth rate, because it is
comparing to nothing last year.
Mr. DiMaria: Yes, that was going to be my next question, thanks for bringing that
up. On the TD side in the US remind us the size of the transformers and that you
guys are making in Mexico and the kind of volumes that you guys are doing.
Mr. Oliveira: We are talking about a kind of midrange size of transformers, so what
we call ... in Portuguese we call "meia força", half-force. I do not know how that
translates. It is a kind of midrange, kind of like you would use in an industrial site
substation, ok? And that is the market that we are going at the US.
Mr. DiMaria: Ok and what kind of volumes are there now? Is that very, very
nominal still or is that growing?
Mr. Oliveira: We are executing according to the plan. We have been able because
apparently our timing was very good. We are penetrating in this market with a very
good timing because we are finding … time actually than one would suppose. We
are going after the more ... as always when you are entering a new market we are
going after the more price-sensitive business building up a track record to go to the
more technical-driven part of the market later on. But we are building up a track
record in the North American market in general and in the US particularly going
after the more price-sensitive. So far we have been able to execute prices going
exactly ... according as planned.
Mr. DiMaria: Ok. I assume that the business outside Brazil is a sort of average
market mix for you?
Mr. Oliveira: Sorry, outside Brazil is ...
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Mr. DiMaria: Out the margins are lower than in Brazil, right?
Mr. Oliveira: Well, the product mix is different in Brazil. When you are comparing
apples to apples the margins tend to be similar, part of the mix is different … what
stage of the market development you are.
Mr. DiMaria: Ok, that makes sense and right now you guys are running ... how far
are you guys running in terms of capacity utilization in Brazil and then will we see a
lot of investments being made for example in the auto industry - you know, US$ 10
billion in the next couple of years - do you guys have the capacity to play there and
then can you grow market share there in terms of auto factories for autos others in
Brazil?
Mr. Oliveira: Yes, yes. I mean, we are approaching what ... if you assume that
around first disclaimer of capacity is a difficult concept for us, because we are
talking about a kind of equipment that it is not off-the-shelf, but anyhow if we
assume that around 90% would be the ideal capacity utilization we are
approaching that number one average.
But still we do have a lot of different levels depending on what you are talking
about; in some markets we are much closer to that number, in some markets we
are working above that number, in others we are still a little bit below that. So there
is some diversity in that number. The average is approaching that number, which
would be ideal, but we are not there yet as we as you can see in terms of the
dilution of the fixed costs is not the ideal yet.
In terms of the new plants we highlight Linhares, for example, which is the new
plant that we have been building up over the past year. So we still have the plant in
India as well. That also works towards helping freeing up a little bit capacity in
Brazil. We can always move production from Brazil into India, for example, the
production there would be directed to the Indian market. Now it can be produced in
India, a little bit more capacity here, so you mentioned the auto industry. We do
have several other industries there, we are very keen about, for example, oil and
gas, ok?
Mr. DiMaria: Ok thanks.
Mr. Oliveira: And that is something we always like to stress: building flexibility of
all the plans that we have. We try to be as flexible as possible, we try to build
assets that are the least possible specific in terms of we can produce highervoltage motors, we can move around and produce generators if that comes to it;
we can go up and down in the production line using the same assets. That is
paramount for us, is very, very important.
Mr. DiMaria: Ok thanks Luís.
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Mr. Oliveira: Thank you.
Operator: Excuse me. Our next question comes from Mr. Timothy Hay with SCM
Invest.
Mr. Timothy Hay: Hi Luís, this is Tim here in London. I just wanted to follow up on
a few points raised: on the margin side what you think is ... in a normalized year
what you think is a sustainable Ebitda margin for the company?
Mr. Oliveira: Well, Tim, thank you for your question. In a normal year if you think
about what we saw before - and we have been discussing that to some extent - we
had a major event in terms of the recession in 2008, 2009; but it is our
understanding that that has not changed the fundamentals of the industry.
Conceptually the industry remains quite similar; it is a matter of getting back on
track to the same level that we were before. So fundamentally ...
Mr. Hay: Are you talking mid-20s for an Ebitda margin in a normalized year or ...
Mr. Oliveira: We are talking about the same range we had before, 22% to 25%.
That used to be our range, that should be the normal range going forward. We are
not there yet, it is hard to tell how much, how long it is going to take for us to get
there; but we are getting there. That should be the normal level.
Mr. Hay: Ok and then you just mentioned in your answer to the previous question
about freeing capacity in Brazil and leading to India. Is that ... India must be coming
on line any day now, right?
Mr. Oliveira: It is approaching. We should start up towards the next few weeks.
Mr. Hay: Right, ok and then one final question you also mentioned expansion in
the presentation above wind, but then you also mentioned earlier on you were in
the gas sector and how much of the company is directed towards the oil and gas
sector?
Mr. Oliveira: You mean ...
Mr. Hay: I mean how much GTD side of it, how much of the GTD side is directed
at the oil and gas sector?
Mr. Oliveira: Well, GTD has a complement of oil and gas because we are selling,
for example, generation systems for the oil platforms for example. It is not as
important, most of the GTD relates to other forms of generation; actually oil and
gas relates more to the industrial equipment part of the business and systems part
of the business, where we can sell, for example, motors for pumps and goes on
and on; the automation around the oil platforms and even downstream we do have
applications as well.
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What we said is we do have the option now, part of the production capacity that we
have here in Brazil, especially in the large machines, is being used to fulfill orders
that we have from India - I mean, we have been fulfilling those orders for a few
years now. With the new plant in India we can start fulfilling those orders using the
Indian plant and freeing up the capacity here in Brazil. Does that make sense?
Mr. Hay: Ok thank you. That makes sense, thank you.
Mr. Oliveira: Thank you.
Operator: Excuse me. Ladies and gentlemen as a reminder, to pose a question
please press star one (*1).
This concludes today’s question and answer session. I would like to invite Mr.
Laurence to proceed with his closing statements. Please go ahead, sir.
Mr. Gomes: Again we thank you for your presence and the questions in this
conference call. We remain confident that the opportunities for WEG in the future
are very attractive and we would like to call your attention to four points of
attractiveness of the longer-term: firstly global growth driven by emerging markets
with specific demands of infrastructure; second the harmonization of regulations of
energy efficiency increasing the market for high-performance products; third, new
forms, more intelligent, efficient, to produce, process and use energy - no as a
smart greed, but which are wider; and finally particular events in Brazil as the
World Cup and the Olympic Games, the pre-salt investments and the pre-salt
investments in oil reserves.
Our growth and profitability track record is solid. We have the broadest portfolio of
electric electronic products in the market from the generation, transmission and
distribution of electric energy to its efficiency in industrial use.
Finally we invite everyone to visit us in Jaraguá do Sul and see our facilities here.
This is the best way to get to know WEG. There will be a great opportunity for this
visit in 2011 as we are preparing our first WEG investor day. Thanks and goodbye
for everyone.
Operator: That does conclude the WEG audio conference for today. Thank you
very much for your participation and have a good day. Thank you.
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