Ternium S.A.

Good morning. My name is Emma and I will be your conference operator today. At this time, I would like to welcome everyone to the Trinium third quarter 2021 results conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, again, press star one. Thank you. Sebastian Marti, you may begin your conference.

Good morning, and thank you for joining us today. My name is Sebastian Marti, and I'm Ternium's Global Investor Relations and Compliance Senior Director. Ternium released yesterday its financial results for the third quarter of 2021. This call is complimentary to that presentation. Joining me today are Ternium's Chief Executive Officer, Maximo Berogia, and the company's Chief Financial Officer, Paolo Briccio, who will discuss Ternium's business environment and performance. At the conclusion of our prepared remarks, there will be a Q&A session. Before we begin, I would like to remind you that this conference call contains forward-looking information and that actual results may vary from those expressed or implied. Factors that could affect results are contained in our findings with the Securities and Exchange Commission and on page two in today's webcast presentation. You will also find any reference to non-IFRS financial measures reconciled to the most directly comparable IFRS measures in the press release issued yesterday. With that, I'll turn the call over to Mr. Bedosa.

Thank you, Sebastian, and thank you all for joining us today. Ternium reported outstanding results in the third quarter, with record EBITDA, sales, margins, and net income. With a strong performance expected also for the fourth quarter, we are headed to a record year in 2021. Let's now review the state of our steel markets. The global steel business environment remains healthy. The USMCA market continues to be relatively tight, although there are some signs this situation is moderating. Steel inventories in the US are increasing, but continue to be at relatively low levels, and lead times are also slowly normalizing. In a recent development, the US and Europe announced an agreement to relieve European steel imports from Section 232 tariffs, subject to certain conditions, including a specified maximum tonnage and the need for the steel to be melted and poured in Europe. In this environment, benchmark steels in the US currently remain at high levels. We continue to believe that steel prices are going to begin a downtrend at some point in the following month, although we don't expect them to reach the lows we saw back in 2020. There are several reasons for us to have this view. Steel demand in the region is steady, especially in industrial markets. Global supply chains continue having significant disruptions. Backlogs in certain industries like automotive and whitewood should help sustain good steel demand levels into 2022. We are seeing near-shoring of manufacturing capacity to the USMCA region and steel production in China is decreasing in line with the country's efforts to control carbon emissions. Looking ahead, After a tight steel market in 2021, we expect the steel supply demand environment to gradually balance in 2022 with steady steel demand and a normalization of global supply chains. Let's move now to a review of our main markets. The Mexican steel market is currently showing two different business environments. On one side, the natural market made up of the different manufacturing industries in the country is working at a very high level of utilization to meet strong end product demand. The only exception to this is the automotive industry, which in the third quarter continues to be significantly affected by the semiconductor supply chain disruption. This is preventing OEMs from utilizing their full production capacity. So, it is possible that Mexican auto industry production in 2021 ends up being similar to that of last year. Opposite to this broadly positive environment in the industrial market, the construction sector in Mexico continues to weaken. This sector has not been able to recover to pre-pandemic activity levels yet, as the industrial sector did. Going to Argentina, steel shipment in this market has been pretty healthy for the last 12 months. After a lengthy restocking process following the COVID-19 related lockdowns, Inventories in the value chain in Argentina are now back to normal level. The best performing sectors are currently the agro-business industry, the automotive industry and construction. We expect to see relatively stable shipments in Argentina during the fourth quarter with some seasonally lower volumes by December. Nevertheless, Argentina continues to suffer from significant uncertainty regarding its main macronomic variables and its capacity to renegotiate its debt with the IMF. Activity in 2022 will depend on how these pending issues are addressed. I would like now to make a quick comment regarding the process on some of our sustainability initiatives in the quarter. In February, we announced a mid-term target to reduce by 20% Ternius CO2 intensity rate by 2030, together with the main initiatives needed to achieve this. One of these initiatives is the expansion of carbon dioxide capture capacity in our facilities in Mexico. This is not new for us. We have been capturing CO2 in our three DRI models for many years. These models in Monterrey and Puebla are among the greenest in the world, and there are actually very few of this kind out there. In September, we finished the first stage of our new carbon capture program with the expansion of the carbon capture system of the DRI models at the Monterey facility, with an increase of 38% in its capture and usage capacity. The CO2 is sold to industries, to different industries, avoiding new CO2 emissions and favoring circular economy. After this expansion, we expect to have yearly carbon capture and usage capacity of 285,000 tons of CO2 between our facilities in Monterrey and Puebla. This represents the annual emission of approximately 61,000 cars. And we have a second stage in the making that will increase this even more. Another development in this field, since our last conference call, is the signature of an MOU with Vale, our main iron ore supplier, to jointly develop steel-making decarbonizing solutions. We are analyzing different alternatives from this. like an iron ore briqueting plant located at Ternium Brazil facility and plants to produce metallic products with low carbon footprint using valid TechnoRed technology, Ternium's HYYL and other technologies for iron ore reduction. Also, as part of our ESG program, we received in September confirmation from UN Women to our application to be a signatory of the women's empowerment principle, which promotes gender equality. Diversity and inclusion are two important topics in Ternium agenda. We work to create a workplace environment that attracts and develops talent across all gender, nationalities, and generations, valuing our individual differences. Another positive development in the quarter was Ternius Board of Directors announcement of an interim dividend payment of 80 cents per ADS. This decision reflects the strong business environment and the significant cash generation the company has achieved so far during this year. It also marks the transition from an annual dividend payment schedule to a 20-year payment, with an advance in November and a fine line payment in May. I believe this change, if in our dividend payment schedule, is a very positive development that underscores our long-term commitment to the return to our shareholders. Before finishing my remarks, I would like to make a quick update about the status of COVID-19 pandemic interneum. Active COVID-19 cases among Tarlim's personnel are currently very low, reflecting a decrease in the rate of infections in Latin America over the last month. Despite this good news, we continue applying strict sanitary protocols in all our facilities. The government vaccination program has progressed well in the different countries where we have operations. And at the moment, 92% of Pernium's employees have received at least one dose of COVID vaccine, and almost 70% are fully vaccinated. Okay, I will stop here and let Pablo go over our performance in the third quarter. Pablo, please go ahead with the Whitecap presentation.

Good morning to everybody, and let me discuss Ternium's performance for the third quarter and the expectations for the last quarter of this year. Ternium has just delivered a very strong set of results, actually the strongest in the company's history. We have a very high starting point here, but yet the company expects to achieve in the fourth quarter should be very solid again. You can see On the page three of the webcast presentations, EBITDA is reaching $1.9 billion in the third quarter, representing 41 percent EBITDA margin. And $612 EBITDA pattern, a net income reaching $1.4 billion, or $6.12 per ADS. For the fourth quarter, we expect a sequential increase in cost per ton, partially offset by an increase in revenue per ton. With shipments remaining relatively stable, this should drive to a slight decrease in the BDA quarter over quarter. Let's analyze this in more detail, starting with steel shipments in the next stage of the webcast presentation. On a sequential basis, sternum shipments in Mexico and in the southern region decreased slightly in the third quarter. In the air market region, shipments increased 7% sequentially, mainly due to higher finish till shipments as slab sales to third parties remained relatively stable. In the next page, number five, you can see that combining these developments, we arrived to consolidated steel shipments of 3.1 million tons in the third quarter. This volume is the same as in the second quarter, at 8% higher year over year. Looking into the fourth quarter, we expect shipments to remain relatively stable, with slight finished steel increase in the other market region upset by lower sales of slabs to third parties and lower shipments in Argentina and Mexico, in part affected by seasonality at the year end of this 2021. Now let's examine steel prices. Changes in revenue per ton has been relatively uniform across the company's main steel markets in their way up to record high levels. Realized prices in Mexico industrial market are expected to increase again in the fourth quarter, reflecting the upward trend in the U.S. spot steel prices with weaknesses this year, as contract prices in Mexico reset with a lag. Turning now to net sales in the bottom left chart, the combination of higher realized steel prices and stable shipments resulted in a 17% sequential increase in net sales. to a record high $4.6 billion in the third quarter. Moving to the next page, let's review now the main drivers behind the sequential increase in quarterly VDA and net income. The DDA chart on top shows that it increased sequentially reflecting mainly higher realized prices, partially offset by an increase in cost per ton on higher raw material prices and purchase slab costs. We expect in the fourth quarter a further increase in cost per ton as higher purchase price of raw material and slabs continue to flow through the company's inventories. As I mentioned in the start of my presentation, the increase in cost and revenue per ton are expected to lead to a slight decrease in EBITDA in the fourth quarter. The chart below shows the sequential increase in net income in the third quarter was due to record high operating income, partially offset by lower results from our participation in Yusiminas, which had, as you remember, a one-off gain in the second quarter. Turning now to page seven, we can see the same changes but for nine months of the year. The drivers of the record high EBITDA level in the nine-month period were the same as in the third quarter. As for net income, the main drivers of increase were record high operating income and equity in earnings in New Simeon. Now, in the last page, let's review the finish, and to finish this presentation, our quarterly cash flow and balance sheet performance. Cash flow from operations in the third quarter was $596 million, even after a significant increase in working capital. As you can see in the upper right chart, the increase in working capital was a result of a combination of factors, such as higher steel and raw material costs, higher inventory volume in part related to the ramp-up of the new hot rolling mill in Pesqueria. Trade receivables also increased mainly as a result of higher selling price with just slight increase in days of sales. Regarding the decrease in commercial debt, it was mainly the result of the decrease in iron ore prices in Torneum, Brazil. Looking forward, as steel prices continue to be high, and the new hot rolling mill in Pesqueria advances in its ramp-up process, we should see some investment in working capital, but nowhere near the figure we registered in the third quarter. Regarding free cash flow, the company generated $475 million of the capital expenditure of $111 million in the quarter. This led to a net cash position of $271 million as of the end of September. As Maximo mentioned, taking into consideration the strength of the company's performance and financial position, the Board of Directors has proposed an interim dividend payment of $0.80 per ADS, equivalent to $157 million, payable on November 16 to shareholders on record as of November 15. OK, with this, we conclude our prepared remarks. Once again, thank you very much for your time and attention. We are now ready to take your questions. Please, operator, proceed with the Q&A session.

At this time, I would like to remind everyone, in order to ask a question, press star, then the number 1 on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Caio Grenier with PTG Bactual. Your line is now open.

Thank you. Good morning. So my first question on your outlook. So you mentioned you expect slightly lower EBITDA for the fourth quarter. And I just wanted to elaborate a bit more on what you're seeing in terms of realized prices and costs for the coming quarter. On prices, you already have a good visibility on the readjustment of your contracts. I do understand that. But what do you expect for the commercial side and other shipments based on spot prices for the fourth quarter? And on the cost side, you mentioned raw materials costs, inflation, driving up costs. And I would assume this is mostly cold prices on the rise flowing through the results. But on the other hand, you also have iron ore prices materially dropping over the third quarter. So if you could please provide some more detail on this equation, that would be very helpful. And my second question, if I may, on Pesqueria, I mean, you guys mentioned the project has been ramping up at a slower pace. So I just wanted to see if you can maybe update what you expect in terms of shipments for the project, that equation of incremental shipments that you guys have been sharing with us over the last quarter. So if you can maybe share what you expect for the fourth quarter and for 2022 in terms of incremental shipments from Pesqueria, that would be very helpful. Thank you very much, gentlemen.

Thank you, Caio, for your questions. Let me try to answer your questions. Regarding the cost, the increasing cost is from the SLAPs, from the purchases of SLAPs. because, as you said, iron ore is decreasing and it compensates by the cost of carbon, which increases dramatically. So both those prices compensate each other. But the slabs we were buying were higher for the fourth quarter than for the third quarter. As you remember, part of our slabs we we ship them from the brazil operation but others we buy in the market so that's the the increase in the cost um and prices is as you said uh prices in in the in the industrial market are going to be higher because of the reset of the comfort prices right in the commercial market as you know there are spot prices and and as you saw the the prices of the cru for example in in in the North American market, it decreased a little bit in the last two weeks. So, we expect a slow decrease of those prices, at least from the Mexican market, not from the other markets. Pesquería updates. Our plan for pesquería is, we have this set back because of the permission issues, to be honest. The equipment was ready and was running, but this authorization for the transportation of natural gas was an unforeseen delay we had. But now the ramp-up curve of the facility is now okay. I mean, we are again in the ramp-up curve. Our expectation for 2021 is that the facility is going to provide us between 1.5 and 2 million tons of additional volume some of that volume is going to to the telegal facility which before that imports material but probably those are the numbers

Just to clarify, Caio, we are referring to 2022 volume. 2022, yeah.

From the year. Okay, that's great. Understood. Thank you very much, Maximo and Paolo.

Your next question comes from the line of Jonathan Brandt with HSBC. Your line is now open.

Hi, good morning, gentlemen. My first question relates to, I guess, pricing and auto demand. Steve mentioned that auto demand wasn't great. I'm hoping you could quantify that a bit, what you've been seeing over the past few weeks and what your expectation is for 2022 and if this is at least in your view, why you think steel prices in the U.S. have been coming down and sort of how much further do you think they could come down given the loosening of the steel supply-demand environment that you're seeing? uh my second question just relates to uh the natural gas uh that you have in in uh the mexican facilities if you could just sort of help me understand how how much of the natural gas price increase that we've seen in the spot market how much of that will will increase uh your your cost base are you on contracts or are you exposed to spot um any data you could give around that would be appreciated and then just a quick third one if you'd allow me just on the dividend payment Could you just sort of elaborate as to why you decided to change the policy or why the board decided to change this policy from annual to semi-annual? Thank you.

Thank you, Jonathan. A lot of questions. I start with the natural gas because it's very simple. We have contracts for the volume of all the natural gas. But those contracts are always based on the Henry Hub. So, yes, with a little bit of lack, but the increase in Henry Hub, not in LNG. In Henry Hub, we suffer that, no? On our cost. That probably is also, I forgot to mention in the cost part in the first question. Thank you, Jonathan. Second, automotive industry. The automotive industry suffered more than what we thought. I mean, the third quarter production in Mexico, I think the number was 220,000 cars per month in the third quarter. And the affection was almost like 70,000 units every month because of this... because of these chips, this was much bigger than the one in the second quarter. So that was a little surprise for most of the market, even for the ottoman makers in Mexico. Things, as we are seeing, are starting to get a little bit better, not still normalizing. And what we are hearing is that normalization will come in the first, second quarter of the year. But to be honest, a few months before, this was three months. They expected this much earlier. So yes, we have an impact. The numbers is that, I mean, from 220,000 to 70,000. These are monthly numbers. And this could have an effect on on the price also, because some of this volume is in storage. I think, Jonathan, another question of you was about the steel prices in general, or I don't remember very well.

Correct. I'm just wondering, you know, what your expectation is of US steel prices, given sort of the auto industry issues with the chips.

Well, I don't think that the automotive industry and the chips is affecting. So it's one more factor in an enormous amount of factors that affect the U.S. prices. And again, the U.S. prices are at a level, at a very high level. I mean, we repeat this in most of our conference calls. I think there are drivers that... are set that the price is going to decrease. I can tell, I mean, clearly U.S. capacity is back to pre-pandemic, still capacity. It's back or even higher than pre-pandemic levels. Inventories in the country are increasing, and lead times are still far away from normalized, but are much shorter than they were a couple of months ago. I mean, lead times of cultural coins now are between five and seven weeks. Normal of that is four weeks or three weeks. But it's far away from the 12 weeks it was. Still imports are high yet. And some new capacity is coming on board in the next couple of months. So those are drivers that said that the price is going to decrease in the next month. But on the other hand, there are drivers that doesn't speak to that i mean demand is very very good i mean if you see this year mexico is going to increase consumption by 13 that's a huge number u.s by 15 other countries in the region even by more brazil by 24 this is the money increase we are seeing in 2022 also demand very china in a lot of sector and if the chip problem is resolved There is a lot of unsatisfied demand that I think those companies are going to produce more cars. Disruption in the global supply chain, I mean, it's still there. And I know a lot of consumers of steel are thinking of importing even less for next year. And freight costs, are continue increasing so these get much more expensive to move steel so so i think as you said another factor also two other factors i think jonathan is one china china production i mean in may china produced almost 100 million tons and september that was 73 million tons That's a huge decrease in the production, which was always a factor that changed the dynamics of the market. And as we heard, this is going to continue to decrease. And so several factors that we see that we are going to have a healthy steel demand in 2022. So prices, as I said, are slowly moving down. but they're going to move slowly down, not at high speed, because of all the things I'm telling. I don't know if I answer or correct the question, Jonathan. I take a little bit of time.

No, that's perfect. Thank you very much.

And so I asked Pablo to answer the question of the dividend.

Okay, yes. Good. Hi, Jonathan. So I think that the move taken by the board is a natural move after increasing the level of DEM paid with the results of 2020 at the beginning of 2021. And as was commented during different conference calls, since this new level is reflecting the strong position of Ternio and the free cash regeneration of the company. And so we consider it is natural in order or in way of sustaining this new level of dividend that this one is divided into an interim dividend in advance. which is a portion of the dividend that then will be decided or proposed during the board of February. So it's clearly as a way of knowing or sustaining this new level of dividend that the company decided to divide it into two, a portion in advance as an interim dividend, and then the full confirmation of the full dividend announced by February.

Okay, so we shouldn't look at this as just split equally in half, so it won't be, you know, 1.6 for the whole year. It's just some portion of it.

Exactly. You shouldn't take a half. It's just a portion of the dividend that then will be discussed and analyzed by the board of directors and then approved by the shareholder meeting in May, in April or May, and this will be the one. So, yes, you're right.

Perfect. Thank you very much, gentlemen.

Your next question comes from the line of Diego Lasuego from Badesco BBI. Your line is now open.

Thank you. Good morning, everyone. Two questions. Back on the dividend question, two questions within that. So why are you not more aggressive on the dividend side, given your net cash position and the positive outlook for the business? Even if your prices are potentially going down, you guys are doing an excellent job. Your margins are still pretty healthy. So why not more aggressive on the dividend front? And within that same question, what should we expect in terms of average payout? Historically, you've paid more like 30% level. Would it be reasonable to think about a 50% payout or something within 50% to 60%? I'm not sure. And then my other question is on the impact of the U.S.-Europe view on the S-232. What is the impact that you're expecting from that, if any? And what do you guys think the next steps will be in terms of the S-232 per se? Thank you.

Thank you, Tiago. I start with the second one. We are not seeing a lot of impact from this arrangement. I mean, Europe was already importing or exporting material to the US, paying the 25% tariffs. I think the numbers are very similar. So, I don't think that much, much more volume from Europe is going to the US. uh i think what we are going to see is probably that europe increases a little bit of prices so that they don't have to pay now the 25 percent uh second on the dividend well we thought we were a little bit aggressive because our policy was always to pay once a year and now within this injury we we are kind of um I don't know, make it forward at least a portion of that interest, that dividend that we pay in May. But for the second part of the answer, I'll ask Pablo to answer it to the question.

Okay, yes. Let me add to that, Maximo, that clearly the company showed an increase in the dividend payment during this year with the results of 2020. And clearly, we understand that what we are showing today is that this is a new norm or a new level that is reflecting, if you want, a more aggressive dividend payment from the company. to reflect the return that we are pretending to give to the shareholders. And on the long run, the numbers will be basically very similar, Tiago. The dividend yield or dividend payout in the long run will continue to reflect probably the numbers that you mentioned. in a specific year probably is not exactly the same, but the company has been showing a sustained increase in dividend payment. We pick up last year with the dividend we paid in May 2021. And what we are doing right now is sustaining this new level of this distribution of dividend to shareholders. So we understand that Of course, you can always be more aggressive on dividend payments, but the company is showing that as the results of the company are better, the dividend payments are increased and sustained. And in general, the payout ratio in the long run should be sustained.

Okay, Pablo, so if I may, and thank you for the answer, for modeling purposes, looking into 2022, would it be fair to assume a payout ratio above the 30%, which is a normal payout ratio for you guys. And then, you know, as we normalize the model, we should continue to assume 30%. Is that fair?

I think that you need to take in the long run these 30 percent. Probably this year is different because the numbers, you basically, you know the numbers that we will be proposing to pay as dividend in the next board. And again, probably this year, the result of 2021 will be extraordinary in comparison to the normalized level of the company, and probably there you have a difference. But in general, this should be, and if you look at the history of the company, you will see that in average, that was our dividend yield.

Okay. All right. Thank you, Pablo. Thank you, Maximo. Thank you, Diablo.

Your next question comes from the line of Carlos Diablo with Morgan Stanley. Your line is open.

Thank you very much, Massimo and Pablo. Just to clarify then, the dividend policy is based on a percentage payout ratio or more than a dividend yield. That would be my first question. The second question is if you could comment as to the levels of profitability that you are experiencing in Brazil, given the different moving pieces, slab prices, raw material costs, I know, and ,, and natural gas and the currency. The third question, if I may, is if you could comment on any potential plans to restructure the corporate structure, how to change, improve, modify the corporate structure of the company in terms of who owns what and potentially making it more transparent or more easy to understand, less convoluted, and therefore easy for the market to value the company. And then finally, and I apologize for all these questions, but I'll just put them all out there at once. In terms of the timing of the potential next big projects, I mean, you are a company that is always investing, sometimes improving the technology, trying to reduce costs, sometimes expanding capacity or adding value. Could you comment as to what are the potential next projects and the timing, and then any update on CAPEX for this year and next year? Thank you.

Thank you very much, Carlos. If you allow me, I will start with the last one. uh which is very interesting as you said we are always looking for for new or big projects and and as i said in the last conference call we are we don't have any particularly now to announce but as you know the the ramp up of the new college hot drawing meet in mexico which took us two months more than what i expected because of this uh these problems in mexico open up a very a lot of opportunity downstream i mean and uh you're going to ask me like what i am going to say like an additionally picking line a cold rolling meal a galvanized capacity all of those things that we are analyzing in mexico there are also other things that are in the process where we should support the growth we have in the metal building segment platform in the south of the US. And so we should increase our prepainting capacity we have there. And also I mentioned in the last conference call, and I think you asked me about if it was going to be blast furnace or no, but we are going to be USMCA compliant in six years. So, we are going to require to expand our upstream capacity and we are analyzing today how or where. So, these are all things that we are analyzing right now, opportunities that I think would strengthen our strategic position in the market and it's going to be a good return on investments. So those are the things we are looking at right now, Carlos. And for the deeper part of the other questions, Pablo, can you answer them?

Yes, sure, no issues. And just to complement on that one, Carlos, you asked on the amount of CAPEX. We are keeping exactly the same numbers because, as Maximo is mentioning, we are still studying, which are our moves. So we will be close to $600 million of CAPEX for this year and without any new CAPEX, as the ones that Maximo mentioned that we are analyzing, continues to be exactly the same. So going to your questions, let me clarify first that we as a company do not have a written dividend policy. So it's not that I can tell you that exactly which will be the number. What we have is a very clear track record of dividend payment with very important increases and sustaining or moving around certain levels. And as I was answering with Tiago's questions, Well, we have a payout ratio of around 30% in the long run. But again, probably when you have some years where you have a higher result or a lower result, probably it's not exactly because, again, we don't have a written median payout.