(Debtwire) Voestalpine to cut capex as steel woes corrode earnings and drive up metrics – New Coverage

16 January 2020 | 15:39 GMT

Voestalpine is still a modest 3.3x net levered, has ample liquidity and can salvage cashflow through capex cuts. Its whopping EUR 4.4bn market capitalization also provides bondholders with a nice safety buffer. But the Austrian-headquartered steel group’s earnings are sliding and it expects a tough 3Q19/20, which could pressure metrics further and push the mere 1% yield on its unrated bonds wider, according to two buysiders and an analyst, with a second analyst positive.

The company has been at the mercy of tough steel market conditions with EBITDA quickly flagging from EUR 1.954bn at FY17/18 fiscal year-end March to EUR 1.565bn at FY18/19 and EUR 1.370bn for the LTM 2Q19/20 period-end September. It is guiding earnings to fall to EUR 1.3bn in FY19/20 given a vicious cocktail of trade conflicts, an automotive industry downturn and increases in iron ore prices.

Net leverage has risen over the same period from 1.5x to 3.3x (see chart below). These metrics exclude a EUR 1.408bn pension deficit at 2Q19/20, which would push adjusted net leverage a turn higher to 4.3x.

Voestalpine generates around two-thirds of its revenues in Europe and around 34% of revenues from automotive end-markets that have been weak. It also faced falling demand while global trade disputes in steel markets have pushed up costs. As a result the group had four profit warnings over the previous calendar year while latest results fell despite an EBITDA boost from IFRS 16 effects, one of the analysts noted.

In its outlook provided in the 2Q19/20 results for quarter-end September, management noted that 3Q19/20 (the results are due to be released in early February) will be as difficult as 2Q19/20 was, when EBITDA fell around 27% YoY. Positively, it expects a 4Q19/20 recovery based on seasonality, positive resolutions of internal issues and a boost from cost and efficiency improvement measures.

“The automotive market is not improving anytime soon but I feel the recession fears for FY20/21 may ease and the economic outlook in Europe could be better. They have had two internal issues, such as an incident in the US factory and the steel plant in Austria being closed for refurbishment, but both these situations should soon improve, and earnings can get back on track,” one analyst said. “It seems euro steel market prices could stabilize, which gives upside given the costs of iron ore had spiked due to issues in Brazil but are now stabilizing. We expect neutral cash generation despite the EBITDA drop as they can reduce capex and working capital can release. So, they will not increase their debt position or reduce liquidity, which is good given the uncertainty in the economy.”

“Around 34% of revenues come from the automotive sector and when you look at the likes of [Spanish automotive components manufacturer] Gestamp and what they say about the auto market you have weaker demand in volumes, which is driving down demand for steel, while the auto sector is also shifting towards light weighting vehicles to meet emissions tests,” one buysider countered. “To make autos lighter, they make components hollow with less steel and replace steel with aluminium which is lighter. Aluminium is looking increasingly attractive, meaning declines in steel volumes from the automotive sector will be larger than the decline in autos manufactured.”

The short auto-motive

Automotive end-markets face pressures with demand for volumes falling while the introduction of the Worldwide Harmonized Light Vehicle Test Procedure (WLTP) will also reduce demand for steel. New emissions tests were introduced in Europe in September last year.

Global trade war headwinds are also hampering earnings as protectionist policies have led to a reduction in worldwide investments with large declines in many key markets for Voestalpine.

Another concern has been rising iron ore prices, which have sparked an increase in Voestalpine’s costs. Prices spiked in July 2019 to their highest level since 2013 following a large expansion of steel production in China as a result of state-controlled infrastructure and real estate projects. “Safeguard Measures” introduced by the EU were unable to alleviate the pressure generated by flat steel imports and crude steel production consequently reduced.

Iron ore prices eased over the summer, but this did not boost EBITDA margins, management noted. Voestalpine expects a normalization of iron ore prices over the course of this fiscal year.

“Prices of iron ore in euros have also risen, and they have to pay more for carbon costs so the top-line is falling while costs are going up structurally,” the first buysider said. “Also, how differentiated are their products? They are extremely commoditized and not in a great position. With a 1%-handle yield there is no reason to go long even if being short may not be a large money-maker.”

“This is not unlike the other steel makers but it has a better mix than the likes of [German industrial group] Thyssenkrupp, doing tubing and specific steels with high value added and more resilient margins. But they have been hit by the economy not doing well and by a rise in costs due to iron ore and inputs to the steel business rising with low reactivity by the European Commission,” the analyst said. “They’ve had profit warnings and earnings have fallen but these guys have a buffer from liquidity and decent cash generation, and they can reduce costs that can help their recovery.”

Nerves of steel

Thankfully Voestalpine can take some measures to try and salvage cashflow. The group will unlikely generate cash in the near-term given it has guided for EUR 1.3bn FY19/20 EBITDA and last fiscal year it faced EUR 1.0457bn capex, EUR 120.7m interest, EUR 232.2m cash taxes, EUR 276.8m dividends and a EUR 137.1m working capital outflow, which would suggest a EUR 500m annual cash burn.

Positively, the group has guided towards reduced EUR 900m capex this fiscal year and then just EUR 700m next year, which should stem its recent cash burn. It is also taking steps to improve working capital swings and can always cut its dividend if necessary, though the company noted it currently does not plan to change its dividend policy.

Voestalpine is also targeting EUR 100m in cost savings, half of which could be achieved in 2H19/20. Its start-up problems at its Automotive Components plant in Cartersville in the US should also be resolved soon with productivity there already increasing, which could boost earnings with positive contributions expected from the end of this calendar year.

The company is still exposed to the volatile steel market sector, making any recovery hard to predict. Global trade war events and protectionist policies continue to weight on steel investments and drive demand declines for Voestalpine. Competition could also increase from Italian steelmaker Ilva, with the Italian government considering whether to become an investor in the company given it employs 8,200 workers in Taranto, according to a press report.

“The profitability of Voestalpine in terms of free cashflow before financing for the last 12 months looks heavily down versus recent years while there has not been an especially large working capital outflow that could change,” the first buysider said. “The interest coverage is down on a free cashflow basis and they are running out of wriggle-room. EBITDA is falling and cashflow deteriorating while we are at the end of the cycle.”

“This looks very tight at 1%. In this market it’s unlikely you’ll be selling a whole lot more steel just because one facility is working better,” independent deep-dive research provider Sarria Research noted. “Working capital could be managed better, but it could become a source of cash and they can cut the capex. This is not an insolvency situation, but it is cheap enough to take a chance with a short.”

The stars Voestalign

The group has a reasonable liquidity position that means it can weather any upcoming cashburn unless earnings really dive. At 2Q19/20 it had EUR 1.895bn of total liquidity, although this included just EUR 313m of cash with EUR 502m of financial assets and EUR 1.080bn of committed lines. Voestapline still has a EUR 4.4bn market capitalization given its EUR 24.6 share price, which means its loan-to-value is still around just 50%, providing bondholders with a comfortable cushion. Voestalpine’s major shareholders at FY18/19 were Raiffeisenlandesbank Oberösterreich Invest GmbH & Co OG with less than 15%, the Voestalpine employee shareholding scheme with 14.8% and Oberbank with 8.1%, according to its annual report.

At least legal risks also appear out the way after the German cartel office fined Voestalpine EUR 65.5m in December for price fixing of quarto plates sold in Germany from 2002 to 2016.

Voestalpine’s unrated bonds trade at relatively tight yields with a local retail bid providing a supportive technical. Its EUR 500m 1.75% senior unsecured 2026s are indicated at 103.25-mid yielding 1.2%, its EUR 500m 1.375% senior unsecured 2024s at 102.25-mid yielding 0.9% and its EUR 400m 2.25% senior unsecured 2021s at 103.25-mid yielding 0.4%.

The yield is similar to just 1.57x net levered Luxembourg-headquartered steel company ArcelorMIttal despite Voestalpine being twice as levered. ArcelorMIttal’s Baa3/BBB- rated EUR 1bn 2.25% senior unsecured 2024s are indicated at 105-mid yielding 0.9%. On a z-spread per turn of net leverage, Voestalpine 2024s yields 30bps per turn versus 67bps per turn for ArcelorMIttal 2024s.

“The [Voestalpine] bonds are unrated but given the current state of the balance sheet and the robustness they would likely still have an IG rating and would be more of a triple B – it’s a resilient business even if the bonds are expensive. They are a cyclical business so 1% is not so attractive but they have large support from the Austrian investors, and it has been a buy and hold for many investors there. The yield is tight in absolute terms but relative to other triple Bs it is still decent,” the analyst said. “Holding the bonds seems okay and they have options through reducing operating costs or cutting dividends. They have the means to alleviate their problems and there should soon be support for the steel market so I’d not worry about Voestalpine.”

“It was tough conditions for them, and iron ore prices are high while energy costs are rising with a cost push squeezing margins, and they have the exposure to the automotive and industrials space. I have nothing good to say about the company’s underlying business environment with the relative value tight and at a 1%-handle yield it does not make sense,” the second buysider countered. “It should definitely trade wider than ArcelorMittal for example, but then the Austrian retail bid supports the bonds and share price, so it is impossible to short and you’d not have made much money on it – it is like [German potash mining company] K+S was in that regard.”

Voestalpine will release its 3Q19/20 letter to shareholders on 6 February. The company declined to comment.

by Adam Samoon