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Edited Transcript of GCC*.MX earnings conference call or presentation 24-Jul-19 3:00pm GMT

Q2 2019 Grupo Cementos de Chihuahua SAB de CV Earnings Call

Oct 4, 2019 (Thomson StreetEvents) -- Edited Transcript of Grupo Cementos de Chihuahua SAB de CV earnings conference call or presentation Wednesday, July 24, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Héctor Enrique Escalante Ochoa

Grupo Cementos de Chihuahua, S.A.B. de C.V. - CEO & Alternate Director

* Luis Carlos Arias Laso

Grupo Cementos de Chihuahua, S.A.B. de C.V. - CFO

* Ricardo Martínez

Grupo Cementos de Chihuahua, S.A.B. de C.V. - Head of IR

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Conference Call Participants

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* Adrian E. Huerta

JP Morgan Chase & Co, Research Division - Senior Analyst

* Alejandro Azar Wabi

GBM Grupo Bursátil Mexicano, S.A. de C.V. Casa de Bolsa, Research Division - Research Analyst

* Carlos García

Signum Research - Senior Stock Market Analyst

* Cecilia Jimenez

Santander Investment Securities Inc., Research Division - Head of Cement and Construction

* Chelsea Colón

Aegon Asset Management - Credit Research Analyst of Emerging Markets

* Daniel McGoey

Citigroup Inc, Research Division - Former MD and Head of Research of Brazil

* Daniel Rojas Vielman;HDI Capital;Investment Specialist

* Eric Neguelouart

BofA Merrill Lynch, Research Division - Research Analyst

* Mauricio Serna Vega

UBS Investment Bank, Research Division - Analyst

* Pedro Fabregat

Compass Group Holdings Inc. - Investment Analyst

* Ramon Obeso

Scotiabank Global Banking and Markets, Research Division - Associate

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Presentation

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Operator [1]

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Good morning and welcome to the GCC Second Quarter 2019 Earnings Call. (Operator Instructions)

At this time, I'd like to turn the call over to Ricardo Martínez, Head of Investor Relations. Please go ahead.

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Ricardo Martínez, Grupo Cementos de Chihuahua, S.A.B. de C.V. - Head of IR [2]

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Thank you, operator. Good morning, everyone, and thank you for joining our earnings call. With me on today's call is Enrique Escalante, our Chief Executive Officer; and Luis Carlos Arias, our CFO.

Before we proceed, let me remind you that the information discussed today may include forward-looking statements regarding company's financial and operating performance. All projections are subject to risks and uncertainties, and actual results may differ materially. Please refer to the detailed note in the company's earnings report regarding forward-looking statements.

I would now like to turn the call over to Enrique Escalante, Chief Executive Officer. Please go ahead, Enrique.

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Héctor Enrique Escalante Ochoa, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CEO & Alternate Director [3]

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Thank you, Ricardo, and good morning, everyone. I would like to begin our call today by discussing the main drivers of our performance this quarter in those markets in which we participate. Luis Carlos will follow to review financial results and will then turn the call back to me for comments regarding this year's guidance.

Our second quarter results continue to be impacted by challenging weather conditions in most of our markets in the U.S. As is widely known, we began the year with an extraordinary winter season with severe snowstorms and longer-than-normal below-freezing temperatures.

During the second quarter 2019, our business was adversely impacted by heavy precipitation and record floods. As a result, the start of the construction season has been delayed. In terms of distribution, the extended winter season resulted in delays, which impeded our ability to deliver our products to end customers and forced us to redefine our cement plant sources and supplier routes. We are also facing a slowdown in the execution of constructed projects due to the related labor shortages in this region.

To a lesser extent, we experienced some delays in the testing and approval process of oil well cement produced at our Chihuahua plant during the quarter, which is now resolved, and we are currently shipping to the Permian Basin. Despite these challenges, I would like to stress the fact that our business fundamentals remain solid with a strong customer backlog in the U.S. We are already seeing signs of recovery so far in July, particularly in cement, with initial sales volumes above our internal forecast as the U.S. weather starts to improve. It is crucial that these favorable weather conditions continue, enabling the shipment of our considerable backlog.

Let me now turn to the key performance drivers in the U.S., starting in the south and moving north. I will then review GCC's Mexico operations. In El Paso, Texas, infrastructure work continued to be the principal driver of growth, but at a slower pace in the second quarter due to delays at a few of our main projects. This includes work related to the Santa Teresa, New Mexico paving project. Also the big airfield runway reconstruction, which was announced last quarter, was slightly delayed due to external factors, but it's now successfully underway.

Turning to the Permian Basin oilfields in West Texas. While cement consumption demand remains strong, we are experiencing a more competitive environment that force us to adjust our pricing strategy accordingly to maintain a healthy balance between volumes and profitability in this area. This resulted in lower sales volumes for the quarter, but we expect to recover these volumes throughout the remainder of the year, in many cases with higher contribution margins.

Despite some delays in the testing and approval process of oil well cement produced at GCC's Chihuahua plant on which I have comment, we have already begun shipping oil well cement to our new terminal in Fort Stockton, Texas, which is now operational. This will increase our exported volumes, and we are confident it will also drive additional customers to the region, while improving product availability to our current clients.

In terms of pricing, we had previously announced the additional USD 8 per metric ton price increase is in place since April 1 in all of our markets, excluding oil well cement. While we're experiencing some pushback, we have achieved an average USD 5 per ton increase. Performance at GCC's Colorado operations has been strong, in line with our expectations, supported by solid demand from public infrastructure projects, which have enabled us to gain share within this market. These dynamics are expected to continue as we're seeing new projects being built.

Turning to the Northern Midwest and Plains states, our performance in these regions was mainly impacted by the heavy rain and floods experienced in the second quarter. In particular, a Nebraska paving works project was affected during the quarter.

In the Dakotas and Iowa, demand was again driven by wind farm construction activity. Despite being more acutely impacted by weather-related delays during the second quarter, we expect this segment to remain strong, particularly in 2020, due to the solid wind farm backlog we are seeing for this market, supported by [the various] incentives for these projects that are still in place at 100% through 2020. After that, the incentives will be reduced 20% on [bill pays out]. We believe this is a segment which will continue to strengthen for our company.

In North Dakota, we are seeing more activity from oil well cement produced at our Rapid City plant as volumes shipped to the Bakken oilfields have been increasing. In addition, prolonged flooding of the Mississippi River in the Western area resulted in supply shortages during the quarter from other producers. As a result, we are starting to benefit from additional demand in this area, potentially at higher prices.

In Montana, we continue to leverage GCC's new Trident plant to serve our Canadian customers, while we address the increased sales we are seeing in both Montana and Idaho. Given the strong demand coming from this market and as part of our original strategy, we continue looking for the best sales mix in order to optimize our profitability in this region.

Let me now provide a brief update on GCC's Rapid City plant. I'm pleased to let you know that the plant stabilization process has been improved significantly during the quarter, reaching production levels which will enable us to successfully meet our 2019 full year demand. On our last call, we noted that we were experiencing 2 main issues related to certain auxiliary equipment.

First, problems related to the coal mill [aggregator] have since been solved. Second, with regards to the conveyor belt, temporary modifications have been made to the [pit] system, and we are working closely with our suppliers to identify the best permanent solution, which is likely to happen by year-end or in the first quarter of next year. However, it is important to note that all major equipment at the facility is running well. And as of today, we have spare capacity and inventory. The efficiency of our variable cost structure is improving now that this operation is more stable, and we aim to achieve target costs at stable production rate.

Another challenge and cost pressure, which has already been resolved during the quarter, was the quality of coal produced and they need to buy from third party, which impacted the majority of our cement [plant]. This issue has also been resolved by adjusting the mine plan accordingly, assuring higher-quality coal moving forward.

Turning to our Mexico operations. We delivered strong second quarter results on the back of both price and volume growth. Market dynamics remain similar to our prior quarter, outperforming the country as a whole with the industrial maquiladora plant, warehouse construction and our robust mining projects driving sales volume. In the northern cities, the middle-income housing segment also continue to show strong demand.

Finally, regarding our sustainability efforts, as an active member of the Global Cement and Concrete Association, we have established our main goal of reducing the net CO2 emissions by 9% by 2020 and by 31% by 2030. In addition, we are currently working on additional long-term targets, which will be developed by year-end.

I would like to share with you some of the key highlights from the annual Sustainability Report we released in April, available in our web page. The use of biomass fuel at GCC Juarez plant reduced CO2 emissions by 38% in 2018. Rapid City has permanently shut down two wet kilns. Two GCC cement plants earned an EPA ENERGY STAR certification, one which achieved the highest possible score. GCC's Mexico Great Place to Work ranking increased to 30th place from our 75th place in 2017.

2019 was also GCC's 14th consecutive year of being recognized as a Social (sic) [Socially] Responsible Company by the Mexican Center for Philanthropy. The above is another example of our commitment to building a stronger and more sustainable company, in line with our overall focus on ensuring we employ global best practices throughout our organization.

Let me now turn the call over to Luis Carlos to review the quarter financial results, and I will return for some closing remarks.

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Luis Carlos Arias Laso, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CFO [4]

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Thank you, Enrique, and good morning to everyone. Let me begin by reminding you that results for the Trident plant in Montana were consolidated effective July 1, 2018. Our results also reflect the reclassification of the Oklahoma and Arkansas ready-mix assets sold in June last year as discontinued operations. Prior period results have been restated in accordance with IFRS 5, including sales, costs, expenses and volumes.

Consolidated net sales for the second quarter increased by 3.5% and decreased 1.1% on a comparable basis, excluding the sales from the Trident cement plant acquired last year. This was mainly driven by the decline in comparable sales in the U.S., which was partially offset by the strong performance of our Mexican operations and better prices in both countries. Pricing dynamics in general continued to be favorable during the second quarter of 2019.

Mexico performed above our expectations with sales growing 8.4% year-on-year, boosted by growth in volumes and better price environment, which was also supported by segment sales mix. Cost of sales, as a percentage of revenues, increased 2.8 percentage points compared to the prior year quarter, mainly reflecting an increase in variable costs in concrete and variable selling expenses at our coal mine as well as at our Rapid City plant related to the last part of the operational ramp-up process; In addition, higher operating expenses associated with the coal mine and the recent acquisitions, which we did not have last year; as well as higher depreciation expenses. Finally, we saw an increase of lower-margin oil well cement sales from our Tijeras, New Mexico plant to the West Texas markets also impacting this cost line.

In Mexico, we continue to see pressures in energy costs. The electricity rate has increased by around 35% year-to-date as compared to first half of 2018. But as we have previously mentioned, we are working on alternatives in the form of renewable energy, and we have already selected a new long-term electricity generator, which we expect will drive significant future cost savings in the beginning of 2021. We will be sure to provide relevant updates as they unfold.

Regarding fuels, aside from the effects of previously purchased and poor-quality coal produced, as Enrique had discussed, we are in the process of increasing the usage of alternative fuels whenever possible at all GCC cement plants in order to achieve between 20% to 45% substitution rates in the midterm. Operating expenses as a percentage of sales increased 1.2 percentage points in the quarter, mainly due to higher corporate expenses due to the activation of the Long Term Incentive Plan, our share-based bonus awarded to our top management tied to ROIC achievement, and the cost reclassification as a result of the creation of the Corporate Technical and Operations Office, which began operations in the first quarter of this year. While these expenses were previously recorded under cost of sales, most have since been reclassified to the operating expenses line.

EBITDA increased 2.2% in the second quarter with the margin contracting 0.4 percentage points to 29.5%. As we mentioned on our previous call, EBITDA this year and hereafter will benefit from the implementation of the IFRS 16 due to the fact that the majority of the former rental expenses from operating leases is now reflected in amortization, increasing this year's EBITDA around $80 million, neither impacting net income, nor free cash flow.

Net financial expenses fell 19.3% in the quarter due to a decline in interest expense and lower debt balance as a result of successfully refinancing all of our debt as well as the absence of fees compared to the second quarter of 2018. Income tax, by contrast, increased $4.3 million year-on-year, mainly due to the higher share of Mexico's pretax income in the consolidated result, which carries a higher income tax rate. Consolidated net income increased 310% to $25.1 million in this quarter.

Moving to our cash generation. Due to the seasonal nature of our business, free cash flow remained negative in the second quarter of 2019 at $15.2 million compared to $2 million last year, mainly reflecting lower EBITDA generation after operating leases, an increase in working capital needs due to higher inventory balance as a result of lower sales and in preparation for the peak construction season, and higher cash tax expenses. Lower interest expenses, lower maintenance CapEx, and a reduction in other expense and accruals partially offset this increase.

We have maintained a strong balance sheet and efficient capital structure that will enable us to deliver strong shareholder value through the combination of the strategic and prudent investments in our business to continue growing and increase dividend distributions, all while maintaining a healthy leverage ratio. As of June 2019, our net debt-to-EBITDA leverage ratio stood at 1.8x, significantly below the industry average level.

During our Annual Shareholder Meeting in April, an annual dividend payment of MXN 0.8 per share was declared. And the Board of Directors approved yesterday for it to be paid on August 15 of this year. This represents a 15% increase compared to last year's dividend payment.

With that, I will now return the call over to Enrique to discuss the new guidance and for his closing remarks.

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Héctor Enrique Escalante Ochoa, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CEO & Alternate Director [5]

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Thank you, Luis Carlos. While the underlying trends of GCC's business remain solid, based on the performance of the first half of 2019, we are revising our guidance for the full year. We now expect total cement volumes in the U.S. to increase 3% to 5% year-over-year with a 1 to 3 percentage points increase on a like-to-like basis. This compared to our previous range of 4% to 6% and 2% to 3% increase, respectively.

Labor shortages continues, and the length of the construction season is hard to predict. Therefore, we do not expect to be able to recover the full volume decrease in the balance of the year. We're expecting volumes at our ready-mix business to remain flat for 2019 as compared to our prior guidance range of an increase between 6% and 8%. This is due to the substantial wind farm volumes we had previously expected during 2019 to be pushed back to 2020 period. And additionally, this segment was more acutely impacted by weather conditions previously discussed.

In terms of pricing in this market, our guidance remains unchanged. Turning to Mexico. Although the business has performed above our expectations, we remain cautiously optimistic given the political and macroeconomic uncertainty, but expect performance in Chihuahua to continue to surpass Mexico's overall performance. Therefore, we maintain our Mexico outlook for the year.

Regarding profitability, we now expect EBITDA to grow between 15% to 17% year-over-year and between 7% and 9% on an adjusted basis, excluding the IFRS 16 accounting impact. Our estimates for capital requirements remain unchanged, but on the back of lower EBITDA generation, we expect free cash flow conversion to be above 40% and net debt-to-EBITDA ratio to be around 1.1x.

I would like to take this opportunity to reaffirm our unwavering commitment to our shareholders. We are committed to generating long-term value. While our company has faced a challenging operating environment, which has impacted certain aspects of this and last quarter's results, we remain focused on those areas and variables within our control, particularly related to our fixed cost as we streamline our costs and increase our sales volumes in an efficient manner.

With that, this concludes our prepared remarks, and we are now ready to take your questions. Operator, please go ahead.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And we will take our first question from Dan McGoey with Citi.

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Daniel McGoey, Citigroup Inc, Research Division - Former MD and Head of Research of Brazil [2]

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Just wondering if you could talk a little bit more on the energy front. You mentioned both the lower quality of coal mined as well as purchases from external sources. Could you quantify exactly how much additional cost that represented, maybe in terms of margin points in the first half of the year, and what you expect given the solutions that you mentioned? And then, Enrique, as well you mentioned about volume opportunities from shortages of supply in the Mississippi River region. And can you talk a little bit about how significant that might add to volumes as well as, I guess, such a longer distance to ship? Would that be a lower margin or higher margin than your other U.S. business?

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Héctor Enrique Escalante Ochoa, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CEO & Alternate Director [3]

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Thank you for the questions. Let me start with your second question on volumes on the Mississippi while we look for more specific answers on your first question. The additional potential volumes that we can get related to the flooding of the Mississippi are basically in the same market area that we are already shipping, namely the Twin Cities market, Eastern Iowa and those regions. So this don't represent any additional distances or costs -- of shipping costs for us, is just incremental volume. And what we are evaluating at this moment in terms of volume is precisely how much we will have available because we committed already volumes to our customer base there.

We are telling them we are going to supply to you all the volume that we committed at the current negotiated prices, and any increase over those committed volumes to them or to additional customers, I mean, is going to come certainly at a higher price, depending on the supply-demand balance as we expect, I mean, the other producers to continue to have enough product available in the region. We are at the moment assessing -- I mean, that potential volume, Dan, I can tell you that today, we may be looking at around 50,000 to 100,000 tonnes of volume, but we cannot commit at this moment to that volume yet because it is being negotiated with the customer base.

In terms of the energy issues we had specifically related to the seam coal at the mine -- to the coal seam at the mine, we were going in the mine through what we call a [butting]. So this is, I mean, rock and sand in between the seam, which lowers obviously the quality of the coal once it's extracted. We were facing these mining conditions during the first, I mean, quarter of the year. Then during the second quarter, what we did is to change the mine plan to go to other different areas in the mine where the seam was of better quality. This improved immediately the quality, and now the plants -- all the plants are receiving high-quality coal, and the efficiencies in the kilns have returned to normal levels.

Also, given that problem, we didn't have enough coal the first part of the year. So we had to purchase, I think, around 40,000 tonnes total in the year from the third parties, which is basically, I mean, coal that we ship to the plant, obviously no profit compared to our own mine produced coal. Everything has been resolved. We don't have to buy any more coal during the second part of the year. And if the mining continues as it is today, we'll have a second half of the year with totally normal cost and quality conditions on the coal side.

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Luis Carlos Arias Laso, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CFO [4]

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I can add, Dan, that of the 2.8 percentage points that I commented on my remarks, almost 1 percentage points is due to both of those 2 things, the increased coal cost between the quality of the coal and higher freight because we have to buy coal from a third party. So of the 2.8 percentage points, almost 1% -- 1 percentage points is both the problem that we have with the coal and the Mexico's increased cost in power.

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Operator [5]

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We will take our next question from Eric Neguelouart with Bank of America.

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Eric Neguelouart, BofA Merrill Lynch, Research Division - Research Analyst [6]

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So I'd like to ask about guidance, a couple questions. First, in the U.S. in the first half of the year, volumes were down 1%. Can you explain the rationale for the 3% to 5% guidance? You won't have inorganic growth in the second half of the year and organic volumes are down 8%. And regarding guidance, the lower guidance is only a result of lower volumes in the U.S., or should we continue seeing cost pressures like we've seen in the first half?

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Héctor Enrique Escalante Ochoa, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CEO & Alternate Director [7]

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Eric, thank you for your question. Again, I will address the second part of the question first. So all the volume decrease in terms of the guidance -- decrease in terms of -- it's thoroughly related, I mean, to the U.S. and weather -- shipping conditions. So again, if we continue to have a good weather for the second part of the year, we will ship the backlog, and that will not change what we have forecast for the second part of the year. However, since we already lost some volume on the first 2 quarters, it's going to be hard to recover those volumes.

The main reason for that, it's, number one, having enough good weather days to ship the volume, and the second part is that it's hard to recover given the labor shortages. Basically, what we have been noticing in the market is that once we lost -- we lose a day or 2 or 3, whatever, because of weather, in the past those volumes were easily recovered by people working overtime or during weekends to recover and catch up on those projects. That is not happening anymore as we see in the industry, at least in the regions where we are, because there is not enough labor to cover for those lost volumes. So again, in summary, that lost volume is weather-related. It's related to the first half of the year. We expect to be okay in the second part of the year.

Now talking about the pushback that I mentioned on pricing, we don't expect to see any more of that in the second part of the year. We feel price have stabilized for us after the discussion that we've had with customers and the action we've taken. And as I mentioned in the report, in many cases, we're looking at higher margins after the shuffling of some volumes with some customers during the first part of the year. So pricing should be stable for the rest of the year.

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Operator [8]

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We will take our next question from Ramon Obeso with Scotiabank.

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Ramon Obeso, Scotiabank Global Banking and Markets, Research Division - Associate [9]

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Two questions, if I may. The first one is a follow-up question on the cost increases we saw in the quarter, especially at the coal mine. So based on previous questions, should we consider this as a short-lived event? Is that correct? And my second question relates to the construction EBITDA margins in Mexico. Could you give us additional color on this? Is it all about energy and fuel cost increases? Is anything else that we should be aware of? And what levels of EBITDA margins should we expect in the coming quarters in Mexico?

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Héctor Enrique Escalante Ochoa, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CEO & Alternate Director [10]

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Ramon, thank you for the questions. Can you repeat just briefly the first question, the coal?

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Ramon Obeso, Scotiabank Global Banking and Markets, Research Division - Associate [11]

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Yes, if the coal expenses that we saw this quarter are short-lived event.

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Héctor Enrique Escalante Ochoa, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CEO & Alternate Director [12]

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Yes. Thank you, Ramon. I think that's what I heard, so I just wanted to reconfirm. Yes, definitely, it's behind us completely. So again, the incremental cost because of purchasing coal and the incremental cost because of lower coal quality, both of those 2 factors impacting the costs are behind us, and we don't expect to have that going forward. I will let now Luis Carlos answer your second question on Mexico margin.

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Luis Carlos Arias Laso, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CFO [13]

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Ramon, yes, basically, the problem that we have with the fuel and power in Mexico are the main explanations. Also, we include corporate expenses in our Mexican operations for this quarter and the first quarter with -- as I said, with the activation of the Long Term Incentive Plan and the reclassification of some expenses that we used to have in cost of sales of the new office that we created. That is impacting the margin of the Mexican operations. But that's because how we treat the corporate expenses in our numbers.

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Héctor Enrique Escalante Ochoa, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CEO & Alternate Director [14]

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And just elaborating a little bit on what Luis Carlos is saying, I think that in summary, we can say that the only permanent cost increases we are seeing going forward are the power cost in Mexico, because, of course, as I said, the fuel cost is going to go down. So the power cost compared to last year is, so far, permanent for the rest of the year. And of course, the Long Term Incentive Plan that we didn't have, I mean, last year, it's also a permanent increase going forward. So having said that, I think that the margin for the Mexico division will remain at the forecast levels for the rest of the year.

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Ramon Obeso, Scotiabank Global Banking and Markets, Research Division - Associate [15]

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Will remain at what levels, sorry?

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Luis Carlos Arias Laso, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CFO [16]

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No. What we mean -- what Enrique means is that we don't foresee any reductions going forward aside of that impact that we had during the first half.

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Operator [17]

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We will take our next question from Mauricio Serna with UBS.

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Mauricio Serna Vega, UBS Investment Bank, Research Division - Analyst [18]

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Just a couple of things I wanted to go over. On the U.S., per the numbers that you provided on the press release, it seems that you still managed to expand EBITDA margins. Just was wondering if that was all due to IFRS 16? I mean, excluding that, is there a decline? And then I was also wondering about -- you also included in the press release that some of the pressure or some of the additional expenses in the U.S. came from the acquired operations. So are these related to the integration expenses or what kind of expenses are we talking about since the operations were acquired almost a year ago? And then, finally, just on the revised guidance, looking at the numbers without the IFRS adjustment, if you are looking for 15% to 17% EBITDA growth this year, it means that it's an implicit growth, I think, roughly above 30% for the second half of the year. So I just was wondering, seeing that nothing is going to change on the Mexico margins and, I mean, you are implicitly guiding for declining volumes in the second half, is it all comes down to the U.S. and how much growth? Or how are we seeing that growth being reconciled to reach the lower end of the guidance?

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Luis Carlos Arias Laso, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CFO [19]

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Mauricio, on the first question, if you remember, we have the divestment of the ready-mix assets last year. So there is a big increase in margin of the U.S. operations with the asset swap that we did. The cement operations are much more -- significantly much more profitable than the ready-mix assets that we sold. So that's a big impact in our U.S. operations, not just for the first half, but also going forward. Can you repeat your second question, please?

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Mauricio Serna Vega, UBS Investment Bank, Research Division - Analyst [20]

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Yes, just was wondering what kind of expenses were incurred on the acquired operations, related to integration or -- just because it's been almost a year since the acquisition.

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Luis Carlos Arias Laso, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CFO [21]

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Yes. Well, it's basically the -- on the fixed cost side is the incorporation of that operation in our P&L since we treat the ready-mix assets that we sold -- those are way below on the discontinued operations. So above in the cost part of the P&L, we are incorporating the fixed cost part of the new operations and in -- mainly in fixed expenses and depreciation and all. So that's the main thing.

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Mauricio Serna Vega, UBS Investment Bank, Research Division - Analyst [22]

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Got it. And related to the guidance for full year and the implicit growth in the second half?

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Luis Carlos Arias Laso, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CFO [23]

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Can you repeat the question, please?

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Mauricio Serna Vega, UBS Investment Bank, Research Division - Analyst [24]

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Yes, sure. Just looking at the numbers from the guide, you have 15% to 17% growth, excluding the IFRS, which, doing the numbers, it implies a 30% growth in the second half of the year. But then, again, you're implying lower volumes in Mexico and stable margins from what we've seen in the first half, which is a decline versus last year. So it all seems that it comes down to U.S. for the -- to reach the full year EBITDA growth. So I was just trying to understand like -- to reconcile these numbers, just to understand where are the improvements from the U.S. coming from exactly.

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Luis Carlos Arias Laso, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CFO [25]

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Yes, yes. Well, as we explained, there is a strong backlog in the second half of the year, and it's the peak construction season. So a lot of the increased margin and increased EBITDA during the second half of the year is explained by operating leverage because we are going to ship quite a big part of the annual volume during the second half of the year. So if you take into account the operating leverage -- and as Enrique explained in his remarks, we are very focused on controlling fixed cost. So that explains how we get to the guidance of the EBITDA numbers.

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Mauricio Serna Vega, UBS Investment Bank, Research Division - Analyst [26]

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So I guess it would be good assume EBITDA margins north of 30% for the second half in the U.S.? Would that be a fair assumption?

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Luis Carlos Arias Laso, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CFO [27]

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I will defer that back to Ricardo and, if you like, after doing your calls with him to give more color on that, and, of course, to everybody on the call.

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Operator [28]

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We will take our next question from Adrian Huerta with JPMorgan.

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Adrian E. Huerta, JP Morgan Chase & Co, Research Division - Senior Analyst [29]

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Two questions. One is just what is the level of annual sales that you expect to have in Canada? And the second question is if you still seeing opportunities to do a catch-up on cement prices in the acquired assets of Montana?

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Héctor Enrique Escalante Ochoa, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CEO & Alternate Director [30]

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Adrian, this is Enrique. Thanks for the questions. So far, we haven't changed significantly the plan of splitting the volume between -- of the Montana plant between the U.S. market and the Canadian market. We continue basically with our original plans of shipping around 130,000 tonnes to Canada. We are, as we mentioned during the call, seeing a potential optimization by taking on some more additional volume in Montana and Idaho, given that those states have currently better margins than the Canadian market. However, since we have a long-term view and treat our customers with long-term commitments, we won't do any drastic changes in the short term. But just the decision will come more from optimizing the whole logistic systems and seeing if, with the new capacity in Rapid City, we can divert more volume towards Idaho and Montana. In terms of -- I'm sorry, the second question, Adrian, was?

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Adrian E. Huerta, JP Morgan Chase & Co, Research Division - Senior Analyst [31]

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Was on price, Enrique, potential catch-up on prices in Montana.

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Héctor Enrique Escalante Ochoa, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CEO & Alternate Director [32]

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The pricing is going well in Montana. No main issues, no pushback in that market or in Canada. So in Canada, we are going as we had agreed originally in terms of pricing with the customer base there.

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Operator [33]

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We'll take our next question from Chelsea Colón with Aegon.

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Chelsea Colón, Aegon Asset Management - Credit Research Analyst of Emerging Markets [34]

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I just have a couple of questions. Regarding the electricity situation in Mexico, can you give a little bit more color around that and this long-term supplier that you selected? Is it renewable energy or regular conventional energy? And I think you mentioned that you're expecting benefits beginning in 2021. But before, I thought you said the benefits would begin as early as next year. So any more information you can give on that would be helpful. And then also could you provide us some more granularity on the utilization rates right now at the Montana plant, the Rapid City expansion and at the Mexican kiln that you reactivated recently?

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Héctor Enrique Escalante Ochoa, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CEO & Alternate Director [35]

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Chelsea, this is Enrique. On your first question on power in Mexico, definitely a big impact compared to last year. As we have mentioned in several forums, that the central power company in Mexico increased rates in the second half of last year. So we are seeing around a 35% increase year-over-year in power cost in -- for the Mexican plant. That's the effect that we have been mentioning on the cost side.

Long-term supply, we are in the process of negotiating a contract. At this moment, we are in the final phase of that contract negotiation. It's going to come -- the power is going to be bought from a new generator thoroughly of renewable energy. And the benefits are going to be, as you mentioned, coming in on 2021. The whole next year is still going to be basically with CFE in Mexico because the renewable energy plan that we are talking about in question here is still under construction, in its final stage. It's going to be operational next year.

In terms of the utilization rates of the plants in the U.S., Montana is going to be running at full capacity, same as the new kiln in Mexico. Ironically, it's an old kiln, but the new production of that kiln. It's a small kiln, about 130,000 tonnes, and it's running now and we expect to keep it running at capacity for the rest of the year. In terms of Rapid City, we are crunching some numbers here to give you the more specific answer. The plant is going to be running basically at 70% of its capacity for the rest of this year.

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Chelsea Colón, Aegon Asset Management - Credit Research Analyst of Emerging Markets [36]

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Can you remind me exactly when that facility started up?

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Héctor Enrique Escalante Ochoa, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CEO & Alternate Director [37]

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December of last year.

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Luis Carlos Arias Laso, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CFO [38]

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The expansion, yes.

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Héctor Enrique Escalante Ochoa, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CEO & Alternate Director [39]

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Yes, yes, the new capacity out there.

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Luis Carlos Arias Laso, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CFO [40]

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The expanded capacity.

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Chelsea Colón, Aegon Asset Management - Credit Research Analyst of Emerging Markets [41]

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So 70% utilization is the average for the year or just for the second half of the year?

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Luis Carlos Arias Laso, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CFO [42]

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This average is the average for the year. And as Enrique is explaining in his remarks, it's more than enough to serve those markets since we expanded our plants from around 700,000 tonnes to more than -- a little bit more than 1 million tonnes. So with that, utilization, it's more than enough to serve our customers there.

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Operator [43]

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We will take our next question from Cecilia Jimenez with Santander.

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Cecilia Jimenez, Santander Investment Securities Inc., Research Division - Head of Cement and Construction [44]

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Most of them have been answered already, but I have a few follow-ups. Number one, in terms of EBITDA margins, I believe -- I have a few questions. Do you think you foresee in the near term it could be possible to reach precut-crisis levels of EBITDA, meaning roughly 33%, 34% EBITDA margins? That's number one. And number two, also in the USA specifically, I'm sorry if you mentioned this before, I got cut off, but do you foresee additional price increases during second half of the year to combine with the increasing operating leverage you will have there? I believe that would drive margins up? So those are my 2 questions. And finally, in Mexico, any specific dates to have the implementation of the substitution of energy in terms of utilization of alternative fuels? Those are my 3 questions.

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Héctor Enrique Escalante Ochoa, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CEO & Alternate Director [45]

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Cecilia, this is Enrique. Thanks for the questions. I will start with your second question in terms of price increases, the potential for additional price increases in the U.S. in second half of the year. No, today, we don't see enough appetite for an additional price increase in the U.S. in general. As I mentioned, there may be some opportunistic price increases given the supply-demand issues in the Mississippi River. So those will be obviously marginal compared to the whole market where we operate.

Having said that, we said in the last call that we were working with the oil well service companies in the Permian Basin, talking about a potential price increase in October. That's still under discussion. That may be a price increase that we could see in the last part of the year. But it's still early to say. And this was basically a result of us not being able to bring in that Chihuahua new capacity on time because of the testing protocols that was also these cost areas. So things have been delayed a little bit there. In terms of Mexico, I didn't understand your question. I think it was on substitution of alternative fuels for the plant in Mexico?

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Cecilia Jimenez, Santander Investment Securities Inc., Research Division - Head of Cement and Construction [46]

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Yes. No, for Mexico and the U.S. as well, but I believe Mexico is probably a bit far behind on that.

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Héctor Enrique Escalante Ochoa, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CEO & Alternate Director [47]

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I'm sorry, okay. So we have here our goal for the Chihuahua plant. It's to reach 30% substitution. I can tell you there that we have fully implemented what we call the [forward] project here in Chihuahua. And last month, we commissioned the new burner in the kiln -- in the main kiln, be able to burn more alternative fuels, and everything is going well. We still have to tweak that system a little bit with one fan that is placed a little bit under rated capacity, but something simple to resolve. And we should be reaching around 30% substitution midterm in the Chihuahua plant. Juarez, we have gone up to 45%, and we expect -- we are doing some changes in raw materials at the moment required by the energy company in the U.S. that we sell the specialty product from Juarez. So that has resulted in a temporary reduction on alternative fuels, but we don't see a problem to go back to 45% level, which was already reached.

Same thing for Samalayuca. Samalayuca should be able to reach a 45% substitution. Pueblo is the only plant in the U.S. that is running on alternative fuels, mainly TDF. There are some plants start burning some other biomass fuels there, and the permit is in place. So we expect to be able to reach around 20% to 25% substitution by the end of this year and with potential to continue to increase that substitution going on next year. On your first question, I will defer that to Luis Carlos to see if we can reach -- you said, if I understood well, pre-recession EBITDA levels. Are you meaning pre-recession, pre-2000...

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Cecilia Jimenez, Santander Investment Securities Inc., Research Division - Head of Cement and Construction [48]

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EBITDA margin, yes, pre-crisis EBITDA level, around above 33% basically?

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Luis Carlos Arias Laso, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CFO [49]

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Yes. But was your question specifically we continue to have that objective going forward?

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Cecilia Jimenez, Santander Investment Securities Inc., Research Division - Head of Cement and Construction [50]

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Yes. And the timeframe for that?

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Luis Carlos Arias Laso, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CFO [51]

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Yes. Definitely, we are very focused on reaching that EBITDA margin. We think it's very feasible. And if you see there -- well, it's -- if you see the last couple years, we have done greater steps in achieving that. In terms of time frame, it's difficult to say it, but I can tell you that every member of this company knows about that objective. So we are very focused on achieving that target.

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Héctor Enrique Escalante Ochoa, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CEO & Alternate Director [52]

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And obviously, the project that we have been discussing (inaudible) specifically, obviously, the target for that, like the power substitution in Mexico and the increase of alternative fuels, [that all expands], so.

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Operator [53]

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We will take our next question from Pedro Fabregat with Compass Group.

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Pedro Fabregat, Compass Group Holdings Inc. - Investment Analyst [54]

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Just wanted to ask a little bit more on the IFRS 16 impact. What I see based on the data provided on the 1Q, the impact was close to 600 basis points, while on the 2Q, the impact was closer to 250 basis points on the margin. But can you give a little bit of color on the impact of this measure, the IFRS 16, going forward? Is there like a chance you could give us the full 2018 EBITDA margin with IFRS? On the other hand, is it fair to assume that most of the impact comes from the U.S. operations?

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Luis Carlos Arias Laso, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CFO [55]

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Pedro, I can tell you that on an annual basis, the effect of the IFRS is around $20 million, and it's split evenly during all quarters. And yes, most of it, it's in the U.S. where we have the larger -- the big part of the leases. So it's around $5 million each quarter. So you can run your numbers with that -- those $5 million per quarter and $20 million on an annual basis.

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Héctor Enrique Escalante Ochoa, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CEO & Alternate Director [56]

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And more specifically, Pedro, the leases in the U.S. are basically the railcar fleet to move the cement, which is around 2,000 railcars that are permanently on lease. The rest is just a small light-vehicle fleet.

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Luis Carlos Arias Laso, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CFO [57]

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And a quick correction. It's around $18 million, the annual impact of the leases. Because $2 million are included in the financial expenses. So it's $18 million on the EBITDA level and $2 million on financing expenses.

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Operator [58]

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We will take our next question from Carlos García with Signum Research.

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Carlos García, Signum Research - Senior Stock Market Analyst [59]

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I only have one question remaining, and it's [in orders] to Tijeras plant. How much of the exposure is said to increase increase the production of oil well cement for the rest of the year?

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Héctor Enrique Escalante Ochoa, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CEO & Alternate Director [60]

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Carlos, this is Enrique. Thank you for the question. So oil well production increase for the rest of the year, it's basically around 50,000 tonnes in the Chihuahua kiln and approximately another 50,000 to 100,000, depending on demand on the Tijeras plant. So this is incremental production that is being shipped to the Permian Basin in addition to the Odessa plant being sold out at full capacity.

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Operator [61]

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(Operator Instructions) And we will take our next question from Alejandro Azar with GBM.

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Alejandro Azar Wabi, GBM Grupo Bursátil Mexicano, S.A. de C.V. Casa de Bolsa, Research Division - Research Analyst [62]

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I just want to get more color on the dynamics of each market. If you could -- mainly on Mexico, if you could explain about which sector is giving all the potential. I just want to know if, for example, the informal sector is declining in Chihuahua also as it is declining in the whole country. I don't know if we can start with that one.

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Héctor Enrique Escalante Ochoa, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CEO & Alternate Director [63]

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Alejandro, yes, thank you for the question. Of course, we can start with that one. Informal sector, generally speaking, has been declining in Chihuahua as a state. However, most recently, we have seen a small, slight improvement in Ciudad Juarez given the full employment in the city and, of course, because of the economy being tied mostly to the U.S. economy. So Juarez has been a little bit of a change, let's say, I mean, a little light at the end of the tunnel because the segment has been not growing in the year. Other sectors that have been doing better, as we spoke before, are the commercial construction, again, in Juarez with industrial buildings for [material] type operations. Some mines remain -- renewing their contracts in the Chihuahua mountains, certainly at a little bit more pressure than last year, but still the volumes are going forward. Middle income...

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Alejandro Azar Wabi, GBM Grupo Bursátil Mexicano, S.A. de C.V. Casa de Bolsa, Research Division - Research Analyst [64]

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Can you remind us how much of your volumes percentages goes to government-related projects?

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Héctor Enrique Escalante Ochoa, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CEO & Alternate Director [65]

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Yes, I will give it to you. Let me ask Ricardo to look for the right number, but it's very minimum. We have basically some work going on in Juarez for the second part of this year with some street paving and a couple of overpasses. That will probably total 7% to 8% of our shipments in this state, what is government infrastructure. So it's really, really minimum. So those -- that's mainly the mix in the Mexican markets. As we mentioned, we're certainly concerned, given what we have been seeing in the rest of the country and, of course, that potentially coming also to Chihuahua in terms of decrease of the overall market.

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Alejandro Azar Wabi, GBM Grupo Bursátil Mexicano, S.A. de C.V. Casa de Bolsa, Research Division - Research Analyst [66]

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And on the U.S., would you say the infrastructure sector is outperforming the residential or which one has the delta in the growth?

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Héctor Enrique Escalante Ochoa, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CEO & Alternate Director [67]

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Definitely infrastructure. It's running strong in most of the markets where we participate.

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Operator [68]

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And there are no additional phone questions at this time. I would like to turn the conference back -- I do apologize. We do get one question from Daniel Rojas with HDI Capital.

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Daniel Rojas Vielman;HDI Capital;Investment Specialist, [69]

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Just a follow-up on the previous one. You said infrastructure is running strong in the U.S. I just wanted to understand, is this at the federal level or is this state spending?

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Héctor Enrique Escalante Ochoa, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CEO & Alternate Director [70]

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Daniel, thank you for the question. Mostly infrastructure, although there is some state spending, I will say, because in many federal projects there is matching funds from state, specifically in infrastructure, in paving and those sorts of projects. But the funds are mainly coming from the federal level.

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Daniel Rojas Vielman;HDI Capital;Investment Specialist, [71]

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And do you think this will continue? Or the mix between those 2 sources of funds, how they should behave in the next following months?

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Héctor Enrique Escalante Ochoa, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CEO & Alternate Director [72]

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We expect it to continue obviously at a slower pace in terms of bidding. I mean, bidding usually, happens mostly at the beginning of the year, as we said in the report. So last month we were still seeing some bidding of projects, which is not very usual, and it's a reflection of how strong the sector is going, on one hand, and, of course, that it has been delayed from last year and this year because of weather, as we explained, in the other hand. But we expect it to continue to be strong the rest of the year and also coming into next year as we explained, for example, with the wind farm project that we have in the [back quarters in] Iowa.

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Operator [73]

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And I would now like to turn the conference back to Mr. Enrique Escalante for any additional or closing remarks.

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Héctor Enrique Escalante Ochoa, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CEO & Alternate Director [74]

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Well, I would just like to take the opportunity to thank you all for joining us today, and we appreciate your interest in our company and, of course, continue to look forward for meeting on one-on-one with you over the coming months and providing relevant updates. And in the meantime, our team remains available to answer any questions that you might have. Thank you, and enjoy the rest of your day. Thank you, operator.

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Operator [75]

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Thank you. Ladies and gentlemen, this concludes today's call, and we thank you for your participation. You may now disconnect.