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Edited Transcript of GCC*.MX earnings conference call or presentation 23-Oct-19 3:00pm GMT

Q3 2019 Grupo Cementos de Chihuahua SAB de CV Earnings Call

Oct 28, 2019 (Thomson StreetEvents) -- Edited Transcript of Grupo Cementos de Chihuahua SAB de CV earnings conference call or presentation Wednesday, October 23, 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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* Francisco Suarez

Scotiabank Global Banking and Markets, Research Division - Associate Director of LatAm Utilities

* Mauricio Serna Vega

UBS Investment Bank, Research Division - Analyst

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Presentation

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Operator [1]

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Good morning, and welcome to the GCC Third Quarter 2019 Earnings Call. (Operator Instructions) Please also note that starting this quarter, a slide presentation will accompany GCC's earnings results webcast. The link is available on the company's website at gcc.com within the Investor section. Also note that there will again be an opportunity for you to ask questions at the end of today's presentation, and that the call is being recorded.

At this time, I would like to turn the floor over to Ricardo Martínez, Head of Investor Relations. Please go ahead, sir.

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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 are Mr. Enrique Escalante, our Chief Executive Officer; and Luis Carlos Arias, our CFO.

Turning to Slide 2. Please note that management will make forward-looking statements that are based on our current expectations, forecasts and assumptions and involve risks and uncertainties. These statements include, but are not limited to, statements regarding the future performance of GCC, including expected financial results for the fourth quarter and full year 2019 as well as the future growth of our business. Our actual results may vary materially from those discussed in this call. You can find more information about risks, uncertainties and other factors that could affect our operating results in our most recent filings with the Mexican Stock Exchange.

With that, let me now turn the call over to Mr. 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. We hope the slides that we show now help you in this conference. On Slide 3, as you have read on our press release, we delivered strong operational results for the third quarter 2019, posting solid top line growth while increasing sales by more than 8% for the quarter and just over 4% year-to-date despite a particular difficult start to the year.

As we reported in our quarterly results released yesterday, improved weather in the third quarter enabled us to trigger our strong backlog, resulting in the strengthened volumes we have anticipated while we benefit from improved pricing in both markets, however, lower than we had expected, particularly in GCC's U.S. cement business.

So let me now take this opportunity to provide a more detailed review of our main drivers of our business during the quarter in those markets in which we participate. Luis Carlos will then share more color on our financial results, and he will turn then the call back to me for comments regarding full year guidance and closing remarks.

Turning to Slide 4. As I had commented, we're pleased with the results we achieved this quarter, particularly in the U.S., where we saw very strong shipments across all of our states to reach record high cement volumes for GCC. Following an extraordinary winter and rainy season which hindered construction activity during the first half of the year, improved weather during this third quarter enabled us to capitalize on pent-up demand on the back of our robust distribution network and operational capabilities.

Despite the impact of labor charges affecting the construction industry throughout most of the regions in which we operate, we expect this robust performance to continue in the fourth quarter, assuming favorable weather conditions continue. Our strong top line performance enabled us to deliver 15.2% of EBITDA growth with almost 200 basis points of margin expansion.

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. On Slide 5, in El Paso, Texas, infrastructure work continues to be the main growth driver, with no further delays at our main projects. Regarding the Permian Basin oilfields in West Texas, cement consumption demand and shipments remained strong despite several challenges that the oil industry has faced. Further, as we have noted on previous calls, we continue to see a very competitive environment in this area as oil well service companies remain focused on cost reduction across the supply chain while they identify new ways to innovate to increase their profitability and cash flow generation.

In light of this, we have made the decision to adjust our pricing strategy accordingly in order to defend our market share as we continue to build long-term relationships with our customers. We therefore do not expect to implement any price increases until the first quarter of 2020. On a positive note, [tight] cost reductions have resulted in layoffs across the Permian Basin, with shale producers turning to workforce cuts as investors step up demands for returns, easing the shortage of skilled workers in the region and expanding our accessible labor pool of permanent maintenance employees with no further need to turn to more expensive outside contractors.

In terms of pricing for 2020, we have announced an additional USD 8 per metric ton price increase that will come into effect across all our markets on April 1, in line with the industry. Looking ahead, given the current tight supply and demand dynamics as well as the high utilization level in the cement industry, we expect to experience much less pushback than what we have been seeing this and previous years. In Colorado, we continue to see a strong performance, underpinned by solid demand from housing and public infrastructure construction.

Turning to the northern Midwest and Plains states, the wind farm construction sector in the Dakotas and Iowa was again a strong driver for demand in the quarter. During the first half of the year, we experienced some weather-related delays, which have pushed some projects to next year. But we're confident this segment will continue to gain traction within our company, particularly in 2020 due to our strong wind farm backlog.

In North Dakota, we're seeing more activity from oil well cement produced at our Rapid City plant as volumes shipped to the Bakken oilfields have been increasing, enabling us to capture additional demand from our customers all the way from North Dakota to Colorado. In Montana, we continue to leverage GCC's new Trident plant to consolidate and sell directly to our Canadian customers while we address the increased sales we are seeing in both Montana and Idaho.

To briefly touch upon our Rapid City facility stabilization process, this plant is now running well, having achieved near optimum levels. The 2 main issues that we faced during the first half of the year related to certain auxiliary equipment are now under control, one of which has been fully resolved. Regarding the conveyor belt, temporary modifications have been made, and we expect to have this fully resolved during the first quarter of next year.

Turning to our Mexico operations on Slide 6. We again delivered strong third quarter results on the back of both price and volume growth in an increasingly competitive environment. However, we haven't successfully defended our market share within this region. Market dynamics remained similar to our prior quarters as the Chihuahua region continues to outperform the country as a whole, benefiting from the positive sentiment toward the enforcement of the new trade -- free trade agreement. Sales volumes are still being driven by industrial maquiladora plant, warehouse construction and mining projects. In the northern cities, the middle-income housing segment also showed strong demand.

Let me now turn the call over to Luis Carlos to review the quarter's financial, and I would return for some closing comments.

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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. So the third quarters of 2018 and '19 are now both comparable. Our results for the 2018 also reflect the reclassification of the Oklahoma and Arkansas ready-mix assets sold in June last year as discontinued operations. And in accordance with IFRS 5, sales, costs, expenses and volumes have been restated.

Turning to Slide 8. Consolidated net sales for the third quarter increased by 8.3%. This was mainly driven by the increase in cement and concrete volumes in the U.S. and Mexico and better prices in both countries. In the U.S., we achieved a 9.8% increase in cement volumes, reaching an all-time high for our company, as Enrique had commented. Mexico continues to perform above our expectations with sales growing 5.5% year-on-year, boosted by growth in volumes, partially offset by the depreciation of the Mexican peso against the U.S. dollar during the quarter.

On Slide 9, cost of sales as a percentage of revenues remained stable at 69.6% compared to 69.7% in the prior year quarter. Increases in variable costs, operating and logistic expenses were offset by favorable pricing. All of this was achieved while ensuring customer service remains a top priority, as we have absorbed significant increases in distribution expenses resulting from rerouting shipments to ensure uninterrupted service to our valued customers.

In Mexico, we continue to see pressures on energy costs. But as we have previously mentioned, we are working on alternatives in the form of renewable energy through the use of new long-term electricity generators, which should drive significant future cost savings, while we continue identifying other solar energy options for our cement operations either through third parties or on-site.

Regarding fuel, we reiterate our commitment to 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.

Selling, general and administrative expenses as a percentage of sales remained stable at 7.3%, benefiting from the growth in our top line.

Turning to Slide 10. EBITDA increased 15.2% in the third quarter, with a 1.9 percentage point margin expansion to 31.9%. On a comparable basis, excluding the IFRS 16 effect, EBITDA increased 8.6% in this quarter. As we mentioned on our previous call, EBITDA this year and hereafter will benefit from the implementation of 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 $20 million, neither impacting net income nor free cash flow.

On Slide 11, net financial expenses fell 5.9% in the quarter, mainly due to an increase in financial income resulting from our higher cash balance and positive barriers in our FX line due to the depreciation of Mexican peso relative to the U.S. dollar. Income tax decreased 3.8% year-on-year to $12.4 million in the third quarter of 2019. As a result of these factors and with the benefit of strong operating results, income from continued operations increased 12.8% to $48.7 million, while earnings per share increased 13.8% in this quarter.

Moving to our cash generation on Slide 12. Free cash flow increased 18.9% to $90.6 million in this quarter, translating into a free cash flow conversion rate of approximately 94%. This strong cash flow generation was driven by increased EBITDA generation after operating leases, lower cash interest expenses, higher noncash accruals and a decrease in maintenance CapEx. Higher cash taxes and lower working capital generation partially offset this increase.

As a result, we remain focused on strengthening our balance sheet, ensuring the flexibility to capture future growth opportunities, which we continue to assess on an ongoing basis. In this sense, our capital allocation strategy remains unchanged, always seeking to improve our returns and deliver strong stakeholder value while investing in our business to capture organic and inorganic growth. Our dividend distributions also remain in place and have increased, consistent with our historical rate.

Along these lines, as we anticipated on our previous call, on August 15, we made a dividend payment of MXN 0.8 per share. This represents a 15% increase compared to last year's dividend payment, all while maintaining an efficient capital structure. Our net debt-to-EBITDA leverage ratio decreased from 1.8x in June 2019 to 1.5x as of September 2019, significantly below industry average level.

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. Turning to Slide 13. While the underlying trends of GCC's business remain solid and despite the strong cement shipments that we saw in this quarter, we're revising our guidance for the full year.

In terms of U.S. ready-mix and cement volumes, our guidance remains unchanged. As a reminder, we expect total cement volumes in the U.S. to increase 3% to 5% year-over-year, with a 1% to 3% increase on a like-to-like basis. We're expecting volumes at our ready-mix business to remain flat for the balance of 2019. This is due to the substantial volumes we had previously expected during 2019, which were pushed forward into the 2020 period. In terms of cement pricing in this market, we're reducing our guidance to between 2% and 3% from 4% to 5%, while ready-mix prices remain unchanged.

Turning to Mexico. We now expect to grow between 1% to 3% from flat volumes in both cement and ready-mix, while pricing is expected to remain unchanged.

Regarding profitability, the incremental logistics costs we faced during the first half of the year, combined with the challenging pricing environment in the U.S., have directly impacted our bottom line. Therefore, we now expect EBITDA to grow between 8% to 10% year-over-year versus our prior guidance of between 15% to 17% and between 0% to 2% on an adjusted basis, excluding the IFRS 16 accounting impact, from the 7% to 9% which we previously expected.

Our estimates for total capital expenditures decreased from $70 million to $65 million, and we expect free cash flow conversion and net debt-to-EBITDA guidance to remain unchanged. We continue to expect to finish the year with a free cash flow conversion rate above 40% and a net debt-to-EBITDA ratio around 1.1x.

Looking ahead, while we face a challenging operating environment mainly due to adverse weather conditions, particularly in the first half of the year, I would like to reiterate our commitment to our shareholders. With our strong balance sheet, state-of-the-art production facilities and our customer-centric flexible distribution network, combined with our continued efforts to streamline our cost structure without giving up growth, we are confident that we're in the right path to continue delivering strong long-term value.

Finally, also related to our sustainability efforts on Slide 14, in September of this year we signed a long-term agreement with a leading U.S.-based energy provider to supply solar and wind power to GCC's Odessa, Texas, cement plant, covering 100% of the electricity consumed at those operations. This 10-year fixed price agreement will begin on July 2022, and represents approximately a 22% decrease from the current electricity price for the Odessa plant, translating into approximately $4.6 million in total savings for this period. This will result in approximately 45,000 metric tons reduction in CO2. This is per year, which is equivalent to around 9,500 passenger vehicles driven for a year, based on U.S. Environmental Protection Agency estimates.

The above is another example of our unwavering commitment to implementing global best practices related to sustainability throughout the organization while further strengthening the company's overall profitability.

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 first from UBS, we have Mauricio Serna.

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Mauricio Serna Vega, UBS Investment Bank, Research Division - Analyst [2]

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Just going back to the U.S. operations. The company did deliver some strong margin expansion despite the cost headwinds. So just was wondering if you could maybe provide a little bit more details on how we should be this -- we should see this cost, I guess, fading throughout this quarter and probably at the beginning of 2020.

Specifically on the issues regarding the ramp-up of the Rapid City expansion, you did mention that the issues with the equipment were solved. But I mean about how much of a headwind should we expect from the conveyor belt, which I think you mentioned was still something that should continue at least in the second half of the year? And also specifically on other things like the sourcing of coal and -- yes, those 2 main issues.

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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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Mauricio, thank you very much for your question. This is Enrique. Luis Carlos is going to, I mean, try to give you some more details on the numbers you're asking for. Let me go to your final questions first about the ramp-up of the Rapid City plant.

What we're planning to do, and we're almost in agreement now with all the team and the technology company, is to install a new conveyor belt which is more robust than the one that we have. It's going to be completely reengineered. It's at the cost of the technology company. So the only cost that we have to, I mean, face here is the installation cost, which is not significantly material. So that shouldn't have an impact on the performance on the cost side of next year.

In terms of sourcing of coal, no, that was only this first half of the year, given the quality issue that we faced with the coal seam where we were mining. As you may remember, we changed that, and the mine is running well. And we don't expect to have any further delays to continue producing all the coal that we need at our plant without having to buy anything external. So the coal -- I mean, cost should remain in line with what we, I mean, expected, I mean, for the second part of this year.

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

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And in regards to the first part of the question, Mauricio, well, as we have explained in this call and the last quarter's call, the challenges -- the main challenges was the transfer freight and the challenges of the Rapid City plant, as Enrique is explaining, in coal that we have to purchase from third party. We don't foresee those challenges to be as hard going forward. We don't see, again, producing coal from third parties or a lot of challenges on the transfer freight part. What -- but we have to take into account that the fourth quarter is a -- the fourth quarter volumes are less than the third quarter in the U.S., so operating leverage is not as strong as the third quarter. That's one of the main factors.

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Mauricio Serna Vega, UBS Investment Bank, Research Division - Analyst [5]

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Got it. And maybe just a couple of follow-ups in the sense of the costs and energy specifically. We've seen the Mexico margins continue to compress a lot despite the strong volumes. Would expect maybe the company, seeing these strong volume dynamics, could it increase prices a little bit more to offset this pressure? Or how are the initiatives moving along in terms to improve or bring back the margins a little bit more in the Mexico operations?

And also just following up, if you have any updates regarding any strategic capital deployment initiatives going forward.

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Héctor Enrique Escalante Ochoa, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CEO & Alternate Director [6]

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On your first question in Mexico margins, Mauricio, definitely, we are planning to increase prices in the near future here in Mexico to offset, I mean, the inflation costs that we are observing mostly, as you said, on the electricity costs. In our specific case, I mean, the fuel cost is going to be a constant -- I mean stable, because of the reasons I just gave about the mine. And so we're working with the team now to announce a price increase shortly for the Mexican market.

And on the cost structure for Mexico, as we have explained in the past, we're working on electricity, solar sources, on a long-term basis. And of course, we are trying to increase the usage of alternative fuels going forward also.

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Mauricio Serna Vega, UBS Investment Bank, Research Division - Analyst [7]

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And the other thing regarding the strategic deployment of capital?

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Héctor Enrique Escalante Ochoa, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CEO & Alternate Director [8]

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No. We don't have anything specific at this moment, Mauricio. We keep working, obviously, permanently in looking for inorganic growth opportunities. And as soon as we have something solid, we'll communicate it to the market.

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Operator [9]

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(Operator Instructions) And moving on, we have Francisco Suarez with Scotiabank.

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Francisco Suarez, Scotiabank Global Banking and Markets, Research Division - Associate Director of LatAm Utilities [10]

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Just to understand a little bit more on what you are seeing in the Permian region. I think that the overall environment for drillers is challenging. I understand the dynamics in Texas and elsewhere on those regions are quite solid. They remain as a sold-out market. Nevertheless, what do you think might change next year in order to see better prices ahead? I mean, do you see overall tighter market conditions in your key markets?

And just if I may, what about the existent utilization rates that you have at Rapid City, if you can share that with us?

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Héctor Enrique Escalante Ochoa, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CEO & Alternate Director [11]

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Francisco, thank you very much for your questions. Let me address the Permian Basin first. As we comment on our report today, yes, we're experiencing, I mean, a competitive market in the Permian basin. And even though demand is strong in Texas, the pressure is coming basically from Wall Street, I mean, to these oil well service companies, where they're expecting them now to improve their profitability and improve their cash flow generation. And we see some of the smaller drillers, I mean, being in a broadly difficult situation. And those -- some of those, I mean, could probably be absorbed by larger oil well service companies. And that's what we expect to see, and that will bring, I mean, probably more stability to that market during 2020. So we are attentive to that. And of course, being careful with our receivables from those -- some of those smaller companies, but everything seems to be going well so far.

There's been conversations already with our customers in terms of the oil well price increase, and it's going to go forward. It has been announced. As I mentioned, we missed, I mean, the opportunity to increase the price in October of this year, which was what we initially planned. But with all that background, I mean, and the discussions with the customers, it seems there is going to be no problem to increase the price in the first quarter of next year. So we're still looking at a strong, robust demand and with this expectation of better margins for the rest of 2020 in that market.

I will turn the question now to Luis Carlos for the Rapid City plant.

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Luis Carlos Arias Laso, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CFO [12]

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Yes, yes. Can you clarify the question about the Rapid City utilization?

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Francisco Suarez, Scotiabank Global Banking and Markets, Research Division - Associate Director of LatAm Utilities [13]

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Yes. I was just wondering what is the current rate on utilization on your new installed capacity on that plant.

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Luis Carlos Arias Laso, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CFO [14]

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Well, we're actually -- as Enrique explained in his remarks, we have solved most of the issues in terms of having a smooth utilization of the plant. It's about the 70s in the last month. So it's a matter of solving the last part of the challenges that we explained.

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Operator [15]

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(Operator Instructions) All right, and it does appear that we have no further questions from the audience. At this time, I'd like to turn the floor over to Enrique Escalante for any additional remarks.

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Héctor Enrique Escalante Ochoa, Grupo Cementos de Chihuahua, S.A.B. de C.V. - CEO & Alternate Director [16]

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Thank you, operator. Well, thank you, everyone, for joining us today. We always appreciate your interest in our company, and we look forward to meeting more of you during the coming months and providing relevant updates. We're open to, I mean, your calls and one-on-ones. So in the meantime, our team will remain available to continue answering any questions on this report that you may have. Thanks again, and enjoy the rest of your day.

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Operator [17]

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And once again, ladies and gentlemen, that does conclude our call. Thank you for joining us. You may now disconnect.