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Edited Transcript of TEN.MI earnings conference call or presentation 21-Feb-19 2:00pm GMT

Q4 2018 Tenaris SA Earnings Call

Lux Feb 26, 2019 (Thomson StreetEvents) -- Edited Transcript of Tenaris SA earnings conference call or presentation Thursday, February 21, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Edgardo Carlos

Tenaris S.A. - CFO

* Gabriel Podskubka

Tenaris S.A. - President of Eastern Hemisphere Operations

* Germán Curá

Tenaris S.A. - Director

* Giovanni Sardagna

Tenaris S.A. - IR Director

* Luca Zanotti

Tenaris S.A. - President of U.S.A. Operations

* Paolo Rocca

Tenaris S.A. - Chairman & CEO

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Conference Call Participants

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* Frank J. McGann

BofA Merrill Lynch, Research Division - MD

* Hin Kin Wong

UBS Investment Bank, Research Division - Executive Director and Analyst

* Ian MacPherson

Simmons & Company International, Research Division - MD & Senior Research Analyst of Oil Service

* Igor Levi

BTIG, LLC, Research Division - Director

* John David Anderson

Barclays Bank PLC, Research Division - Director and Senior North America Oilfield Services & Equipment Analyst

* Michael Hogarth Rae

Redburn (Europe) Limited, Research Division - Research Analyst

* Nicholas James Green

Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst

* Robert John Pulleyn

Morgan Stanley, Research Division - Analyst

* Sahar Islam

Goldman Sachs Group Inc., Research Division - Analyst

* Vladimir Sergievskii

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to our Fourth Quarter 2018 Tenaris Earnings Conference Call. (Operator Instructions) As a reminder, today's conference is being recorded.

I would now like to turn the call over to Giovanni Sardagna, Investor Relations Officer. You may begin.

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Giovanni Sardagna, Tenaris S.A. - IR Director [2]

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Thank you, Victor, and welcome to Tenaris 2018 Fourth Quarter and Annual Results Conference Call.

Before we start, I would like to remind you that we will be discussing forward-looking information in the call, and that our actual results may vary from those expressed or implied during this call.

With me on the call today are Paolo Rocca, our Chairman and CEO; Edgardo Carlos, our Chief Financial Officer; Guillermo Vogel, Vice Chairman and member of our Board of Directors; Germán Curá, Vice Chairman and member of our Board of Directors; Gabriel Podskubka, President of our Eastern Hemisphere Operations; and Luca Zanotti, President of our gas operations.

Before passing over the call to Paolo for his opening remarks, I would like to briefly comment our quarterly results. During the fourth quarter of '18, sales reached $2.1 billion, up 32% compared with those of the corresponding quarter of the previous year, and 11% sequentially, mainly as a result of higher sales throughout North America and the completion of delivery for the second Zohr pipeline in Eastern Mediterranean.

Our quarterly EBITDA at $426 million was 33% higher than the corresponding quarter of 2017, and 8% higher sequentially, with our EBITDA margins stabilizing at around 20%. Our operating income for the quarter was negatively affected by the accelerated amortization of the residual value of the customer relationship of the Maverick acquisition for $109 million. Average selling prices in our Tubes operating segment were up 8% compared to the corresponding quarter of 2017, but down 1% sequentially.

During the quarter, cash flow from operation was $239 million. Our net cash position rose by $77 million to $485 million, following the payment of an interim dividend for $153 million in November last year, and capital expenditures of $76 million. The Board of Directors have decided to propose for the approval of the Annual General Shareholders' Meeting to be held in May, the payment of an annual dividend of $0.41 per share or $0.82 per ADR, which includes the interim dividend of $0.13 per share or $0.26 per ADR that we paid at the end of November. If approved, a dividend of $0.28 per share, or $0.56 per ADR, will be paid at the end of May.

Now I will ask Paolo to say a few words before we open the call to questions.

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Paolo Rocca, Tenaris S.A. - Chairman & CEO [3]

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Thank you very much, Giovanni, and good morning to all of you. This was a good quarter to end the year when Tenaris has demonstrated with its results the strength of its global and competitive position. The market, with increasing global oil and gas rig count, has been a relatively modest 9%, largely concentrated in the U.S. fields. Tenaris has increased by 45% over the year. All our region as well as our non-Tubular business have contributed to this achievement. Our margin has also increased. Our EBITDA margin is consolidated around 20% and our net income margin reached 11.4% of sales, a level which few oil service companies have achieved. This performance also compared favorably against any of our competitor. And in the past years, we have established a clear leadership in our sector, reflecting the effort we have made over many years, industrial excellence in product development in our Rig Direct service and in our global reach and financial strength.

Central to our performance this year has been the extraordinary achievement of completing the delivery of pipes with highly complex specification for 3 offshore gas pipeline in the Eastern Mediterranean, which will change the balance of gas supply and demand in the region. This corresponded to a specific conference of opportunities, created by the fast-track development of these new gas province which contributed 8% to our revenues for the year, and is unlikely to be repeated on the same scale for some time ahead.

We continue to make progress in extending the deployment of our Rig Direct service strategy around the world. During the year, around 60% of our OCTG sales by volume was supplied under Rig Direct condition. We have fully consolidated the service in the U.S. and Canadian markets, and are working to increase differentiation through improving service quality and extending integration with customer operation. Elsewhere, we have successfully introduced the service in Indonesia, in the Emirates, in Guyana and in Brazil. No other company in our sector is capable of deploying, on a global scale, such a strategy of deep integration with customer, with its benefit for reducing cost and simplifying operation.

During the year, we positioned ourselves favorably for many gas development projects around the world. In Argentina, Tenaris supported the rapid development of gas production in Vaca Muerta, while we also won awards for the supply to major gas development in Australia, in Qatar, in Indonesia, in Mozambique, and most recently, in India.

In an era where Section 232 tariff and quota were introduced in the U.S., we expanded our production in all of our plants in the country. In particular, we're refocusing on the ramp-up of our new greenfield mill at Bay City. And in 2019, we will continue working to bring the mill to its full potential.

During the year, we have been researching the application of digital automation and machine learning technologies in our industrial processes, and we incorporated many of these new development into our Bay City mill. Now we're beginning to introduce these new technologies and transform the rest of our industrial system. This work will be strengthened in the years ahead.

Over the past decade, we have focused our expansion strategy on organic growth, with extraction of new rolling mill at Tamsa and Bay City, and the expansion of key treatment, threading and service facility around the world.

Now with the acquisition of a welded pipe mill in Saudi Arabia and the launch of the Tenaris service joint venture project in Russia, we're starting a new phase of industry expansion in key markets for the oil and gas industry. In Saudi Arabia, we will now operate 3 plants with more than 1,000 employee, and the ability to support Aramco with a wide range of product in the country, which is making big effort to increase local and data content.

The Tenaris-Severstal joint venture will build strong industrial operation in Surgut, which is the center of an area where the majority of the country oil is produced and it is consumed and which is located far from the local mill currently supplying the region.

We have completed, in summary, an important year of expansion in sales and results, but if I should look ahead, let me stress that we are faced with a high level of uncertainty in the political and economic environment of many of the countries where we operate, as we are all well aware. I feel, however, that Tenaris, with the global positioning, its diverse and highly motivated team of professionals, its financial flexibility remains better placed than any of its competitor to take advantage of the new opportunity and respond to the different scenario that could unfold.

We will open now for any question you may have.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Igor Levi from BTIG.

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Igor Levi, BTIG, LLC, Research Division - Director [2]

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My first question is on offshore. Offshore FIDs, in the past few years, have seen a big resurgence and since we've been patiently waiting for this to translate into drilling activity and demand for OCTG. And in the previous quarters, your commentary generally highlighted that offshore remains subdued, and it looks like in this latest press release that tone seems more optimistic where you talked about the offshore driving more of your premium sales. So I was hoping to get some more color on what you're seeing offshore. And what has changed from the past few quarters to now?

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Paolo Rocca, Tenaris S.A. - Chairman & CEO [3]

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Thank you, Igor, for the question. In fact, we are perceiving gradual change in the mood of the operator concerning project. But really, we see attention and action concentrated relatively small initiative, not very big. I would ask Gabriel to comment because most of the project we are following occurs in the Eastern hemisphere, to a large extent. And then I will comment maybe on South America and Gulf of Mexico.

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Gabriel Podskubka, Tenaris S.A. - President of Eastern Hemisphere Operations [4]

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Thank you, Paolo. Good morning, Igor. It's true there is a positive trend in the number of FIDs in the Eastern Hemisphere and international markets, that this entails offshore clearly as well, and there's particular (inaudible) oil and gas. The number of FIDs has been growing, continues to grow, but it's important to note that the size of this project is not like it in the past. So what I think is even more relevant than the number of FIDs is underlying CapEx that this project will yield. And in our estimates, our market intelligence and discussion with our customers, we see that the CapEx associated with these FIDs in the offshore growing in the range of 5% to 10%. So there is a positive trend, there is dynamism, but this is not, by no means, going back to the CapEx and drilling activity that we had at precrisis level. Gas continue to be an area of focus. We mentioned, Paolo I think mentioned about the LNGs. We see companies prepare for greenfields in Mozambique, some infill drilling and replenishment in Australia, and expansion that is being discussed and hopefully will be FID during 2019. This is a segment that we are particularly well positioned.

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Gabriel Podskubka, Tenaris S.A. - President of Eastern Hemisphere Operations [5]

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Other area that has picked up in the last few months has been China and India. These are offshore gas developments and we see a change of pace in these 2 countries pursuing domestic gas drilling activities, and we have been particularly successful in capturing the majority of these growth, and this is something that you will see during the numbers during 2019. So there is a positive trend. We are well positioned, but by no means we are going back to the drilling activity in offshore that we used to have.

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Paolo Rocca, Tenaris S.A. - Chairman & CEO [6]

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In the other region, in South America, in Brazil, clearly, with the new government, there is renewed commitment to investing in exploration and development of offshore by Petrobras and by the private company, that is one concession in the offshore. Still, I think that this will materialize later on between 2020, 2021. And will, by the way, be, to some extent, conditioned by the evolution of the government initiative or the new government from Bolsonaro in readdressing the macroeconomic situation in -- to solve some of the macro issue that needs to be solved in Brazil to set the country on a steady recovery. There will be also favorable environment for investment in the oil and gas industry. In Mexico, something similar is happening because in the end, there will be project offshore by the private company, they will materialize gradually, probably in 2020, beginning in 2019, but also there are issue in the political environment that needs to be fixed to create condition for activity by privates and by Pemex in the offshore realm. By the way, we are confident on this. Again in South America, projects like Liza in Guyana and associated project are very important development. Possibly one of the major that we have seen in recent time and this will go on. In Gulf of Mexico, again, there are project, but some of them are related to tieback and to integration of existing field into new discovery and the development. We are following very closely some of this. I mean, some that require very complex and new technology for development in very deep water and in kind of field that has complex condition on the ground.

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Igor Levi, BTIG, LLC, Research Division - Director [7]

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Great. And shifting gears to your EBITDA guidance, which looks like implies just above $1.6 billion for 2019. Could you go over some of the key variables that could realistically drive this figure lower or higher?

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Paolo Rocca, Tenaris S.A. - Chairman & CEO [8]

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Well, what we are seeing is that we perceive that we are now moving around 20% EBITDA margin. As you are aware, as we anticipated. And we expect this to be the level, at least in the first part of this year. But when we look in the second half of the 2019, there are different element of volatility and uncertainty, in my view. So there are upside and there are downside that depends from the level of activity. Drilling in the United States is very important. And this probably is one of the factor that could be relevant for us. Second important is the materialization of the expansion project in Mexico that also is something that is relevant for us. But in general, my perception is that we have issue around the world on the macro and political situation that could have an impact and are creating an environment of high uncertainty. We see this in Europe, you see this on the trade issue concerning relation with U.S. and China, but also concerning the relation between U.S., Canada and Mexico for the negotiation for the next USMCA. These are important factor that could be affecting the level of growth in the world and indirectly the price of oil. And in the price of oil in itself, there are clearly uncertainty concern in the situation of different country, including Venezuela, Iran, and their ability to supply and to participate in the global supply. These things are important. If the price of oil remained sustained, the level of drilling, especially in the U.S. that are fast reacting to this, may have present upside during 2019. So we are doing it over our forecast in the term that I mentioned, we expect margin in the short term to be around the numbers that I mentioned. Looking ahead, we see this as a base, but we may perceive upside depending on the evolution of some of the variable that I mentioned.

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Operator [9]

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And our next question comes from the line of Frank McGann from Bank of America.

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Frank J. McGann, BofA Merrill Lynch, Research Division - MD [10]

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I was just wondering if perhaps you could go into a little bit more how you're viewing the U.S. right now. You mentioned it briefly. But I was just wondering if you're -- how you're seeing the potential for more drilling activity later in the year when you have more takeaway capacity. And then secondly, in terms of Columbia, what are the overall trends there? That's been a good market for you in recent years. I was just wondering how you're seeing the potential for upside there.

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Paolo Rocca, Tenaris S.A. - Chairman & CEO [11]

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Thank you, Frank. I would ask Luca to give a view of how we see the drilling and demand activity in the U.S., and I will comment on Columbia.

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Luca Zanotti, Tenaris S.A. - President of U.S.A. Operations [12]

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Thank you, Paolo. Good morning, everybody. Good morning, Frank. Again, I need to go back to the volatility concept that you brought about before, and there are different factors playing to create volatility. Generally, in the market, we see different factors, depending on the operators. We see the major offshore moving forward. We see there are independents, they are maintaining more or less the activity, and we see a good number of small players that are very susceptible to the oil prices and take very fast decision. So again, overall, we see the first quarter slightly below than the last quarter of 2018. But going forward, it very much goes back to what you said before, Paolo, on the oil prices and how this will be -- how much of this will be credible to these operators.

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Paolo Rocca, Tenaris S.A. - Chairman & CEO [13]

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Thank you, Luca. As far as the Columbia, let's say, in related region operation, we do not expect, let's say, substantial change of the level of operation compared to what we see today. We have long-term agreement with Ecopetrol. We are supplying very large part of the region. We are present with our Dopeless technology in Liza with Exxon and we have contract with major oil company in different part of the region. But the level of activity in Columbia, in my view, should remain more or less in line with what we are seeing in this quarter, maintain the level of today.

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Frank J. McGann, BofA Merrill Lynch, Research Division - MD [14]

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Okay. If I could just follow up a little bit. In terms of Canada, you also mentioned in the release that -- and you said this previously that Canada is expected to be fairly weak for 2019. I was just wondering if you could just give a little more detail on how you're seeing the decisions being made and what -- how weak it should be.

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Paolo Rocca, Tenaris S.A. - Chairman & CEO [15]

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Well, Canada, let's say, in some moment, we are being surprised by how fast the disruption in the transportation of oil has affected the price of the West Canadian crude. And this has clearly impacted on the level of drilling. The level of drilling went down substantially. Then the government intervention on the level of production, then on the transportation may contribute to recovery. But, frankly, we do not have a very positive view of the Canadian activity during 2019. And there is also something unpredictable because it depends from the government support to transportation and to the level of price in the region. Germán, you also are close to the region, maybe you can add something on what we can expect, the next season, no, because this season has been...

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Germán Curá, Tenaris S.A. - Director [16]

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Yes. Thank you, Paolo. Good morning, Frank. I think it's been one of, I'll call it, the early part of the year disappointment, Frank. Decision in Canada, we have seen levels of operation which are about 30% lower when you look at rig count than what we saw last year, given the details or explanation that we just occurred, and the ultimate impact on the price of oil. Now we need to see what's going to happen during the rest of the year. I think the season is "severely affected." Given the seasonality aspects of Canada, we don't expect a major change going forward. And we somehow remain confident that the infrastructure bottlenecks will be resolved, and we should see something a lot better towards the end of this year, early next.

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Operator [17]

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And our next question comes from the line of Ian MacPherson from Simmons.

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Ian MacPherson, Simmons & Company International, Research Division - MD & Senior Research Analyst of Oil Service [18]

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I wanted to ask a couple of questions on the investment side. I think the press release suggested that capital spending would be lower in 2019. I wanted to see if you might quantify that for us or at least point us toward a range. But then also with respect to your investment in Russia, if you could shed some light on the phasing of the $240 million investment over the next couple of years. And then fundamentally, it looks like you -- we would agree you're throwing off significant free cash flow in 2019, and you already have a significant cash surplus, so really what -- where your mind is with regard to capital allocation given the cash surplus that we see in front of us during this year. That's it for me. I'll listen.

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Paolo Rocca, Tenaris S.A. - Chairman & CEO [19]

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Thank you, Ian. As far as the investment -- industrial investment is concerned, we expect to invest this year in the range between $320 million, $350 million. We have some major intervention in maintenance in our facility in January, February in Argentina. We have intervention in Mexico during the months of May in different line. This is a relevant intervention. We'll also, to some extent, stop the plant for a while, while we invest in maintenance and introduce innovation in some of the part of the mill. And we have also another stoppage in Romania in September. So in this, let's say, extraordinary stoppages, we will invest a figure in this range. As far as the joint venture with Severstal -- between Tenaris and Severstal is concerned, I will ask Gabriel to comment on this. We are very confident in the future of this and very satisfied with the relation, but Gabriel, you may comment on the vision behind it.

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Gabriel Podskubka, Tenaris S.A. - President of Eastern Hemisphere Operations [20]

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Yes. Thank you, Paolo. Thanks for your question, Ian. In fact, we are very excited about the new Tenaris-Severstal joint venture opportunity. We believe that this will offer a lot of opportunity for us to grow. Russia is a very relevant market, representing about 13% of the global OCTG demand. And up to now, we have been present lately in the niches of high-end technology. But with this investment that we will deploy during the next couple of years, we will be a relevant player in this market. The plant will be located in Surgut, which is very important because within a radius of 500 kilometers, we believe that more than 50% of this OCTG demand is located. And this gives us a substantial competitive advantage versus the majority of the competitors that are at least 1,000 kilometers far from this area. Regarding the CapEx, we believe that this -- the construction of this plant will take about 2 years, $240 million that we will contribute 50% pro rata our equity. Until we start mid-2019 until mid-2021, where the plant will start operation.

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Paolo Rocca, Tenaris S.A. - Chairman & CEO [21]

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Thank you, Gabriel. So this is, as far as the situation with Russia. We are very excited. And also, Severstal is a very strong partner. They will be supplying the hot rolled coils from their plant in Russia. They will support us in the start-up in the mill. This will be a joint venture among 2 strong companies. Tenaris-Severstal will be a good brand also for renewing introducing new competitor in the Russian environment. As far as cash flow is concerned, maybe Edgardo, you can comment on the perspective of cash flow generation during 2019 after this build-up of inventory now.

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Edgardo Carlos, Tenaris S.A. - CFO [22]

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Sure, Paolo. Thank you very much for the question. Yes, as you said, we pointed out in our press release and in the opening remarks of Paolo, we will continue to generate strong cash flow now that we basically stabilized our working capital. We have been consistently reducing the days of net working capital, reaching 160 day today back from the 190 that we have in 2017. And clearly, we are always looking for opportunities in the potential acquisitions that we may have in the future, and also we will continue looking to paying back to our shareholders with the dividend that we just decided.

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Operator [23]

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And our next question comes from the line of Michael Rae from Redburn.

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Michael Hogarth Rae, Redburn (Europe) Limited, Research Division - Research Analyst [24]

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Just firstly, on the Saudi acquisition, is it realistic to expect that you can establish a Rig Direct relationship with Aramco on the other end of seas, in the Middle East? Is it that the goal? And can you just give us a bit of steer on revenue contribution for this year? Is $200 million a reasonable assumption? And then the second question, can you give an update on the Section 232 raw material exclusion that I think you've applied for? If we just forget USMCA for now, what's happening with the exemption you've applied for? And then finally, I mean, I appreciate this is a Tenaris call but it's not been mentioned, so I thought I would just ask Paolo, what's your response to these charges that are potentially being leveled against you in Argentina? And can you give us a steer on the timetable for any kind of new developments on that?

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Paolo Rocca, Tenaris S.A. - Chairman & CEO [25]

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Thank you, Michael. On the first question, the acquisition and the relation with Aramco. Maybe Gabriel, you can give a comment on what we expect. We establish Rig Direct in the region, and we are hopeful that over time, we will be able to use our pays and more than 1,000 people there to leverage our position.

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Gabriel Podskubka, Tenaris S.A. - President of Eastern Hemisphere Operations [26]

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Yes, thank you, Paolo. Yes indeed, we're also very excited about concluding this controlling state in SSP during the quarter. This, I think, will be another very important platform of growth for us in the Middle East in general. There's a good complementation of SSP broad range, large OV and line pipe with our core and traditionally premium products that we have been selling in the Kingdom. So we have complete product range, you can start imagining and proposing a building value proposition for Rig Direct. So this is something that is a necessary condition to be able to offer something of this nature. We are making progress with Rig Direct in UAE, for example, and we see an interest in general in the region of looking for some efficiency. So this is something that will not be immediate, but thinking of Rig Direct in Saudi Arabia, and to a larger extent, in the Middle East, is something that we are trying to pursue. And we're hopeful that we will, over time, succeed. SSP is a public-listed company. I would refrain from making forward-looking statements, but I can tell you the last year revenues were in the range of $170 million. And we know that this is a base for us. The company has been working at about 50% of capacity in this station, and we are confident on their ability to develop commercial opportunities in Saudi and in the region to make this a growth area.

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Paolo Rocca, Tenaris S.A. - Chairman & CEO [27]

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Thank you, Gabriel. Well, on the question of the 232, for sure, we ask for exclusion of the power that we need to supply production, to support the production from a city. And we are very confident that we should be receiving this. It will take time. The stoppage of the U.S. government didn't help, but we are very confident that we will get it. As far as the 232 relation is concerned, let me tell you that everybody may depend and will depend from the negotiation of the USMCA. But maybe Germán, you can give us a view of this negotiation and the related negotiation of 232 concerning relation within Mexico, Canada and the U.S.?

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Germán Curá, Tenaris S.A. - Director [28]

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Thank you, Paolo. Well, Michael, the perspective of the execution is exactly that. During the last call, we were expecting a positive position towards the end of the year, very early this year. The government shutdown has not helped. But we continue and have received clear indications from the VISD agency, part of the DOC that is managing this, that you should come. So we continue to be confident about the fact of confirming this in the near future. Now with respect to the USMCA and 232, the current discussions and negotiations, we believe that there should be, in a way, an agreement built around 232 as in a way a condition for USMCA to move forward. Discussions are presently going on, and they have taken time. But various indications in Mexico, in Canada, and particularly in the U.S., particularly coming from both houses, Senate and the House of Representatives, are clearly indicating that in the context of a definition of the U.S. -- stratification of the USMCA, the 3 countries should also find a solution to the existing 232 restrictions.

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Paolo Rocca, Tenaris S.A. - Chairman & CEO [29]

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Thank you, Germán. On the last point, well, first of all, let me tell you, Tenaris is not involved in any way in the case that is being raised in Argentina. But I would ask Germán Curá as a Vice Chairman that guided the decision of the board on this issue to comment.

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Germán Curá, Tenaris S.A. - Director [30]

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Yes. Thank you, Paolo. Hello, Michael, hello, everybody. Well, on that point, I would like to comment that -- just a preliminary statement, that, as you know, the Argentinian judiciary is investigating a case of corruption and cartel practice, as evidenced by notebooks kept by a former government driver and leniency agreements by some of the participants, businesspeople and public officials. Also that many former government officials and businesspeople have been questioned and subject to further investigations and proceedings. On November 27, Judge Bonadio issued a preliminary decision, which in Spanish is called an "auto de procesamiento", by which it included Mr. Rocca in the investigation proceedings. I would like here to clarify something. Under Argentina Law a "procesamiento" is not a final -- can be revoked by the same judge that ordered it and does not constitute an indictment. Instead, it really constitutes a preliminary decision to include Mr. Rocca in the investigation proceedings. In addition, the standard of evidence required for the decision to include an individual in an investigation through an "auto de procesamiento" is quite low. It is important also to understand that "procesamiento" constitutes a preliminary decision. Only once the investigation is complete, then the judge consider the evidence collected, as well as Mr. Rocca's defense, before deciding whether there is enough cause to proceed to a trial, which is where we are today. The Board of Directors has been monitoring this situation in consultation with the legal advisers. And after a review of the decision adopted by the judge on November 27, 2018, it unanimously confirmed Mr. Rocca as Chairman and Chief Executive Officer of the company. And the board also instructed at the time Mr. Rocca to continue discharging his responsibilities with the full support of the board.

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Paolo Rocca, Tenaris S.A. - Chairman & CEO [31]

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Thank you, Germán Curá.

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Operator [32]

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And our next question comes from the line of Amy Wong from UBS.

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Hin Kin Wong, UBS Investment Bank, Research Division - Executive Director and Analyst [33]

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It's Amy Wong here from UBS. A couple of questions from me, please. The first one, Paolo, just as relates to your comment earlier about oil prices are -- in terms of you answering the question on upside and downside tick to guidance, and you mentioned oil prices needing to be quite sustained. Could you give some insights into the conversations with some of the international oil companies? Whether you feel that their CapEx approach is a bit more through cycle or is it still their CapEx levels are still quite dependent on oil price levels, please. And then my second question is, I really want to revisit the capital allocation question in terms of just kind of looking -- you made a couple of acquisitions and investments just recently. Thinking about whether you would be looking to fill some more holes geographically or some products in your lineup, just thinking about that investment number on a medium-term basis.

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Paolo Rocca, Tenaris S.A. - Chairman & CEO [34]

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Thank you, Amy. In terms of, let's say, the consideration that we fear -- that we hear from the oil company, well, in my view, the oil company have considered in the repricing the range of Brent in the range between $60 and $65, is something that could be considered reasonable. And probably they are forecasting this as a price and they're projecting their product with a lower level in the range of $50. Having said this, if you look at the 4-, 5-year dynamics of investment in the defense segment, there is not really a strong recovery yet. I mean, the number of investment in the different region offshore, conventional onshore, unconventional, are not showing extraordinary changes. I mean, they were much higher in the period 2012, 2014. They went down by something in the range of 30% in terms of money terms. And now they are recovering slightly, but they are recovering very low pace in all of these regions. Offshore went down by almost 50% and recovered probably by 5% or 6% or 10%, Edgardo would say. And even unconventional, from what we hear from the oil company, we'll basically remain in the range or even slightly lower on what it is in 2018. This is what it is today. Now volatility is also affecting their decision. So the change in politics, in the environment are influencing this, and this may change especially in area that are fast reacting like United States. In our view, this is the area in which we could have upside and changes in the second part of 2019 over the base that we see today that were effective in the level of drilling and operation that we will see in the fourth quarter or in the first quarter of 2019. Now as well as capital allocation, well, in the last 2 years, when we mentioned that Tenaris, after the big acquisition realized in the United States and elsewhere in -- between 2005, 2010, has entered into a stage of organic growth. We grow through the investment in the 2 substantial mill and many other installation during the period 2010, 2018. And we invested a lot in working capital for supporting the Rig Direct model. I mean, this has been a substantial allocation of our part. Now we plan and we need to, at this stage, one, open up for a new phase of positioning that may lead to expand our presence in some of the key markets or consolidating some other; and second, reap the benefit of decent fees of organic growth by bringing the potential, the use of this facility to the potential, and by also optimizing the use of working capital. Edgardo was referring to this when he mentioned that 2019 should be a year of good and strong free cash flow generation. This is coming exactly from this, from optimization in the use of our working capital after a stage of expansion in Rig Direct.

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Hin Kin Wong, UBS Investment Bank, Research Division - Executive Director and Analyst [35]

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All right. That's helpful. I'll take that as probably not too many big investments on the horizon then.

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Operator [36]

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And our next question comes from the line of David Anderson from Barclays.

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John David Anderson, Barclays Bank PLC, Research Division - Director and Senior North America Oilfield Services & Equipment Analyst [37]

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Great. Just a question on pricing in -- of OCTG in North America. We didn't really get the pricing we were expecting last year with the Section 232. Just like to know, in your base case guidance that you highlighted before, what type of pricing increases do you have in there for North America? Maybe just like from now to year-end, is it up 10, is it up 15 or is it flat? How are you looking at that this year?

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Paolo Rocca, Tenaris S.A. - Chairman & CEO [38]

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On this, I will ask Luca Zanotti to give us a reference on how we see that. At least, I don't think we have a view, obviously, for the long run. But I think we have it for the short.

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Luca Zanotti, Tenaris S.A. - President of U.S.A. Operations [39]

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I believe that is very -- with all the variables in play that can add volatility, it's very difficult for us to take a long-term forecast on the pricing in the United States. I would say that, currently, maybe next -- first quarter and second quarter, we are seeing a flattish price, which is more or less mimicking the evolution of the Pipe Logix. That's a short story -- long story short, flattish to slightly lower.

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Paolo Rocca, Tenaris S.A. - Chairman & CEO [40]

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Yes. We will have -- and we will try to recover something of the increasing costs. As you know, the dramatic accident in Brazil has raised -- is raising the price, overall price worldwide of iron ore. This is having an impact on scrap. This is having an impact also, and will have an impact, on hot rolled coils. We expect that this aspect could be recovered.

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Luca Zanotti, Tenaris S.A. - President of U.S.A. Operations [41]

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Yes. This would be one of the volatility aspects I was mentioning.

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Paolo Rocca, Tenaris S.A. - Chairman & CEO [42]

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Yes. I think that this will be recovered, but basically, we do not expect much stronger pricing power in the close time...

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Luca Zanotti, Tenaris S.A. - President of U.S.A. Operations [43]

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Looking forward, it may depends, again, on how different factors will play out in the second half of 2019.

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John David Anderson, Barclays Bank PLC, Research Division - Director and Senior North America Oilfield Services & Equipment Analyst [44]

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And my follow-up question is, Paolo, in your remarks, you talked about kind of Saudi and Russia investments as a new phase of international expansion. These are big, established markets that you haven't had a big presence in previously. I guess, I'm wondering about why now. Why does this make the sense right now? What is Tenaris bringing into the market that gives you the confidence that you can grow share in these markets? Is it Rig Direct? Is at a lower cost operation? I guess, I'm just kind of wondering why now. Why does this make the most sense for you to move in these markets today?

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Paolo Rocca, Tenaris S.A. - Chairman & CEO [45]

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Well, I would say there are different reasons. In the case of Saudi, Saudi is in a process of modernization that includes also the system of oil and service company. There is a drive for local content that we need to understand and accommodate. And on the other side, Saudi is also having an important leadership in the region at this moment. It looks to us very important to expand our position and not only to be focused and limited to OCTG, but to be able to cover the entire range of products that are required by the development of the industry. You know Saudi is investing a lot not only for production of oil, but also for gas and for investing in the value-added chain related to oil. It looks to us that this was the right moment to strengthen our position. In the case of Russia, probably the reason is different. There is a question of opportunity. We see, in this moment, the opportunity to take a position with a strong partner. These are opportunities that come sometimes around the quality of the partner, the joint venture that we can build, and the ability to work together in this. We also perceive that Russia is a challenge in complex project and that the local vehicle will be supporting our positioning in complex project like the projects that are in the Yamal and Sakhalin and Astrakhan. These are areas in which also combining our technology, our product development, our ability to arrive to the client with the presence in the center of Surgut in West Siberia is creating -- let's say, is changing our profile in the country in a way that is -- that fit with the need of the region. Also there's a lot that could be done in reducing working capital, arriving to the rig, transforming the supply chain. And this is something that we are doing in different regions. We think that this -- we identify opportunity for doing this also in Russia. It will take time, but we are very confident that it will be an interesting attempt.

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Operator [46]

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And our next question comes from the line of Nick Green from Bernstein.

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Nicholas James Green, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [47]

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Most of them have been answered, so we can just keep it fairly brief. So firstly, just a bit of thoughts around your dividend, please. Can you talk about your thought process behind why you didn't choose to increase it this year, particularly given the cash outflow is -- 2019, when you expect free cash flow to be fairly strong? Secondly, in terms of your overall returns on capital employed and those kind of metrics. I just wanted your perspective on considering closing some of your oldest and maybe least utilized facilities. How do you weigh that decision up against the investments that we're talking about here, investments in Russia, and obviously, recently, you had investments in Bay City as well. And then the final question is on net working capital. It is good to see the improvements you made in that data point. Can you give a better sense if we are now at the optimal level of working capital? Or do you think, with this cycle, you can be a bit leaner and you still have some improvement in net working capital days ahead?

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Paolo Rocca, Tenaris S.A. - Chairman & CEO [48]

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Yes. Well, on the first, they say the dividend is not a decision, it's a proposal that the board will do through the general assembly. The discussion into the board went around, one, the concept of relative stability in over a period of time. We were slightly higher in the past. In the middle of the crisis, we reduced very slightly. And we look at the dynamic over time. We look also at the payout ratio. Payout ratio, if you look at the payout ratio with this dividend, is relatively high in a cycle in which we see opportunity for investment. So the payout ratio is the second consideration that is important for the determination. And also, the free cash flow generation will be very good, but still have to be realized. So let's realize free cash flow and then we will reconsider when we arrive in November for the proposal of an advanced dividend and then next year for also looking at what we can do. This has been the argument. The argument has been treated, discussed within the board to arrive to this proposal to the general assembly. As far as the return on capital invested, I think you are right on the fact that we will like -- in the past, we had higher return on capital invested. Today, we have important quantity of capital invested in working capital. And I think we need to focus very much on this, because in the end when you invest in a plant, you're investing for a very long time. When investing working capital, we are doing this to support the Rig Direct. We're doing this to assure that we are serving well the market. Now the effort on information technology, digitalization, reduction of lead time, improvement in demand planning, I mean, should allow us to be, in my view, much more efficient in terms of working capital use. Also, on the point of collection receivable, I'll let -- Edgardo, maybe you can add.

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Edgardo Carlos, Tenaris S.A. - CFO [49]

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Sure. Good morning, and thank you for the question. I will say that we reached the best level of net working capital. We will continue facing now that we -- as I said in the last conference call, now we have Bay City also operating. We can reduce, to some extent, the lead time to reach our customers. And the DSO, as well are the ones that we are focused on, mainly I will say that for June, we are targeting probably to reduce approximately between 7 to 10 days of the working capital. And I'm very confident that we are going to -- we're reaching this, this year.

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Paolo Rocca, Tenaris S.A. - Chairman & CEO [50]

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Yes. But anyway, this is very important area of action to improve efficiency in the delivery of the Rig Direct, even considering that Rig Direct is inherently a high working capital demanding piece of model. Now the last point I think is addressed by the -- now the question of the optimum level of working capital, I think we did -- I mentioned it in my previous...

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Nicholas James Green, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [51]

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Yes, that's addressed. Maybe just one very short follow-up is, I think last conference call you had said that Bay City mill, you hope to have more or less full capacity I think somewhere between Q1 and Q2. Maybe just give us an update on the run rate capacity utilization at the mill.

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Paolo Rocca, Tenaris S.A. - Chairman & CEO [52]

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I think in the last call, we were mentioning that we were reaching a run rate of around 300,000 tons in the second half of 2018. And we are there. Now I would say that my target this time will be to reach a run rate of around 450,000 tons by the end of 2019. The process of developing the full potential of Bay City is something that is taking a lot of investment in training, preparation of the people and is a process that will go on, which we are focused during this year.

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Operator [53]

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And our next question comes from the line of Vlad Sergievskii from Bank of America.

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Vladimir Sergievskii, [54]

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Two of them, please. First one on your international expansion side, just to follow up. Do you see opportunities comparable to those you pursued in Russia and Saudi anywhere else? Any other big local markets, which you are not fully present at the moment, you could be targeting in the medium term? And second one, in light of some improvement in demand for offshore projects, et cetera, how would you describe pricing environment offshore and competitive environment. Historically, it has been a very profitable market. Price has moderated a lot during the recent downturn. Any trends you are seeing there?

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Paolo Rocca, Tenaris S.A. - Chairman & CEO [55]

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On the first question, we'll move on with this joint venture in Saudi and the acquisition in Saudi -- the generation in Russia and the acquisition in Saudi. We are considering always the specific of different geography. Tenaris is a global company and we want to be present and have a global approach. I also personally think that the world is going into less globally interconnected world. And there are -- we need to be in many different places. So we are considering different geography, because in the end, this is also a long-term drive, developing a local content. To some extent, the surging of region in which oil and gas activity may be growing. And that means you have to be positioned also to have a, let's say, more stable reaction to macroeconomic and trade variability. Sandvik would come -- nothing that we can or we want to comment now. The other point on the point of pricing in this segment, Gabriel, may you comment on this?

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Gabriel Podskubka, Tenaris S.A. - President of Eastern Hemisphere Operations [56]

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Yes. Pricing, in general, in the international market remains competitive given the dynamics that we explained before. But nevertheless, you mentioned particularly offshore segment, that's where typically technology, premium connections are required. And there we have a full portfolio of different options that allows for the pricing competitiveness to be left in our international markets. During last year, we have renegotiated the majority of our long-term agreements following the cost and price indexes that translated to increases. So we will see that during 2019. We're talking about the increasing gas and premium in our international mix as the pipelines of EastMed are not repeated to this year, so the mix is becoming richer, more premium. So it's not ready to expect that our average pricing in international market will be higher in 2019 versus 2018.

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Operator [57]

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And our next question comes from the line of Rob Pulleyn from Morgan Stanley.

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Robert John Pulleyn, Morgan Stanley, Research Division - Analyst [58]

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Just one question, gentlemen, because a lot has been covered, and apologies if this was mentioned earlier, but perhaps I missed it. Just regarding your Russian investment with Severstal, how do you think about that in the context that these potential enhanced sanctions regarding U.S. -- from U.S. Congress versus Russian energy projects? If you could provide a bit of color around the thinking there.

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Paolo Rocca, Tenaris S.A. - Chairman & CEO [59]

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Thank you, Rob. Frankly, this is eventual that is taking into consideration all the limitation that we are respecting fully, established up to now by the Congress, by the rules and regulation of the U.S. There are many American companies that are operating in Russia that are international company. And also many oil service company like Schlumberger or another that are operating in Russia today. We will follow, let's say, all the rule of the game, and we see no problem in doing this. I think that also our partner Severstal is fully conscious of this. They are very well aware and very conscious on this and has a good track record in this sense. So we see no problem on this count.

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Operator [60]

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And our next question comes from the line of Sahar Islam from Goldman Sachs.

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Sahar Islam, Goldman Sachs Group Inc., Research Division - Analyst [61]

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Just one question for me, please. We've heard from some of your competitors how they've been taking cost out through the cycle, and clearly, you've had a very efficient cost base relative to the industry. But how do we think about how your relative advantaged position changes as the rest of the industry takes cost out and how that impacts your competitive positioning, please?

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Paolo Rocca, Tenaris S.A. - Chairman & CEO [62]

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Thank you, Sahar. Well, I think that Tenaris is a very competitive company. You will see this from our financial and all the margin. The margin -- we mentioned in my opening remark, the net income on sales of 11.4% is very relevant indicator. Not many company are showing results in this range. In this, we have been able to maintain, let's say, a very differential financial performance, even during the worst of the crisis. This is due, to a very large extent, to the effectiveness of our commercial positioning, but also through the product development and through the industrial management. The industrial excellence allow us to be very cost effective. The fact that we are deployed globally, we go from plant in Japan to plant in Argentina, Romania, or in Argentina and the United States and in many other countries, allow us to create synergies in the industrial system. They are -- turned out into a very effective business model from the point of view of the cost. Having said this, it's also true that we are continuously looking for opportunity of improvement. And this is one of the characteristics of the company: discipline on the cost; and permanent detection on opportunity of improvement coming from technology, from supply chain for integration upstream. One case in question is, for instance, the investment in production of power in Mexico. This is something that's giving absolute competitiveness to our operation in Mexico because of the supply of energy. And we are doing the same in, for instance, in Italy and other area. We're focused on this and we're best on cost effectiveness.

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Operator [63]

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And I'm seeing no further questions at this time. I'd like to turn the call back to Giovanni Sardagna for closing remarks.

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Giovanni Sardagna, Tenaris S.A. - IR Director [64]

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Yes. Thank you, Victor, and thank you all for joining us today in our conference call, and to see you soon. Thanks.

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Operator [65]

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Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. Everyone, have a great day.