We’re considering whether this – whether what’s happening in Brazil has come to stay. If Brazil becomes a truly fully open country to the countries of any sort from the Chinese market, that will be a game changer in steel making in Brazil. And over time, this might drive us to make long-term decisions to reduce our level of investment, to reduce our capacity in Brazil and perhaps move part of our assets and capital allocation decisions elsewhere to Mexico, maybe. Mexico has been shown and will continue to be a great platform of steel service for North America. Mexico for the first time surpassed China as the largest exporter to the United States. So all of these things will be considered and these decisions will be made. Leo, perhaps we are not thinking about how Gerdau will continue to operate in Brazil.
For this first phase, it’s about preparing Ouro Branco and not having capacity available for exports. So we’ll have a level of CapEx for that, that will range upwards or downwards compared to last year. But it is a CapEx that we believe will bring a lot of return to Gerdau in the future, regardless of the future size of Gerdau, because what’s there is a platform we will not touch. Now in the short-term, we have been waiting for a decision from the federal government. We didn’t make all of the decisions we can make in Brazil to adapt our production capacity to a reality that in our point of view, will continue for a while and this postponement of the federal government to take measures. So this will involve reviewing the most productive routes that we’re going to have.
Looking forward, do we have the iron ore route, the bio-reduce or the scrap route? And this is not optimized to the situation as it is now. Also, we continue to operate with several mills and small runs. It is not productive to maintain small volumes in many mills. So we are in a moment of adaptation. This will be translated into cost reduction over the year. Perhaps Japur can add to that. I don’t know whether he has made those calculations, but well, you see, it will require adaptation. That’s why I spoke about cost. And as for recomposing price, it’s part of our day to day. We are looking at premiums, what’s coming from imports, the possibilities available, so that we can try to bring our profitability next to historical levels that you mentioned.
We’re not betting everything on that. Can this contribute? Yes, but our bets to again resume adequate profitability in Brazil in this current scenario of stable demand and more imports of steel. All this will involve readapting our way of producing Brazil, the way we set up our assets, the layoffs that will continue. So that’s generally what we’re thinking though Chris. We’re not going to throw the towel because of the situation that we are experiencing. We have more than capacity to adapt in the short and long run to a scenario that I believe we have never lived in Brazil. And it came in a way to kind of change the game in the Brazilian economy, not just in steel making, but in other sectors as well. So that’s the macro view. And Japur, please feel free to add more details.
Rafael Japur: Hi, Leo. I think to add information about CapEx, which was the second part of your question. Can we approve investment decisions or long-term investments? Well, for that, we built over the years a solid and healthy balance sheet so that we could have resilience to go through not so positive moments in the market. But at the same time doing what needs to be done and not having to paralyze any investment that eventually will need to make, perhaps paying two, three times the amount because we stopped it halfway. So those investments that we started that have been dispersed. CapEx that has been used both these investments. We don’t see room for cuts, scale down or great delays and postponements. The R$6 billion CapEx that we communicated for this year might undergo some adjustments, maybe in maintenance of mills that in this macro context detailed by Gustavo, they’re not that useful in the long run.
Perhaps we’ll have to adapt the maintenance CapEx of these mills. But materially, these investments should not affect the 6 billion that we have planned for 2024. Okay. Now, the investments that we have not started making, even those that are in the long-term strategic projects for – until 2026, those that require more studies, hiring basic engineering and suppliers, these investments will depend fundamentally on the economic conditions and market conditions being adequate. We’re not going to go forward with them. We are not going to be approving new investments in addition to that important portfolio that has already been approved in Brazil, until we have more visibility regarding all of the factors that Gustavo mentioned.
Leonardo Correa: Thank you.
Renata Oliva Battiferro: Thank you, Leo. Next question from Ricardo Monegaglia, sell side analyst from Safra. He has also a few questions that came through the chat. First question, could you help us understand how we should think about the evolution of the operating lines in South America going forward when compared to the levels of the fourth quarter? Question number two, what is the view in terms of the mix evolution for the foreign and domestic market for the first half of 2024? Could you give us some color about price transfers in the domestic market? And also he’s got a third question. Could you please mention a few examples of IRA projects, the Infra Bill or the CHIPS Act that where Gerdau is working as a steel supplier.
Rafael Japur: Hi Ricardo. How are you? I think the first question was previously answered when we were talking to Daniel and we talked about Argentina, South America and the divestments in Colombia and Dominican Republic. I would even say that if we had to think about without the effects of Colombia, Dominican Republic and Argentina, well, this quarter there was an improvement because of the operations in Uruguay, Argentina and Peru vis-à-vis the third quarter. So you just have to look at the context and how to evaluate and model these lines going forward towards the next quarters. In terms of what we expect to see in Argentina, the new Argentinian package and the effects we see in the local economy, the recomposition and the rebound we see in Peru and other geographies in the region.
In terms of the mix between foreign and domestic market, this is pretty much along the lines of what Gustavo said before in terms of the recomposition of the mix, a flat demand coming from the construction industry, our cutting band portfolio and the number of work sites. And we haven’t seen any significant moves in terms of the international prices quarter-on-quarter. Therefore, we understand that if things are kept constant, the mix should have some exports, maybe slightly above or below what we saw in the fourth quarter, vis-à-vis our exports also taking into account that everything will be constant and international prices because the demand is pretty much stable with no major price adjustments.
Gustavo Werneck: I believe that the major driver in terms of deciding our level of exports will be – will take into account international prices. And maybe, Rafael, I would like to draw your attention to that 38% increase in exports in Brazil from the – to the fourth quarter. I mean, in terms of shipments, it’s not anything really significant. It doesn’t mean that we have major export opportunities going forward. On the contrary, shipments will be reduced very much related to some of our affiliate companies or someone off things that we could do in the international market with adequate profitability. But it’s far from being anything structural or our idea of increasing exports and exports today at these low levels of prices, this is more like a driver to dilute our fixed cost.
And finally, in terms of our North America product mix and how that fits into the current government policies that involves CHIPS Act, the Infrastructure Bill and the IRA. The main points is that our product portfolio in North America is more earmarked, I mean, less iron ore and rebars, and more related to structurals and merchant bars that are more focused on non-residential construction. So as part of the package of the government, one of the main highlights for us involves sales of products to solar farms for photovoltaic energy. And we are making a major investment in our Midlothian plant in Texas. That’s a privileged location that can cater to the local demand because they’re building solar racks. And the solar racks are used to support the photovoltaic cells.
And as we said in our release, we inaugurated a thermal control plant to offer products of higher added value, catering to industrial lines and other things that are growing in the market right now.
Renata Oliva Battiferro: Ricardo, thank you. Thank you for the answers. Next question from Marcio Farid, sell side analyst from Goldman Sachs. Please can you open the camera?
Marcio Farid: Hello, good morning. Good morning, Gustavo, Japur and Renata. Thank you for your time.
Gustavo Werneck: How are you?
Marcio Farid: I’m fine, thank you. I have two follow-up questions. I think the first point is, I mean, thinking about North America. When we look at your main peers, we see the valuation level around six to eight times EBITDA. And when we look at our numbers, we see the half of that is Gerdau. So my first question, I don’t know whether it’s a philosophical question or not. But the question is whether it would make sense to discuss a potential spinoff of your U.S. business just to try to capture part of that value. Because apparently the consolidated numbers for the market is not capturing the total numbers of the company. And within North America as well, we saw the scrap prices going up, the price spread I think it was a bit more difficult.
But we see more seasonality coming on the third quarter by looking at the margins for the first quarter. Should we consider an expansion when we compare to last year, even though there was a compression on metal spread prices? I know that was a long question. And my second question, I mean, Gustavo mentioned something that was extensively debated in terms of a potential increase in import tariffs. It seemed to me that the industry was very confident back in November when the debate was progressing. But then it faded out a little bit. But in the last two or three weeks, I think that Brazil adhered to the process, trying to add another 100 SCM to the VTechs [ph] that would allow some other industry, including the steel sector, could benefit from tariff arbitration.
This is an important step, I mean, in theory, it seems like we are closer than ever now, but I would just like to know, what is your understanding on the matter?
Gustavo Werneck: Well, excellent questions. Part of the question I will turn to Japur to give you more details about that analysis about the North America business. But in a moment like this, we have to think about everything in Brazil. There is nothing at Gerdau, especially when we are at a moment where our balance sheet is fine. I mean, we have to rethink about some things. I mean, I don’t know whether Japur already has something else in mind, but I would just want you to be very comfortable knowing that this is a moment, this is a very historical moment. We have to think very seriously about this very strong steel penetration in our country with the thought that this economic transition in China, that they are leaving their – the long standing pillars that they had for over 30 years, like civil construction exports, et cetera.
The transition to this new Chinese economy, when they’re focusing to – they’re focusing in their internal market and a green economy, this will take some time. So certainly China will continue to export because this is the way for them to generate economic growth. It’s not something that it would disappear within the month. We have to think about very carefully. I mean, North America has seasonality at the end of the year, which is quite normal. We started the year on a very good stand. I think we have everything it takes to come to the end of 2024, very sound numbers. Whenever you look at our business, I mean, the backlogs, the financial health of our customers, and with all of the infrastructure projects that will certainly increase demand for steel.
We are in a time when things are evolving quite well. And we do believe that by year end, things will certainly end on a good note. There will certainly be some volatilities. And we talked a little bit about the scrap market in December and January due to climate issues. It’s difficult to move scrap and so prices go up and down. And in terms of our peers, it’s also important that you understand and you make a distinction in terms of where they really compete with us. If you look at beams and merchant bars, there are competitors that were all very well consolidated. But we have everything it takes for us to have a very good performance in North America this year. And in terms of results, we’ll be comfortable enough to make all the necessary decisions we have to make in relation to Brazil.
You have to remember that in 2023, and maybe throughout 2024, we will present results that sometimes it would take three years to have these results. Think about the pandemic years now, all – with everything we did divestments and the fact that now we have a very lean company that allows us to make very quick decisions. We are delivering sound results, our balance sheet, our P&L is very sound. That impression you have that things are not – I mean, so good. I mean, it’s because I just stopped going to the press and giving interview. You think that this subject is dying out or fading away? No, it’s not. I’m just not going to the press and speaking my mind. I mean, we didn’t expect a period when it will be so hard to make decisions.
I mean, there is also higher taxes in inflation in Brazil. And then you think that there will be an absurd impact with inflation, but impact will be 0.001%. So this is a very tense moment. Maybe you may think that I am being kind of cold in terms of the subject. Certainly I’m a bit more frustrated because I thought that the government will be able to react much faster and make a decision faster. But I think it’s almost inevitable that this topic about China and steel and the impact of China imports to our economy, it is something that will linger for much longer. So, I mean, Pindamonhangaba is a state-of-the-art union in terms of special skills. We laying off 100 people that were highly skilled and trained. I mean, after all the investments we did [ph] in these people, we had to lay them off.
And this is terrible for us and for the market and also the LCMs that issue. I mean, on the technical side, this probably gives us the possibility of placing new projects as it was limited to 100. There were very few positions that were vacant. But when you grow there from 100 to 200, you can probably put some other products and some other countries who did the same thing going from 100 to 200. They did that just to do that. So I think this is still a decision on the part of the ministry to make sense. I mean, the subject didn’t die out, but in my view, they are taking much longer to make a decision and they are asking for so many details that were totally unnecessary since this is a damage that is already in place. And we are also entering with anti-dumping processes.
These are international facilities, but it takes time, sometimes 12 months to 18 months. But this is inevitable. I know that they will come up with the damage that the Chinese companies are causing to us. So this is just a summary. I think I didn’t answer. If I didn’t answer your question completely, just let me know and I can give you more details.
Marcio Farid: This has been great. Thank you. I just wanted about – to know about the potential of U.S. listings. I just want to understand what the Board and the management of Gerdau were thinking about a potential spin off and U.S. listing?
Gustavo Werneck: Well, Marcio, we do these calculations on a recurrent basis. We put together a spreadsheet and we present it to the management and to the Board of Directors. So we see the total of Gerdau and compare with the multiple of the peers. It seems that there is something missing, there’s something that we forgot when adding the parts and if there’s something very weird about the multiples. But when we think about a possible relisting of Gerdau, all these things are evaluated quite frequently in-house. But we cannot really move forward on tangible trends, moving from studies to actions, until we have it more clear the rules of the game and what’s going to be proposed here in Brazil regarding the tax reform and the tax on income.
Depending on the mechanisms regarding profits abroad, by holding companies incorporated in Brazil, this can point us to one solution, and we might choose a different solution regarding our ownership reorganization, not just in the United States, but around the world. So until we have more visibility regarding what’s going to be proposed, what’s going to be set forth regarding income taxation, particularly profits abroad, it will be difficult for us to take one path or another.
Marcio Farid: Super clear. Thank you very much.
Renata Oliva Battiferro: Thank you, Marcio, for the questions. Next question from Rafael Barcellos, sell side analyst of Bradesco. He would like to speak with an open camera.
Rafael Barcellos: Hello. Good morning. Thank you for taking my questions. My question is kind of a follow-up question regarding the Brazil dynamics. I apologize for insisting on this. But as we said before, with the Brazil margin levels going back to 2015 levels, that’s quite significant. So perhaps it’s worth getting more color on this for neck. It became clear that in the short term, the only possibility to improve profitability would be via cutting costs. So it would be interesting if we could understand the order of magnitude of possible improvement via cost cutting in the short term, if there’s any specific initiative, or if it’s something more market related. That’s my first question. Second question. Changing gears regarding special steels, we have seen a demand from the automotive industry improving in Brazil, and I would like to hear from you if you have any similar feedback in the United States, there’s some benefit coming.
So my goal here would be to hear more from you regarding the potential of improved earnings coming from the special steels BD.
Gustavo Werneck: Thank you, Rafael for these two questions, I’ll turn the floor straight to Japur. Japur is coordinating these initiatives regarding competitiveness and cost reduction. But I can tell you straight away, Rafael, there’s no silver bullet. It is a collection of several actions that need to be taken so that we can be more competitive cost wise. But it involves a complexity. There are a number of variables involved in Gerdau’s operations, so we would need to prioritize. We could reduce capacity, for example. We would prioritize filling the capacity of our mills that are in the route of bio-reducers or scrap. So there are some complexities that we need to consider, but I have to tell you straight away, there’s no silver bullet. Rafael, could you give us more color here? Could you elaborate that will help Rafael understand?
Rafael Japur: Hello Rafael. Congratulations on your new home, your new company. Well, you know our history and our track record. If we get our modeling guide where we have the breakdown of our costs, and we identify costs that are typically fixed and they’re typically variable costs. If we read the Brazil operation we can extrapolate that we had an increase in our fixed costs between 2023 and 2022 of around R$400 million, so we understand that in an environment of adjusting our structure, optimizing our mills, our shifts, our teams as Gustavo has mentioned. During the quarters we should pursue recomposition in that order of magnitude. But as Gustavo mentioned, there is no such thing as a silver bullet. We believe a lot in working hard.
We’ll make gradual efforts. Whenever we speak about reducing fixed costs sometimes we have to make some investments, invest in severance packages and such things, costs to close down units so that we can reap the fruit later. You have to make a sacrifice to make some difficult decisions and I think that in order of magnitude that you asked we should think, I’m not extrapolating a lot, but thinking about what we have that is public information and that is presented to you in our modeling guidance. This is the order of magnitude that we should revisit as opportunities along 2024. So let me talk about Special Steels. There are two different stories here. In Brazil we went through a difficult year for this segment. It’s difficult for us, given demand and the sale of light vehicles, but primarily due to significant reduction in sales of heavy vehicles – heavy duty vehicles.
