Chr Hansen Holding A/S

CSE:CHR

Earnings Call Transcript 2023-Q3

[Operator]

Ladies and gentlemen, thank you for standing by. Welcome to the presentation of Chr. Hansen Interim Report and Conference Call Q3 2022/'23. [Operator Instructions]

I would now like to hand the conference over to your speaker today, Chr. Hansen's CEO, Mauricio Graber. Please go ahead, sir.

[Mauricio Graber, executive]

Thank you. Good morning, everyone, and welcome to the presentation of Chr. Hansen's Q3 '22/'23 results. I am here with our CFO, Lise Mortensen, and we will, as usual, walk you through the highlights of our third quarter and outlook for the year. And as we communicated in the Q2 results, we will also provide commentary on the outlook for the calendar year covering the period from the 31st -- up to 31st of December 2023.

Before opening up for Q&A, I will also provide an update on the proposed merger with Novozymes.

Before moving on, please take notice of the safe harbor statement.

Please turn to Slide 3, please. As the organization remains focused on business execution. Chr. Hansen ended the third quarter of the financial year with a solid result, delivering 9% organic growth for the group. As expected, the positive contribution from pricing continued in both Food Cultures & Enzymes and Health & Nutrition, while volumes were more modest. The positive impact from euro-based pricing was higher, predominantly in Food Cultures & Enzymes.

Looking at the year-to-date, the group organic growth was strong at 10%. Food Cultures & Enzymes delivered strong growth, mainly driven by price, while volume growth was softer. Health & Nutrition delivered solid growth mainly driven by price, which contributed more compared to the previous quarter, but also by volume growth.

EBIT margin before special items was stronger in the third quarter compared to last year, reaching 27.5%. This was 0.8 percentage points above last year as the margin was supported by strong sales development and scalability effects, which was partly offset by a negative impact from higher input costs, a change in product mix and exchange rates. Year-to-date, the EBIT margin before special items was 26.4%, which is 0.1 percentage points above last year.

Free cash flow before acquisition and special items reached EUR 76 million in the third quarter. Year-to-date, the cash flow amounted to EUR 133 million, up from EUR 116 million the prior year. The higher cash flow was due to higher cash flow from operating activities and a positive impact from taxes paid.

Now please turn to Slide 4 for an overview of the strategic and operational highlights of the third quarter. Starting with price. It's great to see the results we continue to deliver from the efforts of our teams on pricing initiatives. In the third quarter, we saw continued pricing impact in Food Cultures & Enzymes, while the impact in Health & Nutrition increased from the previous quarter. We still expect pricing to contribute positively for the rest of the year but at a lower level than in Q3 due to analyzations of the price adjustments from last year. As we continue to see increased pressure across part of our cost base, we will work diligently with our customers to ensure these cost increases are reflected in future price increases.

Continued with the organic growth, our core business remained stable with 8% organic growth in the third quarter. We saw solid volume growth in cheese demand driven by projects related to productivity improvements and yield optimizations, while there was also focused on sustainability impact. With our CHY-MAX Supreme solution, faster and more precise coagulation enables cheese producers to produce more cheese faster, which leads to not only improve productivity, but also reduce cheese carbon footprint. In addition to this, CHY-MAX Supreme helps make the cheese firmer, meaning that the process of slicing, cutting and shredding the cheese at industrial converters who provide the cheese to food service is improved and thus reduces results in less waste.

Within Meat & Prepared Foods, we inaugurated a new customer and application center with a microbial laboratory and a meat processing pilot plant in Pulheim, Germany. This new center will strengthen customer collaborations, both in the fermented meat product segment and in applications such as seafood, hotdogs and plant-based products. Year-to-date, our core business delivered 9% organic growth.

Organic growth in the Lighthouses combined reached 15% in the third quarter. And looking at the year-to-date, they delivered very strong growth of 19%. All the Lighthouses delivered double-digit growth in the first 9 months of the year. And as usual, please note that it's important not to look at the Lighthouses on a quarterly basis, but on an annual basis. Instead, since the businesses combined account only for approximately 10% of group sales.

Now looking at each of the Lighthouses separately. Bioprotection continued solid progress driven by upselling and new businesses. Fermented plant Bases grew from a small base, driven by dairy alternative, where the focus remains on improving the taste and texture profile of plant-based products.

In HMO, we reached an important milestone during the quarter. Chr. Hansen received the EU approval of the final HMO, 6'-SL in our 5HMO mix for higher use levels in infant formula. This is an important step, since now we are able to offer our customers with a mix of 5HMOs, bringing infant nutrition products closer to human breast milk. Product registration in China are ongoing, and we still expect the approval at the end of 2023 or the beginning of 2024.

Lastly, in Plant Health, we saw strong growth both in the third quarter and year-to-date.

Now please turn to Slide 5. In terms of top line performance, the group in the third quarter was mainly driven by price in both Food Cultures & Enzymes and Health & Nutrition. In Health & Nutrition, the impact from pricing stepped up compared to the previous quarter. The total pricing impact on the group was 7% in Q3 and 6% year-to-date. The impact from euro-based pricing was significant in the quarter, mainly impacting Food Cultures & Enzymes. Organic growth in Food Cultures & Enzymes reached a strong 10% in the third quarter and also year-to-date. This was mainly driven by price which contributed 9% in the quarter, but we also saw slight volume growth.

Dairy growth was strong supported by pricing initiative and strong momentum in cheese, while fresh dairy was solid, except for probiotics, which continued to decline. Bioprotection and fermented plant bases also supported the growth in Food Cultures & Enzymes.

Food & Beverage performed well, driven by pricing, while volume declines due to market softness within meat and prepared foods categories.

Moving on to Health & Nutrition that delivered 7% organic growth in Q3, mainly driven by price but also by volume, leading to 9% year-to-date. We saw increased pricing impact in the business in Q3 and the contribution of pricing was 5%.

In Human Health & HMO delivered good growth, driven by pricing. Volumes declined as they were negatively impacted by the timing of orders in HMO.

In general, the market outlook is slightly more positive compared to the previous quarter and the sector growth of probiotic human health products is in line with the midterm outlook of 4% to 6%, with some recent improvements in North America [ consumption ] after a period of very soft growth and despite softness in the South Korean market for dietary supplements. Markets across EMEA and in China have continued to show resilient growth in this segment.

Animal & Plant Health delivered strong growth, supported by both pricing and volume growth.

Now let's turn to Slide 6 for the performance by region. All regions, except Asia Pacific, drove the growth in the third quarter. Looking at the year-to-date, all regions contributed positively to the group organic growth. Now starting with Europe, Middle East and Africa. The region grew 10% organically in Q3, leading to a 15% year-to-date growth. Organic growth was driven by both Health & Nutrition and Food Cultures & Enzymes. Food Cultures & Enzymes was supported by pricing, including euro-based pricing as well as slight volume growth, while Health & Nutrition was supported by pricing initiatives and good volume growth.

North America further improved from the previous quarter and reached 9% organic growth in Q3 and 4% year-to-date. Organic growth was driven by both Health & Nutrition and Food Cultures & Enzymes. Food Cultures and Enzymes was driven by solid volume growth across categories, except for probiotics and meat and prepared foods, which declined in the quarter. Health & Nutrition was supported by pricing initiatives and good volume growth across categories, except for HMO. As mentioned, volume in HMO declined due to negative impact from timing of orders.

Asia Pacific reported a decline of 2% in Q3. Year-to-date, the region, however, grew 3% organically. Organic growth in Food Cultures & Enzymes declined due to lower volumes in China and India, while a decline in Health & Nutrition was driven by softening market conditions in South Korea. Food Cultures & Enzymes was impacted by a tough comparable from the year before in India, while in China, the business saw less favorable conditions, which the country is still recovering from the pandemic lockdowns. Notably, the project pipeline continues to strengthen as our interaction with customers in China increases. Organic growth was also supported by pricing.

Latin America continued with strong growth and delivered 23% organic growth in Q3, resulting in very strong growth year-to-date at 20%. Organic growth was driven by both pricing initiatives, including euro-based pricing and volume growth in Food Cultures & Enzymes, while volume in Health & Nutrition declined driven by negative impact as well on the timing of orders.

Now I would like to hand over to Lise for the financials.

[Lise Mortensen, executive]

Thank you, Mauricio, and good morning, everyone. Please turn to Slide 7 for profitability. The absolute EBIT before special items for the group increased by 9% in Q3 compared to last year, amounting to EUR 92 million. The increase was driven by a positive contribution from pricing initiatives, volume growth and stable operating expenses, which was partly offset by a negative impact from higher input cost and exchange rates.

The Q3 EBIT margin before special items reached 27.5%, which was an increase of 0.8 percentage points compared to the year before. The positive development in the margin was due to the strong sales development and scalability effects, which was partly offset by a negative impact from higher input costs, a change in product mix and exchange rates.

Looking at year-to-date, the absolute EBIT before special items increased by 11% compared to last year to EUR 260 million. The year-to-date EBIT margin before special items was 26.4% compared to 26.3% last year.

The Food Cultures & Enzymes profitability in Q3 improved versus last year. And the EBIT margin before special items reached 30.7% compared to 28.4% the year before. The margin improvement was due to pricing increases and scalability, which was partly offset by higher input costs and a change in the product mix.

Profitability in Health & Nutrition declined in Q3 versus last year. The EBIT margin before special items amounting to 22.4% compared to 23.9% the year before. The negative [ amendment ] was due to a negative impact from product mix, exchange rates and higher input costs which was partly offset by pricing initiatives and positive impact from scalability.

Now let's look at the free cash flow. Please turn to Slide 8. We saw an improvement in the free cash flow year-to-date compared to last year. The year-to-date free cash flow before acquisitions and special items reached EUR 133 million, up from EUR 116 million last year. The increase was due to improvement in operating profit and lower taxes paid despite cash flow from operating activities being impacted by a negative change in working capital driven by increased inventories and trade receivables. The lower taxes paid were due to a one-off tax payment in FY '22 related to acquisitions.

The higher inventory level we have experienced over the past few quarters is partly driven by our strategic decision to secure our supply chains due to higher volatility in the end market demand. We expect the inventory level to start decreasing towards the end of the calendar year. For the rest of the year, we expect a change in phasing of operational investing activities, which will improve the free cash flow for the full calendar year.

Return on invested capital, excluding goodwill, was 23.4% year-to-date, which is slightly higher than the amount year before at 23.3%. The slight increase was supported by strong sales development in Health & Nutrition, while Food Cultures & Enzymes was impacted by the high inflation and operational results.

Now let's move to the outlook for the year. Please turn to Slide 9. We acknowledge that the underlying market growth expectations for the remainder of 2023 remain modest, given the current uncertainty, geopolitical and macroeconomic environment. However, in light of the solid performance for the first 9 months of the financial year, we adjust our outlook for organic growth covering the period September 1, 2022 to August 31, 2023, to 9% to 11%, previously 8% to 11%. The expected growth is composed of price adjustments, including euro-based pricing, combined with growth in Lighthouses and successful execution of the project pipeline in the core businesses.

The EBIT margin before special items covering the period September 1, 2022 to August 31, 2023, is still expected to be in the range of 26% to 27%. As a positive impact from operational efficiencies and pricing initiatives is expected to be partly offset by continued pressure from the inflationary environment and continuing actions to protect against supply chain disruptions. The free cash flow before special items covering the period September 1, 2022 to August 31, 2023, is now expected to be in the range of EUR 200 million to EUR 230 million. Previously, it was EUR 180 million to EUR 220 million, reflecting a change in the phasing of operational investing activities and a positive impact from lower taxes paid.

Please turn to Slide 10 for the supporting outlook for the 2023 calendar year. For the period January 1st to December 31, 2023, organic growth is expected to be 9% to 12%, while the impact from exchange rates on revenue is expected to be negative estimated to be around 4% to 5%. The EBIT margin before special items for the period January 1st to December 31, 2023, is expected to be in the range of 26% to 27% compared to 26.3% in the same period last year. The EBIT margin before special items is expected to be negatively impacted by exchange rates estimated to be around 0.4 percentage points.

The free cash flow before special items for the period January 1st to December 31, 2023, is expected to be EUR 200 million to EUR 250 million compared to EUR 152 million for the same period last year. Due to the change of our financial year to calendar year, we have included financial highlights and key figures that has been restated to reflect calendar year quarters in the Q3 interim report.

Now I would like to hand over to Mauricio for an update on the proposed merger with Novozymes.

[Mauricio Graber, executive]

Thank you, Lise. Let me say a few words on the proposed -- on the progress of the proposed merger with Novozymes. Together with Novozymes, we are continuing to work with additional regulatory filings and are progressing well with the relevant authorities. We have added financial information in order to align with Novozymes calendar year reporting. Regarding the timeline for the closing of the deal, this is unchanged and the closing is still expected in the fourth quarter of the 2023 calendar year or the first quarter of the 2024 calendar year.

In connection with the merger agreement, Novozymes and Chr. Hansen have agreed on certain specific restrictions in respect of distributions to the shareholders until completion of the proposed merger. As part of this, it has been agreed that Chr. Hansen can make a dividend payout in respect of its earnings for the period September 1, 2022 to August 31, 2023, up to an amount corresponding to a dividend payout ratio of 55%. The Board of Directors intends to announce such a dividend in connection with the 12-month report on October 12, 2023, which is subject to closing of the proposed merger, not taking place prior to the payout date.

To sum up the solid third quarter provide -- proved the strength of Chr. Hansen organization, and once the ongoing progress with Novozymes to complete the proposed merger we continue to deliver first-class products and innovative solutions to our customers around the world. To reflect the performance of Q3, we updated our organic -- our outlook for organic growth and free cash flow, while the outlook for EBIT margin is unchanged.

Thank you very much for your attention, and we're now ready to open up and move on to Q&A.

[Operator]

[Operator Instructions] The first question is from Alex Sloane with Barclays.

[Alexander Sloane, analyst]

Two for me, please. Just the first one, in terms of the updated guidance, obviously, for the calendar year, you're guiding to a slightly higher range than for the fiscal. Can we infer from this that you are incrementally confident in volume acceleration into September to December? And if so, I guess, what are the key drivers of that? Or is this -- or is that guidance difference more about pricing tailwinds. That's the first one.

Second one, energy costs have obviously fallen a long way from the start of the fiscal year when you set margin guidance. Do you need to pass back any of that potential benefit to customers in pricing? Or should we assume that it drops to the bottom line? And I guess, if so, when should we be expecting that tailwind?

[Mauricio Graber, executive]

Yes. Let me make just a few general comments. I'll pass it on to Lise on the specifics. I think just taking the -- your second question is -- it's true that energy is declining. There are some other parts of the supply chain, but we still continue to see cost -- input cost increases. But I think consistent with what we have said in the past, our pricing negotiations with customers have taken a long period but they are based on the value that we bring, and we do not expect that these reductions in energy will translate into pricing givebacks as the pricing have been negotiated and included in our contractual agreements with customers.

Lise, I'll pass it to you to comment on the financial year and calendar year guidance growth.

[Lise Mortensen, executive]

Yes. Alex, the outlook on organic growth for 9% to 10%, you should see that as a result out of pricing and also euro-based pricing playing stronger in the calendar year view than in the fiscal year view.

The volume part, I mean, still we are at 4% year-to-date, but the volume part of our outlook is where we are. We need to be cautious, and we see the biggest risk. We are still outperforming underlying markets, but it is a very uncertain macroeconomic environment that we operate in, and that's also taken into consideration for the outlook for the calendar year.

[Mauricio Graber, executive]

Absolutely. I think, Alex, we will only start to see stronger volume growth as I think the inflationary pressures reduces. So I've always viewed those as relatively connected.

[Lise Mortensen, executive]

And to your question on when we see the benefit in our cost, we are definitely seeing the clear signs of our price up having effect. We don't foresee any more input cost tsunamis. So through this calendar year, the lines will cross if everything is continuing the way we are looking at now.

[Operator]

The next question is from Charles Eden with UBS.

[Charles Eden, analyst]

Two for me also, please. My first one is that we've heard from some of your ingredient peers discussed the deterioration in volume trends in recent months, specifically in May and early June. So I wonder if this is a dynamic you've also seen? Maybe you could talk about how volumes trended through your fiscal Q3 and the outlook for the early weeks of Q4? And if there's any product areas or geographies in particular that you would call out as slowing materially or I guess, accelerating for that matter in recent weeks. Could you touch on that?

And then my second question is on China volumes in FC&E, which were lower once again year-on-year. Can you give a little more detail here, please? I get the negative impact that the pandemic had on the fermented dairy business, but with restrictions lifted and on some presumably relatively undemanding prior comps, volumes are still declining. So if you looked at where volumes are in this market for FC&E versus pre-pandemic because just taking the 3 years of volume declines, I would think it's probably double digits below the pre-pandemic levels. Is that correct? And if so, are you confident this is simply a market dynamic effect rather than loss of market share in this market?

[Mauricio Graber, executive]

Excellent. Thanks, Charles. So on your views around -- on your question around volumes first. As Lise mentioned, we are 4% volume year-to-date, and we had 2% volume growth in the quarter. We expected Q3 to have a softer volume, and I think, as I mentioned before, we will need to overcome the current high level of price inflation to see stronger volumes. But we have not seen a stronger volume deterioration. So just to give a little bit more color. I mentioned that in Food Cultures & Enzymes, we see good volume in cheese driven part because of our innovation in relation to CHY-MAX Supreme. And in Health & Nutrition, we have seen the segment -- the underlying segment trending back to the expected normalized growth of like 4% to 6% and our ability to outgrow the underlying market. The pipeline, I particularly mentioned in North America for Human Health is strengthening. So we expect that to be a net positive.

Now moving on to China, just to comment about China. So China, Health & Nutrition, our Human Health have remained strong. We have seen a very dynamic business in Human Health in China. And it's actually -- it was dynamic pre-pandemic and it has come out as very dynamic after the lockdowns. A lot of innovations, a lot of focus on bringing probiotic solutions to consumers and really good growth for us.

I think the other side of the coin is what you mentioned, which is -- and we indicated that in Q2, which is after the last range of lockdowns, it really had a negative impact on volume and our ability to also connect with customers. So while the positive news in China is that our interactions with customers have now really normalized, we have seen a very rich inflow of projects, a strong pipeline, but I do not expect this to be translated into any improvement in China volumes until 2024.

[Charles Eden, analyst]

And am I right in thinking that volumes in that market would be double digits below where they were before...

[Mauricio Graber, executive]

Absolutely. Absolutely. Well deep into the double digits.

[Operator]

The next question is from Soren Samsoe with SEB.

[Soren Samsoe, analyst]

So first question is, again, also on the Health & Nutrition part. I mean the comparables were quite easy in Q3. You said that in the first half, but still weak growth. So -- if you can comment a bit on -- you mentioned South Korea is not going well, but I mean it must be gone really bad if it should pull down growth to that level? And also, it seems like your outlook for the North American probiotics market looks a bit better. Maybe you can give a comment on that?

[Mauricio Graber, executive]

Absolutely. Soren let me take it and Lise please complement if I miss anything. But -- yes, I think 7% for Health & Nutrition was good, still against reasonably high comparables of last year, but you are right that softer than in the first half. I think the positive trend, as mentioned is we see signs in North America definitely on the market strengthening both in the pipeline in our open order books. South Korea is an important market in the sense that it drives a lot of innovation, but we always expect Health & Nutrition to come back to double-digit growth and the -- being a net contributor to our good growth for the group and that is expected to where we want to see this coming in the quarters ahead.

Lise, anything that I missed on?

[Lise Mortensen, executive]

Well, I would maybe say South Korea, we see as cyclical, not as a structural dip, but impacted by the macroeconomic. And then maybe one more thing, Soren, and that was that H&N in Q3 is impacted by timing of orders. You remember Q2 was quite strong. And there was some timing of orders there between Q2 and Q3.

[Soren Samsoe, analyst]

Yes, that's right. And then I just had a second question relating to CapEx and investments. You're talking about phasing of investments, and we're also seeing a higher guidance for free cash flow also for the calendar year 2023. How -- should that be seen some kind of CapEx synergy with Novozymes, i.e., are there some of the investments you had planned that you now see that Novozymes have already covered in what they have and therefore, you don't need to make as many investments?

[Lise Mortensen, executive]

No, Soren, it's completely business as usual that the projects that we've been running have had a little bit higher ambitions and acceleration than they are able to do simply in the market that we are playing in. Processing equipment can be delayed stuff like that. So we have not started comparing notes with Novozymes on these projects yet. That will come on day 1.

[Operator]

The next question is from Joan Lim with BNP Paribas Exane.

[Yuan Lim, analyst]

Just going back to the drivers of your outlook. Maybe just -- what will get you to the upper end of the guidance? And what gives you the confidence regarding pricing, considering the slower end markets? That's my first question. And I guess on the second one, you also talked about pricing. So last quarter, you said euro-based pricing was about 1%. Can you give us an estimate of how much you're expecting it to be for the outlook?

[Lise Mortensen, executive]

Maybe I can start with that. Yes, we did say that we expected euro-based pricing for the fiscal to be around 1% and now we're looking at above 1%. At the quarter, we have realized around 2% of euro-based pricing and a little bit stronger than anticipated when we went into the quarter. And getting to the upper end of our guidance, we'll take through the volume. Our pricing, as such, we are actually pretty confident on. Remember, we have not implemented new price ups. The pricing impact we are seeing now is contracts that have already been signed, so on and so forth. Although we will say that pricing as such, as it from a year-over-year perspective in Q4 will not be as strong as Q3 because we are getting to the annualized impact of our -- in particular, our Food Cultures & Enzymes price-up initiatives from last year.

[Operator]

The next question is from Andre Thormann with Danske Bank.

[André Thormann, analyst]

Yes. Just 2 from here, please. First of all, on free cash flow, I just wonder whether the improvement is not at all related to better operations? You mentioned tax and phasing of investments, but is there nothing of this improvement that is reflected in your upgraded guidance on top line? That's the first one.

The second is just related to the other question on euro-based pricing. You say above 1 percentage points now. Does that mean that this upgrade is actually just related to higher euro-based pricing improvement contribution? That's my second question.

[Lise Mortensen, executive]

Maybe starting with the second, Andre. The adjustment we did to the guidance a quarter back was caused by euro-based pricing. It is true that where we are standing now, the full year impact, a quarter back, we said 1%, now we say above 1%, but it's really decimal points. So the adjustment we made to the outlook this quarter is simply just because we are 9 months in and the risk that we see for the remaining year is more manageable, so to say.

On the free cash flow, I mean, it's ups and downs, but the primary factor is the delay of some of our investment into -- some of the CapEx projects and some timing of tax paid. That's the largest components playing in.

[André Thormann, analyst]

Can I just follow up? What offsets the better operations that you see on free cash flow?

[Lise Mortensen, executive]

Andre, it's really minor. It's small ups and downs in what is the outlook for inventories for net working capital in general, stuff like that.

[Operator]

[Operator Instructions].

[Mauricio Graber, executive]

Doesn't look like we have any further questions. Or do we?

[Operator]

No, there are no more questions registered at this time.

[Mauricio Graber, executive]

Thank you. So this concludes our conference call then and the Q&A session. Thank you all for joining this morning, and we look forward to continuing the dialogue with you virtually over the next few days. Thank you, everybody.

[Operator]

Ladies and gentlemen, the conference has now concluded, and you may disconnect your telephone. Thank you for joining, and have a pleasant day. Goodbye.