Huhtamaki Oyj

OMXH:HUH1V

Earnings Call Transcript 2018-Q1

[Operator]

Good day, ladies and gentlemen, and welcome to the Huhtamäki Interim Report January to March 2018 Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Ms. Katariina Hietaranta, Head of Communications. Please go ahead.

[Katariina Hietaranta]

Good afternoon, everyone. Welcome to Huhtamäki's Quarter 1 Conference Call. And I have here, our CEO, Jukka Moisio; and CFO Thomas Geust presenting this Quarter 1 results. Please let's start, Jukka, go ahead.

[Jukka Moisio, Chief Executive Officer]

Thank you, Katariina. Good morning, good afternoon. I'll go to through prepared notes from the presentation. Solid comparable growth, negative currency impact [indiscernible] before Q1 2018. And I move to Page 2, which is our net sales development. In quarter 1 2017, we recorded net sales of EUR 739 million, and in Q1 2018, EUR 725 million. Components of top line development are such that the organic growth, we had 5.3% organic growth. We also generated additional 1% on package systems, this is the international paper operations acquisition we did in the autumn 2017. And then we had an 8% negative development from currency translation. Most important currencies that contributed to that negative development or translation impact were U.S. dollar by EUR 35 million and Indian rupee by EUR 7 million. Emerging markets, our growth was about 8.4% driven by Eastern Europe, India and Middle East leading the performance. I move to Page 3, which is interlinked comparable growth across the segments. Foodservice Asia-Oceania continued good momentum, [indiscernible] which was achieved at the end of 2017. We had 5% top line growth. Good demand was really in core paper items in Southern and Eastern Europe. North America moved to 2% of 2017, 5%, and that was driven by branded and private label tableware and also opening up capacity in our Arizona facility. Flexible Packaging was at 6%, slightly down from final quarter of 2017, and that was driven by good development in India and Middle East and Africa and also Europe was positive. And in Fiber Packaging, we continued that 5% growth, strong performance in Russia, U.K. and Southern Europe. Currency headwind on Page 4. Currency headwind showed impacted top line by minus 2% compared to 2017 and an EBIT by minus 4%. In constant currencies, we would have had a slight improvement in our reported EBIT, but including the currency, we were at EUR 60 million versus EUR 62.8 million in 2017. Significant earnings improvement was achieved in Foodservice Europe-Asia-Oceania while the North America had earnings decline because of the currency, high distribution costs and Goodyear facility start up. And I move now to business segments and I'll go segment-by-segment. Starting with the Foodservice Europe-Asia-Oceania, which achieved a significant earnings improvement starting on Page 6 of the presentation. So that was driven by the good development of core paper products, especially in Eastern Europe and South Europe. We also had a very strong progress with global key accounts across the geographies and earnings were improved by the actions that we took in China to improve our competitiveness and also restructuring the Chinese operations in combination with IP operations acquisition. We also did quite successful cost management, so in terms of controlling our costly maintenance, wages, salaries, et cetera and keeping our value-add margin at good level. Raw materials prices increased, but our value-add margin remained at good level, so we did a good job in managing our margins. Working capital was slightly increased. That is just because of the season and also the consolidation in North China. That means that the -- they're in the process of combining the 2 Tianjin factories into 1 in the first quarter of 2018. EBIT margin was 9.7% versus 8% in 2017, and return on net assets went slightly up. Working capital, as mentioned, did consume some cash flow and there are a couple of reasons: One is the beginning of the season and the other one is that Easter fell into first quarter in 2018 versus that it was in the second quarter in 2017. I move to Page 7, which is North America. Here we achieved a good growth and that was driven by the retail business. So especially our Chinet brand as well as private label tableware. And that growth was helped by additional capacity coming onstream, namely our investments in Arizona and some other investments in other facilities that also opened up capacity. In the segment, we had a strong currency headwind in net sales. As mentioned earlier, our net sales were impacted by minus EUR 35 million because of the currency conversion and also profitability, EBIT at absolute level, [indiscernible] minus EUR 3 million in the quarter. Operating profitability was also impacted by high distribution costs and Goodyear start-up, where if you would look at the EBIT margin of 2018 at 7.2% versus 2017, 9.1%. The impact of distribution costs and Goodyear start-up cost is about 2 percentage points, both accounting for about 1 percentage points. So if eliminating or assuming that, that impact is eliminated, then we achieved similar margin in quarter 1 2018 versus 2017. Cash flow was impacted by high working capital and also us taking -- paying some of the payables in March in order to benefit from the discounts. Working capital and cash flow will stabilize and gain back the positive momentum in the second quarter. On Page 8, Flexible Packaging. Volume growth was strong in India, so India is back on track. Topline and profitability development was good, especially the domestic demand was quite strong, so we were about 40% growth in domestic demand. We also concluded a label company acquisition in the quarter and incorporate the operations or integrated incorporated operations of [ Ajanta Packaging ] starting on the second quarter, starting at the end of April. Earnings were impacted by margin pressure in Europe and especially us not being able to pass on all the raw material increases to key customers [ had a ] pressure on the material margins. However, the volume growth, to some extent, offset the impact. In terms of currency headwinds, we had about minus EUR 13 million in net sales and about EUR 1 million in EBIT. So eliminating -- or looking at the constant currencies, the absolute EBIT we generated in the first quarter versus 2017 is pretty much at the same level, although the margin is slightly below 2017 level in 2018. I move to Page 9, Fiber Packaging. We improved our profitability. So we had good volume developments in Russia. We also enjoyed stronger volumes in Brazil and South Africa. South Africa recovering from the avian flu and issues in the [ flu ] season. We also had issues with the Northwest Europe, still the demand for eggs and the demand for packaging was impacted by the [ paper mill ] which was initiated or the case was actually valid in the third quarter of 2017, but still having some impact in the first quarter of 2018. Earnings benefited of course from strong volume development, 5% growth, especially strong growth in Brazil and South Africa and also Eastern Europe and also from the low raw material prices in Europe where the recycled fiber had much lower prices in the first quarter versus 2017. EBIT margin in the quarter is 11.4% versus 10.1% in 2017, and capital expenditure below prior year and cash flow at the prior year level. This is a segment review and I hand over to Thomas Geust, our CFO, for financial review. Thomas, please.

[Thomas Geust, Chief Financial Officer]

Thank you, Jukka. I will start on Slide #11 called -- headlined Profitability remained at good level. In relative terms, you will find that the EBIT margin ended up at 8.3%, so slightly below previous year. At our value added remained on approximately previous year level and our gross margin declined at some 0.5 percent points. I can state that the gross margin decline came mainly from distribution cost increases. Distribution cost has been a bit of a theme throughout the last quarters and especially then in North America [indiscernible] increases in that category has been very bad. But, however, despite the decline in absolute numbers, the EBIT margin, I said, remaining on a good level at 8.3%. So really the [ easing ] of the absolute numbers is the product is where we have a EUR 59 million headwind in the top line as declared earlier and EUR 4 million impact on EBIT. Tax rate is at 21% and we have a slight upturning trend in net financial items compared to previous year. That's mainly a question of timing on that. So all in all, EPS at EUR 0.40 versus EUR 0.43 previous year, really as again [indiscernible] impacted by the currency impact. Moving to Slide #12. Some more details into how the currencies have been moving. If you look at the details, average rate Q1, the last column on the right side and compare that to the first column on the left side, the leverage rate 2017, you'll find that the U.S. dollar has actually declined 16% versus the situation previous year. Indian rupee 11% and we have a few other currencies also weakening double-digit, including ruble, Brazilian real and New Zealand dollar. So if you look at the table as such, you will realize that all currencies have actually weakened against the euro. Moving on to Slide #13. We have the raw material price. Movement also here one can state that on general terms, most of the commodities are trending more upwards than downwards. So anything between [indiscernible] and upwards is taken as a trend currently, what we think we will see going forward. Normally Q1 is a bit of a time period for seeking the right positions as well when it comes to raw materials. However, when it comes to recycled fiber here in Europe, the trend has been favorable to us, so decline in prices. Moving on to Slide #14. Here we have a summary of our debt position. No significant changes, so we remain strong when it comes to possibilities of doing acquisitions and funding our capital expenditure. Our net debt-to-EBITDA is at 1.8, gearing at 58% and the debt level, net debt level slightly up from that year-end, however still on a good level. So we are below our ambition level of 2 to 3, so continuing good. Turning to free cash flow. Here we'll find that the change in working capital of [ EUR 14 million ] negative offset the advantage we have in capital expenditure of [ EUR 14 million ] less. So basically decline in free cash flow comes from development of reported EBITDA as well as higher paying taxes. Working capital, as Jukka already mentioned earlier, we tied up a bit of more capital as we were delivering and therefore invoicing, but also going in with a bit of a higher inventory levels compared to year end. And this is something we will pay attention to going forward, so I believe already in Q2, you will see a changing trend here. Moving on to Slide #16, solid financial position. On the movement on the balance sheet, it's mainly -- beyond working capital movement, it's mainly currency movements we see here. On equity for instance, we have translation impact of EUR 30 million versus year-end situation. So that may be how we value the -- restate the balance sheet based on the currency movement. You will see that the dividend proposed and actually approved today is at EUR 0.80 per share. Payout ratio with that one is 42%, and the year would be 2.3% and this gives a continued 10% annual increase starting from 2009. Return on investment was 13.3% versus 14.6% previous year. This is reflecting mainly the increased asset base we have as a result of the investment program we have now been going through. So as we are now getting more returns out of the invested capital, we will also see the returns going up in the future. I turn to Slide #17, progress towards our long-term ambitions. Q1 is not really the right time of the year to make any conclusions on where we are. However, mainly when it comes to the balance sheet ratios, we are more or less on line. However, then when it comes to profit and returns, we still have some way to go. Turning to Slide #19, the outlook. The outlook remains unchanged, which means that we consider conditions to remain relatively stable. Our financial position and ability to generate cash flow is enabling us to look for growth while the capital expenditure is expected to remain at approximately last year's level. With that one, I conclude my part and, I guess, we'll open up for questions.

[Katariina Hietaranta]

Yes, please.

[Operator]

[Operator Instructions] We'll take our first question from Riccardo Romiati from One Investments.

[Peter Testa]

This is Peter Testa here with Riccardo. Two questions please. The first is on the transport cost challenge in North America and wondering how this is linked also to the Arizona facility ramp up, i.e. as you ramp up Arizona, you won't have to transport goods as far and this will come down. And also on transport, there's been pretty good transport pricing on road in Europe as well and wondering whether you felt that was a challenge you would have to face in 2018? Then I'll follow up with a second question.

[Jukka Moisio, Chief Executive Officer]

I think all in all, as stated, transport [indiscernible], the environment, the changing environment on everything from limitations on how you can drive and all of that is a theme I would say across the western world, Europe, as well as North America. So in the structural way, with the limitations you have over in North America, I don't see a change towards the better, short term at least. So it will remain a pressure and addressing your question about how it is with Goodyear. Goodyear, we had, from a distribution point of view, on board already last year. So I would say no significant benefit to be expected out of being closer to the customers there. Of course, to the extent we are now in converting closer to the customers some benefits, but nothing major.

[Peter Testa]

Okay. And then the other question was just on the challenges you've faced in Europe with the material cost clauses and large customers. I was wondering based upon contract clauses or other commercial activities, if you can help us understand how you could work your way through this period or how should we expect this to work its way through Huhtamäki?

[Jukka Moisio, Chief Executive Officer]

Yes, I think that there we need to first of all see that we get the cost efficiency and cost out in our own system, and at the same time of course we gain more volume. So in terms of getting volume and offsetting some of the pressure in the prices will help us to gain first -- in the first stage the same absolute EBIT. And then how we came to margin improvement is really that the cost out actions take traction. This point of time, I would say that if you eliminate the currency impact in the -- or the currency impact between Q1 '17 and '18, we are pretty much delivering the same absolute EBIT, so therefore that part has been achieved. Now we need to work more on the cost out. So that means a simplification of the packaging, simplification of the raw material and simplification of the brand and similar in order to get cost efficiency. That pretty much is pipeline now.

[Peter Testa]

Okay. Yes, and as -- if prices continue to go up for plastics, for example, is that something which your pricing clauses with the customers will start to work and manage? Or is that something which would be more of a challenge?

[Jukka Moisio, Chief Executive Officer]

I think the big dislocation was really in 2017 when many of these initial actions by our customers took place. And now in this current environment and there is opportunity to increase prices following the raw material price increases.

[Peter Testa]

Right. And the cost efficiencies, is that something which you'd expect to realize by midyear, by late year or when do you think you'd be able to point to that?

[Jukka Moisio, Chief Executive Officer]

We started already late last year, mid last year and number of the actions are in the pipeline. So we expect that they would start delivering second quarter, third quarter, [ there's the ] visibility.

[Operator]

[Operator Instructions] We have a follow-on question from Riccardo Romiati.

[Peter Testa]

Just 2 questions on growth. One is just looking at Arizona and the capacity utilization. I was wondering if you could give us any views based upon the contracts you signed in onboarding, what your thoughts were on capacity utilization? And then the other was related to the plants in emerging markets, I think Egypt and India, whether you could give any thoughts in terms of how that should work its way through based upon development and commercialization?

[Jukka Moisio, Chief Executive Officer]

Yes, Arizona, we expect that 2018 should deliver like-for-like growth throughout the year in the 5% to 6% range. So therefore the capacity will be ramped up about halfway by the end of the year of the availability. So there is additional half for 2019, and then when we add new lines, maybe over 2020, that would be significant potential impact. When it comes to Egypt, we expect to start operating towards the end of quarter 3, early quarter 4. We already are operating in Egypt on an import basis. So obviously the currency swings in Egypt are quite significant, so therefore one has to look what kind of volumes we can place in the country right now. But as soon as that starts operating, then lots of new opportunities coming from the market because right now it's limited what we can export or import in the country because of the currency. But as soon as we start operating, we expect that sourcing locally, selling locally and also selling from Egypt to Arab countries and also to some extent Southern Europe with the currency competitiveness and local competitiveness, this will play a significant upside in the volume development.

[Peter Testa]

Right. And then on India? The investment made middle of the year in, I think, consumer soft drinks?

[Jukka Moisio, Chief Executive Officer]

Yes, we expect that India local demand was double-digit already growth in the first quarter and after comparables get pretty weak in the second quarter, third quarter, we expect a very strong development of Indian sales in the coming quarters just because the comparison is very weak in 2017.

[Peter Testa]

Yes. But nothing on the capacity increase affecting this year, more coming next year?

[Jukka Moisio, Chief Executive Officer]

Capacity increase, we basically put 2 new plants in India already in 2017. Most of that capacity wasn't really utilized and then on top of that, we added a few line investments which are starting up in the second quarter. And then additionally, we have the acquisition that we closed and start integrating in this month. So there are number of upside in India. Obviously, we are moving into high season in India right now, so therefore the expectation is that the capacity utilization and the top line development is pretty strong. But there's a lots of new capacity or unused capacity from 2017, this is since [indiscernible] came or is available right now.

[Operator]

And as there are no further questions in the queue at this time, I would therefore like to turn the conference back to our host, Ms. Katariina Hietaranta. Actually, we have another question just queued now, madam. Would you mind if I take that line?

[Katariina Hietaranta]

Not at all, absolutely. Please go ahead.

[Operator]

So we take the next question from Michael Browne from Martin Currie.

[Michael Browne, Fund Manager of Europe]

A very simple question. One of your major customers this week, Costa Coffee, launched a GBP 70 million subsidy fee for recycling with paper cups. Have they asked you to make a contribution to it?

[Jukka Moisio, Chief Executive Officer]

So Costa Coffee launched this GBP 70 (sic) [ GBP 70 million ] per ton recycling of 500 million paper cups. That's correct. Our contribution is that we make those cups and we ensure that the cups we make, either the costs [indiscernible] are recyclable, so that the materials we provide and the materials we use are recyclable. So indeed, when they are collected and put into the pre-operations [ which we cycle ], then that performs well.

[Michael Browne, Fund Manager of Europe]

So you are not making any direct contribution to the recycling of the product beyond the design of the product that will be made?

[Jukka Moisio, Chief Executive Officer]

We make the contribution that the material performs, yes, that's basically our part of the job.

[Operator]

[Operator Instructions] And may I confirm that there are no further -- actually we just have another one now queued. So we'll take this question from [ Philip Gross ] from Lloyds.

[Unknown Analyst]

Yes, I have just 2 questions on the net working capital. So you already mentioned that net working capital has been a headwind for the cash generation in Q1 and then it has been for seasonal reasons anyway. But maybe you can just please add some more color on what drives the changes in net working capital? And to be a bit more specific, how can the tables go up while inventory levels and receivables go up as well? Or payables go up, inventories receivables go down at the same time? And then as a follow-up, whether the net working capital development is pretty much the same in all the regions or is it somewhere skewed to any specific area?

[Jukka Moisio, Chief Executive Officer]

Good questions, all of them. First of all, of course when you are in a growth environment [indiscernible] capital is more on the high side than when you [ run up ] in the season. With the -- Easter being in Q1 this year, we already had the season on, so that naturally ties up some working capital. The other thing is, of course, that as there are [ specifically ] payment terms both ways, which are very close to the month end, depending on how they happen to turn out, if there's not a complete control of the processes, you might get these concerns, getting to your other question, some of the big units might have a bigger impact. And this time for the payables specifically, actually had both high payments flow in North America [indiscernible] big market. So my complete answer to it is that the only way to get -- move to a better level is to very actively follow it, very actively take actions on each of the elements described and then have forecasting capabilities when it comes to the seasons.

[Operator]

And just to confirm, we have no further questions queued, but I'll give a final reminder. [Operator Instructions] And it appears that there are no further questions at this time. So I'll turn the conference now back to Ms. Katariina Hietaranta for any additional or closing remarks. Thank you.

[Katariina Hietaranta]

Thank you. No additional remarks. Thank you, everybody, for participating in our earnings call and we wish you a good day. Thank you.

[Thomas Geust, Chief Financial Officer]

Thank you.

[Jukka Moisio, Chief Executive Officer]

Thank you.

[Operator]

Thank you, everyone. So ladies and gentlemen, that now concludes today's conference call. Thank you for your participation. You may now disconnect.