Hexagon Composites ASA

OSE:HEX

Earnings Call Transcript 2023-Q1

[Karen Romer, SVP Communications]

Good morning and welcome to Hexagon Composites Q1 2023 Results Presentation. My name is Karen Romer, I'm the SVP of Communications. And joining me here on the stage today will be Jon Erik Engeset, our CEO; and David Bandele, our CFO.

This morning we will start out by bringing you the highlights, as well as a business update, followed by financials and outlook, and then also a Q&A. And for the Q&A, those of you that are in our digital audience can please go ahead and fill in your questions as the presentation is being held in the field on your screen. And then we also will be taking questions from the room.

So, I think, without further ado, Jon Erik.

[Jon Erik Engeset, CEO]

Good morning. Thank you for joining us here today.

We have now finalized our 2022 carbon footprint accounts. And I'm proud to report that our solutions in the prior year enabled the avoidance of 1.35 million tonnes of CO2 equivalents. That translates into roughly 300,000 cars on the roads for one year, so a significant contribution. To accomplish that, we in our own supply chain consumed 320,000 tonnes of CO2, the major portion of that is from our suppliers. For more information, please go to our Sustainability Report, which you will find on our webpage.

Looking at the numbers. In the first quarter of '23, our revenues amounted to NOK1.130 million, up from NOK913 million in the same quarter last year. Our EBITDA, however, was at the same level, approximately NOK83 million versus NOK84 million in the prior year.

On the Hexagon Purus side, they continue on their growth trajectory, NOK244 million in revenue in the quarter, up from NOK159 million in the same quarter last year. EBITDA at minus NOK112 million in line with expectations compared with minus NOK93 million in the prior year. Behind these numbers is a solid top line more or less across the board with some softness in the quarter for the heavy-duty, especially the long-haul truck segment.

And in that Hexagon Agility business, the margins have not yet recovered to satisfactory levels and we will revert to that. However, order books look healthy and the contribution margins are expected to improve. And especially the mobile pipeline business unit has very strong markets and a full order book well into 2024.

We also recently launched the smart cylinder pilot project on the Hexagon Ragasco side, with a pilot to AGA / Linde here in Norway. And last but not least, Hexagon Purus in the quarter funded up with NOK1.3 billion with Mitsui as anchor investor, and that enabled the targeted uplisting to the main market of the Oslo Stock Exchange. And that was an occasion for celebration. So this took place in the morning on March 30 this year, a happy day.

But many other highlights also for Hexagon Purus. So most notably we finally signed the final agreement with Hino, delivering battery packs and assembly services, and that contract is worth in the range of NOK20 billion potentially.

And to enable that contract and also to play in the market generally for battery electric heavy-duty vehicles, we depend on battery cell suppliers. And as you who follow us closely, we had - we lost some contracts in '21 due to a lack of secure supplies. So very important milestone for us to get long-term agreements in place with Panasonic, securing then stable and predictable supplies of that very important component.

And then we have five expansion programs ongoing, two of which have recently been completed, official opening in British Columbia, Kelowna, Canada of the tech center and battery line there. And also in Westminster, Maryland, a cylinder and systems facility. So two or five have now been completed and the other projects are on track.

On the Hexagon Agility side of the business, we have recently executed some important management changes. Hans Peter Havdal who joined us earlier this year as Group Chief Operating Officer has taken on the dual role of CEO for Hexagon Agility. And his broad background from the automotive industry is particularly relevant for the phase that we're entering now.

Short-term to restore margins and medium-term to leverage the significant growth opportunities for this business area. And he has a strong team around him mentioned here, Andrew Griffiths, he will continue in his role as CFO and Executive Vice President. And then also Eric Bippus, who many of you have met, has been promoted to Executive Vice President and had his scope of responsibility in the company expanded.

We remain very dependent on regulatory support, fortunately, that support is happening as we speak in all relevant geographies. And just a short update on a couple of changes there. In the EU, It was recently - recently adopted regulation on CO2 emissions, for light-duty vehicles which will require the suppliers to assess the full lifecycle effects of different technologies.

This is very important, because this is a step in changing from measuring what comes out of the exhaust pipe, what we call tailpipe emissions two more holistic well-to-wheel approach, and we think that will pave the way for regulations that will also support renewable natural gas in Europe. And very important for us is that when this regulation has been passed for light duty, it is highly likely that similar regulations will also come into force on the heavier duty vehicle classes.

On the other side of the Atlantic in California, the Advanced Clean Fleet Act came into force recently that supplements the Advanced Clean Truck regulation which has already been in force for some time. This is also a very important development because, so far, the focus has been on the supply side, the OEMs. While the Advanced Clean Fleet also then imposes demands on the fleets and the fleet owners to make use of this technology. So we deem both of these regulations as very supportive.

And California being maybe the most progressive regions of all when it comes to zero-emission and decarbonization of transportation, recently hosted the Annual Advanced Clean Transportation Expo and we had a big delegation there, really good buzz on the floor, and we were joined by many of our customers, suppliers, and competitors.

And a couple of main takeaways there. First of all, technology-wise, there is a lot of attention to electric configurations. But we see a shift away from - on the battery electric, which is a more mature technology and especially in the heavy vehicle classes, now a lot of focus and many examples of hydrogen electric configurations on display.

And also feedback from the main fleets, that we had meetings with, was that they don't see that there is a realistic opportunity to adopt in big scale in the short to medium term, meaning in the next 10 years, maybe more, of battery alone. And they have the same view as us that the only alternative that can make a significant impact in that timeframe is renewable natural gas. So we as a group are agnostic. We are playing in all these technology areas, but we see the strongest logic in order to drive down CO2 consumption by applying renewable natural gas.

Cummins were also present displaying their new 15-liter engine to - and they confirmed that this will be launched in 2024. And the General Manager there, he made a presentation. He also - was also at our stand and he expressed publicly an ambition to reach more than 15% of the heavy-duty market in the next few years. And that represents 7 to 8 times higher market than we currently enjoy in North America.

And on that note, I welcome David to the stage. Thank you.

[David Bandele, CFO]

Thanks, Jon Erik. Good morning, everybody, joining us also on the webcast and in the audience. Good to see you all again.

That was 2024, that inflection point on the 15-liter engine. A lot of miles to go in 2023. First, let's go for the highlights of Q1, 2023. So as Jon Erik covered, NOK1.3 billion in revenues for 24% growth. There were considerable currency effects, U.S. dollar particularly strong against the Norwegian kroner. So even stripping out those effects of currency, we are still 12% and a healthy start to the year in growth.

Strong Mobile Pipeline and I would say solid Hexagon Ragasco volumes played a very strong part in the quarter. And as Jon Erik touched on, we did have expected slower start than in heavy-duty truck.

And then moving over to the right, EBITDA was NOK83 million, in line with Q1 last year. Margin percentages still remain not so relevant to compare given the high-cost base inflation and pricing inflation that we continue to see. But looking at those profit margins in absolute terms, the margin development then on heavy duty volumes, we did turn the milestone.

So in the automotive business, we are seeing the pricing effects actually mitigate the cost effects. But unfortunately, the volumes are lower so you're not seeing that through the margin. Being as the biggest division has the heaviest weight then on the margin currently.

But very good news aside from the mobile pipeline, margins have increased quarter-over-quarter. So we expect it to see. Ragasco has had very positive efficiencies and some favorable currency effects also on the EBITDA level, something we don't see in American business because revenue and cost is in the same currency for Agility.

And then finally a positive contribution from Digital Wave to wrap up that quarter. Let's dig into Agility and then really see the picture there. So we posted NOK898 million in revenue for 23% growth.

As I said, strong mobile pipeline underpinning that. We also had very strong medium-duty volumes, somewhat offsetting the lower long-haul heavy-duty truck. Unfortunately, on the medium-duty, we have quite limited content, whereas we have a lot of content in our heavy-duty applications. And hence, that produces also a negative mix impact in the quarter.

And when we go over to the EBITDA, we posted NOK34 million. So a drop of NOK18 million year-over-year for that quarter. And again, some of the key elements of understanding that margin development. Number one, as we've stated before, the carbon fiber prices, which is a key bill of material for us, remains high year-over-year as it will do through '23 versus '22.

Component cost, still high. So we expect to see some of the - basically the raw materials picture is getting better, but they won't pass through probably till the end of quarter two as we stated last time. So in Q1, component costs are still high. And then again we've had this delay or slower volumes as well coming through. And with slower volumes and new delayed effects of this higher pricing even further as we wind out the backlog and we have a significant backlog still and growing as we come into Q2.

And then finally, just like to say the stronger margins in mobile pipeline also coupled with stronger margins in our European operations, something that has been quite different during last year. So improvements beyond heavy-duty truck.

On Ragasco, we posted NOK188 million in revenues, so for 16% growth and that's the back of typically our seasonally strong European sales. And when you go to the EBITDA level, posting a monster NOK47 million for Q1 and up NOK14 million same quarter last year.

And digging into those healthy margins, again, we have the quite sizable positive currency effects that have helped, and the pricing, of course, now has caught up with the cost base inflation fully. On top of that, Ragasco had numerous production records in the quarter so a lot of volume efficiency. Things going well there.

On Digital Wave then, yes, a very good start to the year, obviously tripling revenues, NOK45 million posted for the quarter. And as we look at the EBITDA side also, a NOK6 million improvement year-over-year. So positive profitable revenue growth. We have this healthy mix of product businesses, our Ultrasonic Examination machines sales, but we also have a Service business in the Modal Acoustic Emission.

So that's the inspection and re-qualification. So that MAE technology, that capability remains core to our product differentiation strategies and that's the whole of Hexagon, so including Hexagon Purus. And also the re-qualification activities we can do using MAE, that's actually central to our certified pre-owned programs. So starting with mobile pipeline trailers, but also available to repurposing automotive applications.

And finally, Purus had a good start to the year. They published their results a couple of days ago, 53% topline growth for the quarter, NOK244 million. Chart in the middle is very impressive. So the last 12 months' revenue up 70% year-over-year and also passing the 1 billion mark. So, kudos to Hexagon Purus. And you can see that their order backlog is extremely strong. And as these long-term agreements actually move into serial production, then you'll get to see a lot more revenue generation at those points. So the next couple of years would be very exciting for Hexagon Purus.

And as usual, we've talked about the left-hand side, the middle when we put these together on a group basis, we did NOK1.261 billion in revenues and minus NOK29 million in EBITDA for the Group.

On the leverage side, we focus on the Hexagon excluding Purus, we closed with pro forma net interest-bearing debt of about NOK1.3 billion and we also have available liquidity then of NOK599 million at the end of Q1.

So just pause for the outlook. So on 2023, we're not given definitive guidance this quarter either, but it's basically the same as one quarter before. The one difference is as we warned we do still see intermittent supply chain delays and disturbances.

And we've experienced that in Q2. So we will have some impact in Q2, but we do expect those to ease over the year and hopefully catch up Q3 and Q4. So it's still a lot of managing to be done. But overall, we still expect healthy growth across most of those segments. And on the heavy-duty truck volumes, we're still watching back end of - I usually say Q4, back end of the year, just to ensure that volumes are what we expect to be.

And then on the EBITDA side then. So as long as there is no major disruptions to volume, then we should see the gradual improvement and probably a little bit - as I mentioned, a more back-end loaded.

Otherwise, key takeaways for the quarter. Solid top-line momentum. We will see the gradual margin improvement in '23. Hexagon Purus, successfully funded and listed on the OSE stock exchange. That's a significant milestone for both companies. And then our 2025 revenue targets, we hold the same. Hexagon excluding Purus of NOK6 billion. A very achievable and particularly with the game-changing engine being launched in 2024. And for Purus, NOK4 billion to NOK5 billion looks quite secure given the long-term agreement pipeline that you have seen.

And on that note, I'll ask Jon Erik and Karen to come back. Thank you.

[Karen Romer, SVP Communications]

Okay. As I mentioned earlier, we are ready to take some questions from the audience. Yes, and we have one right up here front. And those of you on the digital audience, please feel free to fill in the form on your screen.

[Hans-Erik Jacobsen, Nordea]

Hans-Erik Jacobsen, Nordea. It seems somewhat odd that you continue to experience delays in the U.S. Can you dig a little bit deeper into why this is continuing to happen?

[Jon Erik Engeset, CEO]

You mean specifically delays in the supply chain?

[Hans-Erik Jacobsen, Nordea]

Yes.

[Jon Erik Engeset, CEO]

So I think this is an industry-wide problem. You see it from the automotive OEMs also that they report continuous this supply chain disruptions. And it's a very sophisticated supply chain. We have, as most players tuned in our production system to major extent on just-in-time deliveries, and even small components that we never cared about in the past have now become an issue because of domino effects far back in the chain.

Chemical components in one case lacking, which has then affected the sub-supplier orders just as an example. And those ripple effects, they also then affect us. That said, it has improved greatly, but we still continue to struggle with some specific issues, and we expect that will also be the situation in Q2 to some extent. But let me emphasize that there are major improvements compared to what we experienced last year. But this is not unique for Hexagon, it's something we have across the space.

[Hans-Erik Jacobsen, Nordea]

And then on the new Cummins engine, it seems that it has been pushed a little bit into '24. When can we expect to see increased sales from Hexagon, in '25 and onwards? Or do you think it will have an effect already next year?

[David Bandele, CFO]

We think it will have an effect. So I don't think they are behind schedule. So they are homologating this engine now in the U.S. Actually, the engine has been used in China, not the exact same version, but basically the same block, with very good results from what we understand.

So they seem very confident that it will pass homologation. And then it will be brought to the market in the beginning of next year. So we will see sales to customers taking this engine in '24. But the big impact will be from '25 onwards.

[Hans-Erik Jacobsen, Nordea]

And then on the margin side in relation to carbon fiber costs and other components, you are quite confident that you will see increased selling prices and enhanced margins during the course of the year from what you said.

[Jon Erik Engeset, CEO]

Yes. And maybe you...

[David Bandele, CFO]

Yes, absolutely. So we actually are seeing the pricing effects. You are not seeing it because of the volume and mix in Q1 on the automotive side. Mobile Pipeline, Ragasco all of those are under control.

[Hans-Erik Jacobsen, Nordea]

Very good, thank you.

[Jon Erik Engeset, CEO]

Just one additional comment to that. We maintain the view that our markets will be tight on supply when the new engine will be launched. So we, therefore, also have confidence that on the market side, it should be definitely possible to achieve the prices necessary. That said, we will work a lot on our internal supply chain, take out efficiency gains wherever we can. And the sum of all these effects will bring us to the targeted levels.

[Karen Romer, SVP Communications]

Excellent. Do we have another question from the room? I do have one here online. Good morning. Can you give some insight into how the newer Agility orders are priced? And this for you, David. And how this impact margin in percentage point - how this impacts margin in percentage points? And timing-wise, when will the low-margin orders signed in '21 and '22 move out of the quarterly update?

[David Bandele, CFO]

Yes. So, the last one steadily moving out. Again, there has been slower volumes. So you don't see it as quick. But the pricing effects are in there. So all the - they're obviously individual to different customers, but there are significant levels in order to cope with this carbon fiber price increase. So, those are in place, and then it will just take time to wind out when we do the sales. And you will see progressively better margins through the quarter as long as we have the volumes.

[Karen Romer, SVP Communications]

Another question from the digital audience. Could you elaborate on why the Cummins 15-liter engine is such a game changer?

[Jon Erik Engeset, CEO]

So a couple of main reasons. First of all, this is a 15-liter as opposed to the currently largest engine on the market, a 12-liter. And that opens up a big segment of the market, which is not serviceable by the 12-liter today.

So roughly speaking, we are talking about 300,000 trucks in the U.S. Today, the 12-liter hypothetically has an addressable market of 1/3 of that. With the 15-liter, the addressable market in principle is 300,000. And as I mentioned in my presentation, Cummins' own ambitions and expectation is to exceed 15% of that volume. So a significant number of trucks between 40,000 and 50,000 trucks. So that's the main thing.

The other thing is that this is the first natural gas engine in the U.S. specifically developed for natural gas, which then entails significant efficiency improvements. So the expectation is 6% to 7% higher energy efficiency from this engine compared with the previous one. And thirdly, the whole engine has been optimized and has been tested as I mentioned in China, is now being homologated. So, some of the children disease that was experienced with the 12-liter is expected to be avoided with this new configuration.

[Karen Romer, SVP Communications]

Thanks. Then Jon Erik, when can we expect to see the deconsolidation of Hexagon Purus?

[Jon Erik Engeset, CEO]

And it will happen, and I think also previously said that we are targeting that for this year and my answer remains the same. We will go about this in a way, which is as supportive of Hexagon Purus as possible, and certainly also value accretive, both shareholders in Hexagon Composites and Hexagon Purus. But the exact timing, we will revert when we are ready to execute.

[Karen Romer, SVP Communications]

Excellent, great. David, what are the levers to improve profitability in Hexagon Agility?

[David Bandele, CFO]

I think the largest bucket is really the productivity side with Hans Peter, and comes with an automotive experience and quite a laser focus on world-class manufacturing. We've seen that in Hexagon Ragasco. All those who have come to the plant would appreciate that. And we need to further develop the world-class manufacturing on the Hexagon Agility side.

So I think it's also vitally important because if this market is coming, we really need to have the capacity online and be as productive as possible in order to service that market and remain market dominant. But I think that's the largest bucket. There is a lot of margin catch-up, you can say, to come from there. Obviously, a lot of margin will come back just from volume as we talked about on the 15-liter engine, and again nuts and bolts all along the P&L. So we're quite confident in that.

[Karen Romer, SVP Communications]

A follow-up question that. Do you expect your margins in Agility to be up in '23 versus '22?

[David Bandele, CFO]

That's what we expect, yes.

[Karen Romer, SVP Communications]

Do I have any additional questions here from the room? No. And I seem to have taken all that - sorry, one that popped in here. Okay. How relevant - and let me say this would be to you, Jon Erik. How relevant will Hexagon Ragasco remain to Hexagon Composites in the future considering it's different from the rest of the portfolio?

[Jon Erik Engeset, CEO]

It is different but we share the same core technology of Type 4. And as David just touched on, it's really the benchmark for our other facilities with regard to productivity and world-class manufacturing.

And even if Ragasco is not targeting CO2 reductions per se, although there is a case for bio LPG, which we think will come with quite some force in the coming years. But in many areas of the world, it will replace fossil fuels like coal and wood, and enable avoidance of local emissions. So in our mind, it is a clean air everywhere type of technology, and therefore, several reasons why it is a natural part of the Hexagon Group.

[Karen Romer, SVP Communications]

Excellent. I have no further questions from the digital audience. Anything here? And I think we can say thank you for this quarter and we look forward to seeing you again soon. Thank you very much.

[Jon Erik Engeset, CEO]

Thank you.

[David Bandele, CFO]

Thank you.