Hexagon Composites ASA

OSE:HEX

Earnings Call Transcript 2022-Q2

[Karen Romer, executive]

Hi, and welcome to Hexagon Composites Second Quarter 2022 Results Presentation. My name is Karen Romer, and I am the SVP of Communications for Hexagon Composites.

Joining me in the room today is Jon Erik Engeset, our CEO, and our CFO, David Bandele, and they will be presenting the highlights for Q2, and then David will give you the financials and outlook. And then after that, we will be opening up for questions. So on your screens, you should be able to see a link or a button to press that will give you access to a question box. Feel free to send in questions during the presentation and we will take them at the end. If there is any difficulty, feel free to send your questions to [e-mail] and we'll also take them from there.

But without any further ado, I'd like to welcome Jon Erik to the floor.

[Jon Engeset, executive]

Thank you, Karen. Good morning, everyone. Q2 2022 was a quarter of very strong growth for the Hexagon Group. 50% year-over-year growth if we adjust for the acquisition of Wystrach in the fourth quarter of '21. On a pro forma basis, the growth was 39%. We are particularly pleased to see very strong growth in Hexagon Digital Wave, doubling revenue year-over-year. It's our smallest business area, but it's growing strongly and very exciting opportunities for that business area. We also saw a record high demand for our distribution modules and that has significant impact on how we will think about our strategy and priorities going forward. And Hexagon Purus on their side tracking their business plan, 123% growth year-over-year. On a pro forma basis, adjusted for Wystrach, 34% top line growth. Hexagon is all about driving energy transformation, and our Hexagon Agility business in the first half of 2022 enabled the avoidance of 600,000 tonnes of CO2 equivalents, and that is something we continue to be very proud of.

Looking at the headline numbers. The Hexagon excluding Purus part of the business, top line of NOK 1,034 million, new record quarter, comparing with NOK 726 million in the same period last year. That delivered an EBITDA of NOK 90 million compared with NOK 71 million in the previous year. Hexagon Purus, very strong top line, NOK 210 million, delivering on their plan. We remain very confident in the mission and opportunities of this company. We continue to build-out the organization, increase capacity. So still we are in red territory when it comes to profitability and NOK 112 million negative EBITDA, but in line with our plans. So on a consolidated basis, NOK 1,180 million and minus NOK 21 million EBITDA.

So while we are very satisfied with the continued momentum and strong demand and growth opportunity, we also struggle quite a bit with the very high raw materials and component prices. And on top of that, the continuous delays and shortages caused considerable challenges in our own operations and put additional pressure on our margin. And in Q2, things actually moved from bad to worse in many ways and we will continue to struggle and manage through this in Q3 and Q4. However, we see now clear signs of the raw material markets easing. Categories like aluminum, glass fiber, resin, also overseas transportation are starting to come down and we will expect to see the positive impact of that in a couple of quarters' time. So there is a lag obviously before that translates into our bill of materials, which is an advantage when the prices go up and a slight disadvantage when the prices start to come down again as they do now.

Meanwhile, we continue to pass our cost increases on to the market. As you can appreciate, that is a challenging process. Our customers, they dislike increased costs as much as we do, but by good communication, good documentation, they also see that we are reasonable, and we therefore expect that by the end of this year, we will have managed through this exceptional period and return to normal margins. And frankly, the high costs are not all bad for our business, especially if we take a look at the energy prices in the US. So the graph to the left here shows the delta between the diesel prices, [tank] prices and CNG, compressed natural gas prices. And we've never seen a bigger delta in favor of CNG than we see right now. And with the current delta, the payback on a CNG heavy-duty truck compared to diesel is less than 2 years.

So in addition to the environmental proposition, which continues to be what is driving this market for us, there is now also very, very significant financial incentives for the incentives for the fleets in the US to go green. And some pretty remarkable political decisions are being made almost as we speak. The US Inflation Reduction Act passed the Senate last week and is fully expected to be approved by the Congress and by the President in the near future, allocating $370 billion over the next 10 years to energy and climate change in the country, termed the biggest climate investment in US history. And this is directly relevant for us in subsidies and support for clean energy and transportation technologies as well as tax credits and grants for clean fuels themselves and for commercial vehicles.

On the European side, there was already a very ambitious plan in-place, the Fit-for-55, which was approved last year, but with the Ukraine war, the EU has launched the REPowerEU program, which, in addition to combating climate change, also will seek to make Europe energy independent and especially reduce the dependency on imports of natural gas from Russia. So another EUR 210 billion until 2027, of which EUR 37 billion will be earmarked for biomethane and RNG production and EUR 27 billion for hydrogen infrastructure. That should increase the biomethane production on the continent from around 3 billion cubic meters in 2021 to 35 billion by 2030 and taking the hydrogen production from, for all practical purposes, zero in 2021 to 20 million metric tonnes by 2030. And that investment program is starting to happen.

And our distribution modules will play an essential role in bringing this clean fuel from production to the market. So on the biomethane or renewable natural gas side, the resources are frequently located in rural areas, agricultural resources, stranded and the mobile pipelines are needed to bring the resources from the production sites either to the industrial users directly or to be transferred to the fixed grid. And similarly, for hydrogen, where there is no fixed grid, for the foreseeable future, transportation in a compressed form is the only available way of bringing it from the production sites hopefully, to the maximum extent, connected to green energy production like wind mills and then to the market either directly to the users or to filling stations for mobility purposes.

So, for the Hexagon Group, infrastructure is becoming now increasingly important in our segment mix and will also therefore impact our strategic priorities going forward. So the Type 4 pressure cylinder is, in many ways, the core technology of the Hexagon Group, but the same core technology is then used across a number of applications, and the infrastructure part of it will, as mentioned, become more and more important both on the CNG/RNG side as well as on the hydrogen side.

And talking about hydrogen, Hexagon Purus delivered its report on Tuesday. If you didn't have a chance to dial in, I highly recommend to look at the webcast, which you can find on their homepage. Top line from NOK 180 million in 2020 to around NOK 500 million last year, and we are on track to deliver NOK 900 million this year and we have line of sight to more than 50% of the target for 2025 of NOK 4 billion to NOK 5 billion. So we feel very good about the development there.

And with that, I will hand over to you, David, to take us through the financials and the outlook section.

[David Bandele, executive]

Thanks a lot, Jon Erik. So good morning, everybody either joining us on the webcast or here in the studio. It has been a good quarter for Hexagon Composites.

Looking at the highlights, Q2 has really been a follow-on from Q1. So we see extremely strong top line growth, and as Jon Erik mentioned, we are still then having to absorb quite a strong inflationary pressure, so the cost sides are extreme, but also supply chain disruptions, which also affects our efficiency, but despite that, doing very good results.

Starting with Hexagon Agility, they posted a very high NOK 818 million in revenues, 52% growth overall for the segment. Within there, certainly Mobile Pipeline in North America, 3 times growth year-over-year. As I said, we stabilized the margin year-over-year. It is a softer margin, but our price rises in Hexagon Agility, they are lagging the input cost increases. So over-time, we'll be able to correct those.

When it comes to Hexagon Ragasco, another strong top line there, NOK 192 million in revenues. Very pleased that they achieved additional price rises with the customers to actually match then the extreme material price increases. So that has all been achieved for Ragasco in the second quarter. There was reduced sales output and that was due to uncertain supply chain disruptions. There were some global shortages of components and it didn't allow us to deliver the full maximum there. Saying that, Ragasco and Norway in general for businesses are really facing high energy costs, more on that, but that plays down also on the margins.

Digital Wave, over 2 times revenue growth at NOK 26 million; that's driven both by their Ultrasonic Emission technology. These are machines, so machine sales, and Modal Acoustic technology, which is more a service, hence to do with inspections. And that revenue growth allowed them to have a positive EBITDA for the quarter.

On Hexagon Purus, they've doubled their revenues, also continue a strong order pipeline and our ownership post in Hexagon Purus is currently valued by the market at just over NOK 5 billion. As Jon Erik said, for the Hexagon excluding Purus business, it was all-time high, a record quarter, NOK 1,034 million, up from NOK 726 million same quarter last year, and that equates to 31% revenue growth excluding foreign currency effects, 42% headline.

On EBITDA, we posted NOK 90 million, up from NOK 71 million. And although the EBITDA margin as a percentage dropped there, we see that the pressures, as I mentioned, from the costs, inflationary environment, continue to weigh down, but also, as I mentioned, these component related disruptions and that's really across all business areas. But otherwise, very robust overall market demand.

And looking at Agility in particular, the NOK 818 million in revenues is up from NOK 537 million last year. Not only the stellar performance from Mobile Pipeline, but also continued strong momentum in the medium and heavy-duty automotive markets. On EBITDA side, we posted NOK 63 million, up from NOK 44 million the same quarter last year. Again, we have to absorb significant input cost escalations for Agility. These range from 20% to 75% year-over-year rises. So they are very significant. Of course, the volumes then help us to absorb those.

In addition, how the supply chain disruptions commonly affect this business is in the irregular chassis deliveries, so we need a chassis to place and install our fuel systems on. And when you can't predict how these come because there are supply chain disruptions at our customers as well. This means that at the end of the day, there are inefficiencies in our throughput. But saying that, even with these margin headwinds, we generated 43% higher EBITDA and we got to be pleased with that.

Hexagon Ragasco, NOK 192 million in revenues, is up from NOK 175 million the same quarter last year, typically in quarter 2, to have a lot of sales to Europe and that's helped offset softer Asian market year-over-year. As I mentioned, the price increases managed to match the material cost increases. So that's been positive; also some positive mix effects, helping to compensate somewhat for lower volumes.

As we look at the EBITDA, you can see that we have a reduction to NOK 29 million from NOK 34 million same period last year. I can tell you that the energy cost alone is roughly NOK 4 million per quarter extra year-over-year and that goes straight to the bottom line. So you can see most of that deviation is then the energy cost that we are facing at the moment. Also, as I mentioned, these order delays or component delays are resulting in delays to orders.

Positively, we continue a trend this year of more and multiple new introductory orders around the globe. They start as small orders, but they grow. And interestingly enough, whilst the aluminum price is extremely high, it makes our Type 4 cylinder very competitive when it comes to LPG-powered forklifts because we are seeing 5 times of 5x growth year-over-year in forklift truck applications, particularly in North America. So very good and promising developments in North America there.

Digital Wave, NOK 26 million revenue is up from NOK 12 million same period last year, and they have been able to post a NOK 3 million or 12% EBITDA margin for the quarter. Digital Wave will continue to invest in growth in the business to take its product portfolio forward, but it's been doing a very good job of managing its supply chain and input cost challenges there. There are less of these key raw materials in the product offering obviously on Digital Wave. Very good win in the quarter, the Canadian authorities then certified our Modal Acoustic Emission technology for the re-qualification of the breathing cylinders used in firefighting applications. We see this also in the US and we see this as a potential to open-up new territories. Small businesses, but as we can expand them, that is a very good win for Digital Wave.

On the group side, as Jon Erik mentioned, including the Hexagon Purus results, very strong top line, NOK 210 million, a continued cost of growth of NOK 112 million and we get the muted margin on the group level. But if I summarize Q2, we have strong demand and backlog in Hexagon Agility. We will cope with the margin pressure, solid quarter for Hexagon Ragasco despite these challenging conditions, and strong momentum for Hexagon Digital Wave. Also, key that Hexagon Purus remains on-track with its growth targets.

On the balance sheet, most of the movement quarter-over-quarter is really quite heavy currency movements, so US dollar to NOK. So it's just inflated all the posting, saying that, with the supply chain disruptions, it is peaking our working capital levels. And in terms of pro forma leverage, we have stable leverage quarter-over-quarter.

So the first half of the year is in the bag and let's turn our attention to the second half for some data points. So year-to-date revenues are over NOK 2 billion as we close the first half year and year-to-date EBITDA is NOK 174 million.

If I take the top line first, we are confident of hitting the top-end of our guidance there, NOK 3.9 billion, and a good chance to be over that level as well. And supporting that is that we have 6 months backlog in both our Automotive and Mobile Pipeline businesses in Agility for example, so good line of sight to that number.

As Jon Erik has covered in the slide before, we expect certain cost materials or material costs to increase even further in the second half of the year, but of course, higher volumes should help counteract that to some extent. But given the picture, we are targeting them at the lower end of the guidance. So approximately NOK 400 million in EBITDA for the year. I will add that it's a very tough environment out there. So there is a risk of further inflationary and disruptive pressure to that number.

As Jon Erik mentioned, why we're positive then on the outlook for 2023 on the margin side is if we start with the sales, the biggest impact will come from Hexagon Agility. They haven't been able to pass on significant amount of their costs yet and deliveries starting from January 1, 2023 will all be at higher prices. So there you will get the biggest effect on margins come through to the P&L. On the costs side, yes, those raw commodity costs should then feed into our sort of finished goods components like aluminum parts et cetera. If that trend continues, then that's also some positive expectation on the costs side as well in '23.

And with that, I will ask Jon Erik to come back on.

[Jon Engeset, executive]

Thank you, David. So then key takeaways; strong demand, strong order intake, and revenue; supply chain disruptions and inflationary environment compressing margins in 2022, but normalization expected from Q1 '23. And the REPowerEU and the US Inflation Reduction Act should drive Hexagon's addressable markets to new levels, and therefore, we confidently maintain our revenue targets of NOK 6 billion in Hexagon excluding Purus in 2025, and Hexagon Purus maintaining its target of NOK 4 billion to NOK 5 billion.

And with that, I invite David and Karen back up and we are happy to take some questions.

[Karen Romer, executive]

Okay. So first we will begin in the room. If there is any questions for -- yes, we have a gentleman up here, give [indiscernible] a chance to deliver mic, so we can capture it on the webcast.

[Hans-Erik Jacobsen, analyst]

Hans-Erik Jacobsen, Nordea. You're saying that infrastructure will become more important for you in the future. Can you dig a little bit deeper into this, the reason for it and how it will affect your chances of them increasing sales into more traditional area like on the fuel tanks for heavier duty trucks?

[Jon Engeset, executive]

So I think first of all, it is directly related to the program, the governmental programs that we mentioned, the REPowerEU and the Inflation Reduction Act and where infrastructure obviously is critical to bring the energy to the market. And in order to also then get the desired development on the mobility side of the business, that infrastructure needs to be developed first. Now, there is already an infrastructure, but it is a bit limiting. So with these new programs, we expect that infrastructure to be built out, and where our mobile pipeline units and hydrogen distribution units, you can think of it as the missing link in the chain, and that's why with these confirmations now of the governmental support, we think that we will then address this market even more aggressively than we have in the past.

[Hans-Erik Jacobsen, analyst]

And then on your capacity, as you stated, the outlook for increased sales over the next few years are -- they were very good. I guess, that means that you need to increase your capacity as well or do you view it as sufficient?

[Jon Engeset, executive]

Fortunately we made many decisions already. So on the RNG side of the business, we have recently installed a new line in Lincoln, and then we have commissioned a project in Salisbury where we have the systems installation and where we will also add then cylinder line directly integrated with the assembly lines. So I think we will have enough footprint and then the incremental cost of adding more lines into that footprint is actually quite limited.

And similarly, in Europe, in Germany, we have just commissioned a new line for heavy duty -- or cylinders and we also -- they have decided on new site for the hydrogen part of the business, which will free up capacity for more CNG/RNG related production. So I think near-term, it's more about adding shifts and maybe with some limited incremental investments into new lines, but further out, of course, we may need to also expand our footprint, but we don't have plans for that for the time being because we took those decisions last year.

[Karen Romer, executive]

I am going to remind the webcast audience that just you can fill in your questions by pressing the button and writing your question into the open field or you can send your question to [e-mail]. Do we have another question in the room? One in the back there.

[Thomas Dowling Næss;SpareBank 1 Markets;Analyst, analyst]

Thomas from SpareBank 1 Markets. If costs had stabilized in the end of Q1 and given the price increases that you have had, where would you have expected the margin to end up?

[David Bandele, executive]

Maybe we can take that offline, but of course certainly higher. At these volumes, this volume growth, we would expect that to naturally come through our contribution margin significantly, but that's been the change. So it will be certainly higher than they are today and more in line with what you would expect.

[Thomas Dowling Næss;SpareBank 1 Markets;Analyst, analyst]

And in relation to Ragasco, I think I have 2 questions on the margin. Will those introductory orders be at lower margins than the orders that Ragasco deliver on a regular basis?

[David Bandele, executive]

No. Typically -- well, it really depends on geography of course, which markets we go into, but typically once you set that price, that's the price in the market. Yes.

[Thomas Dowling Næss;SpareBank 1 Markets;Analyst, analyst]

Okay. And on the energy costs, the forward curves indicate tough Q3, Q4. Do you do any hedging or how do you cope with the energy prices?

[David Bandele, executive]

Well, firstly, we will try and also pass those on. That will be a little bit tougher, but otherwise, we take the measures we can take, but it's fair to say that a lot of the year is behind us and that is definitely an impact straight to the bottom line.

[Karen Romer, executive]

We do have a question in the webcast. Good morning. Congrats for the good performance and look forward to the coming quarters. On Digital Wave, can you tell us a bit more about gross margin level and how investors should model the revenue growth for the next couple of years?

[David Bandele, executive]

That's a difficult one, as we haven't been so clear ourselves. I mean, we're still in the sort of buildup phase, discovery phase in many ways for new markets and applications. The gross margins, I will say, are higher than the rest of the business. This is after all asset-light, it's software heavy, and it's yes, more service-based income for at least half of the business today. So wait for us to give that guidance, but certainly it does have a bright future.

[Karen Romer, executive]

Excellent. Any questions here in the room? I have another one here online. I believe this is for you, Jon Erik. What are the most important priorities for Hexagon in the second half of 2022?

[Jon Engeset, executive]

So clearly it is to manage our supply chain as best we can, be very close on the suppliers and develop, where possible, alternative suppliers as well. So that's a continuous struggle, a day-to-day fight. And I have to just take the opportunity to really express my appreciation for what has been accomplished because it has really been a struggle so far this year. And we expect that to continue, but we are also getting trained in it. So hopefully we will continue to manage it and get the products to our customers. And then it is this very challenging process of sitting down with the customers and explaining really the increased cost picture. We need to maintain the long-term relations and we need to assure the customers that we in no way are going to take advantage of the situation, and that is time-consuming and a high priority also for the second half.

[Karen Romer, executive]

Thank you. Another question from webcast. When do you expect the increase in European demand for mobile pipeline?

[Jon Engeset, executive]

It is there. It's now.

[Karen Romer, executive]

And can you tell us a bit more about new products in the pipeline?

[Jon Engeset, executive]

You want us to tell the secrets. I think we'll wait with that till we are ready, but there is a lot of interesting stuff going on, obviously on the Purus side. Purus is all about developing new technology. We have several initiatives on the digital side, the smart cylinders for Ragasco LPG we've talked about before. So they are in close contact with key customers on that. So we continue to have great expectations for that. And there is a lot more in the pipeline. So we look forward to sharing more in future reports.

[Karen Romer, executive]

Excellent. Yes. We have 2 questions in the room. We have one in the back, in the middle and then the gentleman over here.

[Fabian Jorgensen, analyst]

Fabian from Carnegie. So with the price hikes now, how sticky are those? Meaning if costs were to come down significantly in 2023, is there a possibility that you would come out with margins that are higher than 2021 levels?

[Jon Engeset, executive]

I think we will -- as I said, we will in no way take advantage of it, but at the same time, we have planned for scale and that scale should have a positive impact on our margins. We believe that for the foreseeable future, there will be shortage of supply also at our level and that bodes for satisfactory margins. And then we need to balance that with our desire to do our part in order to stimulate adoption. So we will not, again, take advantage of the situation, but we also look forward to having reasonable, satisfactory gross margins and EBITDA margins.

[Karen Romer, executive]

Moving on to gentleman over here.

[Unknown Analyst]

I'm [indiscernible]. I was wondering if you can elaborate a bit on the EU and US initiatives or new -- and how you see them playing out, like what kind of use are you seeing for RNG? Is it on the vehicle side or maybe on the industrial side? And also how you see it on hydrogen in terms of type of vehicles and other applications?

[Jon Engeset, executive]

So starting with the US Inflation Reduction Act, it's very new, and honestly, we are still in the early phase of working through it and some of the details are not even clear yet. But what is clear to us is that it will directly stimulate build-out of infrastructure. It maintains the grants and credits for vehicles and it stimulates the development of new biomethane or what they term RNG or renewable natural gas resources on new projects in the US. So you will see the stocks, clean energy, for example, in the US reacted very strongly to that news.

And then on the Purus side of the business, there is a lot also about zero emission technology, and then that is supportive both to our hydrogen business, especially, I would say, near term, the hydrogen distribution business also in the US. But also we are in battery electric vehicles for heavy-duty and we see very strong momentum there, and this should certainly strengthen that momentum further. But if you're interested in the details, then give us some more time to work through it and we can update you.

In Europe, it's quite clear there and I made reference to it in my presentation. So the program to first and foremost -- so 2 priorities. First and foremost, build out the energy sources themselves, so obviously windmills, solar parks, et cetera, and then for production of hydrogen, so from practically speaking zero today to 20 million tonnes by 2030, and then on the biomethane side, continue the build-out and utilize those resources. And again, I've said it many times, but I'll say it again. That is the most environmentally compelling proposition because if you use agricultural resources you will have a negative CO2 effect, we capture CO2, which would otherwise emit into the atmosphere as methane.

[Karen Romer, executive]

We have some questions on webcast from Anders Rosenlund from Arctic, maybe for you, David. What electricity costs -- what's electricity cost's share of total costs in Ragasco?

[David Bandele, executive]

Yes. That's very specific. Now, I think for -- well, I can take that offline with Anders. But just to be very specific, the year-over-year impact is looking at to be NOK 15 million or NOK 16 million, and that's the area that we need to mitigate or do something about.

[Karen Romer, executive]

And a slight correction, Anders is from SEB. And then we have [indiscernible]. How committed are you to keeping your current ownership share in Purus going forward?

[Jon Engeset, executive]

So we've said that since we floated Hexagon Purus that we don't have a target per se to be a majority owner. And clearly, it's complicated to explain the equity story of Hexagon Group because we have the profitable, high-growth RNG/CNG business and then we have the much earlier stage Purus business, which is still EBITDA negative and will remain so for the next couple of years. But then we also want to be a good industrial owner. So as long as the markets are turbulent like right now, we don't think it is the timing to reduce our ownership, but over-time, that is likely to happen. And then Purus will be even freer than they are today. We would want to maintain a significant ownership stake. There are certain partnership sides of this, which should be maintained, on the procurement side, on the R&D side and a few more, but Purus is already quite autonomous in the way it operates. So I would say it's a question of timing. So in sum, we want to be a long-term significant owner, but over-time, we expect to deconsolidate and go below 50%.

[Karen Romer, executive]

Okay. And we have another question from the webcast. What discussions have you had with your heavy-duty truck customers on demand for gas power in light of the significant increases in natural gas prices? And can you explain how price changes flow through? Is that already present in the hydrogen order book?

[Jon Engeset, executive]

So on the natural gas side, then for today, it is for trucks primarily in North America, and then the natural gas prices have not gone up significantly. They have gone up, but the reaction to the CNG price on the natural gas price is much lower than the reaction on the diesel side because so much more of the PEM price is infrastructure related. So on the contrary, the natural gas price has been remarkably stable over the years, which is another advantage of going CNG. So the opposite has happened that gap or delta between the CNG price and the diesel price is at its highest ever. So it's a very, very strong reason to go CNG.

Could you please repeat the second part of the question?

[Karen Romer, executive]

Yes. Can you explain how price changes flow through? Is this already present in the hydrogen order book?

[Jon Engeset, executive]

Yes, if I understand the question right. If it's the pass-through of the cost increases, we are now quoting new projects at higher price level, compensating for the cost increases.

[Karen Romer, executive]

Do we have any other questions in the room? No. And I have no other questions from the webcast. So I think I'd like to thank everybody -- we'd like to thank everybody for attending today. It was nice to see a full room and we welcome you back in the next presentation. Thank you.

[Jon Engeset, executive]

Thank you.

[David Bandele, executive]

Thank you.