Hexagon Composites ASA

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Earnings Call Transcript 2023-Q2

[Karen Romer, SVP Communications]

Good morning, and welcome to Hexagon Composites Second Quarter Presentation. I hope everyone has had a really nice summer. My name is Karen Romer. I'm the SVP Communications for Hexagon. And joining me here today in the auditorium in Oslo is our CEO, Jon Erik Engeset and our CFO, David Bandele, as well as many fine guests here.

And I'd like to point out that during the presentation today, those of you that are in our online audience, you'll be able to insert your questions in the Q&A field to the lower right-hand side of your screen. And for those of you in the room, we will be passing around a microphone after the presentation for Q&A. To kick off the presentation, we will have the company highlights from the quarter from Jon Erik, followed by David Bandele, presenting both the financials and the outlook. So without further ado, Jon Erik?

[Jon Erik Engeset, CEO]

Thank you, Karen. Good morning, everyone. I hope you had a good summer. We have at Hexagon, it has been busy, but in a very good way. In the first half of 2023, we enabled our customers to avoid 727,000 tonnes of CO2 equivalents.

That is equal to roughly 150,000 cars on the road for a year. So a good significant contribution so far this year. In Q2, we enjoyed record high revenues and strongly improved profitability. Also, we executed on the since long announced plan to go or to de-consolidate Hexagon Purus. We did that by dividending out 25% of the outstanding Hexagon Purus shares at the value to the Hexagon Composites shareholders of NOK 1.4 billion.

It also released an accounting gain of NOK 2.3 billion. Market activity has been strong. Of course, we don't announce all orders. Most orders are recurring business, but some notable ones were reported in Q2 at the value of NOK 410 million. And then now in Q3, July, August, another NOK 1 billion.

So the order book is very, very good for the rest of the year. From now onwards, Hexagon Group is without Hexagon Purus. That is not to say that Hexagon Purus does not remain a very important part of the Group in the sense that we hold 38.4% of the shares. And we also have a lot of strategic opportunities and operational cooperation opportunities. So Morten Holum and I, we are tied at the hips, and we will continue to work closely as close relatives.

However, Hexagon Group in the quarter revenues of NOK 1.36 billion, up from roughly NOK 1 billion last year. This year, that generated NOK 148 million in EBITDA compared with NOK 90 million in the same period last year. That translates into an EBITDA margin of 11%, which is still a few points below our targets, but we are on the right way. That is not least due to the Mobile Pipeline segment.

The graph to the left here, it shows the 12 months rolling revenues, which for the first time reached NOK 100 million now in Q2, and we see continued growth for the remainder of the year. And that is largely driven by sustainability ambitions by our customers, by corporations and by governments, supported by very strong financial incentives on both sides of the Atlantic. Also energy shortages in many areas, not least in parts of Europe, is fueling demand for the utilization of stranded natural gas which RNG now represents a larger and larger proportion. The line in the chart to the left there shows the contribution margin also on a 12 months rolling basis. It's an interesting graph, I feel.

It shows that when we went into 2021, we started to see scale or economies of scale effects.

And then we suffered a major setback with the very high cost inflation on our raw materials and components. And we are only now starting to see the effects of the countermeasures that we took in '22 and now in '23 and we see that we are step-by-step returning to the levels where we feel we should be. Now in August, we announced an order of USD 54 million to one of our various end customers in North America, Certarus. We have cooperated with Certarus now for almost 10 years. And this is milestone the largest single order taken in this segment.

And that is part of a very high order intake and strong order book which supports the rest of the year and well into next year, and we are also optimistic certainly for the following years, '25 and onwards. On the mobility side of the business activity and order intake has actually been stronger than we thought 1 quarter ago.

Mainly driven by the Transit bus segment, the Refuse segment and Medium duty. The heavy-duty market is not bad, but it's sort of flattish, a little bit down from last year. But we think that is due to several customers waiting for the launch of the new Cummins 15-liter engine. That will be a game changer. It will effectively increase the addressable market by a factor of 3.

So more or less the total North American market for heavy-duty trucks will be addressable. And we understand that the engine is ready for launch in 2024 as planned, and we think we'll start to see sales in the second half and a strong impact from 2025 and onwards. So although the short term is a bit stagnant, we are bullish especially regarding this segment.

So we are regarding Hexagon Purus. Hexagon Purus presented their quarterly report last Tuesday. If you haven't had a chance, I encourage you to take a look at their webcast, which is available on their web page. They reported yet another strong quarter. The graph to the left here is their 12 months rolling revenue which is up 60% from a year ago, approaching now a revenue of NOK 1.2 billion.

So we are proud to say that Hexagon Purus has delivered on every one of its commitments when we took the company public in December 2020. And we have strong reason to believe that they will continue doing that because their order book is very strong.

They have several long-term agreements booked and recently yet another one, multiyear agreement with a major North American OEM worth USD 150 million for battery electric trucks and also multiyear agreements with a leading energy -- international energy company for supply of hydrogen in Europe or hydrogen distribution modules in Europe. But as mentioned, we did deconsolidate this company with effect from 29th of June. And David will take you through the details of that as well as the financials.

So David, floor is yours.

[David Bandele, CFO]

Thank you, Jon Erik. So let's recap on the events of the end of Q2, some milestone events indeed. And as Jon Erik mentioned, we did dividend out 25% of the outstanding shares. In Purus for a value of NOK 1.4 billion or if your Hexagon Composites share now that's NOK 7 per share that you owned. And at the end of the day, all the transactions we did at the end of the quarter, we are left with the ownership position of 38.4%.

And I point out that in addition to the 25%, we also did a sale of 5% of the total outstanding shares in Purus and that then was to our principal financials and the total return swap. So we own 38.4% as we come out of the quarter. And of course, the rationale, again, we achieved financial deconsolidation of Hexagon Purus. So I'll go through some of the effects soon and then we have obviously increased the free float in Hexagon Purus, so a lot more liquidity in the share there.

And we can now enable both businesses to really fully leverage their growth potential independently. So meaning Hexagon Composites cash flows will be directed solely to Hexagon Composite subsidiaries. Okay. Now the major accounting effects, as you see for the quarter. So first of all, we derecognize the balance sheet items of Hexagon Purus, their assets, liabilities, the noncontrolling interest and equity, and they sum up to a net asset value of NOK 1.5 billion.

Also in Q2, the Hexagon Purus profit or losses, including up to Q2 2023, they are presented now as discontinued operations so they're way below the P&L. And that also includes the prior period comparatives. So what that means is that all the times we've been presenting Hexagon Ex Purus in the past, this is on the same basis as now the Group going forward. So we have perfect comparability.

We, in earnest, generic will remember, really started gathering the Purus P&L back in 2015, and it's been quite the journey. Obviously, in 2020, we did the spin-off and now we've come to the position where we are a noncontrolling partner. Testament to some of the value creation in that period of time, we released an accounting gain then of NOK 2.4 billion, and that's presented as part of those profits or losses from discontinued operations. And in the appendix of the presentation, there's a little summary guide of how that NOK 2.4 billion arose. So going forward, Purus will be classified as an investment in associated company at fair value that booked at NOK 2.1 billion.

And the profit or loss of Purus going forward from Q3 will come through below the line at 38.4%, now including the full sale of the Purus shares.

Beautiful digital cylinder there available in Oslo and Norway. And it's digital because it connects to the end user, but also the distributor, local shops. On the financial highlights for Q2 2023, we did NOK 1.368 billion in revenue for 32% revenue growth. And that strong performance came across all segments, so very key. It was record revenues, and that delivered record EBITDA in our history of NOK 148 million and actually back into the double-digit EBITDA margin territory of 11%.

And the margin improvement really came from significantly improved margins in Hexagon Agility.

And when we dive into the Agility segment, we see NOK 1.11 billion in revenues for 36% growth. and particularly driven by that strong mobile pipeline momentum. But I have to say, very solid in the automotive business, particularly in Refuse Trucks and Transit Bus and they help offset the still relatively low heavy-duty truck volumes, but the heavy-duty truck volumes are up quarter-over-quarter. So that is also very promising as we go into the back half of the year.

Now on EBITDA. Agility delivered NOK 111 million for an EBITDA margin of 10%, and we'll see some of that how EBITDA margins have developed over the past periods in a second. But the recovering margins just to be very, very clear, the effects of higher pricing realized through the P&L are the key reason for this margin improvement and particularly quarter-over-quarter. So, we finally have the effect of new orders, new sales at new pricing and the old orders coming out of backlog are old pricing. That effect is lessening.

So finally, you really see it visible. In Q1, it was not visible, even though the effects were there because volumes were down. So we expect to see that trend going forwards. The other good piece of news is that the cost of most of the other input materials and components seem to be normalizing. So that should be also beneficial going forward.

We still weighed down by higher year-over-year carbon fiber pricing. The only good news is that the effects of that will now probably stabilize by Q3 or level off by Q3 this year. So a very promising picture in Agility. Just to recap, as we came out of 2021, the 11% margin for the quarter was actually the same for the full year. And then steadily through 2022, we had that margin pressure mainly caused by inflation.

Of course, there is price -- there is, sorry, mix and volume in that as well. But it was really the inflationary factors that we're telling. We instigated through 2022, price rises, succession of these actually. But of course, we had Ukraine war and even more pressure on inflation. Carbon fiber prices started raising between quarter 3 and quarter 4 2022.

And finally, last quarter, Q1, we were at a low point of 4% but you can see the change just over 1 quarter when the pricing effects really come through.

So this is a very significant point. Pricing effects are closing the gap on inflation, and our margin recovery is from Q2 onwards. Leaving Agility and going on to Ragasco. Ragasco had a very strong quarter last year, but still a bit this year with 9% growth to NOK 210 million in revenues. We had additional Middle Eastern and African volumes.

And since January 2022, there's really been a strong focus on new customer development. I'm pleased to say that since that period, we've actually increased our customer base by 24 customers, you can call those regions as well. So fantastic work on the top line at Ragasco.

Solid margins of NOK 37 million EBITDA generated an 18% margin, up 3 percentage points year-over-year, and we did benefit a little bit with some favorable currency effects in there as well. For Digital Wave, top line continues to be strong, 54% growth to NOK 40 million in the quarter, and EBITDA down year-over-year to NOK 1 million, but still positive and this is because we have introduced quite a lot of growth costs. These are people, investment in the organization, and there's a lot of pipeline to grab over the next 3 to 5 years. So some growth costs weighing down on margins.

But I'm very pleased at the position of the financial position of the company as we exit Q2 and some days -- a few days after Q2 as well. So just to explain, we have a reported net interest-bearing debt of NOK 1.2 billion at the end of the quarter. And that is equivalent of debt-to-EBITDA leverage of 3.0x. Now remembering the total return swap. So that was executed at the end of the quarter.

Unfortunately, the cash proceeds didn't come until some days into Q3, so some days into July. But we received NOK 274 million in cash shortly after the balance sheet date. And if we accounted for that pro forma, that's NOK 942 million in net interest-bearing debt and then leverage pro forma of 2.3x, so very satisfactory. And if we look through 2021's data, we were meeting our financial leverage target, which is steady state under 3x, quite comfortably. In quarter 1, 2022, we, of course, participated pro rata in Hexagon Purus a raise of NOK 600 million.

And that increased our leverage over those 5 quarters.

Happy to say that the increasing margins and attention to working capital, which was also high after the disruptions in 2022, have already reduced the standard at 3x and the cash from the TRS then puts us in a very, very sound position indeed. Now for the outlook for the rest of 2023, we have really solid backlog and our focus is mainly on the operational output to deliver on the rest of the year. When we start with Mobile Pipeline, well, you saw even those major orders were already totaling NOK 1 billion. The last order for Certarus for NOK 0.5 billion will be delivered through 2024. So we have very healthy, very strong backlog, mobile pipeline well into '24.

Transit and Refuse automotive sectors are resilient. Heavy-duty truck, that was the area of uncertainty going into the year and even as late as last quarter. However, we have visibility in the second half of the year, and our order book looks really healthy. In fact, the backlog extends into 2024. On Ragasco and LPG cylinders, we would expect actually a typical seasonally lower second half of the year, so markedly low profitability than the first half for LPG and for Digital Wave, same as it's been going so far this year.

So in total, revenue for the full year should be a healthy growth across most segments and EBITDA, we would expect the margin improvement driven by Hexagon Agility for the remainder of the year. So key takeaways. 2023 continues our strong top line growth, maybe some strong line growth as well. But also, we've had visible margin improvement through 2023, and we'll see that trend continue. Hexagon Purus was finally deconsolidated at end of quarter.

And again, we will remain strategic partners. Of course, we both will benefit from synergies of R&D, customer relationships and procurement and buying leverage. And our 2025 targets for Hexagon Group, which naturally excludes Purus, that would be revenue greater than NOK 6 billion and EBITDA margin as close as we can to 15%.

And on that note, I invite everybody back up.

[Karen Romer, SVP Communications]

Thank you, Jon Erik and David. We open up for Q&A. So for those of you in the online audience, please use that field that you have on your screen. I did already get a couple of questions. Jon Erik, I have a question.

How do you plan to meet the expected increase in demand following the launch of the 15-liter engine?

[Jon Erik Engeset, CEO]

We have already taken very important steps to prepare for that. So in '21, '22, we added a mobile line in Hexagon in Lincoln. We also added the line in Kassel, Germany, which actually we supply the European bus market, but will free up capacity in the U.S. And then we have under construction a new building in Salisbury, where we'll also install 2 new lines. And that footprint has capacity to take another 5 lines if needed in the coming years at relatively modest incremental cost.

[Karen Romer, SVP Communications]

David, I think this is for you. You are now guiding for greater than NOK 6 billion in revenues in 2025 at around 15%, as you just said, which suggests greater than NOK 900 million in EBITDA. Last year, you did NOK 348 million in EBITDA, and this year may be on track for above NOK 400 million. What concrete measure will you take to reach these 2025 targets?

[David Bandele, CFO]

Obviously, the measures are taken. So first of all, the pricing has been the key factor. It's just that those measures were taken, but now you see the effects of those. And just to quote, remember Agility went from 4% margin in Q1 to 10% in Q2. So the pricing effects have been taken.

But the real sustainable margin improvement will be this added focus on world-class manufacturing. That's going to be over a few years, but we already see quite a lot of benefits in some of the plants that Jon Erik has just mentioned. So both on fuel assembly side of things, the install side of things and also cylinder production. So really sustainable productivity improvements is the other one. And then the third is like really the 15-liter we need to be ready to handle those capacities or that demand increase, which will be significant.

And of course, we do expect to benefit significantly from the scale. So those 3 things would take us to the 15% margin.

[Jon Erik Engeset, CEO]

And if I can add to that, there are significant scale effects in our operations. So the growth also will contribute to the EBITDA margin.

[Karen Romer, SVP Communications]

And while we're talking about Cummins, when do you expect to see a meaningful volume contribution from the new Cummins engine? And will this drive demand for larger fuel systems considering that will be relevant for longer-haul trucking which requires more energy storage. Will Hexagon Agility directly benefit from that?

[Jon Erik Engeset, CEO]

The answer to the last question is yes, definitely. What is meaningful. It's a little bit difficult term to define. So we think we will see sales in the second quarter of next year. So that will be very important but more significant volumes from 2025 onwards when more of the OEMs and the fleets will adopt this new technology.

I think we need to think about it in 2 ways. You have that expansion of the market. That is to a major extent, the long haul with sleepers, those will carry more tanks, bigger systems so that itself will add additional volume to our part of the market. But we will also see 15-liter replacing the 12-liter in the current configurations simply because it's a more efficient engine giving 6% to 7% higher energy efficiency.

So we will see also those trucks that maybe don't need 15-liters, but they will still prefer to use the 15-liter because of efficiency effects. There, we don't expect to see our share of the market growing because of the larger engine but it may be that a bigger share of the market will adopt because of the higher efficiency and more tailor-made engine that this new engine is.

[Karen Romer, SVP Communications]

David, how do you expect your leverage to develop going forward?

[David Bandele, CFO]

I think we've communicated that we like the steady-state leverage under 3x. We have been in the past, acquisitive, et cetera. So there will be times where we might go over there. But as long as we keep to under 3x, that is a steady-state target.

[Karen Romer, SVP Communications]

Great. And we have a question.

[Thomas Dowling Næss, Sparebank Markets]

Thomas, SpareBank Markets. I believe you made some organizational changes in Agility. Could you talk us through some of the steps that have been made? And if you see any impact on that already in 2Q results?

[Jon Erik Engeset, CEO]

I think we do, although the program that we are now executing on was actually kicked off in the second quarter of last year. So David touched on his umbrella brand name, world-class manufacturing everything from procurement to operational efficiency. We have some very, very qualified, capable people now in the organization, leading that drive and other resources being added later this year and we see visible effects in the facilities, and we think that will translate into efficiency improvements over time. So that will be a significant contributor to secure long-term competitiveness.

[Thomas Dowling Næss, Sparebank Markets]

And a bit more boring technical question. Did you have to do the TRS to deconsolidate Purus or was it more in a matter of liquidity?

[David Bandele, CFO]

The deconsolidation of the loss in control event was actually the dividend in kind and the TRS. But of course, dividend in kind doesn't -- you don't receive any cash in. So we did want to delever and the TRS was a good solution.

[Thomas Dowling Næss, Sparebank Markets]

One last question, a bit more fun, maybe. You said there was a lot of pipeline to grab on Digital Wave. Can you elaborate a bit more on that?

[David Bandele, CFO]

I guess we'll come back with more information on that. But it's been significant growth, as you know, over the last couple of years, and we don't intend that to slow down.

[Karen Romer, SVP Communications]

We have somebody in the front here.

[Hans-Erik Jacobsen, Nordea]

Hans-Erik from Nordea . You explained that most of the improvement within Agility was due to higher prices. Couple of quarters ago, we had a lot of logistical problems and lack of raw materials. Is that still a problem? Or is that a thing of the past?

[David Bandele, CFO]

We guided at the end of Q1 quite concretely because we had already suffered some in April, right? And that was one of our -- I was actually in Mobile Pipeline. So things can happen, it was disruptive, but the good news was that the organization back to the Agility organization responded very fast and very precisely and we were actually able to make up for that and have a pretty much a monster quarter in Mobile Pipeline. But we definitely don't rule out disruption happening here and there. But we do feel that when we respond to it better positioned to respond to those disruptions.

But we have to be vigilant. And one area is, obviously, the chassis management and that is another area of focus that we've done in Agility just to try and resource that in a way that allows us to have more productivity in our operations.

[Jon Erik Engeset, CEO]

Yes. But you make a good point and it ties in with Thomas' question on the investments in organizational resources. So we are seeing effects there where we start to get a better control of the supply chain and our own operations and maybe can do more preemptive steps to avoid the type of problems that we have experienced in the last couple of years.

[Karen Romer, SVP Communications]

Great. We do have a question -- a couple of questions from the online audience. I think this is for you, David, congrats with an excellent report. Hexagon Composites ex Purus had a 60% gross margin in 2Q according to my calculation. Is that more or less correct? Is there any nonrecurring positive impacts in the second quarter gross margin?

[David Bandele, CFO]

Nonrecurring impacts. No, I mean, not particularly on the last piece of that. On the first piece, I can't comment on those numbers specifically. I would say that generally, obviously, with the improved margin because you see the pricing, then, of course, the contribution margins have increased significantly. But I can't comment specifically on that math.

[Karen Romer, SVP Communications]

Great. Another question for either of you, should we expect cash dividends going forward?

[David Bandele, CFO]

Do you want to take that?

[Jon Erik Engeset, CEO]

I think it's fair to say it's an objective for us target to be able to pay cash dividends. But honestly, we haven't discussed that in the Board yet. So now we made a significant dividend in kind. But really, we hope that we will be able to generate cash and that we can start bringing cash dividend payer. But exactly when that will happen and at what level remains to be discussed and clarified.

[Karen Romer, SVP Communications]

Excellent. David, what further margin improvement is expected after posting 11% for Hexagon Group and a 10% for Hexagon Agility, up from 4% in Q1.

[David Bandele, CFO]

More of the same pricing effects. But I think what we're trying to say is that the year-to-date margin will increase each quarter, we go through 2023. We did have a weak start to Q1, of course.

[Jon Erik Engeset, CEO]

But then reiterating that our target is 15%. We shouldn't expect to see that this year, but that's what we're really staring towards.

[David Bandele, CFO]

In 2025.

[Jon Erik Engeset, CEO]

In 2025.

[Karen Romer, SVP Communications]

Jon Erik, how do you envisage the cooperation with Hexagon Purus going forward?

[Jon Erik Engeset, CEO]

That's a very broad question, but I think I would point at 3 main areas. Innovation. So we should try to avoid to duplicate resources there. That's efficiency matter, but also we should organize ourselves such that if either side makes good innovations that can be applied on the other side, then we should share. So there are agreements in place to secure that.

Procurement. We think that there are strong reasons to cooperate there for key categories. But also on the market side, we will continue to approach the customers with an agnostic philosophy. So if we think that the right solution for a specific customer would be a battery electric truck or a fuel cell electric truck, we will bring in Purus to offer that. And we think Purus will do the same with R&D because we are convinced that it's not 1 technology that will decarbonize the transportation sector, but it is a combination and that we have the unique position of representing the 3 leading as of today.

[Karen Romer, SVP Communications]

Great. Another question from the online audience. Please quantify committed CapEx for -- I think it meant Q2 or second half in 2024.

[David Bandele, CFO]

We haven't guided that specifically. But I can imagine that the -- you'll see the cash CapEx in the appendix. I imagine the same level for second half as for first half.

[Karen Romer, SVP Communications]

Okay. Do we have any other questions from audience in-house? No. But I think that we've covered that that's come in. So thank you very much.

We look forward to seeing you next quarter, and have a great rest of the day.

[Jon Erik Engeset, CEO]

Thank you.