Hexagon Composites ASA

OSE:HEX

Earnings Call Transcript 2022-Q3

[Karen Romer, executive]

Good morning, and welcome to Hexagon Composites Q3 Results Presentation. Very happy to have you here. My name is Karen Romer, I'm the SVP of Communications for Hexagon. And joining me here in the auditorium in Oslo will be Jon Erik Engeset, our CEO; and David Bandele, our CFO, who will be presenting the results to you in a few moments.

I just want to point out that if you -- for our webcast audience, you are invited to submit questions throughout the presentation and then they will -- the questions will be taken at the end. And the same here, there will be a question-and-answer session for those in studio at the end of the presentation.

So without any further ado, I'll turn over the stage to Jon Erik.

[Jon Engeset, executive]

Thank you, Karen, and good morning, everyone. Q3 was another quarter of strong growth for the Hexagon Group, 42% year-over-year. However, it was also a quarter of continued challenges in our supply chain with high cost of production impacting our margins. We see particular growth momentum now in the infrastructure-related business with significant new orders for mobile pipeline, for renewable natural gas and hydrogen distribution systems and mobile refueling systems on the Hexagon Purus site . Also our smallest daughter, but very pretty and very smart, Hexagon Digital Wave, continues its strong growth in the quarter.

Hexagon remains about driving energy transformation and year-to-date, we have enabled the avoidance of 935,000 metric tonnes of CO2 equivalents. Financially, if you look at Hexagon, excluding Purus, we had a top line of NOK 1.080 billion, delivering an EBITDA of NOK 68 million. So that's up from NOK 848 million revenue last year and NOK 110 million in EBITDA. So that shows the impact of the supply chain challenges that I mentioned.

Hexagon Purus more than doubled its revenue from NOK 103 million last year to NOK 222 million, with an EBITDA of minus NOK 92 million, which is necessary to continue the scale-up of the organization and the ramp-up of the production system to meet the very strong growth expected in the near years.

So on a consolidated basis, top line of NOK 1,243,000,000 billion, up from NOK 875 million last year and an EBITDA consolidated of minus NOK 24 million. So the -- as you understand, operating conditions remain challenging and continued very high cost of raw materials and components and, at least, energy.

And on top of that, we experienced shortage delays that create considerable problems to run a smooth and lean operation. However, we are countering this with profitability measures, some of them implemented and take effect already from Q4. And we see the external side of this easing going into 2023. Some external reports indicate that the worst should behind us when we come into Q2 next year.

And that's important because we are going to grow this business strongly in the years ahead, encouraged by manufacturers, not least by the very strong governmental support from most important countries and regions in the world, not least from the European Commission and from the U.S. government.

In Europe, we, together with our friends in the European Biogas Association, we have formed what's called the Biomethane Industry Partnership with the European Commission. And the purpose of that is to establish the link between the REPowerEU program with its biomethane ambitions and the transportation sector. And also, we expect the commission early next year to propose the new heavy-duty emission regulations. And we are optimistic that, that regulation will focus on the well to wheel as opposed to the tailpipe emission. And that is very important because that will then favor RNG as the most environmentally friendly alternative fuel, short, medium and long-term.

And then on the U.S. side, the Inflation Reduction Act was signed into law on the 16th of August. Also very important, it will increase the incentives for RNG development. It will give more predictability and visibility and, at least, it will make RNG equally treated with other alternative fuels like batteries and hydrogen as examples.

And that will further stimulate the development of RNG. There is already a very strong activity in the area, especially in the U.S. So the mid graph here shows the growth of RNG resources over the last few years. And you see that there are a number of new projects under construction or at the planning stage, which will further double the sector in the near term. And we see energy majors having entered this space in earnest. For example, the BP transaction acquisition of Archaea Energy recently at a value of USD 4.1 billion. So it's becoming a big business in the U.S. and Europe is about to follow suit.

And that's very important for the transportation sector, obviously, because this energy will be made available not only to the transportation sector, but to the transportation sector as one of the hard to rebate industrial areas for decarbonization. Already in the U.S., 64% of natural gas for transportation is renewable and that has grown substantially over the last few years. And we expect that when we get the 2022 numbers, that percentage will have gone up even further.

Another very, very important development for us is the launch of Cummins 15-liter engine. The largest engine on the market today is the 12-liter engine, which is sufficient for medium long haul. But when you want to haul, for example, across the Rocky Mountains, that engine is simply not strong enough. That means that it's only 1/3 of the U.S. truck market, which has been addressable so far.

But with the 15-liter launch, for all practical purposes, the whole heavy-duty truck market is -- or will become addressable, representing more than 300,000 trucks per year on average. And this engine is the first, which is specifically made for natural gas and has superior fuel economy and efficiency. So this is a real game changer.

That said, we don't expect the whole market to adopt renewable natural gas, but we do expect a significant share, up from around 2% today to -- in our estimates, 10% to 15%. You will see that external analysts and some of our industry peers, they actually assume higher level. That's why we've included the high [ KSR ]. But we think it's prudent to assume that the industry will need some years in order to fully get prepared for this transition and to build out the supply chain.

But the infrastructure is already there. The technology is there. So this is not technology for the future. This is already a technology used, to a major extent, by leading transportation firms. So this is why we have indicated a doubling of revenue in the next 3 years in this business.

And we are very well-positioned to play a core role in this transition to RNG. First, on the mobile pipeline side, where we enable the transportation from stranded sources, very often in agricultural areas, removed from the fixed pipeline grids. Or as mobile refueling modules where we can supply directly to the fleets and then systems and technology to the fleets themselves. So excellent growth prospects for agility in the coming years.

Moving to our other businesses. Hexagon Digital Wave, acquired late 2018, had the revenue of $2 million to $3 million. We have invested in the organization and fully commercialized the technology now and we are at the early stage of strong growth in this business. It is complementary to the hardware business that we run through Hexagon Agility and Hexagon peers, enabling the customers to extend the life of the systems, improved safety, but also a lot of information that they currently cannot collect. And in sum, this will drive down the total cost of ownership for the fleets. So this is a differentiator and a business, which will be a core part or our development of our offering in the coming years.

Also for Hexagon Ragasco's growth, smart cylinders is very, very court. So we've talked about the development project. Now this project is ready for field testing, which will happen in 2023. And then we expect to launch it commercially latest in 2024.

Some good end user features, but more importantly, this will help the distribution companies to make their operations more efficient. And that, we think, will allow us to penetrate markets where we today are the niche player in a more comprehensive way.

And last but not least, Hexagon Purus, really on track to deliver on its very ambitious growth plans. So far this year, LTM revenues of NOK 850 million, a strong order book for next year, good line of sight for the following years. So we are on track to deliver NOK 4 billion to NOK 5 billion in this business in 2025 when we expect to be the year where we turn the corner from EBITDA negativity to starting delivering EBITDA in the whole business. Already in the distribution part of the business, we are now EBITDA-positive.

So with that, I invite David to talk more about the financials and the outlook.

[David Bandele, executive]

Thank you, Jon Erik. Beautiful autumnal colors there. So let's go straight into the highlights. Q3 2022. It's very much the same theme as the first half of the year, very strong top line performance, while Jon Erik covered the supply chain disruption and input price inflation continue to weigh on margins, particularly in the Hexagon Agility segment.

And leading off with Hexagon Agility, a very strong NOK 930 million in revenue for 25% revenue growth overall. In the heavy and medium-duty sector, that's where you have the low margins, and that's due to the fact that price rises due in 2023 are lagging the severe input cost increases. However, happy to see that there are higher margins now being achieved in mobile pipeline as higher prices now start kicking in for the second half of the year.

Hexagon Ragasco posted NOK 119 million in revenue for 38% revenue growth, so very good performance there. And of course, Ragasco even since 1st of April, have managed to contain the material price inflation with higher sales prices to customers very successfully. We still have high energy costs, though, particularly here in Norway, and they continue to temporarily ray down on margins.

For Digital Wave, as Jon Erik mentioned, fantastic momentum continues, NOK 30 million in revenues for 58% revenue growth, this time driven mostly by the module acoustic technology services revenue streams and also with those volumes, a positive EBITDA.

And for Purus, our publicly listed subsidiary. As Jon Erik Engeset covered doubling revenue with 2022 guidance on track. And our ownership piece, remember is currently valued at NOK 3.9 billion. So on the revenue for Hexagon, excluding Purus, that was NOK 1,080 million versus NOK 848 million same period last year.

And if we look at the EBITDA, you can see that from last year, we delivered 13% margin. And this year, it's 6%. So 7 percentage points down year-over-year. And the main factors are: one, we don't have the same productivity through our factories, particularly in the U.S. with these disruptions; two, there's actually some negative mix year-over-year. We've done a higher proportion of medium-duty trucks where we have less content than the heavy duty. So you can read that as less margins. But the big one is the input cost price inflation, which currently is not covered by the sales prices.

And when you look at that bar to the right, what we've tried to do is keep the mix of sales that we achieved in Q3 '22, but attached the price increases that have been agreed with customers that kick in, in 2023. And when we adjust for that, we can see that there is a significant increase in margins of 4 percentage points.

And digging further into Agility we see that 25% revenue growth year-over-year to NOK 930 million. Again, strong medium- and heavy-duty truck markets and also mobile pipeline. And then the EBITDA, you can see the spread between this year and last year, 5 percentage margin points versus the 13, has also widened as the issues are contained mainly to Agility.

And that margin pressure, just to dig a little bit deeper into it is elevated carbon fiber prices. So while some components prices might be leveling off, of course, prices to us are still stable, but carbon fiber has increased and will continue to increase also in Q4.

We talked about the industry-wide disruptions and suboptimal efficiency. But also, let's not forget that the light-duty vehicle volumes are still very low and negative year-over-year given the situation with Volkswagen there.

So when we look at the revenue strip -- revenue split, sorry, 40%, so very strong truck. That's the theme for the whole of the year. But happy to see transit bus increase to 17% of share and also refuse truck, healthy and increasing to 13% of the share, whereas mobile pipeline continues to be very strong at 22%. The rest of the 7% is actually mainly cylinder sales to Hexagon Purus. We saw that marvelous growth there, particularly in the distribution modules and Agility currently contract manufacturers cylinders for Purus there, and that's the majority of the 7%.

So what we try to show is that we have very diversified revenue streams within Hexagon Agility supporting the critical infrastructure and also decarbonization targets of municipalities and commercial fleets in North America and Europe.

So Ragasco, Q3 is a seasonally low quarter for volumes. We come off the heavy push for the summer season in the first half of the year for barbecue and leisure activities. We also have manufacturing shutdowns, so a significant manufacturing shutdown in the summer period, but very pleased with the growth there year-over-year of NOK 119 million versus NOK 86 million in revenues. And Ragasco continues to really develop more and more markets. They started small but they grow over time. And we had additional sales into Middle East and African markets, in particular, adding to the volume growth. And I think Ragasco are now at over 100 countries sold. So great stuff there.

Positive margin development year-over-year is good to see. So recording a 7% margin versus the 5% same quarter last year. So we've got better scale from the volumes, while, again, the prices offset the material cost increases. The delta that we're absorbing on energy cost for the quarter, higher energy cost is around about NOK 4 million year-over-year.

So Ragasco continues to be a very resilient business with multiple introductory and repeat emerging market orders, in addition to their core customer base. For Digital Wave, momentum continues. So highest quarter of the year, NOK 30 million versus the NOK 19 million, same period last year for 58% and profitable revenue growth as we see a slight positive EBITDA margin as well. It's been a healthy mix of product and business services products in the ultrasonic examination. These are machines that our large customers using their factories usually to test metal-based cylinders.

And on the services side, we see this increasingly adoption of inspection and requalification activities. In culminating also just recently, Hexagon Digital Wave announced a $2 million order with a long-term key customer in the mobile pipeline applications.

So as we go into the group, we have covered the left-hand side, the Hexagon, excluding Purus results. Purus recorded NOK 222 million in revenues and minus NOK 92 million and a cost of growth and EBITDA. And of course, as Jon Erik has pointed out, when you screen as at group level, you will see then a slight negative EBITDA with Purus dilution over the composite cash-generating businesses.

But as we summarize Q3, we have strong demand, Hexagon Agility, seasonally low volumes for Hexagon Ragasco but with profitable growth, strong momentum for Hexagon Digital Wave and Purus remains on track for its growth targets.

Balance sheet. Not a lot happened except currency movements. They've been quite severe quarter-over-quarter so versus last quarter. So most of that rise in the assets and liabilities to do with the relative weighting of NOK versus U.S. dollar. So U.S. dollar is appreciated. But otherwise, we closed the group with NOK 700 million in cash on the balance sheet and equity ratio of 46%.

And when we look at our leverage, this looks at the Hexagon, excluding Purus, on the bottom. Recall in Q1, we had a large participation in Purus capital raise, which temporarily then lifted leverage, but we have stabilized that leverage over these quarters. And as we end Q3 2022, we have committed financing facilities over NOK 2 billion and available liquidity then of NOK 600 million going into the next quarter.

And on the full year guidance, should be no surprises here. We did have a trading update on 14th October, and what that update covered is, first and foremost, the reason for it, you can say that profitability forecasting at the moment is extremely challenging because of this disruptive and inflationary environment. So trying to predict how our costs move through the P&L from inventory is very challenging in this environment.

Saying that, we don't see any issues on our revenue. So those -- there was no re-guidance on revenues. However, on the EBITDA, we reguided to NOK 325 million approximately. Again, it's challenging to give an exact figure, but that's a midpoint of a range of, we would say, plus or minus, 5%.

And some of the factors that affect getting a more positive result will be those profitability initiatives and how good they can be or what sort of return we can get in Q4. And at the same time, we can hope for some easing of the supply chains, but there can also be surprises. So we continue to manage that situation very tightly.

And on that note, I'll give it back to Jon Erik.

[Jon Engeset, executive]

Thank you, David. So in summary then, healthy demand, very strong growth, continued challenging operating conditions impacting our profitability, unfortunately, but strong long-term drivers in the form of government commitments, regulatory support, primarily for us in the U.S. and in Europe, but also in other regions. So we remain confident in our 2025 revenue targets of NOK 6 billion for the Hexagon business excluding Purus, and the Purus business at NOK 4 billion to NOK 5 billion as we have communicated in the several previous quarters.

So with that, I think we are open for some questions.

[Karen Romer, executive]

So we have a few questions that come in from the webcast. But is there anybody. Yes, we have 1 here in the audience. Elena will bring you a microphone.

[Hans-Erik Jacobsen, analyst]

Hans-Erik Jacobsen, Nordea. On the ongoing logistical issues, are you in any way able to offset that in any way, anything you can do in order to improve the situation or is it entirely up to your sub-suppliers?

[Jon Engeset, executive]

There are always things we can do, and we certainly work on that and developing new suppliers. Of course, that takes a bit of time. But I think what has surprised us and I think a lot of other industry players, it's not only the main categories. It's little nuts and bolts, components, replacement from machinery, small components in our systems that have been considered marginal.

But of course, enough to cause delays in deliveries, et cetera. So I think we and most other industry -- companies will need to rethink the whole supply chain, become less dependent on deliveries from far away suppliers, potentially buffering more safety inventories, that sort of thing. And we are in the midst of all of that, but we keep getting new surprises. So as David pointed out, it is a bit unpredictable, unfortunately.

[Karen Romer, executive]

Do we have any other questions here in the audience? So I'll take a webcast question. "David, do you see any upside potential for 2022?"

[David Bandele, executive]

As I mentioned, I think the key one -- I mean one is we can control, you can say, are the profitability initiatives. So there is upside potential there.

[Karen Romer, executive]

Okay. Jon Erik, "How elastic is the demand for your overall portfolio in a recession scenario?"

[Jon Engeset, executive]

So the scenario which we are potentially facing now is, of course, to a major extent, driven by the energy crisis in Europe and that actually will stimulate demand for our solutions. So that part, I think, is elastic for us, but in a positive way. Then, on the other hand, with very high energy prices, we should expect the transit bus demand in Europe to suffer. And also, we've seen in previous recessions that the overall truck demand is among the markets that indicate a downturn early, and we should also be prepared for that in our business.

[Karen Romer, executive]

Okay. On the mobile pipeline front, Jon Erik, "You just announced an order for mobile pipeline. What do you see is the overall potential for Mobile Pipeline in Europe?"

[Jon Engeset, executive]

So 5, 6 years ago, we had steady sales of mobile pipelines in euros -- Europe. We call it the X-STORE, it's the brand of the module that we sell here. In recent years, we've had very, very little sales. Now we have inquiries every day. We have then a challenge because we are maxed out capacity-wise. So we're now considering various ways of ramping up the systems assembly capacity soon enough in order to service this market.

So with a bit of time, we will, of course, solve it, but we are looking for solutions to be able to deliver to our customers also in the short term. And we see the same on the hydrogen side. We are sold out for hydrogen distribution modules for the full year of 2023 and that is coming out of the facility that we acquired in Germany, the Wystrach acquisition that we made around a year ago in that part of our business.

[Karen Romer, executive]

Okay. Moving on to Hexagon Purus. "Do you plan to reduce your stake in Hexagon Purus? And if yes, do you plan to stay above 50% in the long run? Or could you go lower?"

[Jon Engeset, executive]

So I think we've been consistent on this particular question since we launched Purus on -- Euronext -- EuroGrowth in December 2020 that we see our ownership being diluted over time. And also, we want to retain a significant stake in the company, but not necessarily a majority. And obviously, we see some advantages of being able to deconsolidate Purus from the profitable sections of our portfolio because it's a complicated message to explain that we have these 3 business areas that are profit-making. And then we have Hexagon Purus, which is at an earlier stage of maturity. But we want to do it in the most value-creative way and make sure that Purus is set up for success as we then probably will reduce our relative ownership over time.

[Karen Romer, executive]

Okay. How are we doing on questions in this audience? Okay. I think this is for you, David. "Good morning. Measured on a 9-month results, on 9-month results, your gross margin is 7% points lower in 2022 versus '21. How big are the price increases you have implemented? For example, will they make the gross margin improve 7% points in second half 2023?"

[David Bandele, executive]

Yes. I think I'm trying to explain that it's not just the material cost impact to margins, and we looked at the EBITDA margin effect earlier. Looking at Q3 in isolation, that clearly shows that we can return to reasonable double-digit margins with the price increases. But then what about the productivity? And that's something that we've suffered year-over-year as a secondary effect of these disruptions. So yes, we will be looking at getting back to normalize the margins as we get through this quite exceptional period.

[Karen Romer, executive]

Okay. Looking a little farther ahead. "In light of your claims of high growth in 2024 and your revenue target of NOK 5 billion to NOK 6 billion in '25 billion. What is the associated EBITDA to that revenue target?"

[David Bandele, executive]

We haven't guided on EBITDA for the 5-year picture even from the start. And of course, in this environment, it's difficult enough guiding for EBITDA as you've seen just for full year '22.

[Karen Romer, executive]

And the continuation of that...

[David Bandele, executive]

But I will say that, at the same time, we started that guidance, which was January 2021 at the Capital Markets Day, we hold by it. We also said there are 3 basic financial requirements in Hexagon, excluding Purus, one is 15% growth annualized that will achieve that doubling of revenues. The other one is that we're still holding to chasing 15% EBITDA margin. We're still behind on that, but we closed 2021 at 12%. And we expect then with this 15-liter engine, you will see the volume inflection, particularly from 2024. And then the third financial item was the steady state, 3x leverage, which, of course, will come easily as profits increase with those volumes.

[Karen Romer, executive]

Okay. And continuing related to that, "Where do you see the growth coming from?"" Yes.

[David Bandele, executive]

That 15-liter engine is a key one. So obviously, today, the automotive business is -- in total is about 60% of our revenues. And when you think that the addressable market is going to triple from that point in time, it's kind of gets me happy. So yes, go ahead, Jon Erik.

[Jon Engeset, executive]

No, I just want to say, but in addition to that, we also now see much stronger growth potential for distribution and infrastructure-related solutions as a consequence of the energy situation in Europe and elsewhere in the world. So that is on top of the expected growth in the trucking volumes.

[Karen Romer, executive]

Another question, I think, for you, David, "Could you elaborate a little on the positive EBITDA effect from corporate eliminations?"

[David Bandele, executive]

That's technical, so I can take that offline, but it's, of course, when the results get worse, the LTIPs are accounted for in Central. So there are associated credits against that with the worst performance. But also, Jon Erik alluded to mobile pipeline that generates a royalty back to the center. And of course, sales have been very large there and of course, more credits in the corporate functions. But I can go into more detail later.

[Karen Romer, executive]

And then we also have a question referring to your chart on RNG infrastructure and what you provide there, how much of that infrastructure is common to hydrogen and will be used if and when green hydrogen is available, and then has a PS. Can the 15-liter Cummins engine also be used for hydrogen combustion engine?

[Jon Engeset, executive]

Good questions. So to take the last question first. So Cummins has actually prepared the same block and essentially the same engine for hydrogen combustion purpose. So it will be interesting to see if that demand will develop. And to the first question. So in principle, the hydrogen distribution modules are mobile pipeline modules for hydrogen. So it's the same concept.

You stack cylinders, high-pressure cylinders inside a container. You add to that all the piping and the valves and the steering systems and you have a very, very efficient solution for transportation of gas under pressure from the source to the users.

The demand is a little bit different on the 2 sides for RNG. It is from stranded resources to often, the grid, while for now in most areas, there is no grid for hydrogen. So on the hydrogen side, it is for now the solution to transport from production. For example, at the windmill farm to the users.

[Karen Romer, executive]

Very good. I do not have any further questions from the web audience. Is there anything in the room? No. But then I think we have concluded the results presentation for Q3. Thank you very much.

[Jon Engeset, executive]

Thank you.