Kitron ASA

OSE:KIT

Earnings Call Analysis

Earnings Call Transcript 2023-Q3

[Lars Nilsson, executive]

Good morning, everyone, and welcome to Kitron's Third Quarter Report 2023. I'm Peter Nelson, CEO of the Kitron Group. And joining me as usual is Ms. Cathrin Nylander, CFO. Following today's brief presentation, we'll hold the Q&A. So please post any questions you may have in the Q&A section of the webcast. Thank you. Next slide, please, Slide 2.

So let's take a look at some highlights. I'm excited to present our achievements for the third quarter of 2023. Despite the normal third quarter challenges, we've had an excellent quarter with significant growth in many areas of the business. We achieved a record third quarter revenue of over EUR 179 million in sales. That's an 8% growth over last year. Our operating margin measured as EBIT for this quarter stands at EUR 16.2 million, marking a 41% increase over last year. The EBIT margin of over 9% in the third quarter is indicative of the operational efficiencies we've achieved. Return on operating capital is now 23.2%, up from the 19.8% last year. Many, many financial metrics have improved further strengthening our financial position and Cathrin will come back to those numbers later.

In summary, Q3 2023 has yielded some noteworthy results showing the effectiveness of our efforts. Next slide, please, Slide 3.

So let's take a look at the year-to-date values. Building on a strong first quarter and an even stronger second quarter, Q3 continues the momentum. Year-to-date, we've generated a revenue of EUR 576 million, a 23.5% increase over previous EUR 466 million. Our EBIT has grown substantially, reaching almost EUR 53 million, close to 80% up from earlier EUR 29 million. We now have 4 consecutive quarters with operating margins exceeding 9%. The net income stands at EUR 38.7 million, more than doubled compared to last year, and the cash flow year-to-date is EUR 24.4 million, more than tripling last year's cash flow. We've invested EUR 8.4 million in manufacturing equipment upgrades and capabilities, up from the EUR 5.6 million last year. It's evidence from these metrics that our initiatives are bearing fruit and we're committed to ensuring that this momentum persists.

Now let's take a look at some of the business trends. Next slide, please, Slide 4. Starting with the sector trends. The highlight is the growth we're seeing in the electrification sector. Energy grid and energy storage solutions are growth areas. This aligns with the global trend towards robust and resilient energy grids in 2023 and bullish on the outlook for the coming years. A significant trend in the other quarters is the uncertainties our customers see in the economic outlook. Customers are addressing market uncertainties by optimizing inventory levels and forecasting practices. While this poses challenges in the terms of visibility, it also underscores the need for agile solutions and flexible manufacturing models.

Let's move on to some regional trends. Geographically, the Nordics, U.S. and Central Eastern Europe continue to be our strongholds. The upward trajectory is buoyed by defense contracts, electrification projects and the introduction of new business. This speaks volumes about the strategic importance of these regions and our firm foothold in them.

The business landscape in China is evolving. While the region holds immense potential, the prevailing realignment trends are redirecting China for export volumes elsewhere. We remain vigilant and adaptable, ensuring that we capture emerging opportunities in the China for China business and transfer business out of China.

Western Europe is seeing some interesting changes. The rising operational costs are nudging businesses to explore cost-effective alternatives. And we're witnessing an increased inclination towards our facilities in Poland, Lithuania and Czech. A steady flow of new customers are inviting us to discuss production transfers, and this validates our strategic investments in these regions and furthers our commitment to providing efficient, value-driven solutions.

In sum, these trends shape our approach and strategy, and we're not just reacting to them. We're proactively positioning ourselves to harness their potential.

Next slide, Slide 5, please. So let's take a look at our order backlog. And our order backlog shows an expansion with electrification and defense leading the way. Their robust performance emphasizes the strategic alignment of our business operations with sectors that are currently experiencing a surge in demand. Some customers across other sectors see a softer market for 1 or 2 quarters. And by reducing stock levels and employing shorter lead times, they're standardizing their forecast durations to less than 4 to 6 months.

While this may present the challenge in terms of visibility, it also provides us with insights into market dynamics and customer behavior.

Sitting at EUR 502 million, our order backlog reflects an increase of close to 10% compared to last year. This growth, even in the face of dynamic market conditions is a testament to our diverse market sectors and rapid introduction of new customers and products. There's also a seasonal influence on the order backlog, especially during the third quarter. We see a 6% contraction in the order backlog as we transition from Q2 to Q3, which is a pattern we've observed historically as well. This cyclical trend aligns with the broader industry norms and reflects the inherent and flow of order placements. In our view, our order backlog faces a picture of growth with certain sectors leading the charge.

Next slide, please, Slide 6. So let's expand our outlook with the R12 and R6. These are essential metrics that we use on a weekly basis, providing insights into our forward demand for the 12-month and 6-month horizon, respectively. Historically, they have been indicative of our sales prospects in subsequent 5 to 6 months for R6 and 9 to 12 months in R12. For the defense sector, the outlook is particularly promising with a significant outlook. We're seeing a trend of customers wanting to expedite orders. The demand for electrification solutions, specifically critical infrastructure continues to grow. In other sectors, the defensive measurement measures are evident with frequent changes to demand and the prevailing trend for shorter lead time, which further decreases visibility into forward demand. Reducing stock level outlook is a common action taken.

Overall, in the R12, we see a 5% year-on-year growth with a demand of EUR 745 million from the previous EUR 700 million. However, sequential contraction is evident from the EUR 812 million in the second quarter of 2023, and we see this primarily as reduced lead times and burning off excess inventories.

On the R6, notably, there's a 10% year-on-year growth. The R6 metrics, actually, it's more than 10%, now when I look at the numbers. The R6 metric remains particularly relevant because it also has -- it looks at more at the shortened demand horizon that we're observing from customers. And the uplift is to EUR 426 million on R6, a considerable leap from EUR 333 million we had last year.

So in wrapping up both the R12 and the R6 figures offer valuable insights to our sales trajectory. These metrics underscore the importance of staying attuned to market dynamics being proactive in our strategies and remaining adaptable to the changing demands of our customers. Our forward-looking approach ensures that we're well positioned to meet these challenges and opportunities that lie ahead.

I'll be back in a little bit to discuss the outlook and key takeaways. But for now, Cathrin will review some details behind the numbers.

Cathrin, please. The next slide, Slide 7.

[Cathrin Nylander, executive]

Thanks, Peter. Currency and growth. First, I would like to present some comparative numbers for clarification as of this year change from NOK to euro as presentation currency. The presentation currency change will take out variations in translation differences in consolidation, not underlying currency risk as such in each of the sites. So the waterfall show growth on top in Europe below in NOK. To the left is the quarterly growth and to the right, the year-to-date values.

For Q3, underlying growth is just about 14% in both currencies, and in euro, a negative currency impact of 6% and in NOK, a positive effect of 8%. As year-to-date values to the right, underlying growth, 29% in both currencies, negative 6% in euro and a positive 11% in NOK. In general, the total euro growth rate is trending down from very strong percentages to the strategic growth rate of around 10%.

Next slide, Slide 8, please. Business sectors. Large growth volumes overall continue to create economy of scale in CEE and Nordics, whereas we have volume reduction in China as markets sort from China show less demand. That said, all sites are profitable and all had strong margins also in Q3. So the Nordics, Norway, Sweden and Denmark, revenue growth of 14% and a growth in profit of 27%, EBIT margin at 8.5% for the quarter. CEE being Lithuania, Poland and Czech, revenue growth of 35% and profit growth of 100%, EBIT margin at 9.7%. The Rest of the World, mainly our 2 facilities in China and the 1 in the U.S. as a revenue decline of about 26%, but the profit improvement still of 12%. U.S. is no longer loss-making and has shown improved stable results all this year.

In total, EBIT margin at 9%, slightly down from the 9.3% last quarter and a strong improvement from last year's 6.9% when material allocation limited output. As for the employees in total, 3,069, a growth of 10% from last year and actually a reduction of 6% from last quarter, partially a reduction of temporary staff during the summer, but also a general alignment in China that has taken place.

Next slide, please, Slide 6 (sic) [ Slide 9 ]. Cash flow and net working capital. Operating cash flow ended at a positive EUR 5 million compared to EUR 9 million last quarter and EUR 14.6 million same quarter last year. Net working capital increase was some EUR 11 million in the quarter, mainly due to a reduction in trade payables. Net working capital is at EUR 200 million, and the growth from last year with around 20% following the year-to-date growth of around 20% as well or '23.

Next slide, please, Slide 10. Capital efficiency ratios are stabilized, usually third quarter effect and efficiency ratios as revenue normally slightly lower, although the balance sheet does not change fast enough, which is the effect we see also now in Q3. So the net working capital in percentage of sales is 26.7%, in line with last year's 25.8%, but up from 22.3% last quarter, ROOC at 22.3%, up from last year's 19.8% and at the strategic level of 20% to 25%. The strong ROOC continues to be driven by the strong profitability.

CCC is at 103 and at the same level as last year. Net interest-bearing debt over EBITDA decreased slightly from last quarter's EUR 1.8 million to EUR 1.7 million. The net debt ended at EUR 141.6 million, a reduction of 10% from last year and at the same levels as last quarter's outcome.

On that note, we were currently funded at 6% interest rate. Interest cost in the quarter is around EUR 2 million compared to EUR 1.4 million last year. [indiscernible] loans affects the finance net negative with EUR 1.4 million in the quarter where it was a positive EUR 0.4 million last year. Tax rates year-to-date at 19%, a little higher than last quarter -- in this quarter based on the regional income mix. So net income is affected by this by the higher interest cost and [indiscernible] in the quarter. Equity as a percentage at 28.6%, an increase from 27% last quarter, giving a return on equity of 23.8%. And earnings per share, finally, then EUR 0.045, and an increase of 29% compared to last year.

And next slide, Slide 11, please hand over to you again, Peter.

[Lars Nilsson, executive]

Thank you, Cathrin. So let's move on to the outlook for the full year 2023. Well, when we look at our bookings and we look at what we're running at our sites, we see that demand continues to support the current revenue and profit outlook. So our outlook is we expect revenues between EUR 750 million and EUR 800 million with an operating profit or EBIT between EUR 65 million and EUR 75 million.

Next slide, please. The key takeaways. So really there are 4 bullets to think about from this quarter. We expect the growth to continue in the Nordics, U.S. CEE fueled by defense, critical infrastructure and electrification, regional initiatives and the launch of new programs. A slowdown in the growth rates of certain customers in industry and connectivity due to destocking and some macro challenges.

Regionalization is accelerating. On a global level, China for China strategies are becoming clear as well as the Nordics versus CEE benefits. This means that there are a lot of moving parts and many opportunities to capture new business and Kitron is well positioned to succeed in this environment.

Now let's move on to the Q&A. So next slide, please. Again, I'd like to remind you that we'll shortly start the Q&A. So please post any questions you may have in the Q&A section of the webcast. Thank you. While, we wait for some questions here to come in. Cathrin, what's the discussion point for this meeting?

[Cathrin Nylander, executive]

We have introduced yet another metric now, Peter, the R6. Previously, we only talked about R12 and order backlog. So why don't you elaborate a little bit why we introduced R6 again?

[Lars Nilsson, executive]

We've been talking some about destocking and some defensive measures from customers and as they shorten their lead time horizon and their own outlook on what the market is doing. I think there's a lot of uncertainty. So customers are derisking this by waiting as long as possible before placing an order and even placing a forecast since there's a lot of liability on the customer on the forecast. So they can drop in orders on a very short lead time because they know that maybe there is some extra inventory with Kitron, and they can just place an order in 3 weeks or so. So as we see that dynamic, and this is far from the entire customer mass we have, but there are some customers that are more sensitive to the marketplace they're in. As we see that it's important for us to understand what's happening in the next 3 months and what's happening in the 3 months after that. And usually, right, usually, when we budget to look at what does the demand look like on a longer-term basis, we're pretty happy when we have -- for the current quarter, we're booked to 105%, 110% then we feel pretty secure for current quarter. And for the quarter after that, we'd like to see bookings around 100% to 105% and then 90% and then 80%, 70% and then 60%. So with that horizon and that sort of level of booking when the horizon drops, it becomes -- the R12 becomes irrelevant, right? If you're looking at R12 and thinking that's what Kitron is going to be doing for 1 year or for the next rolling 12 months, then you're wrong, right, because of that change of behavior. But the R6 still is -- it's a good indication of what's going to be -- what the sales is going to be for the next 5 to 6 months, something like that. Not everything is even in that then in addition, there's service sales that we have also, there's no forecast from customers on that all project based. So -- that's why we introduced this to all of you, share with our investors about the security that we're feeling when we look at, at least the near term in the coming 6 months.

[Cathrin Nylander, executive]

Yes.

[Lars Nilsson, executive]

Okay, let's move on to some questions. And the first 1 is from [indiscernible]. And this address to you, Cathrin. How is Kitron's loan structure? Are the financial costs going to rise even more from here? Or is the Q3 a reasonable level going forward if interest rates do not rise anymore?

[Cathrin Nylander, executive]

I will say so. We have now -- we believe that the net interest-bearing debt will change rapidly. And I think it will stay basically the same. And as we're paying, as I said, about 6% now, any changes to that will have to be an interest rate change from the Central Bank, that is determining the level of the interest cost that we have.

That said, in this quarter, we have a revaluation of a loan between Polish zloty and the Europe locally that affects the quarterly finance net, which is a reversal of partly a positive argue, another quarter. So totally, the [indiscernible] is rather not so big, but it looks very large in the quarter. So this is nonrealized changes to our income statement, and it might reverse in the next quarter again. So.

[Lars Nilsson, executive]

That is the debt level rising or decreasing?

[Cathrin Nylander, executive]

No, it's been -- the debt level as such, has been pretty stable the last 3 quarters, I would say. The metric that we have net interest-bearing debt or EBITDA is slightly improving. It improved from 1.0 to 1.0 points about this quarter due to the improved profitability compared to last year. So I think it's pretty stable in that sense. It's [indiscernible] that's creating the havoc as such.

[Lars Nilsson, executive]

And Marcus also as a follow-on question. How do you view Kitron's current margins since they are higher than your targets?

Well, number one, I like it, right? And the follow-on question there, are they sustainable? I mean yes, they are sustainable. If we're in this sort of current level of utilization of our factories. And even surprisingly enough, right, we had a contraction in our China business and our 2 sites in China right?

And Cathrin, what happened to profitability compared to last year?

[Cathrin Nylander, executive]

I think increased.

[Lars Nilsson, executive]

Substantially, right? So I mean it's like -- look, what's going on? How are they being so efficient? And continued efficiency improvements, continued investments in modern equipment, modern processes. We'll continue to build efficiency even if, god forbid, volumes don't increase and remain the same. We expect to see continued efficiency improvements, and we want to stay above 9%.

Let's move on to [indiscernible]. Considering these recently announced in the last few days, economic stimulus packets, the need to rebuild enormous infrastructure destroyed in last year's floods, would this be considered as something Kitron could benefit from perhaps sooner than expected prior to these announcements?

But that all depends on -- we do not have a lot of production for local Chinese companies. We work with big Western companies, Sweden, Norway, Denmark, Finland, Germany, the United States that have operations in the U.S., and we serve those -- have operations in China. And we serve those China operations with local manufacturing since we're a known entity to these customers. So if they win new business, right, if they're going to rebuild electric grids, for example, that would put even more demand on to our customers and even more demand into our production of those types of products. So -- but so far, it's too soon to say if any of that is happening. We're not seeing -- I mean the announcement was just done here pretty recently. And probably going to take the next 3 to 6 months seeing if something happens on that.

How is the customer mix from [indiscernible] -- how is the customer mix, how much of the revenue does the largest customers stand for?

I mean here, it's pretty much unchanged. The top 3 or 4 compete out of being #1 they're between 5% and 7% of our revenue, the top 3 or 4 or 5 customers. Some of them -- 1 of those has a little bit more of a destocking going on, but the others are continuing to show growth.

Then Sandro has a follow-up question, are any of our loans on fixed rates?

[Cathrin Nylander, executive]

No, they are not. They are all surcharge based.

[Lars Nilsson, executive]

And [indiscernible] continues with the question. Do you think your long-term goal of 10% annual growth is at risk due to shorter lead times and changing market environment?

I think our goal remains the same, 10%, even though we've grown faster in the past 18 months or so. Our goal of 10% growth remains the same. We're not going to discuss our outlook or plans and targets for the coming years in this meeting, but we hope to see you at the Capital Markets Day in the beginning of December, where we'll take a look at what's going to happen next year. But I'd be surprised if we don't have growth next year. So we'll come back to that I think, 10%, 5% growth driven by the successful customers you have even in a tough environment and another 5% by adding new business, new programs and new customers is sort of a likely scenario. But we'll come back to that. I'm not going to go into it any further than that.

[indiscernible] looking at your R12 and R6 backlog, we can calculate the 6-month backlog for Q2 and Q3 '24 for EUR 745 million, minus EUR 426 million is EUR 319 million, that would decline -- that would imply a decrease of 17% versus reported revenues of Q2 and Q3.

Yes, if we say that nothing more is going to come in. But I just also explained here that usually for the coming 3 months, we have over 100% of our demand secured and forecast or orders fly a little bit less maybe in the following quarter, but say, 100% there, too. And then it drops to 90%, and then it drops off to 70% and 60% and subsequent quarters. And if you look even further, it's going to drop down to maybe 20%. So -- and 20% would be the demand for Q1 '25, right? If you look at right now, it's booked. So we don't expect a sharp decline in revenues from Q2 onwards. That's why we're showing the R6, right? We're going to show the R6 in the next meeting and the meeting beyond that. And we're going to hope that there are about EUR 400 million and climbing, confirming the trend and the indications we have now of growth. I hope that's clear.

Then from [indiscernible], could you give some guidance on your hedging policy in relation to interest in foreign currency?

[Cathrin Nylander, executive]

When it comes to foreign currency, in general, we have a natural hedge comes to the income statement or the balance sheet, trade receivables, trade payables, et cetera, that means that we make sure that the balance sheet is balanced in all the currencies so that there is no revaluation. And that's what you see under -- the result of that is what you see under other gains and losses. So the revaluation that you see the effect of now is a loan between euro and Polish zloty that has a revaluation, which is not secured and we'll probably reevaluate it again. So in general, for those loans, we don't have a security.

[Lars Nilsson, executive]

And that's so far what we received in questions. I think we'll just hang on for another 15 seconds or so to see if anything further drops in. Usually after every time we sign off in the previous meetings, there have been 3 or 4 questions that soon come in there at the end. But then we're already going. So. Okay. I think that wraps it up for us and hopefully, we'll meet you -- meet the investment community in some of our meetings going on here throughout the quarter, definitely on the Capital Markets Day in December. So we'll see you then and talk to you then. Thank you.

[Cathrin Nylander, executive]

Thank you.