Tomra Systems ASA

OSE:TOM

Earnings Call Transcript 2018-Q3

[Espen Gundersen, Deputy CEO & CFO]

Okay. Let's get started. Thank you to everyone. Before you -- joining us here live here in Asker -- in Oslo, actually, or dialing in listening at the webcast. This is the Third Quarter Presentation for TOMRA. My name is Espen Gundersen. I'm the CFO. Together with me, I have Elisabet Sandnes and all of the staff today; and [ Bing Tsao ], which is our Investor Officer. Stefan Ranstrand is unfortunately traveling, joining the circular economy seminar summit in Japan and, consequently, not joining in on this presentation. So let's look at the figures. Strong quarter, best ever, NOK 2.247 million (sic) [ NOK 2,247 million ] of revenues, and this is actually 21% more than last year, some inflated by acquisitions and currency. But even if you take that out, the growth is 14%. So a pretty healthy top line mainly coming from sorting of 20% but definitely a contribution from collection also at 9%. The gross margin is also improving now at 44%. It's the highest we had in 6 years, actually, again, sorting, that's the contributor with significant improvement in margins, stable in collection.Operating expense is, however, also increasing. It's partly about higher activity. It's partly about the acquisition, partly about New South Wales and, in general, investments preparing for new markets opening up. But bottom line, still NOK 587 million, which is -- sorry, NOK 408 million, which is 35% up from last year. Decent cash flow of NOK 433 million, NOK 375 million in third quarter last year. Headlines in Collection. It's a stable business in the regular markets in Europe and North America, and the growth is mainly coming from Australia, New South Wales. And in sorting, we have a strong order intake, NOK 1.1 billion, 6% up organic and high order backlog of almost NOK 1.6 million (sic) [ NOK 1,600 million ].Take you to currencies. After several quarters with a headwind because of -- sorry, wrong way -- because of the somewhat weaker dollar, particularly measured against the euro, we now have the opposite effect where both the euro and the dollar is stronger than it was 1 year ago compared to Norwegian krone and, consequently, also a positive effect from this. We shall also see on the currency-adjusted figures where both top and bottom line has had some positive effect from currency in the quarter. In the year-to-date figures, we still see that the bottom line has a negative effect, particularly because the euro-dollar cross is hitting -- has been hitting sorting for the -- in the true first quarter of the year. But all in, in the quarter, top line is up 21% and 35% up on bottom line. And for the year, for the first 9 months, we are at 13% on top line and 16% on bottom line. Looking at balance sheet. Fixed assets or noncurrent assets is increasing. But measuring against what we had 12 months ago, the increase is entirely explained by New South Wales, which is tangible, the centers; and BBC, which is intangible, meaning, I mean, the goodwill. And taking those out, there's really no significant change, meaning all investment replacement happens more like -- much the depreciations. That's been booked during the period.Looking at the rest of the balance sheet. Working capital, defined as inventory plus receivable minus noninterest-bearing debt, has increased with 7%, and this is due to higher activity. As you know, top line has increased 21%. And consequently, 7% increase in working capital is, in our view, acceptable. So for this reason, you also see good cash flow in the quarter of NOK 433 million and up from last year and high compared to what we have had the last 10 years also. Solidity stayed strong with 50% equity. The gearing is rather low. It's going down from last quarter. Measured as interest-bearing debt on EBITDA. It's 0.8x, and it will probably go down also into fourth and first quarter because of limited investments in pipeline, save for some investment increase then, there's no significant -- in that respect. And for that reason, it's also assumed that the gearing will also decrease all the way up until May next year when we pay a dividend.Looking closer to Collection Solutions. 9% up on top line. The base business is flattish, stable. And this is the nature of the business we are working in. If in the existing markets, if you go to a store, you set to find the machine in there. And if you establish a new store, as part of quarter-over-quarter, year-over-year, you will usually see the stability in the existing business, not the recurring revenue related to service and replacements from now and then. Not often big orders, but it's more one machine here, one machine there. So this quarter, it was somewhat down in Europe, mainly Germany. And it was some up in North America equals this out. The growth is consequently coming from New South Wales. Margin has been stable during the period, but we are investing, so the operating expenses is significantly up. It's partly about New South Wales, but it's also the new deposit markets that's -- are in pipeline, and we need to prepare for. So this is offsetting some of the positive effect from high volumes. So EBITA is close to unchanged NOK 244 million, up from NOK 236 million last year. As I said, New South Wales is kind of the new event the last year. It introduced deposit first of December in 2017. TOMRA together with Cleanaway bid for 7 zones, which was all the different zones that was set up in New South Wales, and we won all of them. And by this, we have the obligation to establish an infrastructure in New South Wales for collecting all the beverage containers in this state. And all the way from bid of the contract at the end of July last year until third quarter this year, we have been ramping up, but the ramp-up period is now concluded. So we now have a little more than 1,100 reverse vending machines in New South Wales placed at a little more than 300 centers, which on average close to 4 reverse vending machines on this automated -- per automated center.We have investing and losing money all the way up until first quarter -- third quarter. So this quarter, we are around breakeven. And going forward, we expect to make money in this market, particularly also because going into the businesses, which is also improving performance because drinking consumption is higher during their summer.The other event, so to say, this quarter has been Queensland. Queensland is the state that's north of New South Wales, where they also are about to introduce deposit. They have chosen a slightly different approach to this than New South Wales. In New South Wales, the EPA, Environmental Protection Agency, had a rather thorough process where we're involved in the setup, establishing targets focusing upon convenience. And in Queensland, it has been a process where much more responsibility has been placed upon the industry. So the beverage industry has established CoEx, which is the steel coordinator, and they have a large responsibility when it comes to establishing the system. And instead of operating network operators or establishing network operator infrastructure, we see that they have chosen to establish targeted contracts with different operators, being the container refund point operators or collection points as we call them in New South Wales, being the logistic providers and the processing providers. So there's been separate processes for this contract. So we have 1/10 contracts in -- mainly in Brisbane and the larger cities for operating depots where we collect reverse -- where we collect beverage containers inside centers, which is bigger than the automated centers we have in New South Wales. On average, there will be 10 reverse vending machines per center. So Cleanaway will also be present in Queensland, but -- and they have separate contracts on logistics and processing with CoEx, and we're not in a joint venture with them in that respect. The system will be live from 1st of November. Very round figures. We'll invest NOK 50 million in this state. And revenues, very round figures, we'll assume to be around NOK 50 million per year and fully operational.We have, of course, all the markets coming up also. And as I said in the bottom, TOMRA is a rather stable business in Collection, and what's really been driving growth is these new deposit markets. And we can never market TOMRA based upon this because we never know exactly which market will materialize, and it's a political process, and so we never know the outcome on this. But those 3 that are really worth mentioning now is the one on the screen here. Starting with Western Australia. This is a smaller project, 2.5 million citizens in Western Australia. They had the consultation period, which is ended in September. They are looking at both Queensland, New South Wales, to some extent, Europe, to decide what type of system they will go for. And this also a process now where we're not allowed to bid or participate in the setup of the scheme coordinator, which will be -- have a deadline in the mid- of December. So let's see what type of system they choose to go for. But TOMRA eventually will have a role, in that respect. But this is one of those several initiatives in Australia and, to some extent, all states and major territories in a process somewhere for establishing deposits. The second one is Scotland. It's double the size of Western Australia, a little more than 5 million citizens, very clear process. The consultation period ended the 25th of September. They have introduced 4 different solutions, which they now want to provide to get feedback on. Probably some kind of return to retail system but eventually have -- a return will happen inside the store or in the close proximity of the stores. And also, when it comes to financing model, will this be a regular sales service market as we know them from Europe historically? Or will it be more true pit markets like we have in New South Wales, remains to be seen. And the big one, of course, is England, and it's 10x bigger than Scotland and 20x bigger than Western Australia, 55 million citizens. Michael Gove has announced that this will happen. There is expected a consultation period to start very soon, and estimated startup is in beginning of 2021. Of course, we all know the Brexit negotiations and what impact this might have on the British initiatives. It's impossible for us to say. This seem to be a clear commitment, but we don't know more than you do when it comes to the political processes in England and what consequence eventually Brexit might have for this processes. So let's see. It seems to be a clear commitment among most of the countries in EU to implement this directive. There's some resistance and discussions from some of the Eastern European countries when it comes to ambition level. But in general, there seems to be a high support for the main target, which is to introduce a 90% target on beverage containers made of plastic by 2025. So the process from here is that it's currently being debated in the parliament. And after that, if approved, it will go to the council. And stakeholders has signaled that a conclusion before the next election in May 2019 is a clear target. so of course, if implemented the way it's drafted, it will be a positive for TOMRA not only for the Collection business but also for the Sorting business.Yes. So in summary, top line, driven by New South Wales, which is reported in the rest of the world and in North America. Margin, stable. Operating expenses up because of investment and a small increase on the EBITA line.Moving to Sorting Solutions. Again, good growth on top line. Even if you adjust for currencies and acquisitions, we have a 20% organic growth. BBC is included with the figures with NOK 93 million. If you want more details on BBC, you'll find it on the Appendix to the report -- the quarterly report, where we have included some information on that one. Gross margins are significantly up to now 46%. It's effect both coming from mix because of different products, different streams but also higher activity. In general, I could say the cost of goods sold in TOMRA both in Collection and Sorting are all fixed. But you see when you get significant higher revenues that we get some leverage effect also because some fixed cost components in the cost of goods sold, so that also has been a contributor in this quarter. So even though we have also been investing, employing people, being prepared in sorting and increasing OpEx for this reason, EBITA came in at 84 -- NOK 184 million compared to NOK 83 million last year. Order intake at NOK 1.1 billion, 6% up, organic, and order backlog close to NOK 1.6 billion, which is actually up 29% compared to same time last year.Some comments on the business streams. So let's say, the world TOMRA Sorting trends, the bulk sorting, which is -- comprises the business established based upon the Odenberg and BBC acquisitions. So this is everything from nuts to potatoes in size is sorted by -- on belts or threefold sorters. And then we have Compac, which is -- has the line sorters sorting mainly bigger objects, more fragile objects, one and one at a time, typically, apples, oranges, kiwis. And then we have BBC, which is the new acquisition, also including sorting but more the small objects like blueberries, to some extent, slightly down in the quarter, but it's up year-to-date. So it's a stable business overall. In Compac, we acquired this company 1st of February, 2017. It has been -- it was a distressed company when we bought it, but we were back in black last year, and the improvements are continuing. So this year, it's also reporting better profitability than last year. And BBC, as I said, looking at the figure -- look at the figures in Appendix, it's amazing start we have had with that company, and it's performing very well with good growth and very healthy margins, so it's a good contributor. In recycling, recycling is really the star among the business streams in -- for the time being. And regardless of what parameter we look at being -- revenues, order intake or the backlog, it's significantly improved. There's more than one reason for this. But to point out maybe the most important one is what's happening in China, the National Sword where now the quality requirements in China has increased significantly. Previously, it was 90%. Now it's 99.5%, meaning, it's only allowed 0.5 percentage point of a contamination in the waste being imported for China. And as a consequence of this, import of waste to China has almost disappeared. Each of the previous exporters has to deal with their own waste. Waste is piling up. There is a demand for recycling coming out of this. In addition, our combination with this, we also see the marine littering and the concern about all the waste indices. And the new plastic directive we talked about in EU is a direct consequence of this. And we see also other initiatives around the world coming out of this problem. And governments all around the world want to find solutions to deal with this challenge. And there's no one quick -- no quick fix. But what we can do is, going for deposit on beverage containers and this one also banned plastic bags. And we can focus upon plastic littering, trying to be more sustainable models, who are using the plastic held out there. And for this reason, we also see initiatives that benefits TOMRA recycling in TOMRA Sorting. And also, I think it's worth mentioning the focus upon larger corporation's initiatives when it comes to corporate social responsibility. A lot of what happened 10, 15 years ago was more greenwashing where really the focus was really not to increase recycling rates but to reinvest money into this is much higher. So I think a lot would also come as a consequence of these bigger companies' initiatives for creating sharper solutions, so reusing the plastic in a different way than done historically. So good development in recycling.Mining. A small unit, slightly below 10% of revenue today, of the total revenues within sorting. It was larger 5, 6 years ago but because of falling commodity prices, we have had low activity for 3, 4 years, still living on breakeven or a small plus coming from diamonds or diamond sorters. Now there is a significant uptick also in this segment, though from a low level. And it's also interesting to see that the demand is coming in several segments, not only the diamond segments but also, for instance, industrial minerals. So a positive development also in mining.So strong top line growth in regions. All major regions is contributing and has significant increase in revenues, improved margins. OpEx is increasing. But bottom line is, round figures, 100% up from last year.And the order situation is comfortable. Revenues, on the bottom left of the chart, is all-time high this quarter. Order intake is high. It's 3 consecutive quarters with the higher order intake now even if you take out inorganic effect from BBC. So despite a lot of orders being taken to them in -- to P&L, meaning a lot of revenue, the order intake has offset this and we end the quarter with a high order backlog almost in line with last quarter, which was all-time high. The estimated conversion ratio is 80%, meaning we assume that the revenues for fourth quarter will be around 80% of the order backlog we have at the beginning of the quarter. As already said, this is not guiding. This is just an indication for you that want to model TOMRA on a quarterly basis, and our best guess on how much of this that will be delivered the coming 3 months.Looking forward, starting with Collection Solutions. Also the coming quarters, it's fair to assume that the base business, again collection is stable, maybe slightly slower in Europe, offset by slightly more activity in U.S. But then you get the New South Wales effect, as I said, now going into fully operational mode. That infrastructure is in place going into the busy season will improve performance on top line and bottom line in collection. One side comment is also that the seasonality in collection probably will be less now because, as you may remember, we have the seasonality inventory recovery in U.S., which has their busy season during the second and third quarter in the summer there. Now getting New South Wales on the Southern Hemisphere, you'll have seasonality the other way around, so this offsets some of the swings that you've previously seen in the poor performance in TOMRA. But as said, New South Wales will contribute on top line, but at the same time, we will increase operating expenses. There will be a ramp-up in Queensland because they go live 1st of November during fourth quarter. And in general, we will invest in new markets preparing for new initiatives. In sorting, there is general good momentum, particularly in recycling. But overall and with the 80% indication on the conversion ratio, we implicit say that we will have a strong quarter coming up in sorting as well. Yes. Order in the currencies and the impact we have, today, it seems like the dollar is somewhat stronger and the euro is somewhat weaker than it was 1 year ago. So maybe, if it continues like that out the quarter, it will not be any significant impact from currencies because it's a wash, but that can, of course, change.One more slide. We had our Capital Markets Day in 15th of September. We think it was a success in respect that we managed to convey what we wanted to convey, partly focusing upon the environment TOMRA is operating on and how TOMRA will benefit from those drivers and monetize based upon the opportunities that's out there, how TOMRA has the right to participate and win in these markets. And then it was a little more than 100 participants physically in Asker and a little more than 400 looking in on the webcast. We also, as part of this, communicated new financial targets. I just want to very shortly repeat this, making sure that everyone has received them. Top line growth for the next 5-year period, we assume, should be at least 10% on average for the period. Knowing, of course, that, at least in connection, we are depending on political processes. But still, adding opportunities we have in pipeline, we think this is a fair commitment to make. Of course, each year will be different and maybe, particularly in the beginning, it will be harder to make this because there's today not an unknown significant deposit initiative that will triggers significant revenue in 2019. So that will maybe be a tougher year. But then '20, and particularly '21 could be upside down. On bottom line, on margin, we target at least 18%. We are not there today. And it will probably take some time to get there, so it's more on the end of the period. But in a normalized situation, we think this will be possible because we need to invest and increase OpEx today to meet opportunities that we assume will materialize later in the period. So -- but with the growth that we just again will generate, we assume that this is possible to achieve.Dividend. We have a long gearing today. We have a good cash flow, a stable cash flow. And we are consequently committed to continue to provide a decent return to our shareholders, 40% to 60% of earnings should be paid out as dividend. Capital structure. Some. Of the new initiatives will probably be capital intensive like New South Wales, so we need to invest. And we have a significant capability in the balance sheet we have today. But we are not willing to go above or below investment grade and defined industry will be minus in Standard & Poor's index. This will probably mean that we can go to 3x interest-bearing debt on EBITDA. The best time is 4x in the ramp-up periods but not over longer periods. So that's how we define investment capabilities. And rest assured that we will continue to focus upon return on capital employed. We have a very high return today, and we want to continue to have that going forward. So also going forward, we want to have at least 20% return on the capital employed, including also the new projects.So that concludes the presentation. We opening up for questions both from the audience and from the web.

[Elisabet V. Sandnes]

Okay, I think we start with a question from web. So we have one question from Glenn Kringhaug in ABG. You are mentioning an increase in Collection OpEx going forward in preparation for new market. Can you give some flavor on the magnitude of the increase?

[Espen Gundersen, Deputy CEO & CFO]

Internally, we are now using rolling forecasts as 6 quarters because it's a dynamic environment, so -- and this is changing every month because the timing on the different projects. so even internally, we even have different scenarios. I feel at least, it's hard to be precise on this because I don't know. In the short term, you should assume that we had a significant cost last year in fourth quarter related to the establishment of the New South Wales system. Now we don't have that cost, but we have the regular ongoing revenues from New South Wales. We said when we started the project that we think we thought that it will be very round figures AUD 50 million of revenues per year and based upon an investment around AUD 50 million. And with the seasonality that you know there is in New South Wales, the revenues will be somewhat higher in the fourth quarter than on average. So with these parameters and some assumption upon the margins, it will probably be able to have a guess on amount of OpEx in fourth quarter, would be. And then on top of that, you have to add the Queensland ramp-up, round figures maybe NOK 10 million, and then some additional costs related to other markets, maybe round figures also NOK 10 million. So just give you some reference points on how fourth quarter might look when it comes to OpEx and cost to rate expansion.

[Elisabet V. Sandnes]

We have not received more questions from the web, so if there are any questions in the audience, we can take that. So yes, please.

[Knut Erik Løvstad, Equity Research Analyst]

Knut Erik Løvstad from Kepler Cheuvreux. Just a question on Scotland and England and the U.K. There has also been talks that the 4 ministers of the U.K. sort of contrary, start talking together, considering one deposit solution for the entire U.K. Has that been put on the side and sort of each countries is going ahead individually, sort of what we're seeing in Australia? Or do you think that we will see sort of one common system for the U.K.?

[Espen Gundersen, Deputy CEO & CFO]

Do you have anything on that?

[Elisabet V. Sandnes]

Nothing from that they're considering a joint one, but I think it's definitely a willingness from England side. Michael Gove said that they will look to Scotland, and he was also mentioning a uniform solution. But I guess, Scotland has come further than the other regions. England is following. So perhaps, it's a positive for the other regions that Scotland has investigated, and perhaps, they can piggyback on that. Or the other way around, I guess, we can also argue that they might be delayed because they want to have a uniform solution. So I guess this can go both ways.

[Espen Gundersen, Deputy CEO & CFO]

But I think Scotland figure’s little fun being the first one, so I'm not sure it'll wait for England. So let's see.

[Knut Erik Løvstad, Equity Research Analyst]

But they also mentioned that it's not sure that we will see sort of a return to retail. It can be sort of a return to something outside the retail stores, the parking lots or whatever? Or it could also be a throughput model? Or is it likely to be a return to retail?

[Espen Gundersen, Deputy CEO & CFO]

Yes. In Scotland, as part of this hearing, they draw 4 different scenarios and asked for feedback on the mystery front. Being everything from what we know, for instance, the Scandinavian countries with a return to retail inside the store, more and then different versions of this into more kind of recycling centers, still close in the proximity of stores but need not inside. So let's see where they end up. I guess, again, it's probably 1 of the 4 they have suggested. And I assume also, England is looking a lot upon what Scotland is doing and looking upon the model that's been presented there. But we don't know more than that, and we don't know where they will end when it comes to the financing. Will companies like TOMRA need to play a role when it comes to financing this? Or will it be an obligation for those selling beverage containers to take back and finance them self the solutions? It's open question. And we just have to deal with the solution that the governments choose to implement, and we are prepared for doing both. We have talked a lot about this previously, the pros and cons. Of course, selling machines, doing service upon them is the business we know and done for several years and made good money on. But we've also proven that it take a large responsibility owning the infrastructure like you do in New South Wales, like we do in Lithuania. It could be a good model for us. And even though more capital-intensive, we are prepared to stand up and deliver solutions if that's what they want also.

[Knut Erik Løvstad, Equity Research Analyst]

You also said that there is a commitment from many of the EU countries for this EU recycling or plastic initiative achieving sort of a 90% return rate on plastic beverage containers. Have you seen -- have they started sort of looking at how to facilitate that in some of these countries? Are they talking about it, talking with you, talking with others, et cetera, in order to prepare for that? Or we're not at that stage yet?

[Espen Gundersen, Deputy CEO & CFO]

I think what you see in Scotland and England, as example, is not necessarily a direct consequence, but it's linked to this. So some countries are moving on despite or independent of what you do. But still, 2025 is some years down the road, but there are definitely some kind of processes in most EU countries now looking at this and discussing how they eventually should prepare for this. So yes, discussions have started in many places but are on several different kind of stages towards an implementation. But as I said, it's never given the outcome of political processes. We can only point out what's happening here. It seems to be a lot of commitment around this New Plastics Economy directive. I think the discussions remaining is about ambitions level. Is 90% the right target and so on? That's at least what we get out of this talking to people being close to the process.

[Elisabet V. Sandnes]

To add onto that, what we are seeing is obviously a flurry of newspaper articles across any geography, really, in terms of on the back of the EU initiative. And I don't think it's a coincidence that we're talking about collection rates and the higher number given that we need to establish sustainable infrastructure locally now that we cannot as Europe or the U.S. export to China. But these things come at the same time, definitely don't think it's a coincidence in terms of the targets. I think it's ambitious. And what you can see is that, so far, there has not been higher than 90% collection rates from any other system, then a deposit scheme. So to our knowledge, it's a good solution to implement, but quite surely, the beverage industry will look into this from a producer responsibility and because that's also called upon in the draft regulatory. It's one of the solutions in order to get to a higher return rate.

[Knut Erik Løvstad, Equity Research Analyst]

Last question from me. With regards to a throughput system, obviously, we don't have the answers yet with regards to Australia, how the return on investment and margins, et cetera, are going to be for that system. But from Latvia, you have now a couple years where that system has been in operation. So how would you say sort of that throughput system works in terms of return on investments and margins, et cetera, for you compared to the traditional, say, to retail system that you have in other countries?

[Espen Gundersen, Deputy CEO & CFO]

When it comes to the return on investments, it's still hard to calculate on the sales and service because investment is rather low, actually. It's not hard, but it's in the case. It's extreme figures. So -- but I think it's the relevance question is maybe what's the net present value on those 2 initiatives and what you have seen so far that, no doubt, the throughput model have been higher net present value. It's more capital intensive. But you take a bigger responsibility and set up the right way and with the right volumes, it has a higher net present value for us than the regular sales and service models. And then finance area also, because you're taking a higher risk, do an investment upfront not knowing exactly what kind of volumes that will hit you, so you take a high risk and you should be rewarded for that as well.

[Elisabet V. Sandnes]

Thank you. Do we have any more questions from the audience? Okay.

[Espen Gundersen, Deputy CEO & CFO]

Okay. Thank you for joining us. As I said, we are part of the Capital Markets Day that we had. Those presentations are still on the web, so I encourage you, if you not have seen them, got to TOMRA's website and look at them if time allows. Thank you.