AAK AB (publ)

STO:AAK

Earnings Call Transcript 2018-Q2

[Operator]

Ladies and gentlemen, welcome to the AAK Quarter 2 2018 Report Call. Today I'm pleased to present President and CEO, Johan Westman, and CFO, Fredrik Nilsson [Operator Instructions] Johan, please begin.

[Johan Westman, President & CEO]

Thank you very much. Good afternoon, everyone, and welcome to the AAK earnings call for today. Together with me, as you heard, I have Fredrik Nilsson, our CFO, and we will have today's presentation together. And after this presentation we will take Q&A as normal. Before we get started, I'd like to take the opportunity to share a few of my personal reflections, now 2.5 months into the job as CEO for AAK. During this period, I have visited many of our sites and been it to all the regions where AAK is present, including also visits to customers, suppliers, and obviously, more to come during the early fall. I'm very pleased to see that everywhere I go, I meet professionalism, dedication and passion. Passion for our customers, passion for our solutions and passion for AAK and our codevelopment business model. We have a decentralized organization, with a very strong regional leadership and execution. As I reflect, I see these characteristics in the organization as key drivers and enablers for AAK's success over the last years. Equally so, I believe that they are very important for us, as we continue to push forward for profitable growth. It makes me really glad, inspired and highly motivated now being part of the AAK organization, an organization with a lot to give and very promising opportunities going forward. That is really the, kind of, the highlight of what I've seen as I traveled and met leadership teams, colleagues, walked the plant on the operations, and met with colleagues in different positions in our company, again, makes me very glad, highly motivated. With that -- and I'm happy to take, obviously, questions on my personal reflections later on, but with that, let's now move into the comments and details on our quarter 2 results. Heading into Page 2. The agenda for today is an update on quarter 2, some details on the business area, an update on The AAK Way company program, and at the end Q&As. On Page 3, we start with some of the Q2 highlights. We have continued to enjoy strong organic volume growth, up 6% versus last year. Our operating profit also continue to increase, up by 11% year-over-year, and we reached SEK 454 million in operating profit, which is a record high result for a second quarter. Our earnings per share followed nicely, with a 15% increase year-over-year. Operating profit also up, up 5% year-over-year, and further to this, we also had a good operating cash flow on the back of obviously good earnings, but also improved working capital. Turning to Page 4, comments on few strategic activities or initiatives for continued geographical expansion. During the quarter we decided to invest and communicate an investment in a customization plant in the Philippines. Furthermore, we signed a distribution agreement with FSL, and that is to further expand into the Middle East. Both of these activities will help us drive growth in regions where we have had limited presence in the past. On Page 5, our year-over-year operating profit development. The quarter 2 operating profit of SEK 454 million is the highest for second quarter, as I mentioned. When you see it in this context, really the earnings trend that we have had continues nicely and there's still room for further improvement. Page 6, some further details on quarterly development for AAK. Volume trend continues, profit, I already mentioned. We also see a continued upward trend for profit per kilo. And finally, our year-over-year EBIT growth of plus 11% in quarter 2, is in line or even slightly above our long-term management ambition. With that, I will now hand it over to Fredrik Nilsson for further details and comments to our results and our different segments. Fredrik.

[Fredrik Nilsson]

Thank you, Johan. Gearing to some more financial details, we have the very small positive translation impact of SEK 2 million in the quarter. If we look at current currency rates, we should expect to see a continued small positive impact for Q3 and Q4. If we now move to page 8, and look at working capital details, you can see an increase of 4 days since year-end. With the improved product mix on more specialty solutions, we see some more pressure on the accounts receivable days. Inventory in payable days, we have been able to keep it flat since year-end, and then you can see other items is increasing by 3 days, and that's mainly related to changes in our raw material derivatives, which has been partly offset by higher accruals. Let's move down to page 9, and look at the raw material prices. You can see that during quarter that the palm oil price has traded a little bit downwards, while the Rapeseed oil has starting to trade slightly upwards at the end of the quarter. I would also like to remind you that the 10% change in all our raw material prices will have an impact on our working capital with SEK 300 million. And also important to remember is that will come with a time lag of 6 to 9 months from a cash flow point of view. If we then go to Page 10 and look at the more detailed cash flow, you can see a good EBITDA increase of SEK 63 million in the quarter. Paid interest increased versus last year, and that's mainly related to increased borrowings in high interest rate countries, but we are also seeing increased interest rates in a few markets. Paid tax is lower than last year, and you can also see that we have reported lower tax cost versus last year in the P&L. And I would just like to remind you about our previous guidance about the tax rate for the year, and that remains between 27% and 28%. Continuing with non-cash item that's mainly the change of our financial instruments and particularly are the -- our hedging for raw materials. What was really positive, I will say, in this quarter was the positive cash flow from change in working capital. And here that -- we could see a good inventory management, and also higher accruals. This was partially offset by lower payables and also increasing accounts receivables. And that was, of course, very natural with good organic volume growth that the receivable increased. Looking at cash flow for investments, you can see that the investments remain on a high level, and that it's a mix of normal maintenance investments, but we are also adding capacity to our existing facilities. If we then move to Page 11 and look at the return on capital employed, you can see a small improvement in the quarter, and return on capital employed was 15.5% in the quarter. Increased operating profit has been offset by higher working capital over the last 12 months, despite that we saw a positive development of the working capital during the second quarter. If we then move on to Page 12 and look at Food Ingredients, we saw good organic volume growth in the quarter of 5% and also continued good development for our specialties and semi-specialties, with a 5% growth in the quarter. Operating profit continue to improve nicely, 8% year-over-year, and it's very much the same pattern in the second quarter as we have seen now for some time. Going to some more further details, we could see a continued good Dairy development with double-digit volume growth, again, I will say it's more than 2 years now we are seeing a double-digit volume growth for the Dairy segment. Special Nutrition continued strong momentum and reported a good volume growth with the continued improved product mix. What's really encouraging was the development in the Bakery segment. We have now the second consecutive quarter with volume growth. The challenge to change the product mix towards a greater proportion of high-end products remains. That will not change from 1 quarter to another, that's a longer journey. But also part of the thing was that we saw organic volume growth in most of our regions. Looking into the Foodservice business, we saw a tougher market situation in the U.S., while the Nordics, which struggled a little bit last year, we saw some good improvement in the second quarter. Let's move on to page 13. Looking at the trends, you can see a nice operating profit evolution, and it was an all-time high for second quarter. Operating profit per kilo improved by 3%, and the small upward trend continued. If we then go into page 14, and look into some more details about some Chocolate and Confectionery Fats, we saw 2% volume growth in the quarter. However, the volume growth has been impacted by a stretched utilization of some of our production lines, where we also had a plant maintenance stop. We have, however, still see good development from a volume point of view of our high-end products. We have also used the maintenance stop to put in some actions to gradually improve more capacity for the future. Looking from a operating profit of view, we had a challenging first quarter. Now we can see a small positive year-over-year improvement of 2%, and we should also have in mind that the second quarter has been impacted by the maintenance stop, but also the stretched utilization has limited some sales in the quarter. Looking at Page 15, the cocoa butter price, you can see the current price is around SEK 7,000. We have earlier communicated that the real sweets spot is between SEK 5,000 and SEK 6,500, so it just a little bit above that. But I think there's not so much more to say about the cocoa butter price. So let's move on to Page 16 and looking up the trends. As I said, operating profits improved 2%, but still it's the best second quarter ever for the chocolate division. Operating profit per kilo quite stable in the quarter. We had a product mix improvement, but as I mentioned, it was partly offset by the maintenance stop and the stretched utilization. If we then go to Page 17, Technical Products and Feed had a very strong quarter. Volumes were up 14%, with a good double-digit volume growth in the fatty acid business and the feed business. But we should also have in mind the last year we had an extended maintenance stop and this year we have a normal maintenance stop, which gave us some extra volume this year versus last year. Profit wise, strong improvements from SEK 9 million up to SEK 32 million in the quarter. And I would say, there are 3 reasons behind the strong profit improvement. We talked about the maintenance stop, but there's also still a good mix improvement in our fatty acid business, and we should also have in mind that last year was impacted by high raw material prices, and this year we see lower raw material prices for our fatty acid business, which is impacted favorably. Looking at the trend on Page 18, you can see that the strong trend with 4 strong quarters after the weak start last year. And by that, I will now like to hand back the microphone to you, Johan.

[Johan Westman, President & CEO]

Thank you very much, Fredrik. We move on into Page 19. Few comments on our company program, The AAK Way. We are well on track in most of the areas, of course, with some nuances when you look into the details, but all in all, on track. Gladly, Special Nutrition as well as Dairy, within their work stream special focus areas are both ahead of plan. Now halfway into the program, we start to see results, and we expect to continue in a good pace for the second half of this program. This is really when we start harvesting the -- all the efforts that we put into these actions. With that, Page 20. Comments to our long-term management ambition. Our ambition is to achieve, on average, a 10% year-over-year EBIT growth, adjusted for acquisitions as well as FX, the currency impact. The current status after 18 months is plus 11%, obviously, as you can see on the page, with some variations between our businesses, was still plus 11% on average for the AAK company. Moving into Page 21, as a final comment by me. We do continue to remain prudently optimistic about the future. And with that, thank you very much for listening, and we are happy to take questions from now on and forward.

[Operator]

[Operator Instructions] And the first question comes from the line of Carl Mellerby from Nordea Markets.

[Carl Mellerby, Analyst of Healthcare]

My first one relates to the CCF division. You mentioned it has seen or experienced some stretched utilization in Q2. Could you elaborate if you expect to see any impact from this also in Q3? And then also staying within the CCF division, in the Q1 report, you mentioned that you are seen some more aggressive pricing from some competitors. There is no mentioning of this in today's report, so can we assume that you saw no impact from this in Q2?

[Johan Westman, President & CEO]

Thank you, Carl. If we start with the first part of the question, we have -- what we say is that we have been reaching capacity limits to some extent. And there's always a balance when you invest them and when you wait a little bit. It's a positive underlying market development. We see good trends for us in AAK. But at the same time, we reach a point where we are at capacity limits in some areas. As we mentioned, we had taken actions and invested in improved capacity. It will take some time for us to get to the full capacity or the increase. So we expect a continued pressure a little bit on how much we can sell and get through the supply chain also in Q3 and Q4. But again, positively, we have seen also a positive development on pricing as well as expect to be doing better as we go forward. And Frederick, may be you can elaborate a bit on the second question.

[Fredrik Nilsson]

Yes. What we commented upon in the first quarter -- coming back to your question, Carl, was that we saw some price pressure, but we also commented that we started to see some more normalization in the end of the first quarter, and that has continued during the second quarter as well. So there is less impact in the second quarter than we saw in the first quarter. And I will say that there will be no impact going forward.

[Operator]

The next question comes from the line of [indiscernible] from [indiscernible] Asset Management.

[Unknown Analyst]

Johan, welcome on board. Just a follow-up on the capacity, do you see any need for, let's say, reviewing the strategy to may be do some further investments in capacity because we can see that the run rate is around, I think, 550 million tons to 560 million tons, so you need to do something there. That's my first question. My second question is regarding the CCF division. Do you see any signs that you will be able to lift the EBIT per kilo because I mean -- I know from earlier on you had some, let's say, some more commoditized products in your product line, but will you be able to get that turnaround and get some more value-added products into the CCF division and through that lift the EBIT per kilo.

[Johan Westman, President & CEO]

Thank you very much, [indiscernible]. If I start with capacity strategy and maybe this is the simple answer to your question, but obviously, we will -- we are a company that has been growing. We will continue to grow. It is clear in our management ambition that we are -- want to grow EBIT, but to grow EBIT we need to grow as well top line. It will be through organic growth as well as through acquisitions. So from a capacity perspective, I think it is equally important to look at how we grow organically, meaning how we invest ourselves, but also to finding the right targets, where we can offer -- where we can get access to market, region, but at the same time also increase capacity. And further to that, we have invested, as you know in China and Brazil, and we have -- we still have a lot of headroom to lower these plans. So there's also some already made investment that will help us grow. But at the same time, obviously in markets where we haven't invested that much in capacity, we are always looking at how can we improve productivity, get more capacity through that, but then obviously taking investments as we need to. So it is in line with our strategy and ambition already to make investments to continue to grow. And then it's about capacity planning when you do that and so forth. To your question on do we think we can or will increase the margin in the CCF. It is our ambition, it is -- our strategic actions are taken in order to do that. It is our focus, it will remain to be in focus, to focus on high-value added solution to our customers. But when and how that will materialize is something that we'll have to see, and you'll see it in our report going forward, but I will not make any further statements to that or promises.

[Unknown Analyst]

Do you see any compacts of the capacity? Do you see any need for -- or have you scaled up your acquisition agenda? I mean if you are -- what we have seen for the first 2 months, I know it's a very short time, so I won't ask you for any commitment, but do you see any -- I mean, do you see -- it could be a good way to -- I've seen you've done that in the Philippines, and I've seen several joint venture projects and so on. Do you see that a good way to increase the production capacity, and not just only through green fields like you did in China and in Brazil?

[Johan Westman, President & CEO]

Yes, definitely. I -- personally I think that is a very good way to do it and the organization -- the leadership team and the organization in AAK has done it in the past and I think we're all in the boat doing it doing forward. I think it's a good mix to do organic growth, combined with acquisitions, and really the sweet spot in an acquisition is when we can find access to market, high value-added products, synergies, but also capacity that we can help offset potential investments otherwise. So yes, absolutely, it will be in focus, and it already is.

[Operator]

And the next question comes from the line of Heidi Vesterinen from Exane.

[Heidi Maria Vesterinen, Financial Analyst]

First of all you talked about weakness in the U.S. in some particular categories. Can you describe in more detail what you're seeing, especially in Foodservice, because I think this is a new trend. And do you think this is a generalized slowdown among U.S. consumers, or do you think that it's more category specific, maybe people are moving away from fatty food or -- and so on? And related to that, is CalOil doing all right? Can you update us on that? I think the profit were starting to come through. And then the next question. Is it possible for you to quantify how big the non-infant part of Special Nutrition is? I know you said it's small, but can you give some sort of indication on the size? And then last question, maybe want to follow-up on M&A, a question for Johan, I guess. So AAK has tended to buy a lot of turnaround stories. You have seen in the past and many have been good, but some have been quite difficult like the CSM Bakery business. Do think that's the sort of approach that you would like to take? And are there any specific metrics you look at when you evaluate M&A deals?

[Johan Westman, President & CEO]

Thank you. I'll work myself backwards, if it's okay with you, starting with M&As and CalOil and then head in to U.S. more specifically. Well, I do not have a personal agenda when it comes to M&As. It's about -- it's all about finding the right M&As that supports our strategic agenda. So what you heard me comment a little bit to [ Pare ] just now that I think it's -- the sweet spot is when you can combine a few other things that we need. Could be access to market, could be certain products group, technology, and on capacity, and that's what we're looking at. And our strategic agenda is about high value-added solutions for our customer, increasing our core development capabilities, our innovation capabilities. So clearly we want to move in that direction, and whether -- I'm not afraid of a turnaround case, but I'm not afraid of a very strong company that adds to exactly the capabilities that we want to acquire either. So it's -- it has to be evaluated from time to time and depending on where in the market as well. With regards to CalOil, just visited the business in California, just some weeks ago. The team has done a good job. It's really looking good. And from my team members, I hear that it's a good development and it's starting to come around nicely. So short answer to your question that we're moving in the right direction at least. And with regards to U.S. business, as we mentioned, and our comment is, maybe more related, we're still doing good in an absolute term, I would say, in the U.S., but compared to our ambitions that where we want to be, we have seen a trend where we need to improve going forward. And it's about competition, raised competition there, and we have also defended our margins and our positions. And on the back of that, we have seen some volume reduction in some areas, where we're still -- we still think we're doing the right thing, and we will turn that into something positive. But at the same time, as you do that, we have seen in the quarter and call it a bit tougher market position. And with that, Fredrik, any more comments to these questions and also including the question on Special Nutrition?

[Fredrik Nilsson]

I can start with question regarding Special Nutrition. But coming back to that, Heidi, I will save we are normally making the full breakdown of food ingredients in connection with our Capital Market Day. So I'd say, yes, that we wait and answer that question in connection with the Capital Market Day. And just to regarding CalOil, I could just add that we are actually slightly ahead of our internal plan.

[Operator]

And the next question comes from the line of Oskar Lindstrom from Danske bank.

[Oskar Lindstrom, Senior Analyst]

Three questions from my side. First off, you talked about reaching the capacity limit in some of your operations. Will this drive CapEx levels going forward a little bit higher than you've guided for or what we have talked about?

[Johan Westman, President & CEO]

No, I wouldn't say that. So -- I mean, I understand as you read the report and so forth, we have commented on this. It's not a big deal that way, but at the same time we are at capacity limit. So what we’re saying is really that we found ourselves in a position where we may be promised a little bit more than we can deliver, and we're in uptight on capacity and that limits and hit our P&L sheet a bit. And -- but we think we are in good shape. We're taking actions, we're taking capacity actions, we have used the utilization stop this summer to invest and improve. And we are now starting to ramp that up, but these are not heavy investments, but still investments that could not be done earlier, but we had to wait to the maintenance stop to do that, otherwise we would've had more significant negative impact to the business. So it's not massive investments in terms of capital, but still very important in terms of capacity.

[Oskar Lindstrom, Senior Analyst]

All right. So this is not the beginning of, sort of, a period of increasing CapEx.

[Johan Westman, President & CEO]

No. Not at all.

[Oskar Lindstrom, Senior Analyst]

Good. Yes. The second question is coming back -- it's about the higher cocoa price. I mean, in the end, did any of your customers raised prices significantly? Or what was the outcome of that period of higher cocoa prices?

[Johan Westman, President & CEO]

Fredrik, you want to take that one?

[Fredrik Nilsson]

Absolutely. We have not been aware of any more official price increases that we could see for couple of years ago, where we saw massive price increases, that we have not seen this time, Oskar.

[Oskar Lindstrom, Senior Analyst]

All right. Because I looked at sort of vanilla prices seemed to have gone up quite significant, and other costs which are driving -- could be driving chocolate prices -- chocolate bar prices in the market you think?

[Fredrik Nilsson]

No. It's the cocoa butter, it's the cocoa powder and it's sugar. Then you have 3 main components.

[Oskar Lindstrom, Senior Analyst]

All right. So there's nothing else. Okay, good. And then my final question is relating to this, sort of, very dry weather we have in -- or have been having all summer in Sweden. Is that going to have an impact on your, I guess, especially the Rapeseed availability or pricing for you going forward?

[Johan Westman, President & CEO]

It will have -- as you have read, obviously it will have an impact to the Rapeseed as such. So that will also impact us. But we, in our part of the value chain, we also have a possibility to work with the direct supply and also with alternative sources to be able to deliver on our promises to our customers. So the direct impact on the Rapeseed as such in Sweden might not have as big of an impact to us. Fredrik, may be few more comments on that?

[Fredrik Nilsson]

No. I can just say that as you know we take most of Swedish Rapeseed harvest annually, but that's not normally enough, so we are always importing Rapeseed as well. So we have that flow open and just that we are importing a little bit more this year compared to a more normal year.

[Oskar Lindstrom, Senior Analyst]

All right. So it is not -- yes.

[Johan Westman, President & CEO]

We're obviously planning for that. We would've liked to see better crop, we like the sunny weather, but we don't like the impact to the crop. But at the same time we have ways to mitigate.

[Fredrik Nilsson]

And if you look from a price point of view, Oskar, also we are working on European market, so within that, Sweden is still a small part.

[Oskar Lindstrom, Senior Analyst]

And -- I mean if you need to import more than usual, because of this weather situation in Sweden, and then you say that, sort of, changes your mix. Is that something that could potentially cause problems for you in the productions side that all of a sudden the mix is different from what it has been usually and this give rise to problems? I guess a little bit to what you -- maybe you had in the Aarhus plant end of last year, beginning of this year?

[Johan Westman, President & CEO]

I think it's a fair question, and I appreciate that. Our assessment, as of now is not that will have a significant impact. I think it's really a fair question from an operations perspective supply chain, but our assessment is that it will not have a significant effect. Some impact for sure, but not something that we are, at the moment, particularly worried about.

[Operator]

[Operator Instructions] And we have a question from Karri Rinta from Handelsbanken.

[Karri Rinta, Research Analyst]

Just a small follow-up on the China, Brazil question. You mentioned that you have headroom to increase the load on those factories. I noticed that you don't mention neither China nor Brazil in your report, so can you give us an update on that? Where are you roughly in terms of utilization rate in terms of product mix? And maybe, sort of, what should we expect in the next 12 months in terms of those 2 facilities? Had there any indication of how dilutive that is to your earnings at the moment?

[Johan Westman, President & CEO]

Thank you for the question. Perfectly understood. I'll comment a few things. We do see room for volume growth, and with that you read correctly that we're not fully utilized. And we -- a little bit different dynamics in China and Brazil, a little bit more, call it, at plan or ahead of plan in terms of volume in China. A little bit more at plan or slightly behind plan in terms of volume for Brazil. But at -- on the other end, Brazil is doing well in terms of getting the right business, meaning a good net margin business. And the focus forward is for both of these to find business opportunities to load the plant, but to load it with good margin business, high value-added business along with our strategy. That is our main focus, whether that will be -- will we get to a position where we really see that these plants are contributing within better within 6 months, 12 months or 18 months that is too early to say. We are on good track, but we need to continue to push hard to continue to view our core development activities, our customer innovation centers being utilized fully as well. So with all that, we do -- we remain optimistic, but it's too early to comment on the net impact that it has and to give any forecast on that specific topic. But all in all, we're still doing fairly well in the group.

[Operator]

As there are no further questions, I'll hand back to the speakers.

[Johan Westman, President & CEO]

Thank you very much, and indeed thank you for your questions, appreciate that. And if there are no further questions, then I thank you for listening, and thank you, Fredrik, for being part of this call.Thank you very much. Looking forward to talk to you again in the future.

[Operator]

This now concludes our conference call. Thank you all for attending. You may now disconnect your lines.