Cloetta AB

STO:CLA B

Earnings Call Transcript 2022-Q2

[Nathalie Redmo, executive]

Good morning, and thank you for joining us on the Q2 conference call for Cloetta. My name is Nathalie Redmo, and I'm Head of Investor Relations. I'm here today with Henri de Sauvage, CEO of Cloetta; and Frans Ryden, CFO. Henri and Frans will take you through our results for the second quarter and we will then move on to a Q&A session.

And I will now hand over to Henri.

[Henri de Sauvage Nolting, executive]

Thank you, Nathalie. So, first of all, I want to say that I'm really pleased with the quarter with a double-digit growth and also the step-up in profitability. That was really pleasing to see in very uncertain and turbulent times, I would say.

So a few highlights I would like to share with you. So the communicated pricing became effective in quarter 2, which you can also see in our results where we do not see a flattening yet and new pricing has been announced for the second half of the year to compensate for further inflation. We also see many global supply chain challenges, but so far we've managed them in a good way without material disruptions, a lot of good work from our own people also with suppliers looking for alternatives, et cetera. So a quite big achievement.

Then we have now the 6 quarter of growth in Branded. Really pleasing to see that. Our further actions are focusing to grow our market shares in pastilles and gum categories because that's still a weak spot. Our actions taken in the past, within the Pick & mix segment continued to support our profitable growth over there, which is also really good to see. And then where does the higher profits come from? Well, that's from volume and from mix as it was really important that we have volume growth in this business. I don't think that that many you can say that the volume growth and mix both contributing to the operating profit.

All our loan facilities have been extended by 1 year to '24-'26 with our banking group and we got our science-based targets approved. I'll talk a little bit more about that at the end of this presentation. In May, we announced the plan to invest in a new greenfield facility in the Netherlands. The plan has generated questions and comments within the investor community and as a result, we have decided to host an investor event on September 27. This event will allow enough time to share further information on the investment and its benefits to Cloetta and our shareholders, including details on timing, cost, financing and future potential of the investment. Already now, I wish to clarify a few things related to the greenfield investment with [ Aakkoset ], most of the discussion will then be on September 27.

So Cloetta has an overall aim to deliver long-term shareholder value on its path to becoming a leader -- leading food tech company through margin expansion from profitable growth and lowering our total cost base. Over the last couple of years, we've seen solid volume growth in our candy category in the Branded segment as well a robust recovery of Pick & mix volumes, and this is leading to a lot of extra need for capacity in our production facilities. In order to meet this future demand of capacity, we plan to consolidate our 3 current candy manufacturing facilities in Belgium and the Netherlands into 1 new modern greenfield facility, serving our markets in Central Europe and international markets. By consolidating 3 production sites, we also enable significant cost savings through consolidation and automation. As earlier presented, the project will strengthen our EBIT with around SEK 160 million to SEK 180 million by the time of its completion.

And then thirdly, since we have the opportunity to build a new plant, based on the latest technology, we can also make a major step towards our science-based targets and build a truly sustainable plant with less energy consumption and waste. Indeed, this is a very big decision and a considerable investment for Cloetta, where we, within 4 years, will have an efficient production units supporting our core markets. Hence, I wish to make a few clarification. While we realize that the investment is significant, it includes headroom for the current uncertainties on interest rates and inflation and will not be fully incremental to current investment levels. Furthermore, the investment will add another 15,000 tons of capacity within the candy category, whereas less than 1/3 has been included in the estimated EBIT upside.

Finally, the Board reiterates the dividend policy with a payout ratio of 40% to 60% of profit after tax remains intact.

The project is progressing according to plan and during the quarter, consultations with the European Works Council and local unions were initiated and are expected to be finalized during the third quarter. During the quarter, we also concluded on the parameter of the building in order to initiate the permit process.

With regards to financing of the investments, we have several options and are working closely with our banking group to determine the optimal solution. Our ambition is to provide ongoing information on the project on a quarterly basis, as well as to host a digital investor event on September 27, when we'll be presenting details on timing, cost, financing and the future potential of the investments.

With that said, I want to hand over to Frans.

[Frans Rydén, executive]

Thank you, Henri. So as usual, I will start with net sales, which in total is up over SEK 200 million, and where we are again reporting strong organic growth with sales up by 11.9%. And you may actually recall that we added double-digit growth in Q1, but then that was aided by the foreign currency translation. And this quarter, it is true double-digit growth from organic sales and excluding currency upside. So the strong sales are also again driven by both the Branded packaged products and by Pick & mix. The Branded packaged sales grew 8% in the quarter on the basis of pricing and a good product mix, including through last year's strong innovation and again supported by strong marketing. And there is a good mix here, despite, as Henri mentioned, refreshments is still trailing the growth in candy and chocolate.

On the growth driven by pricing with our way of working with our customers, where pricing is taken based on actual world market input cost changes in absolute terms, there will always be a bit of a lag between change input cost and the commensurate pricing coming into effect. I thought about this and I think the best way to actually illustrate it, it's a bit like a game of Whac-A-Mole that you find at amusement parks, where when the mole pokes its head up, you have to whack it down and some delay is inevitable. And the rules of the game are such that you really can't whack the mole before it pops up.

So as you recall, in Q1, we had pricing coming into effect largely to offset the input cost inflation carried over from 2021, while we also flagged that we would take more pricing in Q2 to offset the continued inflation seen early 2022.

As Henri said, that pricing has been done. However, inflation has continued even further during Q2 and to offset that we have announced to our customers even further pricing. That further pricing will come into effect in the second half of the year, and so the lag between increases and input cost and the change in pricing will continue until cost stops pricing. On the other hand, if or when rather, cost at some point starts to come down, there will be a similar lag between the decline in input cost and our commensurate price rollbacks.

Now, similar to Q1, this solid Branded packaged growth was again achieved in parallel with Pick & mix growing 24% in the quarter, which is phenomenal. The growth in Pick & mix is driven by volume and also by pricing, although rather than an established way of working, our ability to price in Pick & mix is dictated by the contract terms, which vary between customers. That said, I do want to call out that these Pick & mix sales again delivered profit and despite the extreme input cost inflation, something which would have been actually difficult to imagine not long ago. And this is the direct result of the diligent focus and effort the last few years on ensuring profitable growth in Pick & mix. So more about profit later. Let's first look at segments over time.

Starting with the Branded packaged segment accounting for the majority of our sales. This is the sixth quarter of growth. We did have 8 quarters of consecutive growth prior to the pandemic, that was a record at the time. So it is great to see that we are continuing to inch closer and closer to that record. Then on the lower half of the slide and the Pick & mix business at over 24% growth. That is again great, and it is fifth quarter of consecutive growth and also the fifth quarter of that growth being doubled double-digit or over 20%. And these sales mean we are at an index constant currency of 92 to the pre-pandemic sales of 2019. And it's another step-up from where we were index-wise in Q1. Now, this growth is also helped by Easter coming in a bit later in 2022 than it did in 2021, but it doesn't change the overall picture.

Moving to operating profit. For the quarter, operating profit adjusted is also up versus last year from SEK 127 million to SEK 162 million. So growing at about twice the rate of the top line being up almost 28%. Likewise, operating profit margin is up by over 100 bps from 8.9% of net sales to 10%. Let me explain this strong result and help put into perspective of what we've said before and what we're seeing in the market. Firstly, I already spoke of the fair pricing for our products and the continued inflation, so while pricing to offset cost is not giving a profit, the sales are underpinned by strong volume growth and better fixed cost absorption and the favorable mix, that together drive the growth in profit. The top line growth is also driven by continued strong investment behind our brands. While in total, our sales, general and admin costs are quite flat versus last year, and I'm going to cover that in a separate slide.

With respect to pricing, I want to emphasize that as we are reporting the quarter's results, cost are continuing to go up. And while our new pricing will also come into effect in the second half, there is no clear end insight for this inflation. I also want to add, even though everyone on this call knows it, that it is not only for raw and packaging material that costs are going up but also for things such as energy and labor. That said, we are committed to ensure a fair pricing for our products. In addition, we'll continue this cycle of driving volume growth, investing behind margin-enhancing products and for a favorable mix. And with a keen eye on keeping our own costs down, basically using all the tools at our disposal and thereby, we still expect to, on the whole, to manage the input cost increases within this year.

Now, our gross margin, excluding greenfield, is down versus last year, which is a reflection of the timing of pricing, but also the dilutive effect of input cost-driven pricing. Simply put, a product with EUR 50 in input cost sold for EUR 100 means EUR 50 in gross profit and a 50% gross margin. If cost goes up by EUR 20 and you can only increase the price by the same amount, then you will still make EUR 50 in profit but now only 42% gross margin, and that is also affecting us now and you can see it in the results.

Then moving on to operating profit by segment. For the Branded packaged business on the top row, operating profit adjusted and margin, it's up versus last year, adding 150 bps to get to 2 point -- 12.7% holding firm on the Q1 operating profit margin despite the dilutive effect of the pricing. Now, the still lower share of our sales that come from refreshment sales, also still suppresses the operating profit and each euro of sales we can clawback there is an important opportunity for us. But despite that, we have a favorable mix in the quarter versus last year, driven by our focus on higher margin products and more efficient promotional spend and a mix between countries. I also want to call out here that, again, the quality of the profit is high as we continue to invest in marketing of our brands at the same level as in quarter 1, even up slightly and similarly to quarter 2, 2021, despite the step-up last year to support new product launches such as fruit-based candy. On a year-to-date basis, we are higher invested in marketing this year than last year.

With respect to Pick & mix, as mentioned, this is the fifth quarter back-end profits, again showing that the recovery has been sustainable, beyond keeping it stable, it does look quite modest. But then you must note the Pick & mix is also impacted by cost inflation and that with a different pricing model, our ability to price has been more limited. And the reason you nonetheless do not see a dilution of margin nor profit is due to continued margin enhancing initiatives and savings, including keeping merchandising cost down despite the growing volume. Had it not been for the input cost, we would be looking at an even stronger margin step-up in the quarter.

Looking then at selling and general and admin cost. With the top line growth, there is a significant drop in spend as a percent of sales, but also in absolute, spend is very flat, up SEK 7 million on the base of SEK 401 million. I already mentioned that our marketing spend on the Branded packaged segment is close to last year step-up spend. And during the quarter, we have also continued to invest in our organization and capabilities such as for net revenue management in e-commerce and to support international market sales. However, this increased spending is largely offset by our cost efficiencies, including, as mentioned on lower spend on campaigns for Pick & mix, keeping merchandising costs down, despite the volume growth, the full effect of the reorganization of our sales force in Sweden and by continuing to largely hold back on spend, that we're all but frozen during the pandemic.

Looking then at cash, as you know, our business cash generation is skewed towards the back half of the year, with inventories normally being built early on and receivables coming down the weeks after the selling for Christmas. This year is not expected to be different. For Q2, our discretionary free cash flow for the quarter was negative SEK 136 million with SEK 57 million in CapEx investments, which is roughly what we tend to spend on CapEx each quarter. Now, the key driver is the working capital where, as usual, we are building inventories, but with the input cost inflation, those inventories are also valued a lot higher. In addition, given supply volatility, we -- where we have an opportunity are building safety stock. Higher input costs also drives higher payables and higher pricing drives to higher receivables. Although also on the receivables, we are up versus last year on account of the strong growth. So that is arguably worth it, which brings me to our net debt and leverage.

With the inventory build and growing receivables, net debt is, of course, up versus our lowest-ever level in quarter 1, but with the dividend payment in quarter 2, I think it is more like for like-for-like to compare to quarter 2 in 2021 when we also paid dividend. So versus a year ago, our net debt is unchanged at SEK 2.2 billion and that is despite both the extra SEK 72 million in higher dividend paid this year and a revaluation effect of SEK 77 million on account of this weaker Swedish kronas, Norwegian kroners and British pound versus the euro. This improvement is also more evident in the leverage, which is at 2.4x and that is down versus last year's 2.9x and also below our long-term target of 2.5x.

During the quarter, we also extend that, as Henri mentioned, all our loan facilities for another year to 2024-2026 with our banking group and as we closed Q2, our unutilized credit facilities and commercial papers and cash on hand were SEK 1.7 billion up from SEK 1.6 billion last year. As Henri mentioned, we are also working with our banks to find the optimal financing for the greenfield and I will provide an update on that in the dedicated September event.

So for my final slide, I want to briefly touch on the one-time cost in Q2 related to the greenfield in the quarter, our items affecting comparability related to the greenfield totaled SEK 225 million, which breaks down as follows: impairments totaling SEK 126 million and I can confirm that while there will be a slight favorable effect on our depreciation going forward, the reduction will not be material, as we will continue to depreciate the assets until they are taken out of commission. The impairment represents the reduced value of those assets that will be sold or scrapped given the factory closures rather than continue to be used for production. The other SEK 99 million relates primarily to provisions, as a result of the intended greenfield, we have done a review of severances, onerous contract, site clean up, et cetera, and the cost reflects the outcome of that review as of today. So after crossing the T's and dotting the I's, the SEK 225 million is within the estimated approximately SEK 250 million we had earlier communicated.

So before I hand back to Henri, I do want to mention that in the presentation that will be available on our webpage, I have also included a simple slide showing our reported number, the numbers related to the greenfield, et cetera, as available in the report, and then our results excluding the greenfield. So you have it in one place and in a simple to read format.

And with that, back to you, Henri.

[Henri de Sauvage Nolting, executive]

Thank you, Frans. So a big thanks to all the work Frans, and now we go to the strategic update to see what is happening during all this hard work to keep the business running with supply chain disturbances and a lot of pricing that's very good progress as well on our strategic agenda. As you know, we have 3 strategic areas, the first one is the growth in the Branded business, 3 categories with 3 focus areas, I will go a little bit deeper into the first 2 worthwhile mentioning is that, we're still expanding our capabilities in e-commerce, even though the sales of most of our customers is down versus the height in the pandemic period, but our capabilities are really improving a lot. And also very pleased to see the progress in the international markets on the particular Branded portfolio, the strategic Branded portfolio and that it is really showing now as one brand as well towards the consumers.

So Nathalie, let's go into the next slide, premium innovations and also innovations, which are really playing into the naturalness trend of consumers at the Gott & Blandat Akta Frukt that this Cloetta made from 50% real fruit, we're the first ones in Europe to have that, so that's really very positive to see, launched across all our main core markets. And what we see over there is that, the target group is much more younger. So you can see at both in the 18 to 24 group, but also the 25 to 34 age group that they really like these kind of products. We're only at the very early start of this. Is it the success? Well, I think we can see that, for example, from Norway where this business is already 20% of the total Gott & Blandat brand. So that is really nice progress and showing that there is a strong consumer appetite for naturalness also in these kinds of categories and that we are able to charge a premium price for that.

Then a little bit of an update on the refreshment category with both pastilles and gum, we're having sales growth in pastilles, but we're not everywhere gaining market share yet. That is in the -- that is a challenge we are full on to that. We can see also over there that we need to rejuvenate, in particular, the buyers, the shoppers of this. So we're launching Lakerol Lemon at the moment, which has a very strong performance in the market, which you can see in the top left, how big this already is and it is very big within the younger target group. So again, very positive to see. Also the cooperation we do with Lakerol YUP for the Pride [ festivals ] in the Nordic market is also being seen as very positive and again addressing the younger target group.

Then on the right you can see all the work we're doing on penetration because arguably with the lower movement of people towards work or schools, we have lost shoppers in both of these categories. So now, as you can see, people are moving back, not fully, but back into out of home. We need to find those people again and address that and that is all the actions we are taking over there with these brands. That is working really well. But we're not completely back to 2019 levels.

Then we have the third focus area, which is cost and efficiency. So very good to see the progress on the net revenue management project. So that is all the cost which are there between list price and the net price we're getting from our customers. So that is fixed prices, promo investment, et cetera. So we're working that together with the renowned consultants company Simon and Kucher, who are helping us in the main markets to do the analysis, but also to get the skill and competence level up to a sufficient level which top FMCG companies would have. And we're implementing a promo planning and evaluation tool based on AI, which is coming from Visualfabriq, we're going live in the Netherlands first and then we roll it out into all the markets, so that we have a much better forward-looking plan when it is about planning and evaluating promotions.

On the cost side, we're working very much with portfolio optimization. As I already told you, we have a lot of growth in the candy category. So it's also a fantastic time to start looking at the portfolio, take out smaller SKUs, take out less profitable SKUs in order to create capacity for higher margin products. So that's a lot of work we are doing over there, both on SKUs and also looking at our brand portfolio. And then, of course, the Perfect Factory program next to all the reformulations, which are happening, we're doing a lot of work on waste reduction within the plants raw material harmonization and also core versus non-core CapEx. So really looking at all the production facilities we have within our factories, whether there are really core important production lines going forward in the future because they support our core brands with high profitability or whether we could make or buy those kind of products. And then, of course, the greenfield development where we will come back in September.

And then last but not least, of course, in the middle, the sustainability drive, so we've now got an approval of our target of 46%, which is linked to the reduction versus 2019, based on the science-based targets initiative. So this is how this works, that the science-based target has a goal to stay within the 1.5% -- sorry, the 1.5-degree climate change and then they calculate together with the businesses, okay, what do we have to do as Cloetta in order to contribute to that 1.5% (sic) [ 1.5-degree ] reduction and that is where the 46% reduction versus 2019 comes from.

And then on the right you can see the 3 different scopes. One and 2 is the stuff we have more under our control and Scope 3 is all the raw materials we are buying and the impact on greenhouse gases they have. So you can clearly see where our biggest challenge lies is in the raw materials that is working, of course, together then with all companies to impact ways of production of the raw materials, but we can also do a bit ourselves with reformulations are moving away from high impact raw materials to lower impact raw materials and that's Scope 1 and Scope 2, of course, is what we are already driving ourselves and also the greenfield will make a step forward in that area. So that was it.

Now, we go back to questions around the quarter 2 and, of course, we can clarify some things, but I would already like to say that all the detailed questions for the greenfield I would really like to get them in September, so that you have a lot of time for them. Everybody can listen then at the same time because it's holidays and there's a lot of quarterly reports coming out today and that we addressed them there in all detail and with ample time available for everybody.

[Operator]

[Operator Instructions] The first question is from Nicklas Skogman from Handelsbanken.

[Nicklas Skogman, analyst]

I apologize, if I asked something you already talked about. I just joined from another call. So first of all, on the -- maybe the outlook, if you will, for Q3. I mean, compared to the Q1 report, I note in this report that there is no comments about mismatches between input costs and price hikes. There are no such comments for Q3 in this report. So should we interpret that as you are now sort of aligned with your input costs and your price hikes for the gross margin in Q3 and Q4? That's the first question, please.

[Frans Rydén, executive]

Yes. Thanks a lot, Nicklas. Let me take that question. So I sort of gave a bit of visual example of how this works. If you imagine that you have at an amusement fair, the game of Whac-A-Mole, where you -- the mole pops up and you have to hit it with the club, and then it goes down again. And, of course, inevitably, there is a bit of good delay before you can hit the mole, so it goes down and. And the rule of the game is such that there is no point in trying to hit it before it goes up. That doesn't making any difference. And it's the same thing for us with the pricing that, that given that our set-up is that, we take pricing based on actual cost increases seen in the markets. Of course, the cost has to go up first, and then we can initiate the pricing negotiations and then the pricing comes into effect. So there will always be a lag there until cost stops going up because then we will catch up.

Now, what we've seen is that, we took the price and we said we're going to take, but costs have also continue to go up during the quarter. And so, we have said, we will take even more pricing now in the second half of the year. But let's say, the lag will continue until those cost stops rising. So that's how it works. But it basically means the lag is already in the numbers you see in the quarter here.

[Nicklas Skogman, analyst]

Okay. Yes, I mean, there was 150 basis point adjusted gross margin decline in Q2 year-on-year. Is it something similar for Q3? Or is it sort of the effect of the lag smaller?

[Frans Rydén, executive]

Yes. So, I mean, it's a couple of things is, one is the margin and the other one is the absolute. And what you saw from the presentation there, we say that the cost net of price impacts on an adjusted basis is SEK 42 million. And then I shared that SEK 70 million of that is coming from the SG&A. So that leaves SEK 25 million. But then what drives that, that's a combination, of course, the increased costs for which pricing had not or hadn't fully kicked in yet. But also higher cost in conversion due to some of the challenges in global supply chain and the normal cost increases. Just as costs are coming back a bit from last year, partially offset by savings. So, exactly how much is the lag? I can't quite give you. But you see there is some -- it's part of that SEK 25 million.

Now, then as a margin, of course, there is another couple of components I think about here, one is the mix between the Branded package business and the Pick & mix, where Pick & mix growing a lot faster but at the lower gross margin. And the other one is the dilution as a result of us pricing for the absolute increase. So that, of course, always means there is a dilutive effect as a result of that. So that is also impacting this.

[Nicklas Skogman, analyst]

Yes, that's true. And in terms of capacity utilization, are you now basically back to levels like peak levels that you previously saw before the pandemic in terms of production?

[Henri de Sauvage Nolting, executive]

Yes. In general, I would say, that is true for our candy business, which is a nice problem to have, I would say, because it also gives us an ability in the previous question to be really firm on the pricing because we can do without some volume sometimes and then move volumes around towards more profitable areas, which means that also in this pricing discussions with customers we are sometimes have situations where for 1 or 2 months we are not delivering to the customer because they do not want to engage in giving us a fair price increase covering only the absolute level. So that is the situation, but it was, of course, also one of the [ background ] drivers for the greenfield decision, which we will discuss in September.

[Nicklas Skogman, analyst]

Okay. And then finally on the sort of the refreshment category, are you moving in the right direction there, would you say in terms of recovery...

[Henri de Sauvage Nolting, executive]

Yes, we're absolutely going in the right direction. If you dissect it a little bit, it's pastilles and gum because it's 2 different categories. We see growth in [ this ] or the top line growth in the pastilles category. So that's positive. But we're not winning market share everywhere because we can see mainly that cough and cold, that is cold, so people who are now having a flu again after the corona that segment is growing. We can also see that with our Mynthon brand in Finland that we have really good growth. That is basically the only brand we have, which is very much into cough and cold. So we just need to become more competitive and that's why I showed as well in the presentation, which you can see that we are focusing, for example, on the younger target group with like Lakerol Lemon or the YUP Pride. So we see that, that's one of the areas where we can do more.

And then on the gum, we have the Dutch business, it's really growing well and then the Finnish business, we still have more work to do to get that back into growth. This has our full attention, Nicklas.

[Operator]

[Operator Instructions] There are no more questions at this time.

[Henri de Sauvage Nolting, executive]

Good. Well, then I would like to thank you. Concluding really pleased with the results, both on the top line and the step-up in profit based on the volume and mix, lot of work to meet on a daily basis, the global supply chain challenges, as well as the continued pricing and that has not gone the way, it's also not easing. We see continued input cost step-ups, which we are compensating with pricing, that is the focus for the coming at least 2 quarters, I would say.

So thank you very much. And see you hopefully in September.

[Operator]

Ladies and gentlemen, the conference is now over. Thank you for choosing Chorus Call, and thank you for participating in the conference. You may now disconnect your lines. Goodbye.