Engcon AB

STO:ENGCON B

Earnings Call Analysis

Engcon Sees Order Intake Rise Amid Revenue Challenges

Engcon's financial performance is gradually recovering with a 26% increase in order intake across all regions. However, net sales decreased by 12% compared to last year due to lower volumes. The company's gross margin stands strong at 45%, and the EBIT margin is solid at 18%, close to the 20% target. There is a noticeable increase in demand across Europe and Japan, while North America faces challenges from high-interest rates. Looking ahead, Engcon anticipates a stronger recovery in 2025, especially in the Nordics, as the market adjusts to macroeconomic conditions.

A Resilient Business Despite Challenges

In the recent earnings call, Engcon presented its business outlook amidst economic headwinds. The company, a leader in tiltrotators, is witnessing a gradual recovery in its financial performance. Despite a revenue dip, there are increased order intakes across all regions, signaling a positive trend. This shift indicates a reduced dependence on specific markets, enhancing the company’s overall resilience.

Key Financial Metrics and Performance

Engcon reported a revenue decrease of 12% to SEK 450 million for the quarter compared to SEK 508 million last year. However, its gross margin improved to 45%, reflecting favorable market conditions and product mix. These metrics position the company well, particularly as it strives for an EBIT margin target of 20%, achieving 18.2% this quarter. Notably, EBIT fell by 21% to SEK 82 million, but the strong gross margin suggests robust underlying efficiency.

Geographical Insights and Market Trends

Engcon pointed to Europe as the strongest market, registering growth in order intake for four consecutive quarters. Key contributors include successful exhibitions like Intermat and a shift towards tiltrotator adoption across smaller machinery. In contrast, the American market faced significant challenges from high interest rates, resulting in a 38% decline in net sales. Positive growth was noted in Canada, hinting at potential recovery. Engcon also seeks to bolster its market presence in Japan, which has shown rising interest in tiltrotators.

Strategies for Future Growth

Looking ahead, Engcon remains cautiously optimistic. CEO Krister Blomgren indicated expectations for continued order intake growth through gradual recovery phases. However, meaningful growth is anticipated in 2025, particularly in the Nordics where aging excavator fleets present replacement opportunities. The company is strategically investing in sales initiatives to educate clients on tiltrotator benefits, aiming to enhance market awareness.

Operational Adjustments and Management Changes

In a move to strengthen its operational capabilities, Engcon will appoint a new Chief Operating Officer and restructure its leadership roles. This decision underscores the company's commitment to preparing for increased demand once economic conditions stabilize. The proactive management approach reflects Engcon’s long-term vision of changing the digging industry through innovative technology.

Conclusion: A Company Preparing for Recovery

Engcon's latest performance metrics and strategic initiatives point toward a resilient company poised for recovery amidst challenging market conditions. While current results reflect transitional difficulties, the anticipated demand for tiltrotators signals a potential shift in fortunes. By focusing on education and market presence, Engcon aims to solidify its position in the industry. Investors should closely monitor the company's adaptability to market changes, alongside its trajectory in product adoption and order intake growth moving forward.

Earnings Call Transcript 2024-Q2

[Krister Blomgren, executive]

Hello, everyone, and warm welcome to engcon's presentation of the second quarter 2024. My name is Krister Blomgren and I'm the CEO here at engcon. With me today, I have our CFO, Jens Blom. Together, we'll take you through the highlights of the quarter and then we will move on to the Q&A session. So let me start talking a little bit about our vision. Our vision is to change the world of digging and with that, we are referring to our mission and vision to revolutionize the construction industry specifically within exploration and digging. We are the leading manufacturer of tiltrotators and by introducing innovative technology and engineering solutions, we aim to transform the traditional digging methods and make them more precise, productive and sustainable. Our tiltrotators allow excavators to have 360-degree rotation and 45 degrees tilting, enabling operators to perform complex tasks with greater ease and accuracy.

Our goal is to optimize digging operations, streamline workflows and reduce environmental impact by minimizing material waste, fuel consumption and machine wear. We believe that by improving digging techniques and equipment, we can contribute to a more efficient and sustainable construction industry. Looking into little bit on the highlights. We continue to grinding our way back on revenue and profitability. We have a high gross margin level on 45% in this quarter, which is mainly impacted by favorable market and product mix. Positive is also that we see an increased order intake in all regions so we aren't depending on 1 region or market. Europe continues to have a strong performance and now for the fourth quarter in a row our biggest region on order intake. In our go-to-market strategy, the meeting with end customers absolutely the most important thing for us.

During the quarter, the exhibition season has started with Intermat in Paris, the Swedish Machine Fair in Stockholm and CSPI in Tokyo among others. These shows give us the opportunity to meet our end customers and the industry colleagues. We also get the opportunity to get a good view how the tiltrotator market is developing. And since Bauma in Munich in the fall of 2022, we have seen a clear trend that the tiltrotator is on its way to becoming an established and recognized product in the digging world. That tiltrotator is more or less in every OEM's booth on these shows nowadays. If we look into the numbers then for the second quarter, we see the net sales decreased 12% organic compared to the high levels last year. During the Q2 2023, we still had a boost from the strong order book. The net sales continued to recover for the second quarter and we see that some markets actually outperformed 2023.

On the order intake, we see an increase of 26% versus last year and I'm really glad to see how all regions increased versus last year. On the gross margin, as I mentioned earlier, we're having a high 45% and it's mainly the favorable product and market mix that give us that high margin. It's really strong especially since we are still on lower volumes. EBIT margin amounts to 18%. Increasing net sales together with the strong gross margin has taken us back to a solid level even though we in the quarter see increased selling expenses connected to trade shows and even if it's increased, net sales is still on a pretty low volume as I mentioned earlier. If we're looking on the return on the capital employed, it amounts to 28% and it's calculated as always on 12-months basis. And Jens will guide you more regarding that later on in his comments then.

So let's move on and take a closer look on the net sales and order intake. On the order intake, continue to increase gradually and we see a strong improvement from last year. I'm very glad to see that all regions are increasing. Excavator sales have dropped in our major regions. Despite that, we can see an increase in order intake. In 2023, the dealers had a lot of tiltrotator in stock and they sold from their own stock instead of ordering it from us. Now the stock of tiltrotator is slow and the demand is increasing. The current situation is now that dealers have a high amount of excavators in stock and don't want to carry tiltrotators in stock also. This means that we need to have a short lead time to deliver when they sell excavators now then. Going over to net sales, the net sales decreased organic with 12%. We are behind 2023 when we were supported by a strong order book as we mentioned.

And I'm glad to see that the net sales continued to increase for the second quarter in a row after the dip in Q4 2023. If we take a look at the order book. In the quarter we can see a small reduction on the order book, but it has been gradually growing since third quarter 2023 then. Let's move on and dig deeper into the regions and we're starting with the Nordic. And demand is gradually increasing and we're seeing a recovery with order intake increasing organically by 30%. Stock levels at dealers are low compared with last year and a gradual increase in willingness to invest is having a positive impact for us. However, we need clear positive signals are necessary for them on a macro level to achieve a broader and more powerful upturn in the region. And what speaks for a faster recovery then? One thing is that the excavators sooner or later need to be replaced.

Last year's replacements has been delayed due to a slow construction sector and it continues during this year. Then users need to update the fleet to avoid high maintenance cost and risk of downtime on the excavator. Further, the excavator stock has been growing at the dealers and depending on how they decide to do with campaigns, will they run campaigns to get rid of the stock or not? If they run campaigns, that can give us a boost in the sales in short term since roughly 90% of the excavators are equipped with tiltrotators in the region. If we look into some numbers for the quarter then, the order intake showed strong increase of 30% organic growth even if it's a little bit mixed signal in each market. Finland and Denmark is taking the lead in Q2. Net sales is 11% behind last year, but continues to grow over the quarters. At the same time as we're having this increase in order intake, the excavator sales has been dropping in the Nordics.

We're moving over to Europe and Europe continues to demonstrate an impressive performance maintaining the highest order intake among all regions for 4 consecutive quarters in a row. It's important with this positive performance across all major European markets. For example France continues to develop showing strong growth also after Intermat exhibition. Intermat is the third largest construction exhibition globally then. Our products have been gaining significant interest in the region as we could see at Intermat. Tiltrotators and hydraulic tools were showed in the majority of the exhibitors' booths mirroring the trend that I observed at Bauma 2 years ago, certainly was tiltrotators in more or less every booth similar to what I saw 8 years ago at Bauma with hydraulic quick couplers and they have really been taking off in Germany after that. We're also having a shift into higher adoption of the tiltrotator concept among smaller size machines in Europe.

This is an important step since the cost for tiltrotator is much higher compared to the machine -- comparing to the machine on the smaller machines. And it's also indicating a growing knowledge about the benefits and value offered by tiltrotators across the construction industry. Let's dive into some numbers also then. The order intake increased strong with 28% organic and we also see a small net sales growth of 4%. We're seeing a convincing order intake increase in the major markets; France, U.K., Netherlands; and we also had a good start with our partners in the DACH region. As with the Nordics, order intake increased despite the drop in the machine sales. We're moving over to Asia-Oceania. That is currently our smallest region where Australia is serving as the main driving force. If we're looking at performance, Korea had a strong first quarter but experienced a decline in second quarter. This pattern follows the pattern of the machine sales in Korea.

But it's important for us to not simply follow that trend especially considering that significant untapped market potential we have in Korea. Our business operations in Japan have mainly been around OEMs making it challenging to figure out specific trends since they are buying more or less in batches. We are recently taking a more proactive approach in Japan following a change in our agreement with Kobelco transitioning to a nonexclusive arrangement with them. And then to boost our presence in Japan, we have signed agreements with a local Volvo distributor and a dealer/influencer. This partnership will greatly assist us in marketing particularly on social media platforms. The Japanese market are significant different from other markets so it's good to get local presence as we get there with these agreements. Overall, we view Japan as an increasingly attractive market. The combination of an aging population and a growing labor shortage shows the need for more efficient digging solutions.

During my visit to CSPI in Tokyo in this quarter, I observed a rising interest in tiltrotator and hydraulic tools in general. Every OEM had a tiltrotator in their booth. That's a big shift compared to just a year ago. However, there's still a long way to go as the majority of end customers have yet to adapt to quick couplers and regulations for OEMs remain unclear regarding tiltrotators. Nonetheless, our ambition is to become big in Japan as Alphaville sang in their song. If we take a look on some numbers, we have a strong order intake increase of 47%, however, with lower net sales versus last year with 27%. We're going over to Americas. In the American region, we are seeing stabilization at a lower level in terms of order intake and net sales. We have faced challenges during the high interest rates on our products and difficulty in securing finance to subsidize these rates as well as a lack of awareness about the tiltrotator concept in the market.

It is key for us to educate both the dealers and end users about our offerings and we must stay true to our go-to-market strategy and understand that there are no quick fixes. In the current quarter we have seen a 38% organic decline in net sales in the American region. However, there are signs that the order intake is stabilizing on lower levels. We have a small increase this quarter with 5% on the order intake. It might be too early to clarify this as a positive trend. We need to closely monitor signals in the upcoming quarters. It is important for us to improve our sales efforts and educate end users about the efficiency gains from our products. Considering the challenge in finding labor in construction sector, our product is a great alternative for that. If you're looking on the positive side on the American region, Canada showing good numbers states. This is actually their strongest quarter ever even though it's from lower numbers, but it's still a really positive sign from Canada.

Then I will hand it over to Jens to guide us through the financial development. So take over, Jens.

[Jens Blom, executive]

Thank you, Krister. Let's start with an overview of the EBIT and EBIT margin. EBIT has decreased by 21% from SEK 104 million to SEK 82 million and the margin is 18.2% compared to 20.5% last year. And as you can see, we are now moving towards our financial goal of an EBIT of 20%. Now let's dig little bit deeper in the profit and loss. We have a net sales of SEK 450 million compared to SEK 508 million and on a rolling 12-month basis we are having SEK 1.5 billion. The gross margin is 44.9% compared to 40.6% and on the 12-month basis we are at 42.1%. If we move further down, it's notable that the selling expenses have increased to SEK 73 million compared to SEK 64 million, which is mainly explained by our participation in 2 large exhibitions during the quarter. If we continue further, we can see that the result has been affected by this change in our business system by SEK 10 million compared to SEK 9 million last year.

And if we wrap this up on the bottom line, we have an EBIT of SEK 82 million compared to SEK 104 million and on the rolling 12 months, we had SEK 216 million. We're going to look little bit on cash flow and on net working capital. The operating cash flow is SEK 32 million compared to the record strong last year on SEK 277 million. The lower cash flow is mainly explained of a lower profit. And net working capital as part of net sales is 29% compared to 23%. And our liquidity reserve is SEK 300 million compared to the record strong SEK 421 million last year. Now we're going to look closer on our efficiency. The ROCE ends up at 27.8%, which is lower than last year and that's due to lower profit and more capital tied up. Since we have invested more in both the ERP system and fixed assets, it affects both the result and the capital binding and the consequence is that we have a lower ROCE. However, these types of investments will give us a good position to meet the upcoming quarters and further growth.

And with that said, I will hand over to Krister, who will take us through the financial targets and give us the summary.

[Krister Blomgren, executive]

Thank you, Jens. Our targets are measured over business cycle. If we look on the growth, we have a decrease from last year, but now we are on a positive trend. If looking into the profitability then, I'm proud that we are closing in on our targets even though we still are at lower volumes. We are now on solid 18% EBIT margin and our target is 20% over business cycle. Taking a look at the capital efficiency as Jens went through earlier on. We are lower on our target as Jens mentioned earlier. If we take a look at the capital structure then, we are well above our target with 52% and we also have paid out 1 or 2 dividends in Q2 so we are well prepared for future growth. Coming into the summary and update. Our financial performance is gradually recovering with increased order intake observed across all regions reducing dependence on specific markets or regions.

We have a really strong gross margin of 45% and, as mentioned earlier, is influenced by favorable market condition and product mix. Europe remains the top region in order intake for 4 consecutive quarters with a successful exhibition Intermat contributing to the positive trend. And most of them or all the major markets in Europe like France, U.K. and Netherlands and the DACH region showing convincing order intake growth. This growth in Europe is despite a drop of the machine sales in the region. Asia-Oceania driven by Australia holds potential for growth despite fluctuations in performance in markets like Korea. And we've also been taking proactive measures in Japan, including partnership with local distributors and influencer, and we aim to increase our market presence given the rising interest in tiltrotation hydraulic tools in Japan.

In the American region, sales stabilization at lower level is noted with challenges of high interest rates and lack of market awareness about tiltrotator's benefits. The positive side in America is that Canada posted a strong quarterly performance indicating positive trends then from low numbers. Overall, the focus is on increasing market presence, addressing the challenge that we have and use our growth opportunity across all regions then. And then in the ongoing patent dispute, we have appealed the decision to grant the patent in question to the European Patent Office, EPO, and we requested that the patent be declared invalid. After consulting with our legal advisers, we have withdrawn our appeal to the EPO. This doesn't really mean anything in the lawsuit in Sweden. They already had a patent when the district court released the verdict that we did not infringe the patent.

And regarding if it will affect our future technical developments, we judge that this is not the case. We don't see any issues with it right now. And we also have some other positive things there. We strengthened our group management by creating a new role of Chief Operating Officer, COO. The change is being made to create better conditions for future expansions. The position will be filled by engcon's former Head of Sales, Anders Smith, who is returning to the company and I'm really happy to have Anders back. As we have earlier announced, Jens Blom is now taking on new responsibilities within engcon. He will from August be a specialist within accounting and tax and Marcus Asplund will take over as CFO from August. And I would like to thank you, Jens, for all the things you have done during our journey as the CFO. We have been working together for many years and we have complemented each other in a great way. And so happy that you are staying within engcon so we can keep on changing the world of digging together. Thank you, Jens.

[Jens Blom, executive]

Thank you, Krister, for the fine words.

[Krister Blomgren, executive]

And then we're wrapping it up with looking ahead. We see a gradual recovery compared to last year for the upcoming quarters. Even if we have increased order intake in all regions this quarter, we don't expect a fast recovery during 2024. We believe it will be a stronger recovery in the Nordics in 2025 since end users in the Nordic region must consider updating the excavator fleets as few changes have been made during the 2 last years. All the machines are associated with increased maintenance costs and high risk of downtime. This scenario with updating the fleet could drive rising machine sales in 2025 especially in the Nordics.

We are preparing ourselves and our suppliers for an increased volume because short lead times for tiltrotators will be crucial given that dealers currently prefer not to hold inventory. We are also well positioned for future growth. Our vision is to change the world of digging. Despite uncertain times and weak economy, our strong financial position has enabled investments in the sales organization, a new business system, new product generation and we also invested in management. Together with our business model based on capital efficient and a scalable production, this will enable us to meet market demand when the economy recovers. As we have said earlier, our goal is to come out strong after a downturn and I believe we are doing that now.

We will now open up for questions that can be asked in the telephone conference. Operator, please go ahead with the first question.

[Operator]

[Operator Instructions] The next question comes from Agnieszka Vilela from Nordea.

[Agnieszka Vilela, analyst]

Krister, you talk about slight growth in your outlook for the coming quarters. What do you refer to? Do you mean the kind of order intake year-on-year? And also maybe does it mean that we should expect just stable sequential orders for you in Q3 and then maybe some typical preordering in Q4?

[Krister Blomgren, executive]

Yes, something like that that we are seeing a smaller increase compared to last year. But Q4 of course might be a little bit higher preordering effect there compared to last year where it was really low preordering effect and our net sales was also really low in Q4. But we don't expect a big growth as we're trying to explain. But for 2025, we are more optimistic.

[Agnieszka Vilela, analyst]

But when you talk about slight growth on the group level, that's still kind of the Nordics that's being a bit more muted, the outlook there?

[Krister Blomgren, executive]

Excuse me, I couldn't really hear you.

[Agnieszka Vilela, analyst]

So looking into the regions, what kind of growth do you expect? Is it the Nordics that is the reason behind the growth rates slowing down a bit?

[Krister Blomgren, executive]

I mean both. We see a big decline in Americas of course also that we didn't really foresee maybe earlier on and we also feel that the Nordics is not really taking off. And as we mentioned, we think they need even more positive macro signals for getting that faster recovery that we are looking at. But we also know that normally then if we're not getting those signals, we don't think that the Nordics where you're having normally a winter season where they maybe can't see so they will probably not invest into tiltrotators or actually excavators then during Q4. They will get those machines in Q1, Q2. So that's why we're expecting the bigger growth coming in early 2025 more instead of late 2024.

[Agnieszka Vilela, analyst]

Perfect. And then maybe on Americas, you had some challenges there. Can you talk about the progress that you are making in the region? And also Krister, you mentioned that you try to increase the sales effort in what way? What are you doing there?

[Krister Blomgren, executive]

The challenges that we had and felt that we've been working with a lot have been on the service and support side and that I think we have been doing good job now. The feeling is that we're fulfilling the needs from the customers and with extra help from Europe where we send over, we are covering that in a good way. What we need to do better is staying true to our go-to-market strategy where it's a lot about educating the people about the benefits of the tiltrotators and so on especially now when it's a higher interest rate and you're actually getting -- it costs you money to invest in the tiltrotator. Then you need to believe in all the benefits that you get with the tiltrotator that you're actually going to make those money back and even more. So earlier when the interest rate was much lower, it was easier for them to gamble a little bit more on it. Now they need more type of proof on the benefits. So that's what we need to be better at and we have. We've been working with sales training materials and so on. We've been running sales training for our staff not only in Americas; but in Europe and Asia and also in the Nordics and so on; to have the benefits that tiltrotators are having, but also the benefits engcon having compared to our competitors.

[Agnieszka Vilela, analyst]

Great. And then maybe just on the profitability. You reached close to 45% gross margin in the quarter despite volumes presumably still being rather low. So can you talk about the drivers behind profitability improvement?

[Krister Blomgren, executive]

It's a positive. On the product side, the right products of course. When we're having a lower volume, our spare parts are increasing in percentage of the revenue and that's of course helping us. And this is the season where you're doing a lot of repairing and so on since the building season is fully up and running now in Q2. So that's of course 1 big part. And then also a positive market mix where Europe is strong and we're having a good margin in Europe. So that's also a positive sign. So it's a little bit mix of a lot of smaller things with products and market mix.

[Agnieszka Vilela, analyst]

And then just last follow-up from me before I get back to the queue. What proportion of your sales is the aftermarket like repairs and spare parts?

[Krister Blomgren, executive]

Jens, do you know exactly? Otherwise I will do the famous guessing.

[Jens Blom, executive]

I don't have exact figures in my head right now.

[Krister Blomgren, executive]

If you don't have exact numbers, normally we are somewhere around a little bit above 15% and then when the volumes goes down, it's increasing up to around 20% of our revenue.

[Operator]

[Operator Instructions] The next question comes from Agnieszka Vilela from Nordea.

[Agnieszka Vilela, analyst]

Okay. And then it's me again. So just maybe on the dispute that you have. What was the reason really to withdraw the appeal with the patent office?

[Krister Blomgren, executive]

I can't really comment on the reason behind it. There was an advice from our legal adviser and it's an ongoing process that we're having then in Sweden so unfortunately, can't comment on the reason why we withdraw.

[Agnieszka Vilela, analyst]

All right. And then maybe the last one for me. On Europe, you mentioned that you do see higher interest for tiltrotators. Maybe you can talk a bit about the momentum in different markets, penetration rates and what you're doing yourself to capture that kind of growth?

[Krister Blomgren, executive]

Yes. What we see in Europe is a positive thing. If we're taking France as an example, then we see growth both in regions where we've been weaker, where the interest for tiltrotators are increasing; but we also see, as I mentioned, a higher adoption rate from the smaller size machines. So the growth is coming both from new regions within France in that case, but also with smaller machines and that indicates, as I mentioned, that if you're willing to invest in smaller size machines, then you really start understanding the benefits of the tiltrotator because that's a hard thing to make the calculation on those since the tiltrotator is pretty expensive compared to the machine then.

In U.K., we see a lot of positive things trend on that they're having a hard time finding labor after the Brexit. So that means that they even starting looking to more technical solutions and also that the operator is getting more to say about it and wants to have tiltrotators more in that way. So that's been a lot of the shift there in the U.K. We also see positive signs on the macro level with the new government in U.K. that are talking about house building and starting up projects regarding that. So I think there are a lot of good signs all over in that way. But they are also not just 1 thing. There are more than 1 thing and that's also really positive. So it's not something that can be broken fast in that way since we have more trends than just 1.

[Agnieszka Vilela, analyst]

And then maybe a follow-up. Do you feel that you will need to invest more in your sales organization or do you think that your current organization, the kind of power that you have would be more efficient and will be able to cover more sales so to say?

[Krister Blomgren, executive]

I don't think there will be any drastic investment we need to do. We decided to try to keep our sales organization pretty as it was even during this downturn. So in that way, I don't think we need to invest in a major investment. It might be those bigger countries. If we see that we are getting increase in the southern part of France for instance that we might need to add something, but not any big thing as I see in front of me like that. And of course if we decide to go into some new countries or something like that, then of course we need to invest into new people there.

[Operator]

There are no more questions at this time. So I hand the conference back to the speakers for any closing comments. Please go ahead.

[Krister Blomgren, executive]

Thank you, everyone, for good questions. And if you have any further questions, please don't hesitate to reach out to any of us. We are more than happy to help you out with that. And thank you for listening in today and we hope to see all of you soon again. Thank you very much from engcon team.