Engcon AB

STO:ENGCON B

Earnings Call Transcript 2024-Q3

[Krister Blomgren, executive]

Hello, everyone, and warm welcome to engcon's presentation of the third quarter 2024. My name is Krister Blomgren and I'm the CEO here at engcon. With me today, I have our new CFO, Marcus Asplund. Together, we will take you through the Q3 report with the highlights and the key financials of the quarter, and then we will move on to the Q&A session after that.



I will start with some background before we move over to the highlights of the quarter. We're still having a lot of uncertainties in the world and in the construction industry. It's relative high interest rates, even if they have started to cut both in Europe and U.S. We also have the election in U.S. coming up soon. Excavator sales are down more or less everywhere in the world. We see that the dealers having stock of excavators. So if the sales start to pick up, we can have a good growth since we more or less doesn't have any stock anymore at the dealers.



We also see that is some good signs on the macro level with lower interest rate and also a budget proposal of infrastructure projects and also signals of increased start of building projects. It will just take some time before the confidence is coming back to the construction industry. During that time, we need to keep educating everybody in the industry about the benefits our products have for the productivity, profitability and also the sustainability advantage we give to the customers.



If we're moving on to the highlights of the quarter then, I'm really proud of our team's strong performance in the quarter with an EBIT margin of 22%. The EBIT margin is a result of the high gross margin and lower selling costs.



Once again, we demonstrate that we can deliver profitability that are above our financial targets despite relative low sales. The gross margin was an impressive 46% compared to 4% for the quarter last year and was primarily a result of strong market and product mix.



We can also conclude that our order intake is driven by Europe. And Europe is the engine of our growth this quarter and have been so the whole year and continued strong demand in the region led to an organic order growth of 39% and a net sales growth of 42%. We also have an experienced and knowledgeable organization and a greater awareness of the tiltrotator concept. That combined with the partnership that we have been starting in the past few years have been proven valuable for growth in the European region. The feeling right now is that we have a good momentum in Europe.



We also have been awarded some prizes that we are really proud of. engcon was awarded the Carnegie Sustainability Award 2024 in the category of Best Newcomer. Sustainability is spread through our entire organization as a driving force for innovation and serves as a cornerstone for future growth. And we're proud that we have been recognized in this sense for our work, especially with our third-generation tiltrotator and that our important efforts are benefiting customers, shareholders and society at large.



We're also very proud of that Stig Engström, the founder of engcon is appointed Entrepreneur of the Year in Strömsund, the heart of engcon. He has again been recognized in his and our hometown. engcon and the municipality is well connected and Stig and engcon are doing a lot of positive things for the people living in Strömsund.



Moving over to the numbers for the third quarter, and net sales continue to rise. It amounts to SEK 412 million compared to SEK 391 million last year and increased organically by 8%. Order intake amounted to SEK 367 million compared to SEK 347 million, also an organic increase on 8% compared to last year. This even though the Nordic and Americas had a weaker quarter. If we take a look at the gross margin, it amounts to a strong 46%, and it's explained by a favorable combination of deliveries to high-margin markets and a beneficial product mix.



The Nordic region is normally weaker from a gross margin perspective. A low share is positive for our gross margin. Now with a high percentage of spare parts, also the Nordic is having a high gross margin. 46% is high, especially on a lower volume level. We can see a couple of things that can lower the gross margin in the near future, and Marcus will come back to this as it takes us through the financials more in details later on.



The EBIT margin amounts to a strong 22%. The high operating margin is a result of the strong gross margin, coupled with our scalable business model. And also, if you're looking on the return on the capital employed, it amounts to 31%. It is lower than the record levels earlier, but the increase from earlier quarters now then.



So we're taking a look to the net sales and order intake. We can see that we are on a stable recovery. We have increase in net sales versus last year in the quarter. Also, the order intake continued to increase versus last year. The third quarter is historically a bit lower than Q2, and we can see that here also.



We see that Europe continue to act as the growth engine. At the same time, the Nordic region and the Americas are having a little bit tougher. So if we're going a little bit deeper into the geographical regions, and let's start with Nordics. It's continuously slow and show flat development versus last year. Demand remains low. And even if customers are needing to replace their fleets, high interest rates have led to cautious purchasing behavior right now.



What we see is a weak third quarter, even if it's normally a slower quarter than Q2. The machine sale is continuously low in the region, but the dealers have a larger stock of excavators. So if it takes off, it can go pretty fast up for us then.



To get the stronger recovery in the region, we need more positive macro signals that can give confidence to the construction industry. We are confident that the increase will come. However, it's hard to conclude exactly when. We also see signals like lower interest rate, increased started building projects for 2025 and also budget proposal for infrastructure projects. We also know, as I mentioned earlier, the need of renewal of the fleet. We believe that the recovery will start when the digging season starts in the end of Q1 in the Nordics then.



Moving on to Europe. The European region are the growth engine in the third quarter and have also been that during the year and are now our largest region if you're looking on rolling 12. The importance of the region is growing, and it makes up to 48% of the order intake in the quarter. And if you compare it to the 2023 when it was 34% of the net sales.



In the quarter, both net sales and order intake increased strongly, as I mentioned earlier, compared to last year. And Europe is our biggest excavator market in terms of newly manufactured excavators. It's only Asia, including China, that's larger, and it feels really good to see these positive trends on this important region. And it's also great to feel that we are well suited in this region with an established sales organization on the most relevant markets.



The sales organization are gradually spreading the awareness of the tiltrotator concept throughout the region. We are also entering in new segments. For example, we have step-by-step increased sales to smaller excavators, and we also have made a simpler tiltrotator for the smallest excavators up to 2 metric tons. Normally, it's harder to sell in the tiltrotator concept to smaller machines because it's a longer return of the investment. But with a simpler tiltrotator, we can offer it to a lower price and the step from a tilting coupler or tilting bucket is smaller for the customer to take.



We also see the strong contribution from the partnerships that we have entered in DACH region to serve mainly the German market. And with the broad development across many markets, we can now see that the hard work and focus on building the market starts to pay off in Europe. The interest in Europe is also one of the biggest reasons to why the interest from the OEMs are still picking up then.



Moving on to Americas. And unfortunately, we continue to see a weak development in the American region. The challenges in the Americas persist with a decline in order intake of 29%. It's high interest rates and a weaker economy combined with the soon-to-come election have set everything on hold. The conditions now are a little bit similar to where we were in Europe a year ago when we saw high levels of excavators in stock at the dealers and a slower market.



As we have previously mentioned, we are continuing our efforts to strengthen our organization in the U.S. We are now on track in the service organization with a local service manager in place. Logistics aren't an issue anymore. Now the challenge is within the sales organization and the currently weak demand. This is similar to what we have seen in Europe in earlier years. It is a little bit 2 steps forward and 1 step back. And right now, we need that step back to rebuild. The positive thing in the region is Canada. That continues to go strong, but the numbers are still too low to have a greater impact on the region.





Moving on to Asia and Oceania. In Asia-Oceania, order intake declined 6%. Since Asia-Oceania is our smallest region in terms of volume, major orders from OEMs lead to a considerable fluctuation in the order intake and net sales between the quarters. And Asia-Oceania is the only region with these type of orders. It can be like that one OEM is ordering something last year in Q3 and this year, it's coming in Q4 are opposite. And that makes these fluctuations, and it's harder to analyze Asia-Oceania than the other regions.



With that, I will hand it over to Marcus to guide you through the key financials.

[Marcus Asplund, executive]

Thank you, Krister. I'm very happy to have joined the engcon team and excited to share my first presentation on engcon's financial development for the quarter.



We see a continued strengthening of the results compared to the previous year. Between the quarters, EBIT increased strongly by SEK 36 million, which corresponds to an increase of 65%. We also see how continuously improved the EBIT margin since the low point in Q4 2023. In the quarter, we are now on a level above our financial target of 20% over a business cycle.



Let's go through the income statement in more detail, starting with the net sales. Like Krister was saying to, the net sales is driven by the growth in Europe. This is mainly a volume effect. The strong gross margin is partly explained by a favorable market mix as the volume in the quarter has largely been channeled through markets where we have higher gross profit than average. This is normally the effect when volume is less centered to the Nordic region.



We also see a more favorable product mix with a higher share of tiltrotators of total revenue at the expense of some other products with lower margins. In the quarter, we have started to see a negative effect from the strengthened Swedish krona. On the other hand, on the selling expenses, we have a bit of a tailwind from the stronger SEK as most of our sales companies uses other currencies.



Generally, on the expenses side, I am pleased to see that our scalable business model runs through the whole income statement. The administrative expenses remain unchanged year-on-year as the implementation costs for the ERP will continue to be elevated also in Q4 due to implementation on Hypercare period in Poland. This means that by the end of this year, the production units will have been implemented.



On the R&D side, we have high activations in the balance sheet due to further development of the third-generation tiltrotators. The total R&D expenditures corresponds to 3.2% in the quarter and 4.2% of the net sales year-to-date. All in all, the higher net sales, the strong gross margin and stable OpEx gives a good EBIT result of SEK 91 million, corresponds to a gratifying EBIT margin of 22% in the quarter.



Moving over to the cash flow. The cash flow from operating activities increases from SEK 108 million to SEK 144 million. We can conclude that the net working capital remains on the same level as in Q3 2023, and the strengthened cash flow is driven by the higher operating profit. The unutilized total liquidity per the last of September was SEK 417 million. As a side note here, the dividend payout was carried out on the 3rd of October.



Return on capital employed continued to recover compared to last quarter and is expected to continue to move upwards towards our target for the coming quarter.



Focusing then on our financial targets before I leave the word back to Krister. It is good to see that we're back to growth on net sales, even though it's purely driven by Europe and partly offset by a weaker Nordic region. As mentioned before, a strong EBIT margin exceeding target, and the return on capital employed is recovering and is expected to grow. And we continue to have a solid equity-to-asset ratio above target.



And by that, I hand over to Krister to summarize it all.

[Krister Blomgren, executive]

Thank you, Marcus. If we're taking a look on and summarize it and as Marcus talked about, the gross margin improved considerably and amounted to the 46%, as we talked about earlier for the quarter, and that was primarily a result of the strong market and the product mix. And we also have the really strong EBIT in the quarter, and that was also a result of the high gross margin and the lower selling cost.



The third quarter really demonstrated that our business model is scalable, and we can have high margins even on lower volumes. We also see that the order intake is driven by Europe. Europe is the engine of our growth and continued strong demand in the region led to an organic order growth of 39% and a net sales increase of 42%. We have a more established and knowledgeable organization there and the greater awareness of the tilt rotator concept that combined with the partnerships that have been started in the past few years have proven valuable for growth in the European region. And the good thing is that we are growing on the exco market that is down, so the penetration level are increasing.



In the Nordic region, the order intake remains at the same level as last year. Demand remains low even if customers need to replace their fleets, they are cautious and waiting for positive signals and the digging season to start. The challenges in the Americas are still there, high interest rates and a weaker economy, combined with the upcoming election have led to cautiousness in the market.



As we have previously mentioned, we are continuing our efforts to strengthen our organization in the U.S. We now have service and logistics organization that we consider to be stable. We need to keep working to improve the knowledge and strengthen our sales organization so they can educate the market during the slower times.



And we also see the sustainability as a future growth driver for us. And with engcon, you get sustainability with the increased productivity. That will be the key drivers for future growth. You don't have to choose, you get both together with engcon. And we don't settle with working only with the environmental part of sustainability. We also add a lot to the safety, both for the people around the machine and also the operator inside the machine.



We believe that CSRD will have a great impact in Europe. And if we push it right, it will be beneficial for us since we both have the sustainability part and also the increase of productivity.



If we're trying to look a little bit ahead then, in the fourth quarter, we do not foresee any major prebuy effects since no major price increase has been communicated, and also to this, the interest rates remain on high levels. And for a stronger recovery in the Nordic region, we need those more positive macro signals that can give confidence to the construction industry. And as we mentioned earlier, we are confident that the increase will come. However, it's hard to conclude exactly when.



We also see the signals like lower interest rate, increased started building projects for 2025, and the budget proposal for infrastructure projects that will push the market to start growing again and also have the need of the renewal of the fleet. So we foresee increased demand in the Nordic region when the digging season starts in the end of Q1. But regardless, we are well positioned for more or less whatever the future will bring. We feel confident with our business model. It is scalable, and we can have high margins even on lower volumes, and we know that we can ramp up if the demand picks up. And with the dedicated people within engcon, we will continue to change the world of digging.



That was all in the presentation, and we will now open up for questions that can be asked in the telephone conference. So operator?

[Operator]

[Operator Instructions] The next question comes from

Zino Engdalen Ricciuti from Handelsbanken.

[Zino Engdalen Ricciuti, analyst]

Just starting off with the gross margin, of course, you said that there was a positive effect from both the market and the products. But just to clarify on the product mix, looking also when you compare to the last quarter, is it that there's a larger amount of the spare parts, so to say, that explains the uptick?

[Krister Blomgren, executive]

Mainly in the Nordic region is it where the -- we see that product mix is that we're having higher spare parts, of course, because of also the total lower revenue in the Nordics, then it's become a higher part of the spare parts there. And as I said earlier, it gives -- normally, we're having a weaker gross margin in the Nordics. If you're looking on the market mix in that way then. But with having a lower part with that and a high part of spare parts, that gives us a higher gross margin there and that benefits also. But there are, of course, a couple of other things that is positive also for us.

[Zino Engdalen Ricciuti, analyst]

Okay. Very clear. And just looking into Europe, which is the growth driver as you were saying, where do you feel that you will put more of the focus going ahead? Is it that you're trying to get on to more partnerships or strengthening the ones that you already have?

[Krister Blomgren, executive]

We -- as I mentioned, we're working a lot also with OEMs and trying to prepare the machines for tiltrotators. And that will be a key thing, not in short term, it will be more a long term because that make it much easier to put on the tiltrotator. So the barriers to get one gets smaller, and it's also pretty high price, especially in the Americas to make an install. So if we can get that down, it will be easier and get the return on investment even faster, and we can even have trial periods and stuff like that when we're getting into that.



So that's where we're working mainly with partnership right now. Otherwise, we are -- in Europe, we're sitting pretty pleased with all our markets. And in Germany, we got with the partnership with the help that we needed. But in the other markets, we are strong. So we don't really seeking partnership maybe right now short term.

[Zino Engdalen Ricciuti, analyst]

Very clear. And last question from me. When you -- when we're looking at the R&D costs, it's, of course, lower when you're comparing to the previous quarters. How should we think about that what we're looking ahead?

[Krister Blomgren, executive]

So yes, lower as in what comes into the income statement, yes, but not lower when we talk about what we put into -- I mean, overall R&D expenditure, and we are still very much putting -- activating a lot due to the -- we're deep in the third-generation tiltrotators development. So over time, as we said, I mean, an indicator, we like to be around 4% as an innovative company. So we are where we want to be there and what is needed right now, I would say.



And we can also say that we have now made the bigger part of DC3 and EC3, but we still have 7 more sizes that we need to do. We are more or less ready with the 319 and finishing that up, but we have 7 more sizes. So as Marcus said, we will keep on investing in that. And we also will need to keep on invest with the OEMs there for preparing the machines there. So I think we will stay on more or less the same level, even if it maybe dropped a little bit this quarter to 3.2 compared to 4.2 or something like that. But I would consider that to be a little bit slower, just this quarter, maybe because of the Swedish summer or something like that.

[Operator]

The next question comes from Agnieszka Vilela from Nordea.

[Agnieszka Vilela, analyst]

So maybe starting with the Nordics, you're positioning for the market recovery. But when we look at the quarterly orders, they went down by 25% sequentially in Q3. So yes, I think you mentioned, Krister, that the recovery will not come before the Q1 season. So can you give us any kind of guidance what you expect from the orders for Q4? Or when will the orders pick up in the Nordics?

[Krister Blomgren, executive]

As you said, we believe that the orders recovery will start to be seen more in end of Q1 where the digging season starts. We don't expect any bigger preordering part in the Nordics since the price increase is low and the interest rate is still high. And the dealers don't want to keep stock.



Right now, they're still having a lot of excavators in stock. So they don't want to tie up any more capital in that way. So as we're saying in this, we're expecting to start seeing the recovery in 2025 and end of Q1. So not that much in Q4 to pick up that much compared to last year.

[Agnieszka Vilela, analyst]

All right. Perfect. And then on Europe, do you expect an acceleration now in the coming quarters? And also, if you can help us to understand how much kind of sales from the -- your cooperations with the distributors in that region helped orders in Q3? Will you be kind of a bit tougher comps now in the coming quarters because of that?

[Krister Blomgren, executive]

Yes. We -- we believe that we will continue to have good growth in Europe. We -- as I said, the feeling is that we have a good momentum there. The good thing is that it's not only one market that is doing good. It's -- almost all of the markets is doing good. So in that way, I think we can continue to be on a good growth level. And might be if one market is slower, the other ones will compensate for that.



So, we will stay on high margin or high growth. So, it's a little bit hard to say how much we have depended on our partnership in Germany. It is not a huge volume. So, I'm not worried that we should see that it's slowing down because of that. So -- because we're doing good in all regions right now. So that's the positive thing -- markets.

[Agnieszka Vilela, analyst]

Yes. And then my last question, I think, Krister, you mentioned that you do see some headwinds maybe for the gross margin in the coming quarters, but I didn't pick up anything except for FX. So maybe some clarification there?

[Krister Blomgren, executive]

If the FX and since we also talked about when the Nordic is having a lower volume, so if Nordic starts to pick up, that might hurt the gross margin level a little bit.

[Operator]

The next question comes from Anna Widstrom from Carnegie.

[Anna L.Widström, analyst]

My first question is if we can go back to the Americas. Obviously, as you say, it's quite a challenging market currently. But given the volumes that we stand on now, what do you -- what could we expect near to midterm?

[Krister Blomgren, executive]

Good question. We still see challenges there. And of course, we believe that it's -- as I said, everything is a little bit on hold because of the election. And that will hopefully make -- when the election is done and people know who will be the President and so on, that means that it will pick up because there are still need. They have started up infrastructure projects and stuff like that. So, I believe it will come more and more from this level.



We are, of course, not pleased where we are. We definitely need to have an increase in North America. I mean it's no reason for us to -- it should be dropping since it's a penetration case. We are only on less than 2% penetration.



The positive things are Canada, where we see that we are increasing and growing. So, there are definitely signals there where we can keep on growing on the market. But to say how much and when, no, that's -- I don't dare to make any guessing on that.

[Anna L.Widström, analyst]

Okay. Great. And do you -- is your assessment that your competitors in the American market experience the same kind of challenges? Or has the market shares shifted in any way?

[Krister Blomgren, executive]

You never know exactly, but the feeling is that the market has slowed down a lot. All of us had pretty good deliveries on 2023, but it definitely has slowed down in the sense of, as we mentioned earlier, with the high interest rates and that the OEMs have been subsidizing their interest rates on their machines, but not on attachments that are not there.



Their own have made people looking like that it's a bigger investment to try a tiltrotator. And we -- the awareness of all the benefits of the tiltrotator is not there, like we are 3, 5 years behind Europe in that. We need to keep on working with that. We need to push out that to the market. And unfortunately, dealers are not normally good enough to open up the market. So, we need to do it the hard way by being on exhibitions, having demo days, meeting end customers and so on.

[Anna L.Widström, analyst]

Okay. And as you mentioned, the prebuying effect is not going to be that huge going into Q4 due to lower price increases. Should we expect like low single digits into 2025 on price effects? Or is it going to be flat basically?

[Krister Blomgren, executive]

One more time, I'm not sure I heard the question there.

[Anna L.Widström, analyst]

It's a question on the price effect going into 2025. You alluded to that it's going to be quite minor. Is it going to be flat? Or is it going to be a price effect of a few percentages compared to 2024?

[Krister Blomgren, executive]

Yes, it is -- yes, more or less just following the inflation right now than in that way. So, we don't doing anything more than that.

[Operator]

[Operator Instructions] There are no more questions at this time. So, I hand the conference back to the speakers for any closing comments.

[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 you all soon again. Bye, and thank you.