Engcon AB

STO:ENGCON B

Earnings Call Analysis

Diversification Cushions Sales Dip, EBIT Stable

In the full year 2023, the company witnessed a net sales decline of 6%, with a more pronounced 23% drop in the Nordic region. However, global diversification stabilized total sales, supported by a strong backlog from 2022. EBIT margin, though down to 6% in Q4, averaged around 20% for the year due to robust Q1 results. The European market played a pivotal role in compensating for declining Nordic sales. Despite the implementation of a new ERP system dampening the quarter's gross margin to 40.3%, the full year remained solid at approximately 42.3%. Operating cash flow was strong, with SEK 96 million for the quarter and SEK 486 million for the year. Complementing this financial health was an above-target Return on Capital Employed (ROCE) at 49.3%. The Board's confidence in the business model and stabilized order intake led to a dividend increase to SEK 0.94 per share. The company anticipates order intake growth by the second half of 2024 and welcomes a new CFO with international experience set to begin in August 2024.

A Transition in Global Sales and Growth Strategy

engcon, under the guidance of CEO Krister Blomgren, presented financials for Q4 2023 and provided a perspective for the future. Interestingly, the company's sales outside the Nordic region surpassed those within for the first time, with 57% of net sales coming from international markets. This represents a significant progression from a decade prior when the Nordics accounted for 88% of revenue. The increase in geographic diversification is pivotal, as shown by strong growth in the Americas, which contributed 15% to total revenue, up from 8% just a year ago.

Resilience Through Economic Cycles and Expansion Efforts

Despite enduring economic fluctuations over the past decade, engcon has managed a compounded annual growth rate of around 16%. With a historically solid EBIT average of 20% since 2017, the firm has navigated the 2023 challenges with an overall good profit, although Q4 saw weakened performance. Notably, they signed significant distribution agreements and orders in Europe and initiated a new logistics hub in North America, showcasing their commitment to long-term growth and market penetration.

Operating Efficiencies and Financial Prudence

While engcon's year-over-year net sales saw a slight decline of 6%, their commitment to efficiency and profitability remained evident with a strong operating cash flow. The company also maintains an impressive Return on Capital Employed (ROCE) at 49.3%, indicating healthy profitability relative to capital usage. These figures become significant as they reflect financial stewardship and resource management, crucial for ongoing investments in research and development as well as expansion into new markets.

Challenges and Outlook: ERP Integration and Market Trends

2023 was marked by challenges, including macroeconomic uncertainties, but engcon surpassed a historical milestone with over 50% of sales generated outside the Nordic region for the first time. The full year saw strong cash flows, giving the company confidence to raise dividends. Looking ahead, engcon anticipates order intake stabilization but does not expect significant growth until possibly the second half of 2024, indicating a cautious but optimistic future outlook.

Earnings Call Transcript 2023-Q4

[Krister Blomgren, executive]

Hi, everyone, and warm welcome to engcon presentation of the fourth quarter 2023. My name is Krister Blomgren. I'm the CEO here at engcon. I will take us through our financials for the fourth quarter and the full year 2023 and also the outlook looking forward. Normally, I have our CFO, Jens Blom with me. Jens is sick today, and I will, therefore, [indiscernible] the presentation on my own.

After my presentation, we'll move on to the Q&A session. If you have joined the telephone concrete, you will be able to ask questions. Let's start with our vision. Our vision is to change to digging. Today, only 2% of all [indiscernible] are using a [indiscernible] It is approximately 90%. We have reached that level already around 2018 in the Nordics.

If you look at this donut chart, if you're starting then with the donut from with 2012, you can see that the Nordics dominated net sales, 88% of our revenue came from the Nordics. The rest of the world was only 12%. We then move on to 2022. You can see that the rest of the world's net sales is 46%, but the Nordics is still the dominating part with 54%. And we said all last year that there was a milestone that the order intake in the rest of the world that year was greater than the Nordics.

And we have now reached another milestone this year, when we have more than 50% net sales, actually 57% net sales outside the Nordic region and getting less and less dependent on the Nordics. We can also see another positive thing how fast you can grow if we're looking between 2022 and 2023, you can see that the Americas has been growing from 8% to 15% of our revenue in just 1 year. This confirms that we are on the way to change the world of digging. And we're moving over to some historic data. On this diagram, we can see our development the last 10 years in business cycle than how we have performed.

Over this period, we've shown [indiscernible] approximately 16%. There are some bumps in the road, but we managed to grow 16% over this business cycle. And this was when the Nordic market, which is mature, we're dominating on our net sales. We believe that it will be easier to grow fast on new markets where we can do the penetration journey. You can also see that our EBIT level have been on a good level with some fluctuation. But from 2017, we have an average EBIT around 20%.

We have seen challenges in 2023, but we delivered good profit even if Q4 was weak. We believe that many challenges will remain in 2024, but we'll probably see a more normal pattern for our business for order intake and deliveries in the same quarter. History shows that a good growth after a dip and the Nordics have dropped a lot, and we grow back up again together with the further growth in the rest of the world. This will boost our future growth journey.

And then [indiscernible] taking some business highlights from the quarter. After closing Q4, we see continued stabilization of the order intake also if we exclude the small prebuy effect in the quarter. We have signed a strategic distribution agreement with [indiscernible] that will help us to grow in the [ DACH ] region, and they also placed the first order in the fourth quarter. We also received an order for [indiscernible] a French machine rental firm. That's an important milestone since this sector normally among the last ones to adapt to [indiscernible] since their business model is to rent out the machine by the hour, and we shortened the time the customer needs to rent the machine. So they really need to understand the benefits or they need to feel the pressure from the customer to take this step. So that's why we consider it to be a big milestone for us.

We also have started up our new logistic hub in North Carolina in U.S. It's now up and running with personnel on site. This will also be very important for our future growth in North America, where we can stock all the items that we need to stock, and we also can have some light assembling and we can also do some e-trumachinery on CNC machines to make our stock more flexible in that way.

But we are concerned about the development in North America. It is challenging there. We have grown fast and increased our geographical territory and also been adding a lot of new employees. This, together with our move down to our new logistic hub, that made us lose our sales focus. But we still strongly believe in the North American market, and we are following our development closely.

We have successfully implemented a new ERP system in our production company in Sweden, and we'll continue the global rollout over the year. This is a must for our future growth since its secure reliable support and is more future-proof compared to our old system. However, the high ERP focus has challenged organization and the profitability and use a lot of resources for us, both internal and external.

We are a penetration case, and we need our focus on sales and our international markets. Because of that, we have added sales focus and more international presence to the engcon Group management. And we believe now that we have the right people to lead us for the future growth.

We'll go into a little bit more numbers and figures, and we're starting with the net sales where we're having a big drop on 43%. And it's mainly two things that affect it: It's the big backlog last year and the supply chain problems that finally started to disappear. So we could deliver out a lot of units in 2022. This year, we have implemented a new ERP system, and it has slowed down our capacity and the demand is also much lower compared to last year.

And looking then on the order intake, it's also much lower, minus 26% compared to last year. That's also because of the demand is slower, but it was also a big preordering effect last year that makes a big difference. Positive is that we see a trend that order intake is stabilized for 3 quarters in a row now. We had no significant preordering this year. So Q4 is a little bit better than earlier quarters this year.

If you're looking into the gross margin, that is 40%, it's mainly affected by lower revenue and also the need for extra resources because of the ERP. If you take a look at the EBIT, that is 6% for the quarter. It's a high cost in relation to low revenue in the period. For example, we had SEK 10 million related to ERP consultants. That's alone is approximately 3% on the margin and of course, that we had a low revenue then. So we are following and looking at the development of the EBIT carefully, but we need the people for the ERP implementation and will -- and it will continue over the year. And we also want to be ready with our sales force and also trained sales force when the market gets warmer, and we can take market shares in that way. Our ROCE is at a good level of 49%.

If we take a little bit deeper look into the order intake. As I mentioned earlier, we can see that it's stabilized and it's 3 quarters in a row that we are in a stabilized level on the order intake. And we also see or predict that we will have a more normal year 2024 compared to '21, '22 and '23 with [indiscernible] is that we have short lead times, and we also delivered the majority of the orders in the same quarter. The net sales, SEK 308 million is slightly lower than expected when we compare it with the order intake we have seen in the last quarters. It's partly because of the implementation that has slowed down the deliveries. Another positive sign is that we have a positive book to bill ratio in the quarter as the order intake exceeds the net sales.

We're looking deeper into the order intake and we go to the regions, but still for the quarters -- for the quarter 4, we have a tough number to compare with on both order intake and deliveries. Last year, we had a big prebuy effect on order intake. And regarding net sales, we had a big order backlog, as mentioned earlier. And then the supply chain issues that were sold and we can deliver it out a lot in Q4 last year. This year, we have the capacity problems in production because of the ERP problem, and we have no order backlog.

Order intake is stabilized compared to earlier quarters, as I mentioned earlier. Looking deeper into each region then. The Nordics, it's a big drop in both net sales and order intake. The construction sector is in a standstill with a few signs of recovery in the near time. Our view is that we are dropping with the market. We are not losing market share.

If we take a look at Europe then, there we can see that the order intake is higher than last year. And that's thanks to the big order in France to the rental company. and also the bigger order from our new distributor in DACH. Regarding Americas then, as I said earlier, the development in North America is challenging. We have in growing pains from challenges with deliveries and installation. And as I mentioned, with geographical increased areas we are in and a lot of new employees.

This, together with our move down to -- our new logistic hub have made us lose our sales focus and have been over there, and we also have sent over more suites to help out with support and installs. And we have also made a lot of other actions to increase our sales focus and get us right back on it. We still strongly believe in the North American market, and we are following our own development closely then.

In Asia-Oceania, we have a stronger performance from all markets this quarter. This is, as I said earlier, is a market where we can get bigger orders from OEM quarters, which make it hard to see trends. But I would like to see that we see a positive trend, especially in Korea, where we started picking up from really low numbers, 2023. We're bad in Korea, but it's been much, much better lately where we're getting orders every week and so on.

So the positive thing this quarter are Asia-Oceania and the European order intake. We keep on looking on the regions then and the order intake and net sales, but now for the full year then. 2023 has reminded us of the importance of not be too dependent on individual markets. The net sales is down 6%. But however, Nordic is decreasing with 23%. This is another confirmation of how our increased global presence makes us less sensitive to circumstances on [indiscernible] markets.

This is, again, showing that we're getting less and less dependent on the Nordic market. So we can hold up our net sales and order intake in that way. We entered the year with a very strong [ backlog ] from high demand and component shortage in 2022. This led to record high deliveries in the first quarter of 2023. At the same time, economic uncertainties had a strong negative impact on the Nordic construction sector, not only the Nordic, but also in the European and had a general negative effect on the demand with a higher interest rate and so on.

We also had stock levels in the Nordics and Europe that had a significant negative effect on the order intake. 2024 is expected to be more normal in this aspect, might only be Finland, but still have some stock left with the dealers. A positive thing is that we -- to see that the Norwegian market with our new sales company, show a net sales increase and had a flat order intake on a year-on-year basis. The other regions show important contribution, especially on the net sales that compensate for the strong drop in the Nordics then.

Now we're going to go to the financial development. And here, it's normally when Jens Blom takes over, but I will try to do my best to fill his shoes and guide you through these slides also. We are starting with [indiscernible] see a big drop in the EBIT margin of -- down to 6% this quarter. The drop mainly depending on low revenue and higher OpEx in relation to the revenue. Despite that, we managed to keep a good EBIT margin on approximately 20% for the year. The majority of this EBIT came, of course, from our fantastic Q1.

Going over to the profit and loss. And here, if you start with net sales, we can see that for the quarter this year, we're having SEK 308 million compared to SEK 541 million last year. And for the full year, our net sales is SEK 1,898 billion compared to SEK 1,938 billion. So we're having a drop in the full year of 6%.

If we take a look into the gross margin level, it's 40.3% for the quarter and lower mainly because of low revenue and the ERP implementation. The ERP implementation wants more resources for us for implementing the new processes that we need to do to be able to continue to grow and be able to produce more units in the future then.

For the year, we are still on a good level on [ 42.3%. ] We also delivered a good result for the year with almost [indiscernible] even if the fourth quarter is low with 6%. In the quarter, we have high sales expense on 20% compared with revenue. We had invested in more people over the year in all regions, also in Norway since we now [indiscernible] own staff in Norway. This is an investment, as I mentioned earlier, for the future. And also exactly as our investment in the new ERP system that's also investments for the future to secure that we are prepared for future growth and expansion into new markets. We also continued investing in our third-generation [indiscernible]. Our total R&D costs, including activated in the balance sheet is SEK 72 million that makes it 3.8% of our total revenue.

I will go over to talk about our cash flow where we're having a strong operating cash flow, both for the quarter on SEK 96 million. And for the year, SEK 408 million -- SEK 486 million. This is mainly because of lower capital tie-up and that especially inventories and accounts receivable.

We will go over to our ROCE, and we have a good return on the capital employed. We are on 49.3%. And as you can see, if you're looking on the graph there where we -- it's the second best that we have for the last 5 years. So it's still a good level on that.

We'll go to the financial targets. And there, we start with that. We are proud that [indiscernible] in the challenging year still can reach most of our targets. Net sales is negative, minus [ 6 ] but we also measure that over a business cycle, and we also compare it to the market. And as we have showed on our historic data, we can have bumps in the road and still be able to grow fast over a business cycle.

We delivered at the EBIT margin with 20% and have an average on being on that level since 2017, as we also showed in the historical data. ROCE is still at a good level and above target at 49%. Capital structure, we are on a high level, 64%, so way above our target. And that, together with that, we have seen that the market has stabilized, opens up for the last financial target, that's the dividend. And then also here, are we delivering on target with 50% dividend or SEK 0.94 per share. This will be paid out in two different payouts as we did last year. So I think it's a good year, even though we are not reaching the net sales target this year.

If we're moving on to the summary and outlook. I'll start with a little bit highlights related to Q4. [indiscernible] the fourth quarter to the other quarters this year, we see the further signs of stabilization of the order intake would give us a lot of comfort with that. We also received important big orders in the European region from our new distributor [indiscernible] DACH and with the machine rental firm in France.

The net sales in the fourth quarter was slightly lower than expected. It has partly been affected by the lower delivery as a result of the ERP implementation. We also have a positive book-to-bill ratio for the quarter. We're trying to summarize the full year 2023. It's been a challenging year with exceptional strong start from a high order book, and we had a weakening net sales throughout the year as a result of macroeconomic and geopolitical uncertainties that together the ERP implementation put pressure on the organization and the profitability.

Despite that, we have passed historical milestone with more than 50% of sales generated outside the Nordic region. We made a smooth establishment of the sales company in Norway and put the full engcon system on the market with increased revenue per unit. We had exceptional deliveries in the single quarters, which confirms that -- [indiscernible] the strength of the engcon business model, and we generated strong cash flow that gives comfort for the future. And together, with the stabilized order intake, gives that the Board the confidence to increase the dividend for this year.

If you're looking a little bit ahead, we are getting more confident that the order intake is stabilized, but we don't see a clear indication of a pickup in the near time. The question is when we go from stabilization to growth. Our guess is early as second half of 2024. We may see a smaller increase in Q2 if the normal historical digging season pattern materialize with that. We will have the ERP rollout continue during 2024. So we still need more resources and consultants for that.

We're also going to finish up with a positive news regarding that we are very happy to be able to recruit our new CFO, [indiscernible] from [indiscernible]. [indiscernible] brings nearly 2 decades of experience from [indiscernible], where we held diverse roles prior to joining engcon, he served as the CFO and COO for [indiscernible] Financial Service in Asia-Oceania, since 2022. Marcus has extensive and solid experience from leading roles within [indiscernible] with international experience in addition to his current role in Asia-Oceania, has previously been CFO for [indiscernible] China; and CFO for [indiscernible] Middle East.

And a little bit fun fact is that Marcus and I worked together at Deloitte [indiscernible], and we both are from [indiscernible] Marcus will move up to [indiscernible] and starts his position with engcon August 2024. He is excited to be part of our yellow family and looks forward to change to world of digging. Thank you. That was all from our presentation, and we will now open up for questions that can be asked in the telephone conference. So operator, please go ahead with the first question.

[Operator]

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

[Agnieszka Vilela, analyst]

Perfect. Krister, you said that you in the coming quarters will reflect more the orders that take in the quarter, so more kind of in and out orders. However, in Q4, you actually built some SEK 100 million in backlog. So my question is, when will this backlog be delivered? Will it be already in Q1? And based on that, should we expect higher sequential sales in Q1?

[Krister Blomgren, executive]

I think it will be split in both Q1 and Q2 because some of it was also like a preordering effect, like the ordering further on the year, but that was a smaller amount. So yes, it's a backlog we're having our book-to-bill -- positive book-to-bill ratio that we're having there. So yes, some of it will come in Q1 and some of it will come in Q2.

[Agnieszka Vilela, analyst]

And then any color on sequential sales development, would you answer that?

[Krister Blomgren, executive]

The sales development, we believe that it will be -- we see positive signals, and we believe there will be small increases hopefully every quarter for 2024, where we made that estimate or guessing was that we hopefully could get -- start seeing some bigger growth in the second half of the year, earliest. But I think Q1 and Q2 will not be any dramatic increases.

[Agnieszka Vilela, analyst]

All right. Perfect. And maybe if you could quantify the order you got from the French rental company and also the DACH order? How much was it just about park number?

[Krister Blomgren, executive]

No, don't remember. We have made a press release on the DACH. I think was at SEK 12 million, SEK 13 million, something like that. And the French order was a little bit bigger than that.

[Agnieszka Vilela, analyst]

Perfect. And just to give us -- if you can give us the status on the implementation of the ERP system. What's left? And would you expect further kind of production disruptions due to that?

[Krister Blomgren, executive]

We -- so far, it's implemented in the production company in Sweden and in one sales company. And we have had disruptions in the production companies, absolutely. But it's -- we're getting signals on [indiscernible] started looking better and better every week, more or less. And we think with the capacity we have now, we are prepared for an increase of getting more order intake and be able to deliver it out fast. We will have short lead times if it's still some parts that are missing or anything like that. But right now, the feeling is getting better and better regarding system. Still the biggest problem is that we need to have a little bit more people because we have changed some processes before people are getting used to that. We will have the need for more people.

[Agnieszka Vilela, analyst]

Some more kind of cost headwind rather than sales headwinds from now on?

[Krister Blomgren, executive]

Yes.

[Agnieszka Vilela, analyst]

Okay. And then if we can discuss costs. I noticed that the number of your employees came down in Q4. Was it mainly in production?

[Krister Blomgren, executive]

Yes, it's mainly production. We've been having a lot of people on -- not sure. We have short-term employed, and we have been ending a lot of people during the year in that way. And also some people have moved into other industries like the defense industry and so on have been popular for people to go to. So we have a more natural way of getting -- letting people go. And right now, for be able to do all the things that we need to do with the ERP system and so on and also keep implementing it in Poland, we need the people that we have right now.

[Agnieszka Vilela, analyst]

Yes. And then in general, how should we think about your other operating costs like SG&As and R&D in 2024? Do you plan to have them flat or expand them? Or do you expect any cuts in this kind of cost?

[Krister Blomgren, executive]

We're still behind on a lot of like tools and stuff. The focus have been on the EC3 and DC3. So we still wanted to get more tools out during 2024. So that's something we will keep on working on. I don't think there would be that high cost as it's been with the EC3 and DC3. Now we are more or less ready for the share production and starting with one size on the EC3 and the DC3 is then more or less fully developed in that way. So it will be some cost them for the different sizes for the EC3, but also a bigger focus on tools for the coming years. So I would [indiscernible] go down a little bit.

[Agnieszka Vilela, analyst]

Going down a little bit, okay. And pricing, how does it hold?

[Krister Blomgren, executive]

Yes, we've made a smaller price increase this year. So we don't see any need for change during the year so far. Of course, we've seen the fluctuations in the currencies and so on that, of course, affecting us. But we haven't made any bigger changes on -- or planning any changes on that right now. It will be a normal price increase, I guess, depending on the inflation and so on for upcoming years.

[Agnieszka Vilela, analyst]

All right. And then my last question, really. So do you think it's a fair assumption that your EBIT margin in Q4 was kind of bottom? Obviously, we don't know about the markets, but it looks like sales might be stabilizing, withdrawing a bit. Pricing is not a problem and maybe some costs are coming down. So do you think it's a fair assumption to think that margin should improve sequentially from here?

[Krister Blomgren, executive]

Yes. I mean we are not pleased with 6%. Our goal is definitely to be higher up. And I think we did a lot to ourselves by moving in North America, our stock from one logistic hub to another logistic hub, and we also implemented ERP system in the Swedish production company that is the biggest. So we managed to destroy a lot for ourselves. So it's not only the market that are disturbing, it's also that we did this to ourselves. So in that way, we have the chance to increase our EBIT margin in a good way for coming quarters.

[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]

Okay. Thank you, everyone, for a good question. 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. Thank you again for listening in today, and we hope to see you all soon again. Thank you very much.