Hexpol AB

STO:HPOL B

Earnings Call Transcript 2020-Q2

[Operator]

Hello, and welcome to the HEXPOL AB Q2 results. [Operator Instructions] Today, I'm pleased to present CFO, Peter Rosén. Please go ahead with your meeting, sir.

[Peter Rosén, Interim CEO, CFO & Investor Relations Manager]

Thank you, and welcome to this presentation of the results for the Q2. I'll take you through the presentation, where we'll start with the business performance. Then I go into the more detailed financials and also give you an update on status regarding cost savings, and we will close off with Q&A. But if I may ask you to turn to the Page 4 Q2 2020 key highlights, and we'll start there. It's obviously a quarter impacted by COVID-19. The pandemic had significant negative impact on the demand and subsequently on sales and results. At the same time, the impact was not consistent during the quarter. And we saw improvements from low April, May to a stronger June demand. But before going into the specifics, when it comes to our operations, all our sites are up and running and have been so throughout the quarter. We continue to work actively with ensuring the safety and well-being of our employees. And we have at every site adopted our operations according to the local requirements and recommendations. And generally speaking, this means ensuring social distancing, both in production and office areas, but also working from home, whenever possible and increased focus on personal hygiene, such as washing hands on a regular basis. Regarding actual production and delivery of our products, we haven't experienced any major issues during the quarter. Our sites have where applicable been deemed essential, meaning that we are allowed to keep them open. So we received all the raw material we need to produce. We can ship all the finished products to our customers, and we deliver on all the orders that we receive from customers. And that being said, as expected, I also communicated earlier, during the first quarter, we saw significantly lower demand during this quarter. The month of April and May were especially hard-hit, when, for example, the automotive producers closed their production in Europe and U.S. more or less completely. Towards or during end of May, beginning of June, depending a little bit on the geography, they started up again, and we saw demand increasing, although from low levels. June in itself saw significant improvement compared to the months of April and May. When it comes to our costs, the need for cost savings in production are handled immediately in the day-to-day management of the business and consists of a combination of short-time work, furloughs, use of whole base and also layoffs, depending on the country and the situation of each site. When it comes to more structural cost reduction programs, we started cost reduction programs already during the first quarter. Those programs were continued and accelerated during this quarter. We also initiated additional cost reduction programs during the second quarter that will further reduce our costs going forward. And as a consequence of this, we took some SEK 26 million as restructuring costs during this quarter. I will come back to the cost savings and give some more details on what we've done and the effects from it. Last but not least, we continue to work actively to bring down our working capital in relation to sales, and I'll come back to this one as well. So all in all, even though COVID-19 had a negative impact around sales and results this quarter, we stand financially strong. Our equity-asset ratio improved compared to last year, and stands at 63%, and our net debt-to-EBITDA ratio remains low at 0.8. If I can then ask you to move over to the next page with the financial highlights, you'd see that sales decreased with about 30% from SEK 3.7 billion to SEK 2.5 billion in the quarter. The lower sales were seen in all geographies to a varying degree and to most customer segments. However, automotive is the customer segment most hurt by this pandemic. During the quarter, the automotive industry to much extent closed down their production in Europe and U.S. China were open. But from our point of view, it's a smaller part of our business, so has less impact on group level. Affected by the lower sales, operating profit came in at SEK 209 million and below last year despite the cost savings during the quarter. And at the same time, the operating margin decreased to 8.3%. On a more positive note, during the quarter, arguably one of the toughest quarters most companies ever faced or at least for a very long time, we still delivered margin above 8%. And this gives earnings per share of SEK 0.40 per share compared to last year, SEK 1.20. If I can ask you move to the next page regarding sales developments. As mentioned, sales decreased with 31% to SEK 2.5 billion for the quarter. Of this decrease, the acquisition of Preferred increased sales with 8% compared to last year, while there were no FX effects during the quarter. Organic sales decreased by 39% in the quarter. And these lower organic sales were seen primarily within Rubber Compounding and 2 low segments within that area. However, as I mentioned, automotive showed most negative impact followed by the general industry. And April and May were especially hard-hit, while June showed significant improvement compared to those 2 months. Also during June, we saw gradual improvements from the beginning of the month towards the end of the month as automotive picks up production but also some other industries. When looking at our regional sales development during the quarter, the Americas in the quarter represents 55% of our sales, while Europe and Asia represent 39% and 6%, respectively. In the quarter, Americas saw a sales decrease of 33% despite Preferred, while Europe showed 32% lower sales and Asia, 11% lower sales compared to same period last year. The U.S. shows larger decrease, mainly affected by automotive starting up production later in the U.S. than in Europe. If we move over and look at the sales for the first 6 months of the year, then we see a sales decrease with 11% to SEK 6.7 billion for the period. Acquisition of Preferred increased sales with 11% and there were limited FX effects of about 2% during the quarter. And for the first 6 months, organic sales decreased 24%, and overall decrease that we saw during the first quarter was offset by COVID effects during the second quarter. When I look at our regional sales development in the first half of the year, Americas represent 59% of our sales, while Europe and Asia represent 36% and 5%, respectively. And during this period, Americas saw sales decrease of 6%, while Europe showed 17% lower sales and Asia 6% lower sales. If we then move over and take a look at the more detailed financials, we delivered then a quarterly result below last year with SEK 209 million. At the same time, even though a very challenging environment, we still delivered an adjusted EBITA margin above 9%. Taking the lower result into account, we delivered stable cash flow for the quarter, and we delivered equity-asset ratio of 63%, which is higher than the same period last year. So despite the challenges brought on by COVID-19, we closed the quarter with a strong financial position. If we then move forward, looking at operating profit. We delivered, I mentioned, SEK 209 million as operating profit. The lower sales in the quarter impacted negatively with some SEK 240 million. And despite substantial cost savings in production, we also saw somewhat lower gross margin that is driven by the lower coverage. From a market perspective, we were not able to fully offset the lower sales in the quarter. Additional OpEx savings for total OpEx in line with last year levels, despite that we have acquired Preferred Compounding. And if we now take a look at HEXPOL Compounding, where we saw a sales decrease of 33% from SEK 3.4 billion to SEK 2.3 billion. We sold our sales to most customer segments in the Americas and Europe affected by the pandemic and automotive was then especially hard-hit after close down of production a large part of the quarter, and we also saw lower sales to general industry. Asia also saw lower sales compared to last year. At the same time, we see increased sales compared to when they were worse hit by COVID-19 during the beginning of the year. From a HEXPOL Group perspective, this has a smaller impact due to the smaller size of our Asian business. The Thermoplastic Compounding saw lower sales, and this is entirely related to automotive closing down during the quarter. While TP saw solid lower sales, but with some exceptions, such as medical equipment customers with recently increased sales. All in all, we saw an operating profit of SEK 178 million in the quarter, which is then below last year from the lower sales. If we then move over and look at Engineered Products, sales came in somewhat below last year at SEK 236 million, and it's given an operating profit of SEK 31 million for the quarter. Even though customers were impacted during the quarter, the overall impact of COVID-19 was smaller in this business compared to compounding. The operating margin was stable compared to the same period last year. If we then move forward and look at the development of working capital. Then at the end of the quarter, our working capital stood at SEK 1.1 billion, which is some SEK 200 million lower than the same period last year. And as you can see, over time, we have some movements in our working capital. This is primarily driven by our acquisitions, Mexico and Preferred are the latest ones. And in general, the companies we've acquired operate with higher working capital compared to HEXPOL legacy business. And when we integrate the acquisitions, we work hard to bring them into the HEXPOL way of working and that based on the working capital. The movement in absolute working capital you see in the graph, the staples are driven by the acquisitions, as I mentioned, and over time, as we integrate the acquisition working capital in relation to sales, that's the line on the graph improves, and we are currently at 7.8%, which is also an improvement compared to first quarter of this year. We move over, looking at the cash flow. We delivered an EBIT of SEK 183 million in the quarter. That is largely translated into cash at SEK 225 million for the quarter. And during the quarter, we saw relatively flat working capital, our investments are below that of depreciation and amortization. And then if we look over -- look at net debt, we have a strong financial position with SEK 1.1 billion cash on hand. We used some SEK 2.9 billion of our credit facilities, leaving us with a net debt of SEK 1.8 billion for the quarter. And the net debt-to-EBITDA ratio stands at a healthy 0.85. I should mention that the total credit facilities that we have at our disposal amount to approximately SEK 6.2 billion. The net debt increased as compared to Q2 2019, but that is driven by the Preferred acquisitions that we did during 2020. Already compared to end of 2019, the strong cash flow we generate on our net debt position which improves. If we then move over to next before we close the presentation, I want to give you a short update on the cost reduction initiatives during the first 6 months of this year. The current run rate of direct labor costs is down 25% compared to the first quarter of this year. And this has been achieved by very strict production planning and adjustment to the current demands. We currently have some 500 employees in various forms of short time work and furlough. And in addition to this, 227 people of our employees left during the quarter. When it comes to OpEx, the second quarter cost level is on the same level as Q2 2019 despite the acquisition of Preferred since then. And if we look at average quarterly costs adjusted for restructuring costs since the Preferred acquisition, our current run rate is down some 14% compared to those quarters. And the cost reduction programs will have further positive effects during the second half of the year. And we expect current OpEx run rate to improve another 10% by the end of the year. And then to summarize the second quarter of 2020. Our business has been impacted by COVID-19, but all our sites are up and running. We work to ensure the safety and well-being of our employees, and we do not experience major supply or delivery problems. We haven't lost any customers. We haven't lost any market share. And so far, COVID-19 is a demand challenge. Sales were, therefore, affected, and we saw a sales decrease of 31% to SEK 2.5 billion for the quarter. And during the quarter, April and May were especially hard-hit, while June showed significant improvement. We brought down our cost level substantially, but were not able to offset the lower sales. However, still delivered an adjusted EBITA level above 9%. Cost reduction programs started during the first quarter were accelerated during the second quarter and additional cost reduction initiatives were launched during this quarter. In addition to some 500 employees on short-time work and furlough, more than 200 employees left during this quarter. And we closed the quarter with a strong balance sheet and overall strong financial position. Looking ahead, it's obvious that COVID-19 will continue to create uncertainty. But it is our belief that the combination of financial strength of the company combined with our decentralized organization gives us good possibilities to come through this in a very good manner. And there, I thank you for listening to the presentation. And I'm more than willing to take questions.

[Operator]

[Operator Instructions] We have our first question. It comes in from Johan Dahl of Danske Bank.

[Johan Dahl, Analyst]

Johan here of Danske Bank. Can you say anything regarding sort of the strength in June, which you talked about, the sequential improvement month by month, how that compares to sort of last year? And if you could also talk a little bit about how you managed to reduce labor costs in the quarter? I mean it's clear that your run rate is now down 25%. But how swiftly, did you manage to get the labor cost down in sort of on average in Q1 -- Q2?

[Peter Rosén, Interim CEO, CFO & Investor Relations Manager]

Yes. I'll start with your first question. I think one has to go back a little bit and look at the 3 months of the quarter. We saw the first wave of COVID-19 was mid -- end of March. And when we came into April, most, if not all, automotive manufacturers closed down their production during April, and to a very much extent, also during May. And we're talking about Europe and U.S. here. So it was virtually a standstill those 2 months. During May and beginning of June, depending on whether it's Europe and U.S., production started up again. And we saw, of course, demand increasing very rapidly. Because of the nature of our very short supply chain, i.e., our customers don't have our products on stock. Any movement in this case, positive where demand increases, we see that quite quickly. And we started to see that end of May, beginning of June. And then it started to pick up almost on a daily basis. So when we looked at June in itself compared to April, May, then we saw significant improvement. That being said, June in itself, without giving numbers, is still below levels if we would go back compared to June last year, but significant improvement compared to the start of the quarter. When it comes to the cost levels, and it comes to the direct labor cost that we have in our production. Here we see one of the strengths of the way we are organized being very decentralized. Every site, every production unit changes their production planning as soon as they see a change of orders coming in, meaning they are very quick to react to the lower demand. And that goes for all our factories. Then the way we react differs a bit depending on local rules and legislations. For example, in Europe, there is a tradition to be able to use short-time work. And there, our factories use those kind of options. In the U.S., they have a little bit different. There, they don't have the short-time work, but then we use either layoffs or use vacation planning to bring down people in production. And it goes very quickly. So that's the reason why we are able to bring down the run rate cost 25% so quickly.

[Johan Dahl, Analyst]

And when did this really come through in the P&L for HEXPOL? Was it sort of -- is that a good depiction of the entire quarter? Or you're talking about the run rate right now in the prepared statements?

[Peter Rosén, Interim CEO, CFO & Investor Relations Manager]

When we talk about 25% that is something that we saw during the quarter. So it's a quarterly statement.

[Johan Dahl, Analyst]

Just finally, can you talk about in the EBIT bridge, you referred to lower gross profit per ton. If you just look on a sort of on a contribution per ton basis, i.e., ignoring fixed costs, can you say anything regarding how sort of margins per ton have evolved in the quarter? And if any changes, what are the drivers behind that?

[Peter Rosén, Interim CEO, CFO & Investor Relations Manager]

We don't publish margins by kilo per ton. But when we look at drivers of -- if we look at the P&L and the margin, the reason, of course, there is a negative impact from lower coverage because of the lower volumes. And we offset a large part of that by decreasing the direct costs that we have both in direct labor and direct other costs. And when it comes to raw material, that follows the volumes quite well. So we don't have big inventories when it comes to raw material. So those are the drivers. And in the quarter, we have seen somewhat lower raw material prices. But as you already know, due to the pricing mechanism we have with our customers, they are with some time lag transferred over to our customers.

[Operator]

The next question comes in from Karl Bokvist from ABG Sundal Collier.

[Karl Bokvist, Analyst]

So my first question comes to Preferred. I'm just wondering if you could give some insight into how Preferred developed during the quarter in terms of sales, did it see a larger sales decline compared to HEXPOL organically? And also, is it possible that Preferred reported a loss during the quarter. I'm just thinking about how HEXPOL legacy has performed in previous downturns? And I think the margin drop itself, perhaps could it be explained by the Preferred acquisition reporting a loss of very, very low margins?

[Peter Rosén, Interim CEO, CFO & Investor Relations Manager]

Without giving numbers, since we don't report Preferred separately. But when we look at the impact on sales for Preferred, they had a similar development as Americas in total. So they were similarly hit by the COVID-19 and then specifically for the automotive customers. And as I mentioned, we don't give details when it comes to parts of the business and in that case, so I can't answer your question on the specific profitability of Preferred. But as I mentioned before and we said during the first quarter and also during now, Preferred does run with a somewhat lower margin than the HEXPOL legacy business does. At the same time, we've seen an improvement since the acquisition of Preferred last summer. So they are improving. They are not yet up to HEXPOL legacy levels. And so in that sense, they do have a negative impact on the group margin for the quarter. But that being said, the main negative impact during the quarter on margin comes from lower demand and subsequently lower sales driven by COVID-19.

[Karl Bokvist, Analyst]

Understood. And is it possible for you to give some form of communication in how you feel that demand has developed in July?

[Peter Rosén, Interim CEO, CFO & Investor Relations Manager]

No, that's too early to say. I think -- our view is looking at the development, again, during the quarter, April, May being very hard-hit, June showing significant improvements. We have a positive view on it going forward that volumes will continue to develop positively. That being said, the uncertainty is very high. It depends very much on how COVID-19 will develop and how it will impact industries. But we don't see any signs, for example, of industries closing down during the second quarter. So generally speaking, we have a positive view going forward.

[Karl Bokvist, Analyst]

Understood. And finally, just coming back a bit to earnings and profitability. You showed them an operating leverage or EBIT contribution that is -- it has been a bit higher than perhaps what is usually the case when you have so -- such a high degree of variable costs. So do you think that one should keep in mind this dynamic even for the upcoming quarters when it comes to a bit higher operating leverage?

[Peter Rosén, Interim CEO, CFO & Investor Relations Manager]

Yes. I mean we will continue to work very actively with controlling, and if needed, lower our costs. Of course, if we are able to maintain current cost levels and add volumes on top, that will, of course, have a positive leverage effect.

[Operator]

[Operator Instructions] Our next question comes in again from Johan Dahl from Danske Bank.

[Johan Dahl, Analyst]

Can you say anything with regarding the factory footprint program, how that analysis is progressing and potentially any actions you have decided or not decided?

[Peter Rosén, Interim CEO, CFO & Investor Relations Manager]

Yes. I mean on a regular basis, we review our manufacturing footprint to see if there are any decisions that we need to take regarding close down. At the moment, we're not at such a point or a decision where we close down. But it's something that we will review on a regular basis, not least after COVID-19. So we will follow the development very closely and then see what happens. But right now, there are no such decisions. I think I could -- should add to that as well. One development that we are following closely is that there are discussions in various industries that the supply chain setups they have prior to COVID-19 with deliveries across borders and across continent, but they -- those kind of supply chains have turned out to be very vulnerable in situations such as COVID-19. Our manufacturing footprint is very local. That means that we supply our customers with local -- from local sites. And we follow very closely those discussions to see if customers are changing their supply chain footprint that they had prior to COVID-19. And we do see some signs that they are looking to have more local suppliers. And looking at our decentralized footprint, that could be something quite positive. So we are waiting to see how -- what -- where those discussions will go, and that also impacts our decision regarding our manufacturing footprint.

[Johan Dahl, Analyst]

So are there tangible examples of that, i.e., orders which you've already signed on this theme? Or is that sort of not proving it?

[Peter Rosén, Interim CEO, CFO & Investor Relations Manager]

Discussion is ongoing.

[Operator]

Our next question is from Riccardo Romiati from One Investments. [Technical Difficulty]

[Peter Rosén, Interim CEO, CFO & Investor Relations Manager]

Excuse me, I didn't hear a question.

[Riccardo Romiati, Financial Analyst]

Hello, can you hear me?

[Peter Rosén, Interim CEO, CFO & Investor Relations Manager]

Yes. Now I can hear.

[Riccardo Romiati, Financial Analyst]

Now just a quick question. Can you please tell us what was the organic impact from lower raw materials in Q2 on the top line?

[Peter Rosén, Interim CEO, CFO & Investor Relations Manager]

Yes, we don't specify that specific. But during this quarter, they were quite limited.

[Riccardo Romiati, Financial Analyst]

Okay. Okay. And based on what was the exit rate of the raw materials? Do you expect that to be more significant going forward without being too precise?

[Peter Rosén, Interim CEO, CFO & Investor Relations Manager]

Yes, we expect more impact in Q3 and Q4 from raw material.

[Riccardo Romiati, Financial Analyst]

Okay. In terms of -- so in terms of negative organic growth development?

[Peter Rosén, Interim CEO, CFO & Investor Relations Manager]

Exactly. So lower raw material prices will, by definition, have a negative impact on sales.

[Riccardo Romiati, Financial Analyst]

Okay. And then when you look at 400 to 500 people that you have on the furlough and different schemes across the different geographies, when do you feel you need to take a decision on them once the programs run out?

[Peter Rosén, Interim CEO, CFO & Investor Relations Manager]

It depends very much on when the demand increases in the various countries. But it's something that we follow on a daily or a weekly basis to see when do we need to bring them back. So it's almost -- it is a day-to-day decision.

[Operator]

As we have no further questions, I will hand the presentation back to Mr. Rosén for his final words.

[Peter Rosén, Interim CEO, CFO & Investor Relations Manager]

Okay. Well, thank you very much, everybody, for participating and listening, and also thank you for your questions. And I wish you all a very nice Friday afternoon. Take care, and stay safe. Thank you.

[Operator]

That's the end of today's presentation. Thank you very much, Mr. Rosén. You may all disconnect now. Thank you very much.

[Peter Rosén, Interim CEO, CFO & Investor Relations Manager]

Thank you.