Hexpol AB

STO:HPOL B

Earnings Call Transcript 2022-Q2

[Operator]

Good day, and welcome to the HEXPOL Second Quarter 2022 Earnings Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mr. Peter Rosen. Please go ahead, sir.

[Peter Rosén, executive]

Thank you very much, and welcome everybody to the presentation of the results for the second quarter of 2022. Presenting today will be Georg Brunstam, our CEO; and myself, as CFO. The agenda for today is to first give you a business update and then take you through how we continue to execute our business model, then go through the financials and the focus areas for the rest of this year, and then we will finish up with a Q&A session. And with that being said, I hand over to Georg, who will take you through the first parts of today's agenda.

[Georg Brunstam, executive]

Yes, Hi. Georg here. The second quarter was a good quarter for HEXPOL. Actually, a record quarter, both in terms of sales and EBIT level. So actually a record quarter so far in our history. We are executing well on our strong business model in a challenging environment that -- I think that the environment has been challenging for a while, and we have been handling and executing a number of quarters in that environment. We are handling our costs. We have a business model, which I will come back to, which do pass on the cost increases, both in terms of overall material and other costs. So a strong execution of a business model where we do pass on the cost increases in terms of pricing. We had record sales, 41% up. It was strong in all regions and in all product segments, especially in Americas. And as I said, the business model we have do enable us to pass on the raw material increases, and a record EBIT of SEK 836 million. The environment is continued quite turbulent and difficult, and we do see some low automotive or light vehicle production volumes due to extensive OEM stops because of component shortages. Other customer segments are continued strong with, for example, building and construction, general industry and wire and cable being strong. We do see continued supply issues globally, and we do see price increases on incoming material and energy prices. We do execute on our M&A agenda. And we had in the quarter, the almaak acquisition, which actually supports our sustainability agenda in a strong way, because it's a company -- a compounder who is basing their products on recycled products. And they are consolidated from 1st of April, and we are happy with the performance and it's in line with our plans. Going forward, we do see the global challenges continue, and -- but we have handled them in some quarters now, so we know how to do that. And of course, we are flexible then we are ready, and then we are capable of handling the expected increase in light vehicle production. And our strong customer focus and the geography is helping us. We can handle our customer demands with short supply chains. In the business areas, we have strong performance in HEXPOL Compounding and Engineered Products. And the comments on Compounding are basically the same as I mentioned on group level. On Engineered Products, sales was well above last year as well. And especially in HEXPOL Wheels, we have strong performance. And the EBIT was very strong in the quarter. And if you look at our sustainability road, we are focusing, and we are on a good track, and we are showing good progress to reach our CO2 reduction targets, and they are a reduction with 75% by 2025. We're also focusing on new compounds based on recycled materials where we also acquired almaak and also bio-based materials. We see high activity in the M&A field, and we have high focus and we are continuing our M&A roadmap. If I then turn to Page #6, there is our culture house. And as you know, we are decentralized, but extremely coordinated and we take the synergies wherever we can find them. That basically we are decentralized, and we are close to our customers. And we have a strong culture, and we are quick in our feet and the decision-making is swift. If I then turn to Page #7, you can see the business model we have. And as I said, we have been executing very well on our business model. And there are maybe 3 points I would like to highlight. We do operate in a fragmented market, and that gives us good M&A opportunities. We have a global footprint, a local presence. And in these days, everybody among our customers are looking for shorter supply chains, and we are able to service them with that. And also on the lower left side, we have very strong and long customer relations. So our products are technically advanced and its part of vital components in the customers' processes. So our business model is strong, and we are benefiting from executing with -- in a good way.

[Peter Rosén, executive]

And if we then turn to Page 8 and look at the sales development. As Georg mentioned, the challenges that we saw during the first quarter of this year with component shortages, the transportation issues and raw materials and price increases, they also continued during this quarter. They were partly aggravated by Russia's invasion of Ukraine, make it even more difficult. Especially this over again the problems with the automotive customers with several production stops following on the component shortages that they face. However, despite this, we increased our sales with 41% compared to the same quarter last year. And out of this increase, 18% came from organic growth and another 10% came from the acquisitions of almaak and Unica. We also saw positive FX effects of about some SEK 500 million, resulting in total reported sales of about SEK 5.7 billion in the quarter. And if we look at the regional development, we saw strong sales growth in all regions, although highest in Americas, followed by Europe and Asia, and part of the European growth is driven by the acquisitions that we did both last year and this year. So overall, very strong sales development. And if we can turn to Page 10 and look more on the financial overview, we delivered an operating profit of SEK 836 million in the quarter, which is well above what we did the same quarter last year, and it's the highest result that we've ever delivered in a quarter. The margin came in at 14.8%, negatively affected by the acquisitions this year, which currently run at a lower margin than the HEXPOL as a group, and the challenges related to raw material shortages and price increases that we've seen for quite some time. The equity/asset ratio remains high at 54% and the return on capital also remained high at 21.6% in the quarter. And if we then turn to Page 11 and look at the development of the highlights. And looking at -- compared to the same quarter last year, we see that the sales increased with 41% to SEK 5.7 billion, while the operating profit increased 15% compared to last year. At the same time, we saw operating margin coming down to 14.8% following on the acquisitions and the raw material challenges, but it's quite close to what we did in the first quarter of this year. And the lower margin is logical when taken into account the mechanics of our price increases. When we pass on the price increases to our customers, we may pass on the absolute increases, not the relative increases. Everything else being equal, this will have a mathematical negative impact on the margin, but not on the profit in absolute terms as we've demonstrated this quarter. If we then turn to Page 12 to look at the drivers of the profit, we see that the increased sales were partly offset by the lower gross margin. And as mentioned before, the lower gross margin is driven partly by the acquisitions, and the lower margins are driven by the raw material price increases. OpEx came in higher than last year and also higher than previous quarter, driven by costs related to the acquisition of almaak in the quarter, as well as the actual running costs of almaak that was consolidated as per 1st of April, but also higher inflation costs and not the [ least ] negative FX effects. And if we then turn to Page 13 and start looking at our 2 business segments. We see that HEXPOL Compounding delivered sales of SEK 5.3 billion in the quarter, which is an increase of 42% to -- compared to the same quarter last year. Also here in this segment the increase is driven by 18% organic growth, and acquisitions of Unica and almaak add another 11% growth. We saw sales improvements in most customer segment, and in all product areas, but again, especially positive with strong development in the Americas. Operating profit came in at around SEK 760 million, which is well above last year, where sales were offset by the lower margin driven by acquisitions and the raw material price challenges that we see. And if I can then ask you to switch to Page 14 on Engineered Products, we see that the sales for this segment increased with 30% compared to last year with overall strong performance, but especially so for HEXPOL Wheels that performed very well. Operating profit came in close to SEK 80 million. It was well above last year, driven both by higher sales and higher operating margin. Included in the results are some positive onetime FX effects related to Sri Lanka. And if I then ask you to turn to Page 15, and we will take a look at working capital. We see an increase year-over-year both in absolute and relative terms. This increase is primarily driven by an increase in inventory. As mentioned also during last quarter, due to raw material shortages and risk thereof, we've decided to purchase what we can in order to secure all the orders that we receive from our customers. In addition to this, we also have almaak included in -- as per end of June, which adds another SEK 200 million in working capital to the group. However, underlying, we don't have any changes in the payment terms with suppliers or customers. So it's quite stable. And then if I can ask you to switch to Page 16, and looking at the cash flow, we saw a quite solid cash flow in the quarter, negatively impacted by higher inventory levels and temporarily higher investment level. This is to a large extent driven by almaak, where previously leased equipment with almaak were purchased by the company after we started to consolidate the company, but also the ongoing investments in our TPE facility in Sweden, driven by our decision to increase our capacity for medical-grade products. But overall, a solid cash flow -- operating cash flow in the quarter. And then if we look at Page 17 and the net debt. The net debt increased some as does the net debt-to-EBITDA ratio, which now stands at 0.89. This is a temporary increase driven by dividend during the quarter, including the extra dividend and the acquisition of almaak. But nevertheless, all in all, we continue to stand with a very strong financial position after the second quarter of this year.

[Georg Brunstam, executive]

Okay. Thanks, Peter. If I then wrap up the quarter. It was actually a good quarter, our best quarter ever so far. We had record sales and a record result, and we are executing very well on our strong business model, which is passing on cost increases in our pricing. We do see the environment still turbulent and difficult, but we are handling it and we have been handling it for a while, but it's not easy. It's a lot of hard work. We have been integrating our latest acquisition, almaak, which is an acquisition, very much in line with our sustainability agenda in growing in recycled materials. And going forward, we do see that the current challenges are continuing. They might change character, but they are continuing. But as I said, we have been handling it in a good way for a number of quarters now. And finally, we are, of course, ready to take on the forecasted and expected light vehicle production increase. We are on our toes to do that. In general, if you turn to next Page #20, our focus for this year is, of course, handling the health and safety, including the COVID spreading, which is actually not over. We are handling it in a good way. We are also focusing, being on our toes to handling the volatility in demand, both up and down. And we are managing the challenges, but it's a lot of work. We are going to continue to focus on the strong execution of our business model and the M&A strategy is valid, and then we are executing along the lines of it. So that was basically a wrap up of the quarter, and that I think we are opening up for questions and answers by that. Yes, please go ahead.

[Operator]

[Operator Instructions] And the first question will come from Gustav Osterberg with Carnegie.

[Gustav Österberg, analyst]

A couple of questions from my side, please. Just on the M&A costs relating to the almaak acquisition, do we have any of those included in the operating results for Q2?

[Peter Rosén, executive]

Yes, we do. All the acquisition cost for almaak are included in the OpEx line for the second quarter.

[Gustav Österberg, analyst]

And could you comment roughly how large those are? Or is that not disclosed?

[Peter Rosén, executive]

We've disclosed some of the costs in the quarter and I think there are 2 cost items related to almaak. One is the acquisition cost for almaak which is -- and then it's the running cost of almaak that we've included in the quarter. And if we look at both of them together, we talk roughly SEK 25 million to SEK 30 million in the quarter.

[Gustav Österberg, analyst]

All right. And then just a follow-up on sort of automotive production in Europe. We're still seeing very low production levels. And thinking about Unica and VICOM, are they seeing a similar demand level? Or are there any meaningful differences from their perspective?

[Georg Brunstam, executive]

I mean -- you just said VICOM, yes?

[Gustav Österberg, analyst]

Yes.

[Georg Brunstam, executive]

Yes. No, they are mostly in wire and cable. But in Unica, we do see a soft automotive market in Europe. And we do see that in our other companies as well. But the other segments are strong and then they do compensate. So I mean, it's a good quarter in all regions, including Europe.

[Gustav Österberg, analyst]

My question was more in terms of looking ahead, where you see that sort of the acquired units are not really in an operating environment where they can reach sort of normalized level of profitability yet.

[Georg Brunstam, executive]

No, but they are improving, and they are behind plan, but in the right direction.

[Gustav Österberg, analyst]

And then lastly, a final question on M&A. You still, obviously, even at the almaak acquisition have a lot of room to continue to pursue further opportunities. I mean, is it Europe geographically that is most interesting? Or are you looking at other geographies as well?

[Georg Brunstam, executive]

I mean, we are looking at all geographies. But of course, we believe that we have bigger opportunities in Americas and Europe versus Asia right now. So -- but no, we are continuing to work on our M&A agenda, which is established. And I think there are more opportunities going forward than there a bit.

[Operator]

The next question will come from [ Julia Yusen ] with SEB A.

[Unknown Analyst]

Firstly, I would like to ask about the situation in Sri Lanka. So from what I've understood, there has been fuel consumption restrictions from the beginning of this year, but the situation become much worse during the last weeks into a scenario where there, at some places there's no fuel supplies at all. So I would like to ask how are you securing your fuel supplies there and how is the situation developing for your workers?

[Georg Brunstam, executive]

Thanks, Julia. It's a very valid question. However, Sri Lanka for us is 1% of group sales. So it's a very minor part of our business. But having said all that, what you are describing is a very, very difficult situation. We are actually not in a bad situation. We are export-oriented. Basically everything we manufacture there is sold in dollars and euros. And that means, of course, that we are in a priority from the government. They do need foreign currency badly. So all export companies, including us, are prioritized which means that we are able to buy fuel and other energy from our dollar and euro accounts. And as a matter of fact, we are renting in buses and filling them up with diesel we can get, so we get our employees in. So we are running. No -- basically no interruption at all. And people are very happy to come to work that they cannot come themselves as we -- so we have to arrange that. But for us, not a good situation, but not a bad situation. But it's tough in the country, of course.

[Unknown Analyst]

And due to the uncertainties, I still want to ask in a worst-case scenario where your 2 manufacturing plants in Sri Lanka would close in worst case, how will that affect your total production?

[Georg Brunstam, executive]

We don't see that. We don't see that at all. I mean we are extremely important. The country really needs foreign currency and export-oriented industries are really in priority. So in scenario like that, we don't even see and we cannot [ ambit ]. And as I said, it's 1% of our group's 1%.

[Unknown Analyst]

I think only 1% of your sales, but isn't it 20% of your workers being there on Sri Lanka?

[Georg Brunstam, executive]

Absolutely, yes.

[Unknown Analyst]

But I mean, it could be a larger part of the production there, isn't it?

[Georg Brunstam, executive]

No, no. But it's only the labor intense production we have there. That's the reason it's so many people. It's a manual -- it's all the processes in Engineered Products we cannot automize, we have in Sri Lanka since many, many years.

[Unknown Analyst]

Would it be possible to reorganize, if needed, for example, to Stellana in China, right?

[Georg Brunstam, executive]

Absolutely. We are doing exactly the same things there today.

[Unknown Analyst]

So on another topic, and thank you very much for describing the situation in Sri Lanka. The other topic, based on your price adjustments and raw material prices, how do you expect the cost price balance to behave going forward based on the inflation environment so far?

[Georg Brunstam, executive]

It's extremely hard to predict. I mean, we do receive monthly or even shorter pricing from our suppliers. And we don't know. I mean, we can only say that so far prices has been going up, maybe at a lower pace than before. And we are continuing to be very short in our pricing as well to customers, which is part of our business model. But I must say my forecasting, my crystal ball, I have no real idea where the prices will go.

[Unknown Analyst]

And if you compare the market sentiment today for increased prices compared to previous years, you think that customers are accepting the situation to a larger extent now? Or does this talk about the catch-up effects rather make customers more difficult to make an agreement with?

[Georg Brunstam, executive]

It has been extremely difficult all the time with these high price increases and also lack of availability. It's been extremely tough, and it's been extremely tough for us and for our customers, and for our customers' customers. But I don't see any change in the sentiment.

[Unknown Analyst]

Are there any specific divisions where customers tend to use more dual sourcing and maybe go to another supplier if the prices increases too much?

[Georg Brunstam, executive]

No, I don't see that.

[Unknown Analyst]

Is it less or more the same in all your divisions or in...

[Georg Brunstam, executive]

Yes, yes.

[Unknown Analyst]

I mean?

[Georg Brunstam, executive]

Yes, yes, it is.

[Operator]

The next question will come from Douglas Lindahl with DNB Markets.

[Douglas Lindahl, analyst]

On organic growth, 18% in the quarter, I think I've asked this question every quarter, by the way. But are you able to break down volume versus pricing or at least give some sort of indication? Did you see positive volumes in the quarter to start there?

[Georg Brunstam, executive]

You're correct. You normally ask that question and you'll get a very similar answer. As you know, we don't publish volume numbers, but if we compare to last year, there is a single-digit volume growth. And then in addition to that, we have price increases, and we have positive mix effects and positive mix effects should be understood as we've been able to sell more of the -- more higher value products in the quarter. So those are the 3 drivers of the organic growth.

[Douglas Lindahl, analyst]

And on a positive mix effect, do you expect that to persist? Or is it a temporary effect, you would say?

[Georg Brunstam, executive]

No. And no, I think that's deliberately done and executed. And hopefully, we can continue with that.

[Douglas Lindahl, analyst]

And on pricing, are you able to comment anything on what you see beyond Q2 starting of Q3 now? And also a theoretic question on that, if we were to see prices come down, given your pricing model, how would that impact absolute EBIT in your view? Will it be net positive, net neutral or just your thinking about that would be interesting.

[Georg Brunstam, executive]

I think, and I'm quite confident that we will continue to execute on our strong business model, including the pricing. If price increases are continuing, we will continue to do the same things we have been doing. And if the prices are going to be flat or flattish or decreasing, we will do as we have always been doing. We will discuss with our customers, and we will be transparent in also decreasing prices where we need to.

[Douglas Lindahl, analyst]

But I guess, energy cost also becomes more of a topic in those discussions?

[Georg Brunstam, executive]

Yes. It is already a topic. And we are passing on the energy cost increases as well.

[Douglas Lindahl, analyst]

And maybe I missed it, but on M&A multiples, are you seeing those coming down given the current market environment, would you say?

[Georg Brunstam, executive]

Yes. That's a good one. We are hoping and maybe we haven't seen it yet, but you know where it is. I mean, if somebody is selling they always look at the recent transaction, and they expect the same. But I don't see that -- I mean, they must turn down, I think. But it might take some time.

[Operator]

The next question will come from Karl Bokvist with ABG.

[Karl Bokvist, analyst]

Just wanted to follow up on Douglas' question there, sorry for not hearing that. But what was the comment you made on the volume development? Was it slightly positive in this quarter or mid-single or what did you say?

[Georg Brunstam, executive]

Slightly positive, correct.

[Karl Bokvist, analyst]

And then just on M&A contribution, this quarter you had, correct me if I'm wrong here, but in part you have a recent M&A, such as almaak and then for the next quarters we will, of course, no longer see the M&A contribution from, for example, VICOM. Just could you help us here, it was SEK 400 million this quarter. Should we expect M&A contribution from next quarter already coming down perhaps towards something like SEK 200 million just in terms of how the acquisitions were closed?

[Georg Brunstam, executive]

Yes. In this quarter, we have contribution from acquisitions from 2 companies. Unica, that we consolidated from 1st of July last year, so we have Unica in this quarter, and we also have almaak in this quarter that will be consolidated from 1st of June. When we move into the third quarter of this year, we would only have almaak. Because in the third quarter, we will have -- third quarter of last year, we had both VICOM and Unica fully consolidated.

[Karl Bokvist, analyst]

And I think the last number you provided there on almaak, was that in SEK, it could have annual revenues of about SEK 1 billion, was that correct? And...

[Georg Brunstam, executive]

No. We said that last year, they had sales of 70 -- above EUR 75 million.

[Karl Bokvist, analyst]

All right. But -- okay, sorry. I thought that was just for something like 70%. So that was the full group revenue.

[Georg Brunstam, executive]

For Almaak, correct.

[Karl Bokvist, analyst]

And then on the Engineered Products, the specific positive effects, what was that related to? And I mean in the grand scheme of things, it might not be a too large number, but roughly how large was this onetime effect?

[Georg Brunstam, executive]

You're correct. It's not -- in the grand scheme of things it's not a big number. We talk less than EUR 1 million positive FX effects, and this is related to the Sri Lankan currency implosion.

[Operator]

The next question is a follow-up from [ Julia Yusen ] with SEB A.

[Unknown Analyst]

We already had a question on M&A. But to follow up on that one, is there any specific that you think you should particularly complete -- particularly could complete your current product portfolio when you're looking for new target?

[Georg Brunstam, executive]

I mean we had a -- we have a specific and pretty extensive road map for our acquisitions. And I think we have been showing some of the areas before and there is no change on our M&A strategy. We will continue to execute on our new materials, including the recycled materials, including white spots in geographies, including globalization of some of our product areas, which are not global today. So basically, following the strategy, which we have outlined before.

[Unknown Analyst]

I think that your recycled materials and bio-materials focuses are very exciting. And I know it's just a small part of your business today, but could you describe a little bit of what potential development here you see going ahead? And specifically, to what extent do you think you will have to invest in new technologies or how demand on those products are developing?

[Georg Brunstam, executive]

No, I think we are very positive on that. I mean recycled material is around 10% of our business already since some time. We are accelerating that with new products and also bio-based products. And we are also accelerating it with quite substantial acquisition, EUR 75 million plus in the same field. So we are accelerating it in a strong way. And we will continue to do that.

[Peter Rosén, executive]

And when it comes to investments in production equipment that is not needed just because it's more recycled materials.

[Georg Brunstam, executive]

We can handle it in our present facilities.

[Operator]

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Peter Rosen for any closing remarks. Please go ahead.

[Peter Rosén, executive]

Well, thank you, everyone, very much for listening in and also posing questions. And we wish you a very nice weekend when you get there. Thank you.

[Georg Brunstam, executive]

Thanks a lot.

[Operator]

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.